Indemnification Clause In Indian Commercial Contracts

An indemnity clause is a legal provision that shifts the responsibility for financial losses from one party to another. In an indemnity claim, one party, known as the Indemnifier, agrees to protect the other party, known as the Indemnity Holder, from any financial losses or expenses incurred due to the Indemnifier’s actions or those of a third party. This principle is commonly included in commercial contracts as a means of managing risk and protecting one party from the consequences of the other party’s actions.

The concept of an indemnity clause in India is defined in Section 124 of the Indian Contract Act, 1872, which states that it is a contract in which one party promises to protect the other from losses caused by the conduct of the promisor or any other person. Indemnification clauses play an important role in commercial transactions by protecting one party from the financial consequences of the other party’s actions.

Importance Of Indemnity Clause In India

The Indian courts have recognized that indemnity holders have the right to sue the indemnifier even before incurring any actual damage or loss and that indemnities are not limited to repayment after payment. However, parties need to ensure that the indemnity clause is well drafted so that it provides full-proof protection and balances the interests of both parties to the contract. Indemnity clauses in India can be broad, covering third parties and circumstances beyond the ordinary breach circumstances actionable under common law. Additionally, it’s important to note that indemnities can also extend into unintended onerous obligations, which the common law would not impose.

Components Of The Indemnity Clause

Several key components make up an indemnity clause in India. These include:

1. The indemnifying parties: This is the party that is agreeing to provide the indemnification and take on the financial risk of any future losses.
2. The indemnified party: This is the party that is being protected by the indemnity clause and will be able to claim any losses or expenses incurred as a result of the indemnifying party’s actions or those of a third party.
3. The scope of the indemnification: This defines the specific types of losses or expenses that the indemnified party will be able to claim under the indemnity clause, such as property damage, legal fees, or other costs incurred as a result of the indemnifying party’s actions.
4. The period of the indemnification: This specifies the duration of time during which the indemnified party will be able to make claims under the indemnity clause.
5. Exclusions and limitations provisions: This section specifies any limitations or exclusions to the indemnification, such as limits on the amount that can be claimed or certain types of losses that are not covered by the indemnity clause.
6. Survival of the indemnity: This specifies the duration of time after the termination of the contract during which the indemnity will survive.

Key Considerations From The Perspective Of Indemnified Party

When drafting an indemnity clause in India, it’s important to clearly define the scope of losses and liabilities that are covered. The definition should use phrases like “losses include” to allow for flexibility in interpretation. Consideration should also be given to the party who may be in breach of the contract and the type of potential breaches and their immediate quantifiable losses.

A claim notice provision should be included in the indemnity clause and state the threshold for triggering an indemnifying party’s payment obligation. Lastly, indemnity payments may have tax consequences and the indemnity clause in India should address this. The indemnifying party should be responsible for absorbing the tax consequences and the indemnity payments should cover both the indemnity claim and any taxes due on receipt.

Key Considerations from the perspective of Indemnifier

It is important to include indemnification clauses that specify the length of time an indemnity claim can be made after the termination of the agreement. As an Indemnifier, it is important to have protection against the ability of the Indemnified party to settle or defend cases without consent. There should be a limitation of the remedy clause to clearly outline the exclusive remedy in case of a breach. It is also important for Indemnifiers to tailor the survival clause in the indemnity clause, specifying a limited period for claims arising from breaches of representation.

Indemnity Clauses In M&A Transactions

In M&A transactions, indemnification clauses in share purchase agreements (“SPA”) are carefully negotiated to limit future liabilities for both buyers and sellers. To ensure protection, it is crucial to draft a strong indemnity agreement in any Mergers & Acquisition transaction, especially in cases of outright purchases. In M&A transactions, buyers often have more bargaining power than sellers, so the indemnity language in the SPA needs to include restrictions and exclusions that protect the seller’s interests.

Additionally, limitation of liability clauses can limit the amount of time and money spent in the case of an indemnity claim by specifying a period for filing claims and a proportion of the acquisition price for claims. To further protect the Indemnified, an escrow can be established to fulfill any potential obligations without the need for litigation or arbitration.

Conclusion

Indemnity clauses are commonly used in commercial contracts to shift the risk of potential losses from one party to another. These clauses are often negotiated to protect against specific risks and are essential for parties to carry out the agreement. However, it is important to draft indemnity clauses carefully and precisely to avoid ambiguity and ensure that they cover the expected losses. Negotiating indemnity clauses in India correctly is crucial as they can have significant consequences if not done properly. Parties should consider their specific needs and potential risks when drafting the indemnity clause to ensure that the indemnified party is protected from unforeseen losses.

FAQs