Contract of indemnity under Indian Contract Act 1872
Adv Akansha Vajpayee

Contract of indemnity under Indian Contract Act 1872

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The term "indemnity" has a broader meaning because it covers loss arising from the actions of third parties in addition to the party having a direct contractual responsibility. Conversely, damages are firmly limited to the parties to the contract and have a narrow scope of applicability. Replacing a person in the same role or under the same conditions as before the responsibility arose is the basic idea behind indemnification. Furthermore, in terms of monetary damages, an indemnity award can exceed the true adversity and fail to fairly represent the true difficulty.


In most cases, an indemnity claim entails an agreement between two parties (the indemnifier and the indemnity holder) to protect the indemnity holder against any loss, expense, cost, damage, or other legal repercussions resulting from the indemnity holder's actions or inactions, or those of any third party. Transferring duty, in whole or in part, from one party to another is the main goal of an indemnity clause in a contract. The indemnity provision is a topic of much discussion and consideration during commercial contract negotiations. A badly worded indemnity clause could cause major problems, act as a spoke in the wheel, and be detrimental to the party's interests. The essential query, then, is whether there is any basis for requesting indemnity in lieu of pursuing the lawfully allowed course of suing under the Indian Contract Act of 1872 (the "Contract Act") for statutory damages. 


Status Legal

 "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," according to Section 124 of the Contract Act."

Section 125 of the Contract Act enshrines the rights of an indemnity holder. In accordance with the aforementioned clause, the indemnity holder shall be entitled to the following damages from the indemnifier:

(a) any and all damages for which he might be held liable in a litigation pertaining to any issue covered by the indemnity;


(b) whatever expenses he would have to pay in any such action if, in initiating or defending it, he followed the promisor's instructions and behaved wisely in the absence of any indemnity agreement, or if the promisor granted him authorization to initiate or defend the action;


(c) Any sums he may have paid under any settlement of any such suit, so long as the compromise was allowed by the promisor, followed the promisor's instructions, and represented what the promisee would have done in the absence of the indemnification contract.


Protection from Indemnity 

An agreement's indemnity clause is a clause that commits one party (or both/all parties) to paying the other (or each other) for any damages, liabilities, or losses resulting from the agreement. In most situations, when one party is at fault, the other agrees to compensate the former. This clause may also be used to release a party from liability or any damages resulting from the agreement's commercial transaction. 


An indemnity provision often transfers risk and obligation between the parties, functioning as an inter-party insurance. This is accomplished by establishing a duty on the side of one party (the indemnitor) to compensate the other party (the indemnitee) for losses for which the latter becomes liable, whether such losses are associated with the agreement or arise from specific kinds of claims. 


From a contractual perspective, an additional duty that is frequently included in the indemnity provision is defence, meaning that the party providing indemnification will not only cover the indemnitee's losses but will also, through engaging legal counsel, defend the indemnitee in court against the claim. 


Promise and Liability

Indemnities and guarantees are frequently used interchangeably. Nonetheless, there is a fundamental distinction between these two legal terms that should be considered when creating an indemnification clause in order to prevent confusion.


A guarantee, on the other hand, is an assurance that you will pay for the debt or default of a third party. Therefore, the desire of the parties to assure the performance of that duty through the guarantor and the existence of third party obligations are the fundamental components of a guarantee. Secondary obligations mean that a guarantee is only triggered in the event that the original party is unable or refuses to fulfil its end of the bargain. On the other hand, a guarantee obtained via deception or withholding of important information is void. However, duties under an indemnity are separate and primary from any other commitments. It is not necessary for a third party to bear vicariously liable in order for indemnities to apply.


Liquidated Losses and Compensation 

When one party violates an obligation, the other party suffers consequences. Sometimes the parties predetermine the amount of damages necessary to be paid in the event of a default, non-compliance, breach, and the like. This serves to encourage parties to be compliant and disincentivize any breaches. 


Liquidated damages, which are also known as liquidated and ascertained damages, are damages that are agreed upon by the parties during the negotiation of an agreement and that the injured or non-breaching party will receive as payment in the event of a specific breach (such as a failure to perform or a delay in performance).


The basic purpose of a liquidated damages clause is to have a punishment for non-compliance, not to punish the party that is in default. The amount agreed upon in accordance with this paragraph need not be enormous or disastrous for the party in violation, but it must be high enough to justify compliance. Rather to punishing the parties for non-compliance, the underlying goal is to make them compliant. 


It is important to remember that the words indemnity and liquidated damages are not interchangeable. On the other hand, these two legal terms function entirely differently when viewed through the lens of statutes. First off, damages can only be awarded against the promisor—the party that made the promise—while third-party claims are protected by an indemnity. Furthermore, claims for indemnity may be made even prior to a party suffering a loss. In addition, a damage claim only covers direct losses and excludes indirect losses from its scope. In contrast, an indemnity provision permits the recovery of consequential, indirect, and remote damages. While damages require evidence of a clear and sufficient connection between the event of breach of contract and the loss suffered, losses may be pursued for indemnity without having to show that the loss was caused by the incident. 


It is obvious that a claim for indemnification provides the party with greater and more comprehensive protection. As a result, it's crucial to properly craft indemnity terms in contracts. It is necessary to give careful thought to the different kinds of losses, the settlement process, and subsequent control. 


In the context of M&A, indemnity

Since the parties highly negotiate this indemnity idea, it has substantial value in private M&A deals. These clauses specify the circumstances in which one party will be expected to reimburse the other for any damages the latter may incur after the transaction closes. 


It is crucial to identify the indemnifying and indemnified parties in order to further clarify the extent of indemnity. Usually, the indemnification coverage in a share sale transaction is supplied by the sellers or the departing shareholders. In contrast, indemnification coverage in a share subscription agreement is provided by the corporation, promoters, and majority shareholders. Because of this, the concept of joint and several liability becomes significant if there are multiple indemnifying parties. It is important to remember that under the joint and several responsibility concept, the party receiving indemnification can select which party to file a claim against. The aspect of joint and several liability becomes essential in the case that one of the parties to the agreement dies, providing the indemnified party with much-needed relief to approach the other indemnifying party. 


As previously mentioned, indemnity is normally given for the loss. Generally speaking, the definition of loss is included in the final agreements and includes, among other things, any damages, penalties, fines, costs, and expenses, including legal fees. Simultaneously, a seller limits the provision of indemnity coverage against consequential and indirect losses. Due to the restricted visibility into the target's business, it is commonly stated that it is very difficult to determine the qualification of loss; consequently, indemnities act as comfort for the buyer against known and unknown losses. 


Generally speaking, indemnity events in M&A transactions are initiated when there is a loss resulting from fraud, willful misconduct, a breach of covenants, or a breach of representations and warranties. In this sense, a well-written indemnity clause will give the party being indemnified much-needed relief while making sure that all potential outcomes are sufficiently covered in the final agreement to protect the party being indemnified's interests.     


Particular Liability

Every M&A transaction inevitably necessitates a thorough legal due diligence assessment in order to weigh the advantages and risks of the proposed investments and to appraise all previous and current business events. Frequently, certain regulatory slants or non-compliances by the target firm are found during the due diligence process, and the buyer is aware of these as potential risks. Consequently, each particular non-compliance that impacts the fundamental principles of the transaction dynamics necessitates special attention, which is typically parked within the specific indemnification and is unrestricted by qualifiers or changes. 


Restrictions on Liability

Although risk allocation may appear theoretically straightforward to the buyer, the sell side may provide some challenges when establishing indemnity clauses. It can occasionally be very challenging to define the scope of a party's indemnity duties in a way that is suitable to the value (real or imagined) inherent in the contract as the size, complexity, and economics of a transaction expand. Nonetheless, sellers typically set up their affairs to restrict the sums for which an indemnifying party may be liable and discourage a party from filing baseless claims in order to provide clarity to their agreement.


In indemnity agreements, the following carve-outs are frequently negotiated, particularly when a seller is involved:


De Minimis Amount: The de minimis amount establishes the minimal amount that a single claim must surpass in order to qualify for indemnity. Only when a claim's worth above a minimal threshold—which may be stated as a percentage of the purchase price or a fixed sum—can a party seek indemnification.


Tipping Basket: Before a party can file a claim for indemnity, the total value of all claims must be more than the specified threshold. The indemnifying party will be responsible for all damages incurred after the threshold is crossed.


Indemnity Cap: A cap on indemnity sets a maximum sum that a party providing indemnification may have to pay. The cap amount might be a set sum or it can be determined as a percentage of the purchase price.


Survival Period: Generally, a time period known as the "survival period" is negotiated based on the representations and warranties included in the final agreement. This allows the seller to make sure they are not responsible for providing indemnity coverage indefinitely. 




The indemnified party would always prefer a wider coverage, and the indemnifying party would insist on certain checks and balances to be carved out while extending the indemnity coverage as this provision operates on the principles of minimising own risk and maximising its own benefits from various viewpoints. In the business and transactional world, indemnity clauses are a subject of intense negotiation because their primary objective is risk allocation. Because of the parties' ongoing tug-of-war, there is intense bargaining as a consequence of which the benefits of the indemnity coverages change in favour of the party with more experience and negotiating muscle. 

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