When starting a business, it is normal to do so with enthusiasm and the idea of achieving great things together. The same is true when two people who love each other decide to start a life together. In both situations, failure is not an option in the beginning.
But reality is not always a fairy tale, and in both business and love, things sometimes do not turn out as we dream. And when the conditions or agreements for those moments are not established in advance, problems tend to snowball.
It is common for a couple to agree on assets and those that will be generated throughout their relationship before saying "I do." And it should be just as natural for business partners, or a parent company and its supplier, to agree on clauses that anticipate future problems before signing a contract.
What is an Indemnity Clause?
Sometimes situations arise in business related to breach of contracts, late payments, damages that are difficult to quantify, or conflicts that, if taken to court, can take years to resolve. A good way to anticipate and limit these risks is to include an indeminty clause in contracts.
These clauses are defined when one party agrees to compensate the other for losses, damages, or harm that may arise from previously defined situations. These can be issues such as breaches, false statements, or damage to third parties.
As highlighted by the Secretary-General of the United Nations (UN) Commission on International Trade Law in the report Conventionally Fixed Indemnity Clauses and Penalty Clauses, one of the purposes of setting an agreed sum "is to avoid the difficulties of investigating damages."
The report explains that "due to the difficulties sometimes encountered in proving the amount of the loss, the amount of compensation resulting from litigation may be uncertain and insufficient." On the contrary, if it is set in advance, "the debtor has advanced knowledge of his maximum liability." In addition, it should be noted that if a plaintiff must prove their loss "in a foreign court, they may incur considerable expenses without knowing for certain what amount they will recover," it concludes.
In summary, indemnity clauses are a mechanism that provides certainty to a transaction. Thus, in the event of default, there is already a previously agreed amount or formula that avoids total dependence on a judge's decision.
This last point is essential to bear in mind in a country like Guatemala. According to the World Justice Project's Rule of Law Index 2024[1], Guatemala's civil justice system ranks 135th out of 142 countries. Among the areas with the lowest scores are the lack of effective enforcement of civil justice and the unjustified delays in such proceedings.
Importance of Including these Clauses
Imagine that a multinational company does business with a local company to exclusively distribute its products. Suspicions arise, and after an investigation, the parent company discovers that the distributor has breached certain clauses, which has a negative impact on the company's finances and reputation. Unfortunately, they did not have a compensation clause in their contract.
At that point, the only way to claim damages is through legal channels, which could take more than four years, not to mention legal fees. But the situation would have been different if the contract had included a clause stating that, in certain situations, the distributor would have to pay a specific amount as compensation. In this case, the parent company would have had:
- Greater financial certainty: as it would have prior knowledge of how much it would receive in payment in the event of an adverse scenario.
- Less dependence on external factors: these clauses reduce the risk of litigation, which can be lengthy and costly.
- Better protection of its investment: it would have ensured that it would not bear the losses alone in the event of problems.
On the contrary, not having such clauses would place it in a position where compensation would depend solely on what a judge determines, if it ever reaches that point in the civil proceedings. It is important to note that this decision will not always be objective and may not satisfy the claims, as it is not always easy to prove with certainty damages that have not been previously agreed upon.
In addition, the process could be affected by judicial delays, corruption, or delays in the Guatemalan justice system. You may even receive nothing because the claim is rejected on procedural grounds.
In short, compensation clauses are an instrument that serve a dual purpose. On the one hand, they are preventive, deterring non-compliance by providing for clear economic consequences. On the other hand, they are remedial, guaranteeing certain and sufficient compensation without the need for lengthy legal proceedings. Their inclusion, always in accordance with good faith and proportionality, brings security, efficiency, and balance to modern contracting, especially in the context of international trade and complex litigation.
If you have any questions, please do not hesitate to contact us.
