Indemnity is a term that you may have heard or read often while going through commercial contracts. Do you know what does indemnity mean? Indemnity is defined as compensation which one contractual party gives to the other for the loss suffered. However, it is not this simple, and there are many contractual issues involved. We shall discuss and explain the issues associated with indemnity.
What is an Indemnity Clause?
It is a promise to hold a person harmless from the consequences of his act. It can be express or implied. Companies, while entering into a contract, happen to mention an indemnity clause so as to manage risk arising out of acts by another party effectively. It is viewed as a form of security against a financial loss. The contracting party who promises/gives the indemnity is called the indemnifier while the contracting party to whom indemnity is given is called the indemnity holder. The definition of Indemnity in Indian Law is narrower compared to the English Law. While the latter definition includes within its scope losses arising from any cause (fire, ravages of the sea, etc.), the Indian definition only allows for a promise to indemnify losses arising out of actions directly attributable to the promisor or by any other person. Basically, loss must be on account of human agency.
What Can be Claimed as Indemnity?
An indemnity is typically required under certain events. These include intellectual property rights infringement, loss to property, losses to third parties, etc. Even if one has indemnified a product for a particular amount, a valid claim can only be made for the exact amount of loss made and not the entire amount. Also, it is a settled law position that a party can be indemnified before suffering actual loss provided that such loss is imminent.
Are Indemnity and Damages Same?
Damages are described as compensation for legal injury. The following are differences between Damages and Indemnity :
- Action for damages arises when a breach of contract has occurred. The loss incurred needs to be due to the actions of the contracting party. In Indemnity, losses arising out of third-party actions can be claimed and does not necessarily entail a breach of contract.
- Damages can be claimed only for losses arising out of reasonably foreseeable events. Indirect or remote losses cannot be claimed. This is not the case with indemnity where indirect and remote losses can be claimed.
- A duty to make up for the the loss by the party is implied in damages, whereas it has to be explicitly included in Indemnity clauses.
How to draft an effective Indemnity Clause?
There is a tendency to simply use previous indemnity clauses without tailoring it to the requirements of the contract at hand. This diminishes its effectiveness. Certain key points to keep in mind while drafting the Indemnity Clause are:
- Sources from which potential losses may arise, need to be identified, so as to ensure a proper comprehensive indemnity clause.
- One should define loss in an exhaustive manner as remote, consequential, and indirect losses can be claimed under this clause. Such an attempt reduces the possibility of a loophole.
- Also, wide definitions, vague expressions should be avoided as they might be read down, which might lead to the exclusion of some of the anticipated liabilities.
- An Indemnifier should consider adding a clause to put an obligation on the Indemnity Holder to mitigate its loss following the breach.
- The indemnity holder should be limited from benefitting from his own negligent/irresponsible conduct.
- It is absolutely necessary to ensure that the indemnifier is financially capable of making good on the loss suffered in accordance with the contract.
Thus, Indemnity clauses seek compensation for actual or potential damages arising out of certain set events. They are usually subject to intense negotiations on account of the liabilities they impose. Such clauses should be drafted with care and should be tailored as per the requirements of the contracting circumstances. Otherwise, they are likely to be rendered useless when a dispute arises.
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