Contract of Indemnity

A contract of Indemnity is a contract, express or implied to keep a person, who has entered into or who is about to enter into, a contract or incur any other liability, indemnified against loss, independent of the question of whether a third person makes a default.

Indemnity is protection against possible damages. Deriving from a Latin word, indemnis, which stands for ‘unhurt’ or ‘free from loss’. In its broadest sense, it means to compensate for any loss that a person has incurred. The liability or the duty to pay arises out of different reasons such as an agreement or from obligations arising out of the relations between the concerned parties or by statute.

In English Law, indemnity is the promise to save a person from the consequences of an act, the promise may be expressed or implied. Indemnity is not limited to cases of contract. A right of indemnity may arise between a principal and agent, an employer and employee and so on.

Definition of Contract of Indemnity

According to Halsbury, Indemnity is a contract, express or implied to keep a person, who has entered into or who is about to enter into, a contract or incur any other liability, indemnified against loss, independent of the question whether a third person makes a default. Black’s Law Dictionary defines Indemnity in various instances;

“A contractual or equitable right under which the entire loss is shifted from a tortfeasor who is only technically or possibly at fault to another who is primarily or actively responsible.” As was described in Moorhead v. Waelde^[1].

To understand the concept of Contract of Indemnity, the facts of Adamson v Jarvis^[2] serve as a perfect illustration.

The defendant instructed the plaintiff, who was an auctioneer, to sell certain cattle. After a while, it came upon the knowledge of the plaintiff that the defendant did not own the livestock in the first place. The owner of the livestock sued the plaintiff as he was the auctioneer and the plaintiff sued the defendant for indemnity for the loss, he had suffered due to the defendant’s actions.

The court was of the opinion that the plaintiff having acted on the request of the defendant, was entitled to assume that, if what he did, learned to be wrongful, he would be indemnified by the defendant.

The indemnity does not need to be expressed. In the case of Secretary of State v Bank of India Ltd^[3], Ms Gangabai held a government promissory note for Rs. 5000. Her broker Acharya forged her endorsement to his favour and endorsed it to the respondents who applied to the Public Debt Officer to have it renewed. Gangabai, when aware of this forgery, sued the appellant and recovered damages. The appellant then brought an action against the respondents to be indemnified against the loss. The State was allowed to recover from the bank on an implied promise of indemnity.

Under circumstances not too different from this, in Starkey v. Bank of England^[4], a bank was allowed to recover indemnity from an agent who presented a transfer document on which one out of three signatures were forged, even though he was unaware of this fact.

The Indian Contracts Act 1872 lays down the definition of a contract of indemnity, the extent of the liability of the indemnifier and various other provisions in relation to the same. It is both an amending and a consolidating act. Indemnity is essentially a contract of protection which need not always be expressed.

Section 124 of the Indian Contract Act and Contract of Indemnity

Section 124 of the Indian Contract Act defines Contract of Indemnity 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 the conduct of any other person, is called a contract of indemnity.

The person who gives the indemnity is called the indemnifier and the person for whose protection it is given is called the indemnity-holder or the indemnified.

Key elements of a contract of indemnity include:

1. Valid Contract: It must fulfil all criteria of a valid contract under the Indian Contract Act, including lawful consideration and free consent.
2. Loss Protection: The indemnity contract’s primary objective is to protect the indemnified from potential losses.
3. Express or Implied Terms: The terms can be explicitly stated or inferred from the conduct of the parties.
4. Single Agreement: Unlike guarantees, a contract of indemnity involves a single agreement between the indemnifier and the indemnified.

Nature of Contract of Indemnity

Contracts of insurance, indemnity and guarantee are contingent in nature. A contingent contract is a contract to do or not to do something, if some event, collateral to such contract, does or does not happen.

Contracts of guarantee and contracts of indemnity perform similar commercial functions in providing compensation to the creditor for the failure of a third party to perform his obligation. A contract of indemnity is an agreement to be liable for the acts of another and one of its essential features is that it exists only between two parties and no other party is relevant to the subject matter of the contract. This is the primary difference between a contract of indemnity and a contract of guarantee.

Under indemnity, the indemnifier undertakes an independent obligation to discharge the liability in any event and makes himself primarily liable voluntarily.

All contacts of insurance are contracts of indemnity except life insurance but it is not the same vice versa. Life insurance requires payment of premium during one’s lifetime and in return, the person shall receive the reimbursement at the time of death or maturity. Since the existence of a quantified loss is absent, which is essential for a contract of indemnity, life insurance is not categorised under indemnity contracts.

New India Assurance Co. Ltd v. State Trading Corporation of India^[5] states as follows,

“Almost all insurance other than life and personal accident insurance are contracts of indemnity. The insurer’s promise to indemnify is an absolute one.”

The obligation of the liability may arise out of legal or equitable duty to indemnify in a particular set of circumstances. Indemnity can also be a useful remedy in cases of innocent misrepresentation. A third party cannot sue the indemnifier based on the principle of privity of contract as was held in National Petroleum Company v. Popat Lal Mulji^[6] in the High Court of Bombay.

A number of changes have been made within the concept of indemnity in contracts, in spite of which it still has a rather restricted scope and does not serve its purpose as well as it should. The Law Commission of India has submitted in its reports in the past, their concerns about the enforcement of this Act. Their recommendations for improvement have now been successfully added to the Act. The definition provided under the Indian Contract Act is not inclusive of many circumstances and leaves room for interpretation, which may lead to ambiguity and confusion.

Types of Indemnity

Indemnity agreements are categorised into two main types based on their nature and formation:

Express Indemnity

This form of indemnity is explicitly stated in a written or oral agreement. It specifies the rights, duties, and obligations of both parties, leaving no room for ambiguity. Express indemnities are commonly found in:

• Insurance policies.
• Construction agreements.
• Agency contracts.

Implied Indemnity

Implied indemnity arises from the circumstances and conduct of the parties, without the need for a formal agreement. A classic example is the master-servant relationship, where the master indemnifies the servant for losses incurred while acting under lawful instructions.

A notable case demonstrating implied indemnity is Adamson v. Jarvis (1872), where an auctioneer sold goods following the owner’s instructions. When the real owner held the auctioneer liable, it was determined that the auctioneer had the right to recover from the original party who instructed the sale.

Rights of the Indemnity Holder

Section 125 of the Indian Contract Act, 1872, enumerates the rights of the indemnified party. These rights ensure that the indemnity holder receives adequate protection and compensation under the contract. The rights include:

• Recovery of Damages: The indemnified can recover all damages incurred in suits or legal proceedings within the scope of the indemnity.
• Recovery of Costs: Costs incurred in defending or initiating legal action can be claimed if the indemnifier acted prudently and did not violate the indemnifier’s instructions.
• Recovery of Settlement Sums: The indemnified can recover sums paid in compromise or settlements, provided the compromise was made in good faith and was not against the indemnifier’s orders.

Rights of the Indemnifier

Although the Indian Contract Act does not explicitly detail the rights of the indemnifier, judicial precedents have clarified these rights. An indemnifier gains subrogation rights after compensating the indemnified. This means the indemnifier can step into the indemnified’s position to recover losses or enforce remedies.

In Gajanan Moreshwar v. Moreshwar Madan (1942), the Bombay High Court held that when the indemnified’s liability becomes absolute, the indemnifier is bound to fulfil their obligation without waiting for an actual loss to occur.

Similarly, in Lala Shanti Swarup v. Munshi Singh & Others (1967), the Supreme Court ruled that an implied indemnity contract arises only after the indemnified has been fully compensated for the incurred loss.

Extent of Liability in Contract of Indemnity

Section 125 lays down the extent of liability or the rights available to the indemnity holder. The promisor shall be liable in any event whether or not the promisee makes a default.

The promisee is entitled to recover damages that he was compelled to pay in a suit for which he was being indemnified-

• All damages which he may be compelled to pay in any suit in respect of any matter to which the promise to indemnify applies.
• All costs which he may be compelled to pay in any suit if, in bringing or defending it, he did not contravene the orders of the promisor and acted as it would have been prudent for him to act in the absence of any contact of indemnity, or if the promisor authorized him to bring or defend the suit. A prime example would be the case of Adamson v. Jarvis^[7] where the court held that since the plaintiff acted according to the defendant’s instructions and incurred a loss because of the same, the plaintiff was entitled to compensation.
• All sums which he may have paid under the terms of any compromise of any such suit, if the compromise was not contrary to the orders of the promisor and was one which it would have been prudent for the promisee to make in the absence of any contract of indemnity, or if the promisor authorized him to compromise the suit.

A truck, under indemnity insurance for Rs. 2,00,000, was stolen with no chance of recovery. It was held that the amount of indemnity fixed by the surveyor was Rs. 1,87,492. Furthermore, it was also held that this was payable with 18% interest due to the delay period. The settlement of claims at a lesser amount by insurance authorities was arbitrary and unfair under Article 14 of the Constitution. (Equality before law.)

Re British India General Insurance Co. Ltd^[8] tells us that any person who claims under an indemnity must prove that they have suffered a loss.

However in Khetarpal Amarnath v. Madhukar Pictures^[9] it was held that the right of the indemnity holder need not be confined to the contents of section 125. His rights are not limited by the provisions of this Act. The indemnity-holder is open to use for the specific performance of the contract of indemnity if an absolute liability is incurred by him. Therefore, there is no particular straitjacket approach for the determination of the extent of liability as it depends on the nature and terms of the contract which is subjective to each case.

Indemnity cannot be implied in favour of a person who has executed a bail bond for the appearance of an accused in court as it would be considered unlawful, this was explained in Mehrauli v. Sariatulla^[10]. An indemnity bond shall be valid in case a lessee agrees to pay rent to one of the two people in consideration.^[11]

In Geismar v. Sun Alliance and London Insurance Ltd^[12], it was held that an assured cannot claim indemnity against consequences of an intentional wrongful act. Geismar had brought into the U.K. jewellry which he failed to declare to the customs and on which he did not pay customs duty. Later, Geismar claimed indemnity from the defendant insurers for the loss through theft at his home of the uncustomed jewellery. The judges held that Geismar could not enforce the contract of indemnity. The shipowners who were promised indemnity were unable to enforce the promise.

Commencement of liability of the indemnifier

After providing the promise of indemnifying losses, when does the indemnifier become liable to pay? And under what circumstances can the indemnity holder be entitled to recover the promised indemnity?

According to the original English Rule, the maxim of law was “you must be damnified before you claim to be indemnified”, which means that only if you have suffered an injury, you can claim indemnity. However, the law has transformed over the years. In present times, the indemnifier shall not wait for the indemnity holder to claim the reimbursement, he shall make it as soon as the liability occurs.

In Liverpool Mortgage Insurance Co^[13] case, where the judges opined that the plaintiff was entitled

“Indemnity does not merely mean to reimburse in respect of money paid but to save from loss in respect of the liability against which indemnity has been given because otherwise, indemnity may be worth very little if the indemnity holder is not able to pay in the first instance.”

Before the evolution of this rule, the indemnified could take no action under the English common law until an actual loss had been incurred. In such a case if a suit were to be filed against him he would have to wait till the judgment for him to sue on his indemnity. This puts the burden upon the indemnified. He could not avail himself of his indemnity till he had satisfied the judgment. Hence, the courts of equity held that if the liability incurred was absolute, the indemnifier had to pay off the claim or pay sufficient money into court, to pay off when the claim was made. The whole process was explained by J. Chagla in Gajanan Moreshwar v. Moreshwar Madan.^[14] it was held that the Indian Contract Act is not an exhaustive code to provide each and every condition to be fulfilled in the contract.

Logic along the same lines was explained in The New India Assurance Company Ltd. v The State Trading Corporation of India Ltd and Another^[15], and the aforementioned view was upheld, where the bench opined that irrespective of whether a loss has been incurred, the defendant is liable in case of breach of contract.

In cases where there is a requirement to fulfil a condition, the liability shall not arise until the condition is fulfilled. For instance, a contract for indemnity in a hire purchase agreement arising from a contract becoming enforceable does not become operative is an implied condition of providing a log book is not fulfilled. The loss in such a case arises because of the plaintiff allows dealers to hand over the car without the log book.

Osman Jamal and Sons Ltd. v. Gopal Purushottam^[16] was one of the first cases to provide indemnity before payment. The plaintiff company was a commission agent for the defendant’s company and in return, they promised to indemnify any losses incurred by the plaintiff with respect to these particular transactions. Upon one such incident where the plaintiff incurred losses, they filed for recovery of indemnity from the defendant since their firm went into liquidation. To this, the defendant argued that the plaintiff was entitled to maintain the suit only if they paid the amount of liability. The court held that,

“Indemnity is not necessarily given by repayment after payment. Indemnity requires that the party to be indemnified shall never be called for payment.”

Thus, the liability commences the minute loss in the form of liability becomes absolute.

The liability of the indemnifier arises when the indemnified suffers a loss, as was held, in Chand Bibi v. Santosh Kumar Pal^[17]. At the purchase of a property, the defendant’s father agreed to pay off the plaintiff’s mortgage debt and indemnify if they were made liable for the same. He later failed to do so, following which the plaintiff filed a suit to enforce the promise of indemnity but the court held that the suit was premature in relation to the contract of indemnity as the plaintiff had not suffered a loss yet.

Duties and Liabilities of the Indemnifier

An indemnifier’s duties are activated once the conditions of the indemnity contract are met. These include:

• Indemnifying Damages: Compensating for direct or indirect damages suffered by the indemnified.
• Indemnifying Costs: Paying for legal costs incurred by the indemnified, provided there was no breach of contract terms.
• Indemnifying Compromise Amounts: Reimbursing settlement sums paid in good faith, as long as the compromise aligns with the contract’s terms.

Duties and Liabilities of the Indemnity Holder

The indemnified party also bears certain responsibilities, which include:

• Adherence to Contract Terms: Acting within the scope of the indemnity agreement.
• Mitigation of Loss: Taking reasonable steps to prevent or minimise loss.
• Actual Loss Requirement: Ensuring a real loss has occurred before claiming indemnification.

Conclusion

Force Majeure and Indemnity

The impact of force majeure clauses on indemnity obligations has been a subject of legal scrutiny. In Woolworths Group Ltd. v. SCT Logistics (2021), the New South Wales Supreme Court ruled that force majeure does not automatically absolve indemnity obligations unless explicitly stated. The case emphasised the importance of clearly drafting force majeure and indemnity clauses to avoid disputes.

Importance of Contracts of Indemnity

Contracts of indemnity serve as a critical tool for risk management across industries. They:

• Offer financial security and protection against unforeseen losses.
• Facilitate smoother transactions by clarifying responsibilities and liabilities.
• Provide legal recourse for recovering damages or costs.

Conclusion

A contract of indemnity is an essential legal instrument that safeguards parties from potential losses and liabilities. Governed by the Indian Contract Act, 1872, it establishes clear rights and duties for both the indemnifier and the indemnified. While certain aspects, such as the commencement of liability, remain ambiguous, judicial interpretations have provided valuable guidance. Whether express or implied, indemnity contracts play a pivotal role in fostering trust and mitigating risks in contractual relationships. By understanding the nuances of these contracts, parties can ensure greater security and compliance in their dealings.

^[1] La. App. 499 So, 2D 387 389

^[2] (1827) Bing 66:5 LJ OS 68

^[3] AIR (1938) PC 191

^[4] (1903) AC 114

^[5] AIR 2007 Guj. 517

^[6] (1936) 38 BOMLR 610, 165 Ind Cas 338

^[7] Ibid

^[8] AIR 1971 Bom 102

^[9] AIR 1956 Bom 106

^[10] AIR 1930 Cal 596

^[11] Radha Govinda Rai v. Khas Dharmabank Colliery Co. Ltd. AIR 1963 Pat 160

^[12] (1978) QB 383

^[13] (1914) 2 Ch 617 at p. 638

^[14] AIR 1942 Bom 302 at p. 304

^[15] AIR 1969 Guj. 18

^[16] AIR 1929 Cal. 208

^[17] AIR 1993 Cal 641

Author Details: Rashmi Rawat (Student, PES’s Adv. Balasaheb Apte College of Law, Dadar) and updated by Aishwarya Agrawal.