In any contract the parties deploy various risk allocation methods to ensure that no party ends up facing more liability than it bargained for. If one party commits a breach of its war- ranties or obligations, as a principle of law, the other party should be put in the same position it would have been in had the breach not occurred.
The non-breaching party can achieve monetary compensation in two ways: (1) through a claim for damages – a statutory remedy available to the non-breaching party; or (2) through a claim for indemnity, provided the non- breaching party has negotiated such a right under the contract.
For example, if Company A proposes to buy the business of Company B, Company A would rely on the repre- sentations and warranties provided by Company B in relation to its busi- ness. If any of those representations and warranties were to be untrue, to get compensated for the resultant loss, Company A can either choose to claim damages or, if under a contract Company B has agreed to indemnify Company A, it can choose to raise an indemnity claim against Company B.
While both remedies can achieve the same objective, the contractual right of indemnity has certain advantages over the right to seek damages under gen- eral provisions of contract law.
Right to sue before incurring loss: To claim damages, the non-breaching party has to suffer a loss, i.e. make a payment. In contrast, once a liability has been incurred and that liability is absolute, the indemnified party is entitled to call on the indemnifier to make the payment without actually going out of pocket.
This is premised on the fact that an indemnity may be worth little if the indemnified party cannot enforce the indemnity until it actually pays the liability. This principle was first laid down by Bombay High Court in the case of Gajanan Moreshwar Parelkar v Moreshwar Madan Mantri and was later reaffirmed by the other high courts.
Quantum of damages: To arrive at the quantum of damages, there has to be a natural connection between the actual consequences of breach and the quantum of damages. On the other hand, where the agreement provides for an indemnity, compensation is on a rupee-to-rupee basis, which includes all reasonable costs and expenses incurred by the indemnified party. There is no need to make a natural connec- tion to the breach. Also, the party that is likely to be subject to a claim for damages under a contract usually likes to limit its exposure by way of period of claim, claim amount and overall cap on potential claim. An indemnity clause under the contract helps to bring clarity on these aspects.
Specific indemnity: To make a claim for damages, a breach of contract and consequent damage is a prerequisite. It is not the case with indemnity. In the above example, if Company B has made certain disclosures in relation to tax demands, Company A would not be in a position to claim damages, as there is no breach of contract. However, the parties are free to identify certain mat- ters arising out of such disclosures as specific indemnities in the contract which would enable Company A to get compensated in the event of loss resulting from such disclosed matters.
Consequential loss: Under sec- tion 73 of the Indian Contract Act, 1872 (Contract Act), the claim for dam- ages cannot be made for any remote and indirect loss or damage. The clas- sic case of Hadley v Baxendale, from which the principle of indirect loss has been adopted, lays down that “loss that arises from a special circumstance of the case is recoverable if it may reasonably be supposed to have been in the contemplation of the parties at the time they made the contract, as the probable consequence of the breach”.
In other words, if the party in breach of contract was aware of the special cir- cumstances of the other party when the contract was entered into, the losses may be recoverable. However, from a plain reading of section 124 of the Contract Act, which defines the con- tract for indemnity, it appears that these restrictions do not apply to a claim for indemnity. Therefore, the indemnified party can claim losses even if such losses were not in contemplation at the time entering into the contract.
Mitigation of loss: As damages are compensatory and not penal, the one who suffers loss from breach of con- tract is required to take every reason- able step that is available to mitigate the extent of damages caused by the breach. A well drafted indemnity clause may discharge the indemnity holder from such an obligation.
Additional remedy: Contracting parties need to keep in mind that indemnity is an additional remedy. An indemnity agreement does not restrict the right of the non-breaching party to claim damages or pursue other legal remedies, instead of indemnity.
Once the claim is made, receipt of compensation by way of indemnity may be a time consuming process considering the jurisdiction involved. Nonetheless, for reasons stated above, indemnity provisions are important and continue to take substantial time and effort during negotiations.
Darshan Upadhyay is a partner and Amruta Kelkar is an associate manager at Economic Laws Practice. This article is intended for informational purposes and does not constitute a legal opinion or advice.
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