Introduction
In the ever-evolving landscape of business transactions, partnerships, and collaborations, uncertainty and unexpected challenges can arise at any moment. As entrepreneurs, innovators, and decision-makers, we are constantly faced with the daunting task of mitigating potential risks, legal entanglements, and financial liabilities that could impact our work and cause losses. When it comes to the realm of contracts, an important tool for protecting oneself from harm caused by other party and ensure protection against such uncertainties and unforeseen consequences is the clause on indemnity (“Indemnity Clause”).
Indemnification, in its simplest form, is a situation where one party replenishes the losses suffered by aggrieved party due to acts or omissions committed by the replenishing party. It is a legal concept that refers to compensation provided to one party by another for potential losses, damages, or liabilities that may arise from a specified event or circumstance. Indemnity Clause is a contractual provision that seeks to transfer the burden of potential loss or liability from one party to another. Its purpose is to safeguard one party (the indemnity holder/ indemnified) by ensuring that any potential losses, damages, etc. caused to it are assumed by the other party which has caused such potential loss or damage (indemnifier/ indemnifying party).
Legal Framework
Section 124 of the Indian Contract Act, 1872 (“Act”) provides for the principle of indemnity. It states that indemnity refers to a contractual agreement where one party commits to compensate the other party for any loss incurred as a result of the promisor’s actions or the actions of another party. This Section 124 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, is called a “contract of indemnity”. In the case of HP Financial Corporation v. Pawana & Ors[1] of 1997, it was held by the Himachal Pradesh High Court (and later reiterated by the Supreme Court in Deepak Bhandari vs Himachal Pradesh State Industrial Development Corporation Limited[2]in the year 2010) that a contract of indemnity is an independent and separate contract from the main contract. A lesser-known fact is that, subject to applicable State laws, the stamp duty payable on indemnity clauses is separate and in addition to the amount payable for a general agreement.
Further, Section 125 of the Act provides the indemnity holder with certain rights that the indemnifier is obligated to fulfill. These rights encompass the recovery of damages, reimbursement of legal costs, and the right to recover any sums of money paid as part of a compromise or settlement of a lawsuit.
Nevertheless, the scope of indemnity as defined in the Act is limited as it requires the loss to be a result of the actions of the Indemnifier or a third party. This definition does not encompass all the consequential or specific obligations that may arise from an Indemnity Clause.[3] For instance, several concepts such as implied indemnity[4], indemnity holder’s right to sue the indemnifier even before experiencing any real damage or loss[5], etc. are still evolving under indemnity law jurisprudence. Thus, given this disposition, investing in an Indemnity Clause for commercial agreements in order to allocate risk, maintain fairness and balance while protecting a party’s interest becomes crucial.
Exceptions to indemnification
Indemnity Clauses in contracts often contain exceptions that limit the scope of indemnification. One significant exception relates to “negligence or gross negligence” on the part of the indemnified party. In such cases, if the indemnified party’s actions display a lack of reasonable care, then the Indemnity Clause may exclude indemnification for any resulting claims or losses.
Another exception arises when the indemnified party misuses or uses the products in a way that goes against their intended or specified use. In such cases, the Indemnity Clause may not provide coverage for claims or losses resulting from such improper usage.
Similarly, if the indemnified party acts in bad faith or fails to fulfill its obligations as outlined in the agreement, the indemnification provision may not apply. Deliberate breaches of contractual duties or non-compliance with agreed-upon obligations can result in the exclusion of indemnification for any resulting claims or losses.
Drafting of Indemnity Clause
- When drafting an Indemnity Clause, it is important to consider several key factors to ensure comprehensive coverage and clarity –
- Defining the extent of indemnification by specifying the events or circumstances that trigger the indemnity. This ensures that all potential risks and liabilities are adequately addressed.
- Establishing a concise timeframe for invoking indemnification helps in facilitating timely notification and resolution of claims.
- Outlining a well-structured procedure for making a claim, including specific requirements for notice and documentation, which enhances efficiency and transparency throughout the process.
- For the Indemnifier:
- restrict the scope of indemnities provided in the Indemnity Clause; and
- consider incorporating a clear obligation for the indemnified party to mitigate any potential losses.
- For the Indemnity holder:
- be cautious not to draft the Indemnity Clause too broadly, as it may lead to unintended consequences, potentially excluding some anticipated liabilities;
- ensure the wording of the clause is clear and unambiguous to avoid any misunderstandings or disputes; and
- in addition to relying on common law rights, consider including specific indemnities for breach of contract and negligence to bolster protection under the contract.
- The parties should also address the allocation of legal costs and determine whether the indemnity covers such expenses. It is also essential to explicitly state any limitations or exclusions to the Indemnity Clause, providing clear guidance on exceptions.
- Lastly, it is important to ensure compliance with relevant laws and regulations and conducting a thorough review of the clause’s validity and enforceability.
Ensuring Enforceability
Ensuring the enforceability of indemnity contracts requires careful drafting and adherence to allied legal compliances. Courts typically scrutinise the clarity and specificity of the language in which the Indemnity Clause has been drafted.
However, there have been instances where the courts have interpreted a plea for indemnity beyond a written contract. For instance, in the case of Adamson vs. Jarvis[6], the plaintiff, an auctioneer, sold cattle on the defendant’s instruction. However, it was later discovered that the cattle did not belong to the defendant but to someone else, who held the auctioneer responsible for the conversion. The auctioneer then sued the defendant for indemnity, seeking compensation for the losses incurred while following the defendant’s instructions.
The court ruled that because the plaintiff had acted based on the defendant’s request, it was reasonable for the plaintiff to assume that they would be indemnified if any issues arose. Consequently, the court ordered the defendant to indemnify the plaintiff for the losses and damages suffered.
Therefore, parties must craft precise and unambiguous language to avoid any ambiguity that could lead to disputes.
Conclusion
The clause of indemnity plays a crucial role in diverse types of contracts, especially those related to business transactions. They establish a mechanism to allocate and manage risks, thus safeguarding the interests of the parties involved. These clauses typically cover a broad range of situations, including contract breaches, intellectual property violations, third-party claims, various potential liabilities, etc.
Therefore, it can be concluded that the Indemnity Clause acts as a shield against unexpected circumstances. It accompanies one through the twists and turns of business contracts, collaborations, high-stakes projects and also acts as the guardian of one’s interests further offering unparalleled protection.
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[1] HP Financial Corporation v. Pawana & Ors, Civil Appeal No. 1971 of 1998.
[2] Deepak Bhandari vs. Himachal Pradesh State Industrial Development Corporation Limited SLP (Civil) No. 30825 of 2010.
[3]Gajanan Moreshwar Parelkar vs Moreshwar Madan Mantri, 7, (1942) 44 BOMLR 703.
[4] The Secretary of State vs The Bank of India Limited, (1938) 40 BOMLR 868.
[5] Khetarpal Amarnath vs Madhukar Pictures, 6, AIR 1956 Bom 106, (1955) 57 BOMLR 1122.
[6] Adamson vs. Jarvis, 4 BING.66:29 R.R 503.