How to Draft an Indemnity Clause in a Commercial Contract in India

An indemnity clause is one of the most important risk allocation mechanisms in commercial contracts. Under Section 124 of the Indian Contract Act, 1872, a contract of indemnity is defined as a contract by which one party promises to save the other from loss caused by the conduct of the promisor or any other person. This guide explains how to draft an effective indemnity clause, the types available, and the key considerations for Indian commercial contracts.

Types of Indemnity Clauses

Broad Form Indemnity covers all losses, including those partly caused by the indemnified party's own actions. Limited Form Indemnity restricts coverage to losses caused solely by the indemnifier's conduct. Proportionate Indemnity allocates liability between the parties based on each party's contribution to the loss. The choice of form depends on the bargaining position of the parties and the nature of the commercial relationship.

Step 1: Define the Scope of Coverage

Clearly specify what losses are covered by the indemnity. Use inclusive language such as 'losses include but are not limited to' to allow flexibility, while still providing certainty about the core categories of covered losses. Common categories include direct losses, third-party claims, regulatory penalties, costs of legal proceedings, and settlement amounts.

Step 2: Address Consequential and Indirect Losses

Indian courts generally do not award consequential or indirect damages unless they are specifically contemplated by the parties. If you want the indemnity to cover loss of profits, business interruption, or reputational damage, these must be expressly included in the clause. Conversely, if you wish to exclude such losses, include an explicit carve-out.

Step 3: Set Monetary Caps and Baskets

To avoid unlimited financial exposure, include a cap on the total indemnity obligation. Common approaches include tying the cap to the contract value, a fixed monetary amount, or insurance coverage limits. A 'basket' or 'deductible' provision requires the indemnified party to absorb a minimum threshold of losses before the indemnity obligation is triggered.

Step 4: Include Claim Procedures

Draft a detailed procedure for making indemnity claims, including notice requirements (timeframe and manner of notification), the right of the indemnifier to control the defence of third-party claims, cooperation obligations of the indemnified party, and the timeline for payment of indemnity amounts.

Step 5: Address Survival and Duration

Specify how long the indemnity obligation survives after the termination or expiration of the contract. Common survival periods range from one to three years, though certain indemnities, such as those covering fraud, wilful misconduct, or intellectual property infringement, may survive indefinitely.

Step 6: Consider Tax Implications

An often-overlooked issue in India is whether indemnity payments attract GST. When structured as pure compensation for loss rather than consideration for a service, indemnity payments should not attract GST. However, poor drafting can result in unexpected tax liability. Ensure the clause characterises the payment as damages or compensation, not as a fee or service charge.

Enforceability Considerations

Indian courts will enforce indemnity clauses that are clear, fair, and reasonable. However, courts are reluctant to enforce clauses that exclude liability for fraud or wilful misconduct. Ensure the clause passes the tests of clarity (unambiguous language), fairness (not unconscionable), and consistency (aligned with the contract's limitation of liability provisions).

For related guidance on arbitration clauses and dispute resolution mechanisms in commercial contracts, see our other articles.