Nature of Indemnity Clauses

By | December 26, 2019

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Nature of the Indemnity Clause is very wide and ambiguous also at times. Since the liability to pay damages through these clauses is far more volatile than in the case of liquidated damages in normal contracts, a lot more degree of caution is required before framing the clauses.

Introduction

Indemnity is a special type of contract giving protection to the one indemnified against the future course of events that may happen. This shows the existence of two parties clearly, namely-

  1. Indemnifier
  2. Indemnified

The Indian Contract Act, 1872 (hereinafter “The Act”) recognises the validity of this type of contract and grants legal backing to this relationship. Section 124 of the Act provides guidance as to what will constitute indemnity. The text is hereinafter produced verbatim-

  1. “Contract of indemnity” defined.—A contract by which one party promises to save the other from loss caused to him by the contract of the promisor himself, or by the conduct of any other person, is called a “contract of indemnity”.

The best example to illustrate the meaning of this relationship is a protection clause from any kind of proceedings that may arise from the subject matter of the dispute in future. Even the Illustration that is so provided in the Act talks on similar lines.

Hence, the insertion of indemnity clauses becomes very crucial to understand in terms of their impact on the contractual liability that will so arise in the future. In the coming article, this aspect would be discussed in detail.

Meaning of Indemnity

One party has to promise to the other party in terms of protecting that other party from a loss that would arise in future. When consent in terms of offer and acceptance would be deductible from both the sides, then the contract can be termed to have been fructified.[1]

The obligation to pay for the damages that may arise in the future would emanate from the assured alone for the contract of indemnity that exists between the parties. Hence, the right of the indemnified is not only dependent upon the privity of contract but the nature of the indemnity clause that exists between the parties.[2]

Scope of Indemnity

It has also been settled long back in the landmark case of Gajanan Moreshwar Parelkar v. Moreshwar Madan Mantri[3], that the Indian Contract Act is not an exhaustive code to provide each and every condition to be fulfilled in the contract.[4] Thus, the Chartered High Court at Bombay categorically ruled that the common law principles would be worth governing the relationship of the indemnified and the indemnifier.

This enlarges the scope of the indemnity clause to such an extent that a lot of confusions and ambiguities may arise as to its nature and scope. Thus, a lot more reason now exists to investigate into the ambit and the nature of this clause minutely.

Reading Contract as a whole

When a company says to a cooperative society that it would protect it against all losses, claims, damages, actions and costs which may be suffered by it, the contract construed the said clause to be an indemnity clause.[5]

In the case so mentioned above there was no particular clause as such where the company, Pentagon had to provide a bank guarantee. Since, no specificity could be found in the contract as to what should be nature of the clause, indemnity or guarantee, the court construed it as indemnity given the wordings used there.[6]

Quantum of Damages

Per contra, if the indemnity clause becomes enforceable and passes the Equity test, the quantum of damages that would have to be so awarded also needs due consideration. Payment of contract price would be the fundamental basis that would depend upon the market value of the subject matter.

The courts have considered, in such situations, only that pecuniary loss that emerges directly from the breach would become payable. Hence, every loss under the sun cannot be enforced on the head of the indemnifier and then the money cannot be accordingly asked for.[7]

Wide Nature of the Clauses

Lord Justice Brett has thrown considerable light on the subject of indemnity in the following manner-

“This contract means that the assured, in case of loss against which the policy has been made, shall be fully indemnified, but shall never be more than fully indemnified. That is the fundamental principle of insurance, and if ever a proposition is brought forward which is at variance with it, that is to say, which either will prevent the assured from obtaining a full indemnity, or which will give to the assured more than a full indemnity, that proposition must certainly be wrong.”[8] 

Inclusion of Third-Party Claims

This definition along with the statutory definition as was present in Section 124 of the Act shows how the entire risk of a loss that would arise in the future comes rested on the shoulders of the Indemnifier.

This wide proves how wide the clause is which even takes third party claims into its ambit.

On the strength of indemnity note so attached with a consignment order for railways, the latter delivered the goods to a third party. Though that was challenged in the court of law, the Supreme Court remanded the matter back to the Railways Tribunal since, via the nature of the indemnity clause, the action of the railways was appearing to be good in law[9]

Essential Role of Equity

The nature of the indemnity clause is also construed along with that of the Chancery concept of equity. The courts have been benevolent in that regards wherein a larger and wide right has been recognised to be vested in the indemnified.[10]

In a court of equity, thus, the indemnified would be entitled to maintain an absolute action against the Principal Debtor and obtain an order of full payment in tune with the liability that so arises. Hence, Indemnity requires that “party to be indemnified shall never be called upon to pay.”[11]

It ensues from the wideness of the nature of this clause along with the equity that gets mixed with the conceptual framework that the right gets vested in the person to get indemnity long before. It means that it is not necessary to wait for the loss to take place. Even before the actual accrual of the loss, the indemnified can ask for the money.[12]

Due to the possible inclusion of the indemnity clause in a contract, courts have rendered validity to the Government contracts. It happened in such a way, that when the government refused the bid to the highest bidder, on tier policy grounds, courts have reprimanded and reminded the government of the nature of indemnity clause.[13]  Thus, the court set aside the rejection of the bid accordingly.

No requirement of reasonability and foreseeability

The restriction that applied through the version of liquidated damages and the requirement of reasonability is not applicable upon the indemnity clause.[14] The reasonable contemplation by the parties is complete rules out and is also not necessary in common law. The observations made by Lord Justice Staughton is very crucial to note at this juncture-

“Indemnity” may refer to all loss suffered which is attributable to a specified cause, whether or not it was in the reasonable contemplation of the parties.”[15]

Hence, Section 73 of the Act that asks for the foreseeability of the damages as a precondition before asking for liquidated damages is not applicable to the present case.  Even before the actual loss has occurred, the party can use the wideness of the indemnity clause and claim suitable damages.

No need to show nexus

Since the repayment is not necessarily given after payment only[16], it leads to a logical conclusion that it is not necessary to show a sufficient and direct nexus with the damage that has happened. As shown above, the test of the direct effect of the breach was important, the rule is flexibly applicable in the situation of indemnity.

No duty to mitigate losses

Even, the duty to mitigate the losses that generally exists in the case of the normal contracts is absent in the situation of indemnity. In the United States, it has been the case whereby, the defence to incur liability in an indemnity contract cannot include the argument that the other side failed to mitigate the losses.[17]

This shows that it is immaterial for the indemnified to prove the fact that he or she had tried to mitigate the losses, only then would he or she would be eligible to get the damages. It is very much clear that very existence of the indemnity clause inside the contract would suffice the court to invoke the liability of the indemnifier.

Suo Motu Exercise of Indemnity

The indemnity can even be exercised by the courts suo motu. Though, at the same time, a considerable degree of caution is also exercised given the obligatory nature of the indemnity clause.

In the landmark case of Priyanka Estates International (P) Ltd. v. the State of Assam,[18] the court found patent illegality in the construction of buildings and flats and held the builder solely responsible for the same. It was also acknowledged that the buyers of the flats who were put in the possession of the illegally constructed building were innocent.

Under the extraordinary powers so granted under Article 142 of the Constitution, the court considered that granting compensation to the victims in the nature of an indemnity can be done, but it did not choose to. The simple reason was the fact that there were a number of disputed questions so involved in that case.

Unenforceable Clauses

Indemnity clauses can be rendered unenforceable by the courts through their juridical powers. Justice V.R. Krishna Iyer had done the same in the case of Union of India v. C. Damani & Co.[19] In this case, there was an indemnity clause between a local contractor of silver and the State Trading Corporation. It laid an obligation on the respondents to provide for damages to the STC for not being able to provide silver.

But, the contract itself got frustrated due to the ban on the export of silver by the Government of India. In this event, on the grounds of equity, it was held that the Damini & Co. cannot be held obligatory to fulfil such responsibility which is impossible to perform.

In such situations when the contract becomes frustrated and impossible to perform, it has a direct bearing on the effect of the workability of the indemnity clause so inserted inside that contract. Hence, the person on whom the obligation was being trusted can very well in full capacity overcome that particular liability.[20]

When the contract becomes so unenforceable, it is appropriate for the other party to rightfully claim the benefit so conferred earlier. Under the purview of the indemnity clause, the losing party is entitled to do the same but within the scope of the indemnity clause itself. Hence, if the recovery was been enforced once, it was not permissible to get it enforced once again.[21]

Conclusion

The above-mentioned examination of the nature of the indemnity clause throws considerable light on the wide and expansive nature of the concept of indemnity. As was clear from the definition expounded at the beginning of the article, the primary object that the law seeks to achieve is restoration.

The party who was so promised that the loss would be so compensated for an activity that would take place in future, the law seeks to restore the position of the party who has effected a change in his/ her conduct to be in the similar position that existed before the contract was entered into.[22]

Hon’ble Supreme Court has also validated the statement that the contract of indemnity is a separate contract apart from the main contract. [23]It leads to the invocation of a separate and independent right. Such a right, as discussed above, would be more than a legal right is also an equitable right.

The stipulations in the contract with respect to the indemnity and its clauses, would of course not affect the nature of the transaction.[24] It means that a sale deed would not become a piece of weapon attracting universal liabilities.

But, the addition of an indemnity clause with intent to protect the other party from harm and loss is additional in nature. Such enforcement of rights leads to a lot of problems as well as the benefit for the indemnifier and indemnified respectively.

As a law student or a law enthusiast, the point to wonder is that the nature of the clause is so wide that various liabilities can come within its ambit comfortably.


[1] State of Orissa v. United India Insurance Co. Ltd., (1997) 5 SCC 512

[2] Union of India v. Sri Sarada Mills, (1972) 2 SCC 877.

[3] (1942) 44 BomLR 704.

[4] Id.

[5] State Bank of India v. Mula Sahakari Sakhar Karkhana Ltd., (2006) 6 SCC 293.

[6] Id.

[7] Union of India v. Sagauli Sugar Mills Pvt. Ltd., (1976) 3 SCC 32.

[8] Banerji, Marine Insurance relied on in State of Orissa v. United India Insurance Co. Ltd., (1997) 5 SCC 512 at page 515 (¶11).

[9] Shree Shyam Agency v. Union of India, (2013) 1 SCC 283.

[10] Osman Jamal and Sons Limited v. Gopal Purshattam, (1928) ILR Cal 262.

[11] Id.

[12] Jet Airways (India) Limited v. Sahara Airlines Limited and Ors, 2011 (113) Bom LR 1725.

[13] Jespar I. Slong v. the State of Meghalaya, (2004) 11 SCC 485.

[14] Total Transport Corporation v. Arcadia Petroleum Limited, [1998] 1 Lloyd’s Rep. 351.

[15] Id.

[16] Khetarpal v. Madhukur Pictures, AIR 1956 Bom 106.

[17] Am. States Ins. Co v. Glover, 960 F. 2D (6th Circuit 1992).

[18] (2010) 2 SCC 27.

[19] AIR 1980 SC 1149.

[20] State Trading Corporation v. Union of India, 1994 Supp (3) SCC 40.

[21] A.S. Motors (P) Ltd. v. Union of India, (2013) 10 SCC 114.

[22] McDonald v. Black, 20 Ohio, 185.

[23] H.P. Financial Corporation v. Pawna, (2015) 5 SCC 617.

[24] Vimal Chand Ghevar Chand Jain v. Ramakant Eknath Jadoo, (2009) 5 SCC 713.


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