Authored By – Soumya Shekhar
The concept of indemnity under the Indian Contract Act, has been theoretically explored many times in the past. However, how are indemnities used in practical life is an area which still remains untouched. Section 124 of the Indian Contract Act defines 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”. If we break down the definition, we note that an indemnity is essentially a promise to make good the loss of the other. This loss can be caused either by the promisor or by the conduct of any other person. This brings us to another question: If indemnity is the making good of loss, then where do damages come into the picture? Through this post, I attempt to explore the practical undertones of the concept of indemnity and how it is to be distinguished from the concept of damages.
Almost every contract from a Master Services agreement to a Software licensing agreement has an indemnity clause. Indemnity clauses enable the contracting parties to offset the risk which may arise, as a result of any wrongdoing or breach on the part of one of the parties. For instance, if A licenses a software to B, B would typically have an indemnity clause, which states that if in the future a third party comes and lays claim to the ownership of the software, then A would be liable to “defend, indemnify and hold harmless” B against the same. Simply put, this means that A would make good any loss which may occur as a result of A infringing a third-party’s ownership rights. Similarly, while drafting an indemnity clause, many grounds are included which form the basis of indemnification. Section 125 of the Indian Contract Act lays down the rights of an indemnity holder, which forms the basis for the usage of the terms, “indemnify, defend and hold harmless”. Section 125 states that:
“The promisee in a contract of indemnity, acting within the scope of his authority, is entitled to recover from the promisor (1) all damages which he may be compelled to pay in any suit in respect of any matter to which the promise to indemnify applies; (2) all costs which he may be compelled to pay in any such suit, if in bringing of defending it, he did not contravene the orders of the promisor, and acted as it would have been prudent for him to act in the absence of any contract of indemnity, or if the promisor authorized him to bring or defend the suit; and (3) all sums which he may have paid under the terms of any compromise of any such suit, if the compromise was not contract to the orders of the promisor, and was one which it would have been prudent for the promise to make in the absence of any contract of indemnity, or if the promisor authorized him to compromise the suit.”
If we break down Section 125, we see that an indemnity-holder has the following rights:
- Right to be paid the damages that may be awarded in the suit related to the indemnity.
- Costs of the suit/claims brought against him including but not limited to lawyer’s expenses.
- Any settlement amounts which may have been paid under the relevant suit.
It is in consonance with these rights of an indemnity holder that the terms, “indemnify, defend and hold harmless” are used in contracts.
Another key area, where contract drafting professionals face issues is the exclusion of indemnity from the limitation of liability clauses. If we analyse the rights of an indemnity holder, we see that these rights include not only specific and direct losses but also indirect damages which cannot be quantified. Another important reason why indemnities are feared is that they are payable without having to prove actual loss. This is why the party which is entitled to the indemnity always attempts to exclude the same from limitation of liability clause (a contractual mechanism to limit the liability of a party to the contract).
ARE INDEMNITY AND DAMAGES DIFFERENT?
Yes! Indemnity and damages are two diverse concepts and hence, it is imperative that both are included in a contractual document. Section 73 of the Indian Contract Act, deals with the concept of damages. Section 73 states that:
“When a contract has been broken, the party who suffers by such breach is entitled to receive, form the party who has broken the contract, compensation for any loss or damage caused to him thereby, which naturally arose in the usual course of things from such breach, or which the parties knew, when they made the contract, to be likely to result from the breach of it.
Such compensation is not to be given for any remote and indirect loss of damage sustained by reason of the breach.
Compensation for failure to discharge obligation resembling those created by contract: When an obligation resembling those created by contract has been incurred and has not been discharged, any person injured by the failure to discharge it is entitled to receive the same compensation from the party in default, as if such person had contracted to discharge it and had broken his contract.
Explanation: In estimating the loss or damage arising from a breach of contract, the means which existed of remedying the inconvenience caused by non-performance of the contract must be taken into account.”
The provision at the outset clarifies that only the person who has breached the contract shall pay the damages. This is in stark contrast from the concept of indemnity where even the conduct of any third-party triggers the indemnity payments.
Secondly, damages are not to be paid for remote or indirect consequences arising from a loss. Indemnity on the other hand, envisages all kinds of losses and hence is more expansive in nature than damages.
Knowing how to draft indemnity is tricky. One of the first things as a contract drafting lawyer that one should know is the reasons behind provision of indemnity. While drafting an indemnity clause, think of all the possible scenarios which may occur, where a third-party claim may be brought against your client. The typical grounds of indemnity are: infringement of intellectual property rights, confidentiality and breach of applicable laws. An indemnity clause should be drafted after understanding the concerns of the parties and the context of the contract.
 About the Author – Soumya Shekhar is the Founder of Remote Lawyer, a virtual legal consultancy which provides commercial contracts drafting and corporate advisory services to startups. Soumya is an alumnus of National Law University Delhi and National University of Singapore. She was the recipient of the prestigious Faculty Graduate Scholarship at the National University of Singapore. Apart from being a lawyer, she also runs her YouTube channel, where she routinely shares her insights on commercial contracts drafting.
 S. 124, Indian Contracts Act, 1872.
 Ibid; S. 125.
 Supra n.1; S.73
 Maharashtra State Electricity Board v. Sterlite Industries (India) Limited, 2000 SCC Online, Bom 89.
 Jet Airways (India) Limited v. Sahara Airlines Limited, 2011 SCC OnLine Bom 576.