All you need to know about Contract of Indemnity

The article 'All you need to know about Contract of Indemnity' explores the meaning, nature, scope, and important case laws in the context of indemnity.

One of the most significant types of business contracts is an indemnification contract. Many industries, including the insurance sector use these contracts. Due to the nature of these contracts, this is the case. In essence, they assist companies in covering their losses and lowering their risks. The importance of this cannot be overstated, both for small and large organisations.

In a nutshell, an indemnification agreement entails a promise from one party to the other to compensate for losses. These losses may result from either the other party's or someone else's behaviour. In essence, to indemnify something is to make up for a loss. In other words, it signifies that one party will compensate for any losses the other sustains. 

Introduction

The Latin word "indemnis," which implies unharmed or free from loss, is the source of the English word indemnity. As we all know, the main goal of an indemnity or indemnification is to shift all or part of the risk from one party to another. This means that one party to the contract, known as the "indemnifier" or "indemnifying party," makes a promise to defend another party, known as the "indemnity holder" or "indemnified party," from loss, cost, expense, and damage as well as from any legal repercussions resulting from an act or omission by either the indemnifier or a third party or any other event. Section 124 of the Indian Contract Act (1872) defines a 'contract of indemnity'. 

To indemnify means to make up for harm, loss, or damage to another person. Contracts for insurance and indemnity have many similarities. In an insurance contract, the insurer guarantees or promises to compensate the insured for any losses. He is given payment in the shape of a premium as compensation. The Contract Act does not apply to these kinds of agreements. This is true since laws with specific requirements for insurance contracts, like the Insurance Act, exist.

Meaning of indemnity

According to Halsbury's definition, an indemnity is a contract that expressly or implicitly shields the party entering into or about to engage in a contract from any losses, regardless of whether the activities of a third party caused those losses. The Latin term "indemnis," which means freedom from loss, is the source of the word indemnity, as was already mentioned. It is protection against any kind of loss, expense, etc. in the form of a promise to cover those losses, according to Longman's dictionary.

Illustrations: In exchange for a set amount of money, X agrees to defend Y in court if Q takes legal action against Y. Contract of indemnity is the name of this agreement or guarantee.

Nature and Scope of Indemnity

A contract of indemnity is entered into to protect the promisee from unforeseen losses. An agreement to indemnify another party may be expressed or inferred. In other words, participants in such a contract may explicitly impose their own requirements. Implied indemnity duties may also be created by the nature of the circumstances.

A contract of indemnification has a conditional framework, is contingent in nature, and primarily serves as a safety net against potential risks and uncertainties. Like any other contract, an indemnification agreement must adhere to all legal standards in order to be enforceable. As an example, A complies with B's request for action. When A promises to cover B's losses, should he suffer any, they implicitly create an indemnity contract.

Because a party might not be able to control all obvious factors of a promise's execution, an indemnification contract is crucial. A party may be held liable for another's acts when the circumstances surrounding the performance are beyond their power and control. A contract of indemnity is a particular kind of contract, and indemnity is a subset of compensation. The indemnifier voluntarily and knowingly assumes the responsibility of indemnification.

An insurance contract is typically not regarded as an indemnification contract in India. Contrarily, contracts for marine, fire, or auto insurance are regarded as contracts of indemnity because, unlike life insurance, which pays out a specific sum of money upon the death of the policyholder, a creditor becomes entitled to a specific sum of money when he purchases a policy on the principal debtor.

Difference between Indemnity and Guarantee

The indemnifier and the indemnified are the two parties to an indemnity agreement. In addition, there are three parties included in the guarantee agreement: sureties, major debtors, and creditors. The majority of the time, indemnification is utilised to make up for losses, whereas the guarantee safeguards the creditor. Under a contract of indemnification, the indemnifier's liability is first and foremost caused by an accident. After finishing his portion of the contract, the indemnifier has no claim against the third party and may only bring legal action against the third party if an assignment is made in his favour.

Osman Jamal and Sons Ltd. v. Gopal Purshottam [1]: In this instance, the official liquidator was defending the plaintiff's company, which was in the process of being liquidated. The plaintiff's business served as the defendant's business commission agent for the procurement and sale of specific commodities. Additionally, the plaintiff company was to be protected by the defendant firm from any loss or damage related to this transaction. Due to the defendant company's failure to accept delivery, the vendor was able to resell the products for less than the agreed-upon amount. As a result, the plaintiff filed a lawsuit to reclaim the money. The judge made a ruling in the plaintiff's favour.

Indemnity under US and English Law

Under English law, "indemnity" has a broader definition. It also includes a commitment to protect a person from harm brought on by other people, organisations, or uncontrollable events like accidents. It also classifies other insurance policies as indemnity contracts, aside from life insurance. The denial of life insurance as indemnification has a straightforward justification. It is thus because each of their environments is unique. For instance, a life insurance policy may offer payment upon a person's passing or upon the conclusion of a predetermined time frame. Yet, this is not covered by indemnification.

Section 124 of the Indian Contract Act signifies that it is a contract where a party promises to protect others against any type of loss resulting from the promisor's or any other party's conduct. This definition excludes losses that are brought about by uncontrollable or unforeseeable occurrences and is solely applicable to losses brought about by human or agency action.

Important Cases

State Bank of India v. Mula Sahakari Sakhar Karkhana Ltd. (2006) [2]

Facts: A cooperative society that is the respondent signed a deal with a business to establish a paper mill. For the release, the corporation provided a bank guarantee or indemnity. The location received 10% of the retention funds from the invoices for the supplies to be utilised in the installation. However, there were some disagreements between them, so the response called off the agreement and used a bank guarantee to sue the business.

Issues related to the case: Is the business responsible for this bank guarantee? Whether the bank will honour such a claim?

Judgment: The contract, which guaranteed the indemnity holder's protection from all losses, damages, and other claims, as well as the supplier's financial responsibility, was cited by the court in this case. According to the Honorable Supreme Court, the contract's wording show that it is an indemnification agreement rather than a guarantee. The Court further instructed the Bank not to honour the claim made regarding the contract's termination in the absence of any justification or proof.

Dodika Ltd. and Ors. v. United Luck Group Holdings Ltd. (2021) [3]

Facts: The High Court of England and Wales rendered its decision in this particular case. In this instance, the parties had a sale and buy agreement pertaining to the sale of the seller's portion of a corporation. Because the tax covenant protected the buyer from hidden tax liabilities, Dodika requested final payment. The notification comprising all the essential information had to be served on the other party in accordance with the terms of the agreement in order to make a claim for money and get indemnification. The buyer, Dodika, did not provide this notification to the seller, United Luck Group. Following an investigation, notice was given.

Issue related to the case: How effective was the notice Dodika provided to United Luck Group in attracting the claim under the terms of the contract?

Decision of the Court: The Court remarked that the notice issued by the buyer provided a chronology of events but did not clarify how investigations would be done or what the next steps were. The Court ruled that the notification was insufficient, and the agreement could not be invoked in any way. The court additionally stated that the language and words used in the notice, as well as the information included in it, will be utilised to determine whether a notice is sufficient to assert an indemnification claim under the agreement.

AXA SA v. Genworth Financial Holdings Inc. and Anor. (2019) [4]

Facts: In this instance, a large insurer, AXA, agreed to purchase shares of the two businesses from Genworth. In the event that the two companies were bought, AXA would be entitled to reimbursement for certain compensation payments under the Sale and Purchase Agreement due to the company's misrepresentation of payment protection insurance products.

Issues pertaining to the case: Whether the agreement's payment or reimbursement clause served as an indemnification or a payment covenant.

Decision of the court: In this case, the court had to decide whether the agreement's clause was an indemnification clause or an absolute covenant. It was decided that the provision was an unbreakable covenant. The Court interpreted the clause's essence and common interpretation while reaching its decision in the case. It was noted that the clause made no commitment to shield the customer from losses he might incur when conducting business or commerce. Furthermore, if it had been indemnification, a claim for damages rather than obligations would have resulted from it. As a result, it is an absolute covenant rather than an indemnity.

Conclusion

Indemnification refers to a duty or obligation placed on a person to cover another person's losses. An injured person has the right to place the burden of the loss on the offender. It is absolution from any fines or obligations brought about by any actions. It is also known as protection against harm, loss, or punishment. In simple terms, indemnity is the obligation of one party to hold the other party harmless in the event that they suffer any of the costs outlined in the indemnity contract.

In addition, an indemnification contract requires the promisor to shield the promisee from losses sustained as a result of the promisor's default or a third party's. This loss only applies to losses brought on by people or by any agency; it does not cover losses brought on by fires or other uncontrollable events. The parties are the indemnifier and the indemnity holder, or the indemnified, and a contract must meet the requirements listed in the article in order to be considered an indemnity. Because both indemnity and guarantee entail preventing losses, we occasionally misunderstand them. Nonetheless, they both differ from one another in the aforementioned ways.

In a contract for indemnity, one party agrees to pay the other party's losses or damages as a result of the promisor's or the other party's conduct. Because the law forbids persons from trying to shift their own blame onto others or evading liability, a straightforward indemnification clause in a contract does not always resolve liability difficulties. A straightforward indemnity clause will never be able to resolve liability issues.

Those who want to escape accountability for their actions or want a waiver of those obligations are not supported by the law. A careless party shouldn't be able to totally transfer all claims and damages brought against him to another, non-negligent party, and this is the main justification for this.

References

[1] AIR 1929 Cal 208, 118 Ind Cas 882 

[2] (civil) 2801 of 2006 

[3] [2021] EWCA Civ 638

[4] [2019] EWHC 3376

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