Friday, April 29, 2011

Contract Killers: Indemnification


One of the keenly debated issues in contractual negotiation is that of "indemnity" or more specifically what are the indemnification obligations to be incurred by either party to a contract.

Let us proceed to take a detailed view of the same:

a) Definition:

S.124 of the Indian Contract Act states "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".

Some other generic definitions read as follows: I. An agreement whereby one party agrees to secure another against an anticipated loss or damage. For example, someone may agree to turn a business over to another person for a reduced price if they pay the debts and other obligations of the business. In a broad sense, insurance policies are indemnity contracts. A provision in a lease that requires a tenant to pay (indemnify) a landlord for damages. (

II. act of holding harmless, amends, assurance against loss, compensation, full satisfaction, lex oblivionis, payment, protection against loss, recompense, recoupment, redemption, refund, remuneration, repayment, requitement, restitution, restoration, return, security, security against damage, security against loss, setoff, vindication An indemnity contract arises when one individual takes on the obligation to pay for any loss or damage that has been or might be incurred by another individual. The right to indemnity and the duty to indemnify ordinarily stem from a contractual agreement, which generally protects against liability, loss, or damage. (legal-dictionary.the free-dictionary)

b) Debate:

Given that indemnification requires the defaulting party to compensate the aggrieved party for their losses, a keenly disputed issue is always whether indemnification obligations should be limited to third party claims only, supporters of this rationale elaborate that "direct indemnification" would place the indemnified at an unfair advantage, as all such party would be required to do is claim from the indemnifiying party for alleged losses. While it therefore seems pertinent to limit indemnification obligations to third party claims (and therefore logically to intellectual property related matters), one can consider that off-beat request where the indemnified party may request protection in terms of consequential/indirect losses, while the textbook approach is to exclude such losses, acceptance of the same would lead one to concur that such losses are "direct" in nature (i.e. entirely dependant on the indemnifying party) and therefore any indemnification in respect of indirect/consequential losses would be a "direct" indemnification as opposed to a third party indemnification.

c) Summary:

Any debate surrounding indemnity related obligations, has necessarily to consider the following:

i) The subject matter on which indemnification is offered (intellectual property, indirect claims etc.)

ii) The grounds on which indemnification is offered:

a) Whether the indemnifying party is entitled to a sufficient prior notice in respect of any claim
against the indemnified property,

b) Whether the indemnifying party can settle the claim on behalf of the indemnified

iii) The time period for which such indemnification obligations last ( in perpetuity, for a certain
period after the termination of the agreement).

In closing, it is enlightening to note, that S.125 of the Indian Contract Act, 1872 requires that any compensation amounts arising from indemnification obligations are subject to adjudication by a court of competent jurisdiction. In so prescribing, statute has in no small manner mitigated the risk of accepting an onerous indemnification obligation.

Let the debate begin:

Till next time!

Vikram Koppikar

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