Negotiating indemnities: An investor’s perspective

Indemnity clauses in investment agreements are generally highly negotiated, as they can have a significant financial impact on both sides long after a transaction has closed. The first draft (typically circulated by the investor’s counsel) sets the tone for the negotiation bearing in mind that an investor typically wants the widest indemnity provision ensuring full and fast recourse. In contrast, a target/promoter will try to ensure that the indemnity provision is narrow, specific and limited, so as to minimize potential loss.

Indian Contract Act, 1872: Section 124 of the act defines an “indemnity” as a contract by which one party promises to save the other from loss caused by the conduct of the promisor or of any other person. Although views diverge on whether: (a) the indemnity holder is required to suffer an actual loss before it can claim on the indemnity or (b) a claim can be made once the loss is absolute or crystallized, recent judgments of various high courts favour the latter view.

Foreign Exchange Management Act, 1999: Under the act, permitted transactions involving the inflow or outflow of foreign exchange require the general or specific approval of the Reserve Bank of India (RBI). There is no general policy on granting approvals for indemnities to be given by residents in favour of non-residents, and the RBI decides each application on a case-by-case basis. As a general rule, however, the RBI is reluctant to permit residents to incur foreign currency exposure. The RBI is likely to require complete details of the transaction or project in relation to which an Indian person or entity has given an indemnity to a non-resident person or entity, the relationship between the two, and other details which will help determine the circumstances and the approximate amount of any foreign exchange outflow. If however the indemnity becomes payable on the basis of an arbitration award, the RBI and authorized dealer (banker) would generally permit such a payment.

Bakhtiar Sunavala is a founding partner of I&S Associates. The views expressed are the author’s and are not a substitute for specific advice.