A contract of indemnity is an agreement where one party promises to compensate another for loss caused by specified acts or events, typically arising from the promisor’s conduct or that of a third person, and is widely used in banking for letters of indemnity, escrow, agency, custody, and transactional risk allocation.
Meaning
- A contract of indemnity promises to “save harmless” against loss resulting from defined risks; the promisor is the indemnifier, and the protected party is the indemnity-holder or indemnified, with enforceability contingent on loss within the agreed scope.
- While Indian statutory language focuses on loss caused by human conduct, commercial usage and case law recognize indemnities that cover broader liabilities and expenses associated with specified events, including third-party claims and legal costs, subject to contract.
Rights of indemnity holder
- On proper terms, the indemnity-holder may recover all damages, costs, and sums paid in compromise of claims covered by the indemnity, provided actions were prudent and within authority, enabling upfront protection against liability exposure.
- After making good the loss, the indemnifier typically acquires all means and remedies the indemnified possessed against third parties (by subrogation or equitable assignment, as applicable) to mitigate or recoup the payout.
Implied indemnity
- Indemnity may be express (written or oral) or implied from the relationship or conduct, such as a principal indemnifying an agent for acts done in good faith within authority, or commercial customs creating an obligation to hold harmless for instructed actions.
- Courts infer indemnity where justice and established trade usage support the indemnitee being kept harmless for liabilities incurred at the indemnifier’s request or for the indemnifier’s benefit, even without a formal clause.
Enforceability of contract of indemnity
- Validity requires standard contract elements: offer, acceptance, lawful consideration, capacity, free consent, certainty, and lawful object; indemnity terms should clearly define covered losses, procedures, exclusions, and limits to avoid ambiguity.
- Although traditional views linked payment to occurrence of actual loss, modern commercial practice recognizes that once liability becomes absolute or imminent, the indemnity-holder can require the indemnifier to step in, fund defense, or secure performance as per the contract’s risk allocation.
Banking applications
- Banks use indemnities for lost instrument replacements, documentary discrepancies, custodial releases, agent instructions, and M&A/financing warranties, often covering third-party claims, taxes, penalties, legal fees, and enforcement costs on an indemnity basis.
- Best practice includes precise drafting of scope, trigger events, exclusions (e.g., wilful misconduct), caps, baskets, notice and defense control, duty to mitigate, subrogation, and survival periods to ensure predictable risk transfer and recoverability.
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