Decoding the Indemnification Clause

Introduction

An indemnity clause is a contractual transfer of risk between two contracting parties, generally to prevent loss or compensate for a loss that may occur as a result of a specified event in a specific agreement.  

The term ‘Indemnity’ is elastic and may be used more generally to describe any arrangement under which a party is not to suffer loss. In its widest sense, "indemnity" means recompense for a loss or liability. Indemnities find their basis in common law, typically the common law of contract and the common law of agency.

Indemnity is a legal exemption from the penalties or liabilities incurred by any course of action. Indemnification is a promise, protecting one party from financial loss. This is something stated as a requirement that one party hold harmless the other.

Legal Background

Section 124 of the Indian Contract Act, 1872 (“Act”) defines a contract of indemnity as “A contract by which one party promises to save the other from loss caused to him by the conduct of the promisor himself, or by the conduct of any other person.” The principal concern addressed in Sections 124 and 125 is with promises to indemnify against claims by or liabilities to third parties

Indemnity is considered as a subclass of compensation, and Contract of Indemnity, as a class of contracts. The responsibility to indemnify is a willing responsibility taken by the indemnifier.

In addition to express promise of indemnity, sections 69, 145, and 222 of the Act provide for implied indemnity. In accordance with section 69, a party who is interested in payment of money that another is required by law to pay, and pays it themselves, is deemed to be indemnified. In accordance with Section 145, a party has the right to demand indemnification from the major defaulter for any amounts that he has lawfully contributed to the guarantee. Further, according to Section 222, the agent is entitled to indemnification from the principal for all sums paid in the proper execution of his duties.

Need for an Indemnification Clause

An indemnity clause is required in order to transfer or allocate the risk or expense from one party to another. It is possible to describe a business transaction between two parties more clearly by requiring one party to cover certain expenses paid by the other party. Contractual indemnities are used for a variety of purposes, including the following:

• Securing contractual performance of another person to a contract;
• Transfering the financial risk of a named event from one party to the other party, where it might not ordinarily or otherwise lie;
• Negating the need for a misrepresentation claims where the primary remedy is rescission.;
• Removing the burden of proof for breach of contract.

Application of an Indemnification Clause in a Contract

To understand this in a broader context, it is necessary to understand what all can be covered as a breach of a contract, which could lead a party to indemnify the other party. In most cases, indemnity is usually clearly set out to avoid any future discrepancies.

Indemnities are often drafted too widely to cover anything and everything that would help a party to recover any kind of damage and safeguard themselves from the same. Ideally, an indemnification obligation shall be capped to a certain amount or limit in an agreement, which would otherwise make the indemnifier onerous for circumstances that would otherwise not be a part of any indemnity. It is essential for the parties to carefully examine the indemnification clause because the interpretation of the indemnification clause and its operation may be very different.. Ambiguity in drafting this clause should be avoided. An indemnity clause is always based on the type of contract one is dealing under. 

Drafting of Indemnity Clause

The following factors should be taken into account when creating an indemnity clause in a contract:

• Who is the indemnity-holder and indemnifier?

• Whether or not there is a need for indemnity at all, does the indemnity offer more protection than what the common law would typically offer for a violation of contract? 

• The amount of indemnity which is granted when entering into a contract must be limited by the indemnifier. To reduce the loss, an unambiguous requirement must be made, and the duration of time in which a claim may be made must be restricted.

• A claimant seeking indemnification should take care to ensure that the indemnity clause is never written broadly since doing so runs the danger of attaining the intended claims and may even exclude some anticipated liabilities.

• In addition to the common law rights, indemnity for breach of contract and violation of negligence must be taken into account.

Enforcement of Indemnity Contracts

An indemnity may be invoked according to the terms of the agreement like an express promise. The courts in India have, time and again, taken the position that an indemnity holder is entitled to sue the indemnifier even before incurring any actual damage or loss and that an indemnity is not necessarily given by repayment after payment. Hence, an indemnified party can call upon the indemnifier to make the payment once the damages have been incurred. The concept of accrual of loss or liability and the attendant obligation to indemnify can be contractually agreed upon between the parties.

S. 124 does not limit or restrict an indemnity claim to anything that is only reasonably foreseen or to the ordinary rules of remoteness. Thus, consequential, remote, indirect, and third-party losses can also be claimed by the indemnified party unless specifically excluded in the indemnity clause.

In light of principles of equity, it has been held by courts that if the liability of the indemnifier becomes absolute, indemnity arises, however, upon the court’s satisfaction of the clear existence of an enforceable claim.

The exercise of the discretion to grant relief requires a balance to be struck between the severity of the protection and the perceived threat of dissipation of assets.

Conclusion

It should be understood from the above-made statements that an indemnity clause is one of the most important clauses and should be dealt with utmost care as this includes all the risks involved in the parties' obligations which are to be performed under a contract. 

---

Disclaimer:
This article has been prepared for general guidance and information as a guide to understanding the concept of an indemnity clause in any agreement and does not constitute professional advice or a legal opinion and are the personal views of the author. The matters described herein are general in nature and have not been evaluated based on applicable laws. This article is based on information available in the public domain and has not been verified for its accuracy. You should not act upon the information contained in this note without obtaining specific professional advice. No representation or warranty (express or implied) is given as to the accuracy or completeness of the information contained in this note. Treelife and its employees accept no liability, and disclaim all responsibility, for the consequences of you or anyone else acting, or refraining to act, in reliance on the information contained in this publication or for any decision based on it. Without prior permission of the author / Treelife this note may not be quoted in whole or in part or otherwise referred to any person or in any documents.