Distinguishing damages from indemnities

An important consideration while drawing up any contract is deciding between having an indemnity provision or the usual right to recover damages for breach. While the distinction between the two can sometimes be blurred, it is important to know both and distinguish between them as the rights and enforcement events associated with them are very different.

Cause for confusion

A 1923 Madras High Court case sums up the reason why the two terms are often confused: “these two rights are confounded and one reason for the confusion is when a contract is broken, indemnity is often found to coincide with the measure of damages. In such case, whether the right is called the right to indemnity or right to damages, the result is the same, yet the words express two fundamentally different legal ideas.”

In drafting a contract, while a lot of time and effort goes into predicting the whole gambit of events that may eventually lead to a loss, it is this fundamental difference that is often overlooked.

What the law says

The term damages is defined in section 73 of the Indian Contract Act, 1872, which states that when a contract has been broken, the party suffering from such breach is entitled to receive, from the defaulting party, compensation for any loss caused, which arose from such breach, or which the parties knew, when they made the contract, to be likely to result from such breach.

Section 124 of the act defines a contract of indemnity as one where a party promises to save the other from a loss caused to him, by the conduct of the promisor himself, or by the conduct of any other person. As stated in Black’s Law Dictionary, an indemnity clause – often referred to as the “hold harmless” or the “save harmless” clause – is a contractual provision in which one party agrees to answer for any specified or unspecified liability or harm that the other party might incur.

Basic differences

The right to damages and the right to indemnity differ in that damages arise only when there is a breach of the contract, while indemnity, which stems from an agreement between the contracting parties, is not dependant on a breach of the underlying contract.

Furthermore, the basis for the cause of action in damages is the breach of the underlying contract. An indemnity action on the other hand is triggered by the specific clauses that provide for it in a contract.

Under the Indian Contract Act, a party is statutorily entitled (by section 73 of the act) to receive damages, but the right to indemnity originates from specific provisions included in the contract.

In that sense, the provisions relating to indemnity in a contract are a separate agreement within the larger contract. The provisions of the Indian Stamp Act support this idea, as indemnity provisions require stamp duty to be paid over and above the duty payable on an agreement.

Prior knowledge

Further, if a party is aware of a breach of a contract, it may be precluded from raising a claim on that basis in the future, as it had pursued the contract despite knowing about the breach. However, in case of a claim under indemnity, this may not apply. In fact, parties usually negotiate specific indemnities for unresolved issues discovered in the due diligence process.

On the issue of quantum, while parties to a contract may agree on what is payable in case of default or breach of a specified clause (the concept of liquidated damages provided under section 74 of the act), there is generally no concept of a pre-agreed amount payable under a contract of indemnity.

Easy remedy, tough negotiation

It would perhaps suffice to say that damages are ultimately based on the court’s judgment of whether an event has caused a loss to a party. However, an indemnity is an agreement that provides a party with an express remedy for a loss and if it is enforced, there is a relative ease of recovery as it has been agreed upon.

This is the key reason why indemnity provisions are vehemently negotiated between parties.

Thus, to be able to establish and enforce a predefined right, if it has been provided or commercially intended in a contract, it is important to understand indemnity and to be able to appropriately capture it while drafting a contract.

Soumya De Mallik is a senior associate at Amarchand & Mangaldas & Suresh A Shroff & Co. He can be reached at soumya.demallik@amarchand.com. The views expressed in this article are those of the authors and do not reflect the official policy or position of Amarchand Mangaldas.