Indemnity vs damages: Negotiating contracts the right way
Contracting parties (and their respective lawyers) spend a substantial amount of their time during negotiations of any contract on the reliefs available to their client in the event of breach of terms of such contracts. Such reliefs can be monetary (such as damages or indemnity) or non-monetary (such as specific performance, injunction and rescission of contract). While non-monetary reliefs have their limitations, it is the monetary reliefs which are hoarding all the controversy spotlights nowadays.
As set out above, monetary reliefs are of two broad types—damages and indemnity. Whilst the two are not mutually exclusive, it is important to understand the advantages of one over the other.
So how exactly are damages different from indemnity? And how is one better than the other? For starters, damages are a general statutory relief available under the Indian Contract Act, whether parties specifically agree to it or not, and indemnity is a special contract which parties have to specifically enter into in order to derive benefit from. The reason parties should prefer to enter into indemnity contracts is that indemnified parties are typically on a better footing for claiming monetary reliefs than parties merely claiming damages. For instance, indemnified parties do not need to establish actual losses or foreseeability of such losses. Also, indemnified parties may raise indemnity claims for consequential or indirect losses. Further, unlike damages, indemnity can be claimed for third-party losses as well, and indemnified parties do not automatically carry a duty to mitigate any losses.
In terms of the procedure to claim indemnity, it is not very different from the procedure to claim damages, but the downside is that it can take as long and be just as costly to obtain finality in the claim. For instance, it took Docomo almost three years to finally claim relief against Tata in relation to the dispute regarding their joint venture—and this despite the fact that both Tata and Docomo had eventually reached a settlement. Of course, a contributing factor to the time it took for Docomo to get relief was also that Docomo was a non-resident entity. In this case, in respect of Docomo’s exit from the joint venture, it was finally held by the court that the amount payable by Tata to Docomo was not an assured return (as contended) and was, in fact, damages payable on the breach of contract by Tata, which was contractually provided (at the cost of oversimplifying) as a ‘downward protection’ to Docomo on its investment. Thus, it was ruled by the court that if any payment is sought to be made as damages or indemnity to a non-resident, the same is not prohibited under foreign exchange laws (though this sort of a blanket ruling, in my view, isn’t entirely correct) as contrasted against assured returns on foreign investments which are not permissible under the extant foreign exchange laws.
In light of the above, it is strongly advisable that indemnity protections should be carefully negotiated and drafted into contracts to ensure adequate relief options available to the parties. Parties are often known to contractually limit indemnity claims to actual and direct losses and require a duty to mitigate losses. It also becomes a lot trickier when contracts stipulate that indemnity shall be the sole and exclusive remedy available to parties under any contract. Courts have held in the past, in specific fact situations, that parties cannot contractually rule out the relief of damages.
However, in cases of investments contracts, such clauses are yet to be tested judicially.
All in all, depending on the commercials and the value of transactions, suffice it to say that the tug between indemnity and damages is imperative to ascertain the reliefs that shall be available to parties in the event of breach and such discussions should not ever be taken lightly.
Jay Parikh, is a partner with Shardul Amarchand Mangaldas. The views expressed in this article are those of the author and may not reflect views of the firm.
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