Legal Environment for Business in Nepal

26 December 2016

Saroj Shrestha 1

To indemnify means ‘to compensate or to make good the loss’ A contract of indemnity means ‘a promise or statement of liability to pay compensation for a loss or for a wrong in a transaction’.In the law of contract, indemnity is the obligation, undertaken by one party to cover the loss or debt incurred by another. A contract of indemnity differs from indemnity for the breach of contract. The first is related to the contract or bear the anticipated loss by

one party and the latter one is related to the 2

Damage for the breach of contract by the breacher party.

A contract of indemnity is a part of a general contract and is of special nature. Sec. 22 of Contract Act, 2056, contains “where any person has concluded a contract relating to indemnity, with the provision to pay to any party to a contract or a third person for any loss or damage that may result from his actions, while working under the direction of that party to that contract , he may realize as compensation.”

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Similarly, Indian Contract Act defines it 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 conduct of any other person, is called, contract of indemnity.”

In English law, it is defined in a wider sense than the above two laws “a promise to save another party from a loss caused as a result of a transaction entered into at the instance of the promisor”. It covers all types of losses caused by events or accidents (Personal or natural).

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Black’s Law Dictionary “Indemnity is an undertaking whereby one agrees to indemnify another, upon the occurrence of the anticipated loss”

Thus indemnity is a kind of security for the loss made by the concerned or a third party. The person making an indemnity is primarily liable and can be sued by the person with whom he makes the transaction. The indemnifier is liable for the prescribed loss. The terms and conditions must cover all the aspects of the contract. In the absence of clarity of the condition, legal remedy will not be available.

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A Contract of indemnity is a security for an anticipated loss

It covers the loss suffered by the concerned party or a third party and is of special nature

It must fulfill all the essential of valid contract-(lawful object, free consent, capable parties, consideration etc.)

It may be made expressly or impliedly. It covers only the loss caused by an event

mentioned in the contract. It covers the promised loss.

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It is dependent on the good faith or prudence of the concerned party.

There are two parties- the indemnifier and indemnity holders.

Contract of Indemnity and Indemnity for Breach

A contract of indemnity differs from the indemnity after the breach of contract.

1. A contract of indemnity is agreed at the time of making contract on any transaction whereas, indemnity for breach of contract is obligatory after a loss.

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2. A contract of Indemnity is provided for in the Chapter 4, under the topic of the ‘contract relating to a guarantee, indemnity and subrogation’. But indemnity for the breach of the contract is provided in chapter 12 of Contract Act, 2056 under the ‘topic of ‘Breach of Contract and its remedy’.

3. A contract of indemnity is meant for the compensation for an anticipated loss but indemnity for the breach of contract and law os the damage after the loss to the injured party occurs.

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4. A contract of indemnity is meant for the remedy based on the good relationship (good faith and prudence) between the parties but indemnity for the breach of a contract is based on the dispute, created by the misunderstanding between the parties.

5. The contract of indemnity is preventive in nature and indemnity of breach is curative in nature.

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Indemnity holder (i.e. indemnified) is the party who has been assured of recovery of a loss by the indemnifier. Contract Act, 2056 has made the provision regarding the rights of an indemnity holder. The indemnity holder is entitled to recover any or all of the following amounts of indemnity under the contract

All the indemnity amount (damage) mentioned in the contract

All the damage he may is compelled to pay to a third party for the loss or damage.

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All the costs spend on the case filed or defended by him in connection with the contract relating to indemnity

All the costs of a legal action, if it becomes necessary to initiate such an action for a failure to pay the amount mentioned in all the above clauses.But except otherwise is mentioned in the contract, in the contract, the indemnifier will not be liable for the loss in the following circumstances. They are called duties of indemnity holder too. (sec. 22 (2) of CA, 2056)

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If he is acting against the instruction of the indemnifier

If he works negligently If he is acting with the intention of causing

any loss or damage If concerned or third party suffers a loss

thereof.Besides these, an indemnity holder can

compel the indemnifier to make a payment even before the indemnity holder has met his liability.

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1. Happening of loss: There must be a loss in accordance with the contract to make the indemnifier liable.

2. Occurrence of event: There must be an occurrence of the anticipated event. Without any occurrence of the prescribed contingent event, there is no indemnity by the indemnifier.

3. Prudent act of indemnity holder: Where the right of indemnity is used by the indemnity holder prudently and the instruction of the indemnifier is not contravened or when there is no breach of contract.

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4. No negligence and bad intention involved: If the costs demanded by the indemnifier area not caused by negligence, bad intention and reckless behaviour.

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Guarantee means ‘assurance’. A contract of guarantee is a promise to be responsible for something, to perform the promise or to discharge the liability of a third person, in case of his default. Such a contract involves three parties: The creditor, the surety and the Principal debtor.

Sec. 15 (1) of Contract Act, 2056 has provided the definition of a Guarantee Contract: “A contract relating to a guarantee shall be deemed to have been concluded in case it provide that if any person defaults in the repayment of the loan obtained by him or

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fulfillment of the obligation accepted by him, it will be repaid or fulfilled by a third person.”

Indian Contract Act define it “a contract of guarantee is a contract to perform the promise, or discharge the liability of a third person in case of his default.”

Creditor: The person to whom the guarantee is given.

Surety: The person who gives the guarantee Principal deptor: The person, in respect of

whose default, the guarantee is given.

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The Contract of Guarantee must be in written form (Sec. 15 (3) of CA, 2056)

A tripartite concurrent agreement between Creditor, Surety and Principal debtor

There must not be any misrepresentation or concealment of the facts regarding the contract

A security for repayment of dept or performance of promise

No direct consideration contract between the surety and the creditor. Consideration of the Principal debtor is considered to be sufficient for the surety.

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Primary liability is of the principal debtor and secondary liability is of the surety.

The involvement of competent parties is a must, along with other essentials of a valid contract.

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Differs in Contract of Indemnity

Contract of Guarantee

1. Purpose of the Contract

To save the indemnified from loss caused to him by any event collateral to such a contract

To provide necessary security to the creditor against his debt and credit to the principal debtor

2. Number of Parties TWO parties- Indemnity holder (Indemnified) and indemnifier

THREE parties- Principal debtor, Surety and the Creditor

3. Number of Contracts

There is only one contract between the indemnified and the indemnifier

Three different collateral contracts between- Principal debtor and Surety, Principal debtor and Creditor, Creditor and Surety 19

4. Nature of Liability Primary liability is of t he indemnifier and it arises immediately after loss from the collateral event.

Secondary liability is of the surety and it arises only on the default of the principal debtor

5. Consideration The consideration for the indemnifier is from the creation of the contract.

Consideration for the surety is not direct. The creditor’s consideration is considered adequate to the surety.

6. Commencement of liability

Liability of the indemnifier arises after the happening of the collateral event

Liability of the surety arises after the default by the principal debtor.

7. Discharge from liability

The indemnifier discharges after paying indemnity to the indemnified party. 20

8.Nature of Contract

Indemnity is a contract of contingent nature

Guarantee is a contract of general nature

9. Right to reimbursement

The indemnifier has no right of reimbursement of the amount paid to the indemnity holder.

The Surety has the right of the reimbursement of the amount from the Principal debtor, which is paid to the Creditor.

10. Number of promisors

Indemnifier is the only promisor for the loss of the indemnified party.

The surety and the Principal debtor are the two promisors for the debt of the creditor.

11. Scope Scope of indemnity is limited in itself

Scope of Guarantee includes indemnity too. 21

22Saroj Shrestha

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