India: Party Claiming Damages Under Indemnity Clause

Introduction

The term indemnity comes from the Latin term "indemnis" which means uninjured or suffering no damages or loss. The term Indemnity always has a wider approach because it covers loss arising out of the action of a third party along with the party who has a direct contractual obligation. On the other hand, damages are always limited to the parties who were part of the contract. The core principle of indemnity is to return an individual to the situation/circumstances where he was before the breach occurred. Moreover, whenever it's related to money-related damages, in the case of Indemnity a grant might be more than the genuine adversity that happened and not exactly the real adversity that happened.

Legal Status

The Indian law on indemnities has in some respects diverged from English law and followed its own path. Such differences are, however, greatly outweighed by their similarities.¹ In India the law of indemnity covers:

It is observed that Sections 124 and 125 of the Indian Contract Act are not exhaustive of the law of indemnity hence the Courts generally apply the same equitable principles that the Courts in England do. Therefore, if the indemnified has incurred a liability and that liability is absolute, he is entitled to call upon the indemnifier to save him from that liability and to pay it off.²

Whereas Section 73 and 74 of the Indian Contract Act established that the breach of policy/contract must be so fundamental in nature that in the instances of claiming the damages, it brings the contract to an end.³ Therefore, in such cases, damage/loss arising out of the actions of the parties must be a result of a concluded contract.⁴

But we should also note that the terms Indemnity and Damage cannot be used interchangeably. So, a very fundamental question that arises when looking at the two concepts of Indemnity vs. Damages is whether Indemnity Clause or General Damage Clause under the contract would offer better protection to the contracting party. The comparison drawn for the captioned terms are as follows;

1. Third-party claims – One of the biggest advantages of a claim for indemnity is that while liquidated damages can only be claimed for breach of contract (by a party to the contract),⁵ an indemnity claim can be brought against the indemnifying party as well as "any other person".
2. Timing of claim – While a liquidated damages claim can only be brought after the breach of a contract, an indemnity claim may be brought before the breach. E.g. – An indemnified party may ask the indemnifying party to defend a suit against them instituted by a third party.⁶
3. Scope of claim – While Section 73 (Compensation for loss or damage caused by a breach of contract) of the Indian Contract Act only allows for damages to be claimed for loss or damage "which naturally arose in the usual course of things from such breach, or which the parties knew, when they made the contract, to be likely to result from the breach of it", S.124 of the Act does not put any restriction on the scope of indemnity. Hence, an indemnity claim may even allow the party to claim indemnity against unforeseeable and indirect losses.
4. Duty to mitigate – Section 73 of the Indian Contract Act puts a duty on the claimants to mitigate their losses and states that they may not claim losses that arose due to their failure of mitigation. However, Section 124 of the Indian Contract Act puts no such obligation on the indemnified party.

Hence, it is clear that a claim for indemnity offers better and wider protection to the party. So it is highly important to draft Indemnity Clauses carefully in the contract. For example, an Indemnity Clause must include the period of time under indemnity cover, types of losses, how indemnity interacts with other provisions, when should it come into force, and requisition too while applying the clauses. All the above-mentioned points will avoid any unintended consequences during litigation.

From a Different Lens (Viewpoint)

Generally, Indemnity Clauses are written into contracts to allow an Indemnifier to take on any losses incurred by a party in the contract. It's used to compensate the party who is suffering but here the question arises that why only one party gets the protection and why the Indemnity Clause is not twofold or covers both the parties in cases of breach. In the present underline circumstances, this clause only will extend and benefit the beneficiary party listed in the agreement and not stretched to any other person (Indemnified Party).

This leads to complications sometimes in a contract, which can also lead to delays in negotiating an agreement. This is one of the limitations of the Indemnity Clause which simply limit the liability of the Indemnifier but does not rule out other contractual remedies to be pursued against the Beneficiary. It would be advisable to have two separate provisions with respect to indemnity arising out of breach (of a party which included both the parties) and separately for third party claims.

To support this point the Court of Appeal of New Zealand had another occasion to apply the Cavendish formulation in 127 Hobson Street Ltd. v. Honey Bees Preschool Ltd.⁷ In the context of a rather unique indemnity clause in the agreement collateral to the lease. This clause entailed that in the event of failure to install a second (additional) lift in the building within the specified time, the landlord was liable to refund the rental amounts and other ancillary charges received from the tenant. The Court of Appeal found that the tenant, which was a preschool, had a "legitimate interest" in securing the construction of this second lift given that the building housed a number of businesses, including a hotel, and residential premises, and was in dire need of lift access. The Court held that risk and reward could be structured by parties in a variety of ways in commercial settings, and so long as the structure is not out of all proportion to the legitimate interest, the provision should be enforced.

Therefore, the rights of the indemnified party in the defense of a third-party claim are still not settled. From the contractor's perspective, limited liability under an indemnity is the most preferable because it limits the scope of indemnity obligations.

Conclusion

In the business community, Indemnity is a form of protection and Damages are a form of compensation or relief. So it is advisable that both clauses should be part of the contract.

But recently, indemnity clauses have become quite popular and are used widely in commercial transactions because of their wider protection, especially in terms of tax liabilities, labor troubles, etc., which are essentially unforeseeable events at the time of entering into a contract. In recent times the Court has confirmed its approach of interpreting indemnity clauses strictly too,⁸ so as to give effect to the party's intentions. As a result, it is crucial to pay attention to the specific wording used when drafting the provisions.

Moreover, a typical indemnity clause thus provides for protection against all kinds of losses, claims, and liabilities, howsoever arising in relation to the specified transaction. Thus, the Indian law position seems to be no different from the common law one in this regard, though it much depends on the nature and wordings of the contract in question and the Court's inference of the intention of the contracting parties to include consequential losses.

We can conclude that as a general rule, the drafting of such Indemnity or Damage Clauses must go into a lot of negotiations because it is one of the essential clauses in the contract. All such clauses not only deal with the risk on the part of the defaulter but also covered the rights of the defrayer. Due to this, the consequences may be faced by both parties in case of ambiguities being present in the clause with regards to the coverage of the losses. Therefore, keeping in mind all these factors, the drafting of the indemnity clause must be done precisely while finalizing the contracts.

Footnotes

1 Indemnities and the Indian Contract Act 1872 by Wayne Courtney, 27 NLSI Rev 66 (2015).

2 New India Assurance Company Ltd. vs. the State Trading Corporation of India Ltd. and Anr. AIR 2007 (NOC) 517 (GUJ.).

3 Lakshmi Chand vs. Reliance General Insurance (07.01.2016 - SC) : MANU/SC/0016/2016.

4 Vedanta Limited v. Emirates Trading Agency LLC, 2017 SCC OnLine SC 45.

5 Jet Airways (India) Limited v. Sahara Airlines Limited, 2011 SCC OnLine Bom 576.

6 Maharashtra State Electricity Board v. Sterlite Industries (India) Ltd., 2000 SCC OnLine Bom 89.

7 127 Hobson Street Ltd. v. Honey Bees Preschool Ltd 2019 NZCA 122 (Three-Judge Bench).

8 Zayo Group International Ltd v Ainger and Ors (13.10.2017 - UKCM) : MANU/UKCM/0086/2017.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.