Indemnity Process

Indemnity is a fundamental legal concept under contract law that provides protection against financial losses, damages, or liabilities. In India, indemnity is primarily governed by the Indian Contract Act, 1872 ("Contract Act"), specifically under Sections 124 and 125.

As per Section 124 of the Contract Act, a 'contract of indemnity' is defined 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", whereas Section 125 allows the promisee in an indemnity contract to recover damages, costs, and sums paid under the compromise of any suit, from the promisor.

An indemnity is, generally provided in relation to the representations, warranties and covenants provided by the indemnifying party. While representations are statements of facts made by one party to the other, warranties are assurances regarding any future performance and guarantee that certain facts and circumstances will remain true. On the other hand, covenants are promises to do or refrain from doing certain acts.

Indemnity is an agreement that safeguards one party against the financial impacts of specific actions or events.¹ An indemnity construct in a contract outlines the manner in which one party will execute the indemnity and discharge its obligation associated with such indemnity. It describes the obligations of the person granting indemnity (the indemnifying party) to reimburse the party receiving the indemnification (the indemnified party) for certain losses or damages. The indemnity clauses protect not only the direct parties but also their officers, directors, and affiliates. Most indemnity clauses also entail the classifications pertaining to which claims are covered, the process for claiming such indemnity, timelines for claiming and any pecuniary capping.

Components of Indemnification Clause

An indemnification clause consists of two separate and distinct obligations: an obligation to indemnify and an obligation to defend².

1. Obligation to indemnify: The obligation to indemnify requires the indemnifying party to reimburse to the indemnified party all crystalized costs and expenses, also known as losses, incurred by such indemnified party as a result of any action or inaction of the indemnifying party.
2. Obligation to defend: The obligation to defend is typically covered in third-party claims raised against the indemnified party. It extends to making advance payment for unpaid defense costs and expenses by the indemnifying party and further, having the right to assume and control the defense of the third-party suit by such indemnifying party. Typically, such right or an obligation is legislated in the indemnity clause and provides for the manner of discharging such obligation.

Process for Claiming Indemnity

The procedure for claiming indemnity follows a structured yet nuanced process that begins with suffering of a loss, giving rise to an indemnity claim. The following is the procedure for indemnity claims which are generally captured in agreements between the parties:

1. In the event, that the indemnified party suffers any loss or damage arising from a breach of any of the representations, warranties, or covenants made by the indemnifying party under an agreement, the indemnified party then promptly notifies the indemnifying party, within a specified period (which is commonly a 30-60 day period) in accordance with the notice provisions as captured in that agreement.
2. Upon receipt of such notice, the indemnifying party typically has the right to investigate the claim and may request additional information or documentation. Following which, the indemnifying party either accepts or rejects the claim. If the claim is accepted, the indemnifying party satisfies the claim. If the claim is rejected, the parties then resolve the matter through dispute resolution procedures, as specified in the particular agreement, or any other mutually agreed resolution procedure.
3. If the claim involves third-party claims, the contract usually specifies who has control over the defense. The indemnifying party often has the primary right to control the defense, but with obligations to keep the indemnified party informed and, in some cases, obtain consent for major decisions or settlements. The indemnified party typically has obligations to cooperate in the defense, including providing access to relevant documents and information.
4. Many contracts include specific dispute resolution mechanisms for indemnity claims, such as mandatory negotiation periods, mediation, or arbitration. If the parties cannot reach agreement through these mechanisms, the matter may proceed to formal dispute resolution process as specified in the contract. Throughout this process, both parties must be mindful of any applicable limitation periods, both under the agreement and applicable law.

Analysis of Agreements

Indian Perspective

In India, indemnity clauses and claim processes vary significantly across different types of commercial contracts, each tailored to address specific risks and commercial realities of the underlying transaction.

The aforesaid can be witnessed through the analysis of indemnity clauses in transaction and service agreements, such as the following:

Mergers and Acquisitions Agreements

In mergers and acquisitions, wherein transaction documents such as Share Purchase Agreements, ("SPAs"), Share Subscription Agreements ("SSAs"), Shareholders Agreements ("SHAs"), Share Purchase and Subscription Agreements ("SPSAs"), and Share Subscription and Shareholders Agreements ("SSHAs") (collectively, "M&A Agreements") are executed, indemnity clauses may be incorporated to cover any claim that the parties believe is appropriate in consonance with the terms and scope of the transaction in question. A standard indemnity clause in M&A Agreements primarily focuses on protecting buyers against disclosed and undisclosed liabilities and breaches of representations, warranties and covenants. The claim process in M&A Agreements usually follows the procedure as discussed in the preceding paragraphs. However, it is pertinent to note that apart from the standard structure of an indemnity clause, there are certain features in each of the M&A Agreements, as discussed below, which make them distinct from one another:

SPAs

1. Indemnity Matters: SPA's generally include indemnity protection from tax-related liabilities preceding the date of the transaction, claims against the title of the shares, breach of any representations and warranties, non-performance of covenants, and third-party claims for the pre-closing period.
2. Period: Indemnity clauses in SPAs usually cover indemnity for the period prior to closing.

SSAs

1. Indemnity Matters: As SSAs focus more on anticipated protections, indemnity clauses in such agreements typically cover misrepresentations in disclosure, title and authority, compliance with laws, and fraud or negligence by the company.
2. Period: Unlike in SPAs, the claim period for indemnity in SSAs is not limited to the pre-closing period.
3. iii. Notice Period: The claim process in SSAs tends to be more straightforward than in SPAs, with shorter notice periods.

SHAs

1. Focus: Typically, SHAs govern the inter-se rights between shareholders who become shareholders by virtue of SSAs or SPAs, through which the company, sellers and/or promoters, as the case may be, have already provided representations, warranties and covenants, which are backed by indemnity and specific indemnity related provisions under such documents. Hence, typically, the SHAs do not contain indemnity related provisions, since such protection are already provided under the SPA or SSA, as the case may be.
2. Indemnity Matters: In case an indemnity construct is included in an SHA, such protection covers losses which may be incurred for any action, inaction, commission or omission on part of the shareholders, which is not already covered in SSA or SPA. Further, it may also cover any potential losses suffered due to inter-se disputes between the shareholders.

SPSAs

1. Focus: SPSAs combine elements of both SPAs and SSAs, creating a more nuanced indemnity framework.
2. Indemnity Matters: The indemnity clauses in SPSAs address both past liabilities and future compliance obligations, often incorporating specific business warranties and regulatory approval requirements which are incorporated as conditions precedent and conditions subsequent. Any item that is identified as part of due diligence process and not undertaken as a pre or post-closing action item is entailed as a specific indemnity matter.

SSHAs

1. Focus: SSHAs combine elements of both SSAs and SHAs, also creating a more nuanced indemnity framework.
2. Indemnity Matters: SSHAs typically provide broader indemnity coverage, encompassing not only governance-related matters but also representations and warranties about the company's business, financial condition, and compliance status.

Service Agreements

Indemnity clauses in service agreements, including, but not limited to, development-management agreements ("DMA"), construction agreements ("CA") and joint-venture agreements ("JV") (collectively, "Service Agreements"), typically designate the service provider as the indemnifying party, obligating them to compensate and protect the indemnified party from any losses, damages, or liabilities arising from specified events or actions for the services rendered during the term of the agreement. In such agreements, mutual indemnity is generally not applicable as onus is on the service provider, as the indemnifying party, and not the service recipient to provide indemnity. It is pertinent to note that Service Agreements may also provide for indemnity claim procedures at the behest of the parties. Apart from the standard structure of an indemnity clause, there are certain features in Service Agreements, as discussed below, which make them distinct from one another:

DMA and CA

1. Focus: Since DMAs are entered into between an owner and a development manager, the indemnity clause imposes obligations on the development manager as he is the service provider. Similarly, in CAs, the obligation is imposed on the contractor, who acts as a service provider. An indemnity claim under a DMA and CA arises due to the failure on part of the service provider to discharge obligations under the terms agreed between the parties in the agreement.
2. Indemnity Matters: In DMAs and CAs the indemnity clauses cover any losses arising from any fraud, criminal act, misappropriation of funds or wilful misconduct in connection with the discharge of obligations, if any, by the service provider. The indemnified party may even claim indemnity in the instance of occurrence of accidents or personal injury to a person directly or indirectly employed by such service providers in relation to the construction or development projects or if the service provider fails to comply with any labour laws. Further, such indemnity may even arise in the instance an action is taken by a governmental authority on account of any breach of the labour laws. Furthermore, the indemnity clause also covers failure to adhere to timelines for completion of the project, deficiency inquality of service, as agreed between the parties and breach of material obligations as per the agreed commercials.

JV

1. Focus: Indemnity clauses are usually incorporated in such JVs entered into by the parties where any services are being provided, such as a cross-border JV with a distributor in which it is contemplated that the distributor shall provide certain services/goods.
2. Indemnity Matters: Standard indemnity clauses are incorporated for losses caused due to the breach of the agreement.

American Perspective

In the United States of America (USA), various contracts approach indemnity provisions with distinctive characteristics that reflect the American legal system's emphasis on detailed risk allocation and precise procedural requirements. American agreements provide extensive indemnity provisions, which contain a broad indemnification obligation covering breaches of representations, warranties, and covenants.

M&A Agreements

An analysis of American M&A Agreements indicates that the agreements are very nuanced. The time period to claim an indemnity under SPAs for general business representations stretch for a period of 12- 24 months post-closing, while specific categories like tax and environmental representations might survive for longer periods tied to the underlying statutory limitation periods. Indemnity provisions in SHAs focus on protecting governance rights, which are outside the ambit of the dispute resolution clause and maintaining agreed corporate structures and often include provisions protecting minority shareholder rights through specific indemnities for losses caused due to breaches of reserved matter rights. Further, the focus on indemnity provisions in SSAs are extended to cover violations of securities law, anti-bribery law and insider trading laws.

It is pertinent to mention that SPSAs and SSHAs are complex transaction documents that combine multiple elements of SHA, SPA and SSA, resulting in layered indemnity structures. These agreements require particularly nuanced indemnity provisions due to their hybrid nature, addressing both immediate transaction-related risks and ongoing operational concerns.

Service Agreements

Indemnity clauses in American Service Agreements typically reflect the allocation of risks between the parties involved, such as the development manager, contractor, employer or subcontractors. Indemnity clauses in American Service Agreements are majorly similar to Indian Service Agreements. A distinct feature in American CAs may be the use of indemnity insurance to mitigate risks, in addition to the incorporation of indemnity clauses in such agreements. Herein, insurance is procured in the name of the contractor, with a specified coverage amount and duration and deductibles are allocated as an when the any action or inaction of the contractor results in arising of a cause of action.

The indemnity obligations in American DMAs and JVs are mutual in nature, entailing that both the owner and the development manager have indemnity obligations to each other. A notable feature of such clauses is the survival of indemnity up-to a certain period post the termination of the agreement.

Comparative Analysis Between Indian and American Perspective

Indian M&A Agreements share several fundamental similarities with the American M&A Agreements in terms of indemnity claim procedures, however, they also exhibit distinct features. While the basic structure of indemnity claims in both jurisdictions follow a similar pattern, beginning with the suffering of a loss, followed by notice requirements, claim substantiation, and resolution procedures, the implementation and emphasis of these elements often differ significantly.

Indian M&A Agreements emphasize on upholding indemnity clauses in true letter and spirit. In the event, such indemnity claim is not honored, then an amicable resolution may be resorted to, as agreed between the parties, such as settlement through negotiations, before proceeding to formal dispute resolution mechanisms. On the other hand, American M&A Agreements typically provide detailed, step-by-step procedures for claim resolution including extensively detailed claim procedures for third party claims which provide for detailed clauses pertaining to control of defense, selection of counsel, and settlement authority. It is also pertinent to note that such agreements provide for a shorter time period for survival of claims, as compared to the Indian perspective, wherein the claim process is governed by the statute of limitations.

Indian and American CAs are usually unilateral wherein the service provider is the indemnifying party.

While both jurisdictions have standard indemnity clauses, American CAs generally contain the provision of insurance as an added protection for the employer or owner to mitigate risks with specified coverage amounts, in addition to indemnity clauses in such agreements. While Indian DMAs and JVs have unilateral indemnification clauses, indemnity obligations specified in the American DMAs and JVs are reciprocal, wherein both parties indemnify each other for breaches, negligence, or misconduct.

Conclusion

The processes for claiming indemnity across different types of agreements highlight the necessity for specialized approaches based on the underlying commercial relationships and risk allocations. Since indemnity is governed as a separate contract under the Contract Act, it is pertinent to have distinct procedures in place to deal with the claim process.

Each type of agreement addresses distinct business risks and complexities. Agreements like SPAs require comprehensive indemnity provisions as the claim processes in these agreements are necessarily more detailed to account for the discovery and verification of pre-existing issues. SSAs and SHAs incorporate ongoing protection mechanisms because they govern continuing relationships between shareholders.

On the other hand, service agreements deal with more predictable operational risks, allowing for simpler and straightforward indemnity process. In service agreements, where service providers typically have less negotiating power, indemnity provisions tend to be more standardized and unilateral.

Therefore, differentiating indemnification procedures is crucial as it provides the parties a clear framework for protection against potential losses without directly resorting to dispute resolution and enables them to manage risks that are tailored to their unique business relationships.

Footnotes

1 https://legal.thomsonreuters.com/en/insights/articles/indemnification-clauses-in-commercial-contracts

2 https://uk.practicallaw.thomsonreuters.com/w-025-4389?transitionType=Default&contextData=(sc.Default)&firstPage=true

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.