CS Shruti Patwardhan
“Indemnity” is a term used for providing compensation for damages or loss. The concept of indemnity is based on a contractual relationship enumerated under commercial agreement executed between two or more parties, in which one party agrees to pay for potential losses or damages suffered by the other party.
In common law, an indemnity is an obligation by a person (indemnifier) to provide compensation for a particular loss suffered by another person (indemnity holder).
Section 124 of The Indian Contract Act, 1872 defines “Contract of indemnity” as “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, is called a “contract of indemnity.”
A contracts to indemnify B against the consequences of any proceedings which C may take against B in respect of a certain sum of 200 rupees. This is a contract of indemnity. A contracts to indemnify B against the consequences of any proceedings which C may take against B in respect of a certain sum of 200 rupees. This is a contract of indemnity.”
Contractual indemnity is different from common law indemnity. Indemnity provisions in a contract allocate the risk of a business transaction between the two parties by obligating one party to pay the compensation/damages to the other party under certain circumstances.
Indemnification clauses are often closely tied to representations or warranties, which are promises that certain things are a certain way.
There are two basic types of indemnity: express indemnity which is based on a written agreement, and implied indemnity which is not in writing but which arises out of a contractual relationship between parties.
Bare Indemnities – One party indemnifies other party for all liabilities or losses incurred in connection with specified events or circumstances without setting out any specific limitations.
1. Reverse Indemnities – One party indemnifies other party against losses incurred as a result of other party’s own acts, omissions or negligence.
2. Limited Indemnities – One party indemnifies another party against losses except those incurred as a result of another party’s (indemnity holder’s) own acts omissions or negligence.
3. Third Party Indemnities – One party indemnifies another party against liabilities to or claims by third party (non contracting party).
4. Guaranteeing Indemnities – Party A indemnifies Party B against losses incurred if Party C fails to honour the financial obligation (i.e. the primary obligation) to Party B (most often these are coupled with a guarantee), and
In the case of Gajanan Moreshwar vs Moreshwar Madan, AIR 1942, Bombay high court observed that the contract of indemnity held very little value if the indemnity holder could not enforce his indemnity until he actually paid the loss. If a suit was filed against him, he had to wait till the order (judgement) is passed before suing the indemnifier.
In the case of State Bank of Saurashtra vs Chitranjan Ranganath Raja 1980, the bank failed to properly take care of the contents of a godown pledged to it against a loan and the contents were lost. The court held that the surety was not liable for the amount of the goods lost.
Creditor’s duty is not only to take care of the security well but also to realize its proper value. Also, before disposing of the security, the surety must be informed on the account of natural justice so that he can have the option to take over the security by paying off the debt. In the case of Hiranyaprava vs Orissa State Financial Corp AIR 1995, it was held that if such a notice of disposing off of the security is not given, the surety cannot be held liable to indemnify for the shortfall.
The indemnity clauses are often misinterpreted. Therefore one has to take caution while negotiating commercial agreement so that specific commercial risks of the concerned party gets protected and covered under Indemnity Clause.
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(Republished with Amendments by Team Taxguru)