Importance of Indemnity clause in commercial contracts.
Author: Shrankhala Parwar, School of Law, DAVV, Indore.
IMPORTANCE OF INDEMNITY CLAUSES IN COMMERCIAL CONTRACTS
Introduction:
According to the dictionary meaning, indemnity is protection against possible damage or loss, especially a promise of payment, or the money paid if there is such damage or loss. It is a security against, or compensation for loss, etc. This is where a claim for indemnity arises, in such a case there are two persons one who agrees or promises for the reimbursement or incurring the loss such a person can be called as “indemnifier”, and the other person to whom such a loss has been caused is the “indemnity holder” or “indemnified”. This is how in such cases the loss gradually shifts from one person to another person.
What is indemnity?
The claim for indemnity or indemnification arises when a party (indemnifier) promises to protect another party (indemnity holder) from any kind of loss, cost, expense, damage or any other legal consequences caused by the conduct of the indemnifier or any third party. Initially, the basic importance of the indemnity clause is to shift the liability, in whole or in part, from one party to another party. Section 124 of the Indian Contract Act,1872, lays down that the claim of indemnity arises when a person agrees or gives assurance to another person to save him from any kind of loss that has been caused to him by any action of the person who is promising or action of any other person who may not be a party to the contract. Here it is very clear from the above definition that the provision of indemnification arises only when a prior promise is made to save a party from the loss. The question of reimbursement arises only when there was an anticipation of loss and in that context, a promise was made to incur the loss.
Under the following section, the main criterion which usually gives rise to indemnity is “any action or conduct of the indemnifier or any other person or let’s say the third party who may not be a party to the contract due to which the loss or any damage that has been caused to the indemnity holder”. Section 124 of the Act only covers those cases where the loss or damage that has been caused by the action or conduct of the promisor himself or any third party. It is very clear that it does not include any such cases where human conduct is absent.
Under Indian Law Previously under Indian law, the definition of Section 124 of the Indian Contract Act, 1872, it included only those cases of indemnification where the loss or damage has been caused by the action or very conduct of the promisor himself or any other third party from which the claim of indemnity arises. Any promise to compensate for a loss that has not been caused by human conduct was not covered under the purview of the section of indemnity. The section did not cover the contract of insurance. But later on, The Law Commission of India in its 13th Report in the year 1958, recommended to amend Section 124 of the Act and accordingly Section 124 was amended to include all the cases of loss or damage that may or may not have been caused by the action of any person. Promise to indemnify must be implied as well.
1. What is an Indemnity Clause? Commercial contracts typically include an indemnity clause among other standard terms (also known as boilerplate clauses). Words such as “hold harmless”, “defend”, “make good” or “compensate” often indicate the clause is, in effect, an indemnity clause. The list is by no means exhaustive.
Indemnity clauses often set out a list of what actions a party is insured against, for example:
All lawsuits, actions or proceedings, demands, damages and liabilities. All claims, liabilities, losses, expenses, and damages arising from a contract.
Loss, damage, injury or accidental death from any cause to property or person occasioned or contributed to any of your acts, omissions, neglect or breach or default. Here is where the scope of the indemnity can be much wider than it needs to be for the purpose of the contract.
2. What are the types of Indemnity Clauses?
There are loosely six types of indemnity clauses, which provide a guide to their scope and operation, including:
Bare Indemnities – Party A indemnifies Party B for all liabilities or losses incurred in connection with specified events or circumstances, but without setting out any specific limitations. These indemnities will be silent as to whether they indemnify losses arising out of Party B’s own acts and/ or omissions, and maybe be interpreted to have the effect of a reverse indemnity Reverse or Reflexive Indemnities – Party A indemnifies Party B against losses incurred as a result of Party B’s own acts and/ or omissions (mostly Party B’s own negligence) Proportionate or Limited Indemnities – These are the opposite of Reverse Indemnities. Party A indemnifies Party B against losses except those incurred as a result of Party B’s own acts and/ or omissions Third Party Indemnities – Party A indemnifies Party B against liabilities to or claims by Party C Financing Indemnities – Party A indemnifies Party B against losses incurred if Party C fails to honour the financial obligation (ie the primary obligation) to Party B (most often these are coupled with a guarantee), and Party/ Party Indemnities – Each party to a contract indemnifies the other(s) for losses occasioned by the indemnifier’s breach of the contract.
3. What is the Extent of an Indemnity Clause?
Indemnity clauses are sometimes reasonable for the contract’s terms or even essential for parties to carry out an agreement. Other types of indemnity clauses are completely unnecessary and could expose a party to liabilities they have no control over. Where an indemnity clause continues long after a contract ends is when a problem can arise – ensure you negotiate the term so as to narrow its scope and duration.
4. How Does an Indemnity Clauses Affect Your Business? If you are entering into an Agreement and required to provide an indemnity, you should first negotiate its removal entirely. However, if the other party insists on the clause, you should ensure it is narrow, so you are less exposed to risk. For example, you may be able to word it to exclude you from being liable if a loss is the other party’s fault, or you could set a maximum amount that they could claim under the clause.
If you are seeking an indemnity from the other party, for example, asking the other party to indemnify you for any losses you incur as a result of doing something on their behalf, be reasonable. Although it may seem like a good idea to negotiate broad protection, the other party may require the same of you.
5. How Should Your Insure Yourself Again Indemnities? An option to consider is obtaining insurance to cover any indemnity you provide. Obtaining insurance in this instance is not to be confused with Professional Indemnity Insurance, which covers you for negligent advice or misrepresentations among other things. For some indemnities, you may be able to get quotes for insurance and, in fact, asking for these may open your eyes to how much risk you are taking on.
If you are asking for an indemnity, remember that much like a guarantee, it’s only as good as the person giving it, so you may wish to insist on the other party obtaining insurance. Insurance may provide an inflated cost of an indemnity, but obtaining a quote can offer perspective on whether it’s necessary to have all those indemnity clauses for the contract to work for both parties.
6. Can an indemnity holder seek indemnity before he has suffered any actual loss? It has always been a controversial point, regarding whether the indemnity holder can seek indemnity before he has suffered any actual loss in this context.
Under English common law, no action can be brought against the indemnifier for reimbursement until the indemnity holder has actually suffered any loss. This provision creates great hardship for the indemnity holder as in some situations he might not be in a position to meet the claim or the damages from his own pocket. In those cases, relief was provided by the Court of Equity. The Court of Equity evolved the rules as a result now the indemnity holder can seek indemnity from the indemnifier in respect of the obligation against which the indemnity has been promised.
In India, there have been different views among various High Courts regarding whether or not the indemnifier can be compelled to indemnify before the indemnity holder has suffered any loss. According to Nagpur High Court, a person cannot be indemnified before he has actually suffered any loss. The High Courts of Bombay, Calcutta, Madras Patna, and Allahabad have expressed a different view, and they are of the opinion that the indemnity holder can seek indemnity before he has suffered any actual loss.
Rights of the indemnity holder when an indemnity clause is inserted in a commercial contract
● When a suit is instituted against the indemnity holder or the indemnified, he may be compelled to pay damages, and incurred costs, etc. While in a similar way he can bring an action against the indemnifier to compensate for the damages and costs, etc. paid by the indemnity holder himself, if the indemnifier has agreed in such a case for reimbursement or indemnification. Section 125 of the Indian Contract Act lays down the provision regarding the rights of the indemnity holder-
● If a promise has been made in a contract of indemnity to save an indemnified from a loss or any damage by the indemnifier and the promise made by the indemnifier is within the scope of his own authority then the indemnity holder is entitled to recover from the indemnifier the following-
● All such damages which the indemnity holder may be compelled to pay in a suit in respect of any matter provided that the promise applies to the following matter;
● All costs which the indemnity holder may be compelled to pay in any such suit which he has brought without contravening any orders of the indemnifier and acted as a prudent man in the absence of any such contract of indemnity, or he was authorized by the indemnifier to bring or defend such a suit;
● All sums which the indemnity holder may have paid in a case of any compromise of any such suit, if the compromise was not contrary to the orders of the indemnifier and is one in which the promise would be prudent to be made in the absence of any such contract of indemnity, or if the indemnity holder was authorized by the indemnifier to compromise the suit.
While drafting an indemnity provision in a contract the following points must be considered-
● Who is the indemnity-holder and who is the indemnifier?
● Whether or not there is any need for indemnity at all or the indemnity provides greater protection for the breach of contract than would normally be available for the breach of contract under the common law? If not, indemnity is not needed.
● An indemnifier must limit the number of indemnities that is given while entering into a contract. An express obligation must be imposed so as to minimize the loss, and the duration of time in which the claim can be brought must be limited.
● An indemnity-holder should make sure that the indemnity clause must never be drafted in a wide manner as it risks the effect of achieving the desired claims and might even exclude some anticipated liabilities,
● Indemnity for breach of contract and breach of negligence must be considered in addition to the common law rights.
● In the event of a breach of contract, the effect of indemnity should be- 1. The breach will also give rise to other remedies under the contract (termination, liquidated damages or rights to payment) 2. The breach will allow the indemnified party to be entitled to a payment, compensation or reimbursement.
Duration of liabilities It is critical to understand that the limitation period in relation to an indemnity clause starts from the date on which the indemnifier refuses to honour the indemnity. The indemnified party would then have a further 6 years from that date within which to bring legal proceedings to enforce the indemnity. Consequently, an action on the indemnity to seek recovery of its loss may be brought many years after the right to bring damages for breach of contract has expired. In most instances, parties granting indemnities are not adequately advised of this potential impact and the extended period of risk they are assuming as part of their indemnity obligations
Conclusion Generally the indemnity clauses arise out of commercial negotiations and seek to protect specific commercial risks. Indemnity clauses are sometimes reasonable for the contract’s terms or even essential for parties to carry out an agreement. Indemnity clauses must be negotiated properly before putting it into a contract. Serious consequences can arise due to a poorly negotiated indemnity clause. Ambiguity in the drafting of an indemnity clause presents a risk that the indemnity will not be held to cover losses, which they expected to cover. It is very important to draft the indemnity clauses properly and precisely. They are reasonably important as it shifts the loss from one party to another which might have been caused due to the negligence of the former.
Reference:
Ranganath Vs. Pachusao and others (NAGPUR JUDICIAL COMMISSIONER’S COURT March 7, 1935).
Gajanan Moreshwar Parelkar vs Moreshwar Madan Mantri (Bombay High Court April 1, 1942).
Prafulla Kumar v. Gopee Ballabh Sen (Calcutta High Court 1944).
Ramaligna v. Unnamolai, 791 (Madras High Court).
Chunni Bai v. Nathu Bai, 655 (Patna High Court).
Abdul Majeed v. Abdul Rashid, 598 (Allahabad High Court 1936).
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