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INDEMNITY CLAUSE: ALL ASPECTS

As per Black’s Law Dictionary[1], “Indemnity is defined as a collateral contract or assurance, by which one person engages to secure another against an anticipated loss or to prevent him from being damnified by the legal consequences of an act or forbearance on the part of one of the parties or of some third person.”

It is a promise to make good the loss of other party which may be caused due to damage. In simple language, it is a transfer or management of risk to prevent loss or compensate for a loss which may occur as a result of a specified event against a contractual default or party’s negligence. Further, it means one party agrees to pay losses suffered by another to a third party.

Section 124 of the Indian Contract Act, 1872 defines 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.”

Why Indemnity is Important?
As it is a promise to make good the loss of other party, it protects businesses from potential lawsuit and claims. If we do not put the indemnity clause in a contract, the contract may put one or both parties at a higher risk of Claims. It protects a party or both parties from financial liability arising from the acts of other party. It significantly increases the level of trust in the contracting parties as one party is willing to protect and cover the losses of other party. It ensures court costs, lawyer's fees, and potential settlements are all covered.

Type of Indemnity:
The Indemnity clause or agreement provided in a contract will determine how much indemnity one party will have to bear on behalf of the other. There are mainly three (3) types of indemnity.
  1. Type I or Broad from Indemnity;
  2. Type II or Intermediate form Indemnity; and
  3. Type III or Comparative Form Indemnity 
In Type I, it is provided expressly and unequivocally that the indemnifier party shall indemnify the Indemnified party for the negligence of the Indemnified party, even if the indemnified party liability arises from its active or passive negligence. Hence, as long as the indemnified party is not solely negligent and its misconduct is not willful or gross, the party indemnifying has a duty to indemnify all of the indemnified party’s negligent conduct.

In Type II, the indemnifying party is to indemnify the indemnified party for the negligence of the Indemnified party, be it sole or contributory, but only if the Indemnified party’s liability arises from its passive negligence as opposed to active negligence. Hence, if the indemnified party was actively negligent, the indemnity provision will not apply and the liability will be apportioned according to the percentage of fault.

In type III, the indemnifying party is to indemnify the indemnified party for the indemnifier party’s own negligence; however, the indemnifier party has no duty to indemnify the indemnified party if the indemnified party was in any way negligent, either active or passive, regardless of whether the Indemnitor was also negligent. The indemnified party shall be solely liable for any of its own negligent conduct.

Distinction from Damages:
Enforcement of Indemnity may be brought before or after the actual breach of contract[2]. However, enforcement of damages only be brought after the breach of contract. To claim damages, a claimant has a duty to mitigate damage and if the claimant fails to mitigate the damage, he may not claim damages. A contract of indemnity can be enforced for claims for loss arising out of any act of third (3rd) Party to a contract whereas, damages can only be enforced for loss arising out of a breach of contract against a breaching party. Indemnity put a person back into the place where he was before the loss occurred however, the award of damages may be more or less than the actual loss. Indemnity is a special right which can be enforced when it is agreed between the contracting parties and incorporated in contracts, whereas Damages is a statutory right can be available to parties even without incorporating the provision for damages. Damages do not cover consequential or remote or indirect losses eventually it may not be enforced for loss of profit or opportunity costs, if any[3]. Indemnity covers all loss suffered which is attributable to a specified cause, whether or not it was in the reasonable contemplation of the parties.”[4]

Distinction from guarantees:
A contract of indemnity is different from a contract of guarantee, which is the promise of a third party to honor the obligation of a party to the contract should that party be unable or unwilling to do so (usually a guarantee is limited to an obligation to pay a debt)[5]. In a contract of indemnity, the primary responsibility to indemnify the indemnified with the Indemnifier whereas in a contract of guarantee it is with the party whom the contract is being performed.

Distinction from warranties:
In a contract of indemnity, an indemnifier guarantees compensation equal to the amount of loss subject to the indemnity, while in a contract of warranty, the concerned party only guarantees compensation for the reduction in the value of the acquired asset due to the warranted fact being untrue (and the beneficiary must prove such diminution in value). In a Contract of warranty requires the beneficiary to mitigate their losses, while the contract of indemnity has no such requirement. Contract of warranty do not shield problems known to the beneficiary at the time the warranty is given, while in a contract of indemnity do.

Rights of indemnity-holder (Indemnified) when sued[6] - The promisee in a contract of indemnity, acting within the scope of his authority, is entitled to recover from the promisor.”
  1. all damages which he may be compelled to pay in any suit in respect of any matter to which the promise to indemnify applies;
  2. all costs which he may be compelled to pay in any such suit if, in bringing or defending it, he did not contravene the orders of the promisor, and acted as it would have been prudent for him to act in the absence of any contract of indemnity, or if the promisor authorized him to bring or defend the suit;
  3. all sums which he may have paid under the terms of any compromise of any such suit, if the compromise was not contrary to the orders of the promisor, and was one which it would have been prudent for the promisee to make in the absence of any contract of indemnity, or if the promisor authorized him to compromise the suit.

 How to negotiate better the Indemnity Clause?

[For Indemnified party]
  1. It is significant to avoid verbiage like “make good” or “compensate” as the courts may interpret it as covering claims only due to the actual loss suffered by the indemnified party and not cover instances where the liability has accrued but no payment has been made. Therefore, it is recommended to use the words like “hold harmless” instead to cover make good or compensate[7].
  2. The words “protect from liability” stipulates that the indemnifier has an added responsibility to defend the indemnified against the contracting party or third-party claims. The Indemnity clause may provide that the right to defend the indemnified party by the indemnifying party shall start with any claim is made by any third party.
  3. It is recommended to avoid usage of “losses means” and rather use “losses includes”, because consequential, indirect and remote losses can be claimed under the indemnity clause, it is important to not give an exhaustive definition to Losses.
  4. The words “arising out of” are wide. The relevant relationship should not be remote, but one of substance albeit less than required by words such as “caused by” or “as a result of”. It is recommended to use the verbiage “arising out of” which is given a broad interpretation by the courts and mere occurrence of the event would suffice the need. Terms such as “a result of” or “connection of” require close nexus to be established should be avoided[8].
  5. The payment of indemnity should prompt on issue of a notice of claim. The provision must clearly provide that upon the notice by the indemnified party to the indemnifying party of any claim that may arise out of an indemnity clause, the duty of the indemnifying party to make the payment shall become due and payable upon receipt of the notice or within certain number of days of receipt of such notice. Further, it is recommended to include that the delay in making any claims or giving notice does not waive the obligation of indemnifying party.
  6. In case of a dispute of the claim amount and the Indemnified Party has invoked the alternative dispute resolution process or any other modes for resolving the dispute then it is recommended to include in the indemnity clause that the claim amount shall be deposited with the arbitrator, the mediator or with the competent court deciding the dispute. It is to make sure that the Indemnifying Party is competent to pay the claim amount if by any chance Indemnified Party wins the matter.
  7. Any gross negligence, breach, misrepresentation, misconduct or fraud committed by the indemnifying party may be excluded from the scope of the limit of indemnity.
 [For the indemnifying Party]
  1. Indemnity is a special right only available if included in contracts, similarly duty to mitigate may not cast upon any duty on the indemnified party to mitigate losses, if not included. It is advised to the Indemnifying party to include or negotiate to include this in contracts.
  2. It is recommended to incorporate a ‘limitation of remedy’ clause which covers both the limitation of liability and exclusive remedy clause. It will candid and clear to parties and leaves no rooms for ambiguity in interpretation.
  3. fdvfbbThe survival clause should be customized. Illustration: it may be incorporated any indemnity claim arising out of breach of representations may be valid for a period of a certain number of years post the termination of the agreement.
  4. Since Limitation of liability is an exculpatory clause, and it gives a strict interpretation. Therefore, any exclusions that are to be made from an indemnity clause are to be expressly provided in the Indemnity clause.

a.       It is recommended to add an actual or constructive knowledge qualifier.
b.      The indemnifying party may include that it will not be held liable for any net quantifiable financial benefit that could arise to the indemnified party from any loss suffered.
c.       The indemnifying party may consider include that it shall not be liable in respect of any liability which is contingent unless such liability becomes due and payable to the indemnified party.
d.      It is advised that the indemnified party is not entitled to recover more than once in respect of the same matter or event which has caused the loss. Further, it may be included that the indemnifying party shall not be held liable in respect of any claim to the extent such losses are covered by an insurance policy or from a third person.
e.      It must be incorporated in the contracts that Indemnifying party shall not be held liable in respect of any claim if proper allowance, provisions or reserve is made in the books of accounts of the indemnified party.

Exclusive Remedy Clause with Limitation of Liability:
In order to limit the extent of liability, parties can agree to an exclusive remedy indemnification clause which will be certain and fundamentally immune from the discretion of the courts. In the Exclusive Remedy Clause, it may be considered to include that ‘indemnity shall be a sole remedy in relation to the transactions intended under this agreement to the exclusion of all other rights and remedies including those envisaged in tort. The Limitation of liability clause which must provide the total liability under the agreement shall be limited to the amount and conditions agreed in the indemnity clause. In this situation, on grounds of equity, reasonableness and good conscience indemnified party may try to claim for losses/ damages, over and above of the limit of indemnity.

Points to Remember:
  1. Indemnity does not waive the parties of their normal obligations.
  2. As the Contract Act is not exhaustive and common law principles are to be taken into account. Hence, the common law principles vis-a-vis to interpreting contracts will continue to govern the indemnity clause, unless there is a conflict with the Act or any judicial decisions[9].
  3. The indemnity clause interpreted as a claim for debt and not as a claim for damages and hence the duty to mitigate does not apply.
  4. These are just the general rules regarding Indemnity clause, however, they are not conclusive and if not expressly stated in the contract, when deciding which type applies and who is indemnified it ultimately depends on the particular language of the Contract, the intent of the parties, and the facts of the case.
  5. Parties must be mindful that Type I Indemnity is the most onerous and Type III indemnity is the least.
  6. When any claims arise, immediately consult with your attorney to evaluate your contract to determine your rights & obligations vis-a-vis to indemnity and defense.

 You are most welcome with your queries or comments to the author.
[1] See page # 910, 4th Edition
[2] See Jet Airways (India) Limited v. Sahara Airlines Limited and Ors, 2011 (113) Bom LR 172; Osman Jamal and Sons Limited v. Gopal Purshattam, (1928) ILR Cal 262.
[3] See Ruxley Electronics and Construction Limited v. Forsyth, [1996] AC 344. See also the landmark case Hadley v Baxendale [1854] EWHC J70
[4] Total Transport Corporation v. Arcadia Petroleum Limited, [1998] 1 Lloyd’s Rep. 351.
[5] See Birkmya v Darnell
[6] See Section 125 of Indian Contract Act, 1872
[7] See Queen Villas Homeowners Association v. TCB Property Management, 2007 Cal. App. Lexis 470
[8] See Samways v. WorkCover Queensland and Ors. [2010] QSC 127.
[9] Gajanan Moreshwar Parelkar v. Moreshwar Madan Mantri (1942) 44 Bom LR 704.

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