Contract of Indemnity: Indian Contract Act

Indemnity contract is 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. These are used for life insurances, fire insurances, etc. The rights and duties of both these parties and the nature of their relationship is written about in this blog.

According to Longman’s Dictionary meaning, Indemnity is protection against loss, especially in the form of a promise to pay, or payment for loss of money, goods, etc. It is a security against or compensation for loss etc. For instance, A contracts to indemnify B against the consequences of any proceedings which C may take against B in respect of a certain sum of 200 rupees. This is a contract of Indemnity. In the contract of Indemnity, the person who promises to indemnify is known as ‘Indemnifier’ and the person in whose favour such a promise is made is known as ‘Indemnified’ or ‘Indemnity Holder’.

According to Section 124 of the Indian Contract Act, 1872, a contract of Indemnity means “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”.

Essentials of Contract of Indemnity

This provision incorporates a contract where one party promises to save the other from the loss which may be caused, either

  • By the conduct of the promisor himself; or
  • By the conduct of any other person.

This definition covers for loss caused by the human agency only.

Indemnity Insurance

Indemnity Insurance is a way for a company (or individual) to be protected against indemnity claims. This insurance protects the holder from having to pay the full sum of an indemnity, even if the holder is at fault for the cause of the indemnity in the first place. Many companies make indemnity insurance a requirement, as lawsuits are common. Everyday examples include malpractice insurance, which is common in medical fields, and errors and omissions insurance (E&O), which protects companies and their employees against claims made by clients and applies to any given industry. Some companies also invest in deferred compensation indemnity insurance, which protects the money they expect to receive in the future.

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Like any other form of insurance, indemnity insurance covers the costs of an indemnity claim, including but not limited to court costs, fees, and settlements. The amount covered by insurance depends on the specific agreement, and the cost of the insurance depends on many factors, including past history of indemnity claims.

Property leases also include indemnity clauses. In the case of a rental property, for example, a tenant is typically responsible for damages due to negligence, fines, lawyer fees, and more, depending on the agreement.

In the case[1], the cover note stipulated delivery to the consigner. Moreover, on its way to the destination, the goods were to be stored in a godown and thereafter to be carried to the destination. While the goods were in the godown, the goods were destroyed by fire. It was held that the goods were destroyed during transit, and the insurer was liable as per the insurance policy.

Liability of Insurer and breach of the fidelity insurance contract

Where insured bags of fertilizer stored in plaintiff’s godown, were found missing due to the act of embezzlement by the employees of the plaintiff company. Defendant Company had ensured to indemnify the plaintiff against loss sustained by such an act. The alleged breach of condition in the contract notice to be given to the defendant regarding the discovery of such action could not be said to be fundamentals breach. Held, that it would not permit the defendant to negate the legitimate claim of the plaintiff, hence decreeing suit for declaration and recovery of the amount with interest by Trial Court was proper[2].

Rights of Indemnity Holder

In a suit against the indemnity holder, he may have been compelled to pay damages, and incurred costs, etc. In his own turn, he can bring an action against the promisor (indemnifier) to recover damages and costs, etc. paid by him, if the indemnifier has promised an indemnity in such a case.

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Rights of Indemnity holder when sued

According to Section 125 of the Indian Contract Act, 1872– the promise in a contract of indemnity, acting within the scope of his authority is entitled to recover from the promisor-

  • 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 contract of indemnity, or if the promisor authorized him to bring or defend the suit;
  • 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 promise to make in the absence of any contract of indemnity, or if the promisor authorized him to compromise the suit.

When can an indemnifier be made liable? Can he claim to be indemnified before he is indemnified?

There has been controversy regarding the point, as to whether the indemnifier can be asked to indemnify before the indemnity-holder has actually suffered the loss, or his liability arises only after the loss has been suffered by the indemnity holder.

According to English Common Law, no action could be brought against the indemnifier until the indemnity-holder had suffered an actual loss. This situation created a great hardship in those cases where the indemnity-holder was not in a position to meet the claim out of his pocket. Relief was provided to the indemnity-holder in such cases by the Court of Equity. According to the rules evolved by the Court of Equity, it was no more necessary for the indemnity-holder to be indemnified before he could be indemnified.

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There has been a difference of opinion between various High Courts in India as to whether the indemnity-holder can claim indemnity before he has actually suffered the loss.

According to the view expressed by the Lahore and Nagpur High Courts, a person must be demnified before he can be indemnified, i.e., no indemnity can be claimed until the indemnity-holder has already actually suffered the loss.

In the case[3], the respondent, a co-operative society, having a sugar factory entered into a contract with one M/s. Pentagon Engineering Pvt. Ltd. For the installation of a paper plant. As per the agreement, the Pentagon furnished a Bank Guarantee/Indemnity for the release. The retention money of 10% from the Proforma Invoices of the material reached at the site. The operative portion of the bank read as “to indemnify and keep indemnified Mula Sahakari Sakhar Karkhana Ltd. Against all loses, claims damages actions and cost in respect of such sums which the supplier shall become liable to pay as the terms of the said order”.

Disputes and differences arose between the parties and as a result, the respondent terminated the contract and invoked the Bank Guarantee against the Pentagon. Holding that the document indemnifying the respondent was a contract of indemnity and not guarantee, the Apex Court said that the claim made by the assured on termination of the contract need not be honoured by the Bank without the proof of loss.

Also read Section 70 of the Indian Contract Act, 1872: Decision upon liability to pay.

[1]United India Insurance Company v. M/s. Aman Singh Munshilal, AIR 1994 P. & H. 206

[2]Oriental Insurance Co. Ltd., Ahmedabad v. Gujarat State Warehousing Corpn., Ahmedabad, AIR 2003 Guj. 159

[3]State Bank of India v. Mula Sahakari Sakhar Karkhana Ltd., AIR 2007 S.C. 2361