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Party Claiming Damages Under Indemnity Clause – Contracts and Commercial Law



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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:

Section 124 of the Indian Contract Act, 1872 (“the
Indian Contract Act”
) states, “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.” Further, Section 125 provides a remedy to the
promisee in a contract of indemnity acting within the scope of its
authority.

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.



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