Overview: Contract of Indemnity | Law of Contracts - CLAT PG PDF Download

Contract of Indemnity - Definition, Nature and Scope 

• A contract of indemnity is a legal agreement where one party (the indemnifier) promises to compensate the other party (the indemnified) for any losses they may suffer. The term "indemnity" literally means "security against loss." In simple terms, it means protecting someone from financial harm.
• According to English law, a contract of indemnity is defined as a promise to keep a person safe from the consequences of an action. This promise can be either explicit (clearly stated) or implicit (understood without being stated).
• For example, in the case of Adamson v. Jarvis, an auctioneer sold cattle on the instructions of a defendant. When it turned out that the cattle did not belong to the defendant, the auctioneer was held liable and sued the defendant for indemnity. The court ruled that the auctioneer had the right to assume he would be indemnified by the defendant if his actions were found to be wrongful.
• In another case, Dugdale v. Lovering, the plaintiff delivered trucks to the defendants based on an implied promise of indemnity. When the trucks were claimed by another party, the plaintiffs were entitled to recover indemnity from the defendants.
• The Indian Contract Act also defines a contract of indemnity as an agreement where one party promises to save the other from losses caused by the promisor's actions or the actions of another person. This definition emphasizes that the losses must be due to the actions of the promisor or someone else, not accidental events like fire or natural disasters.
• In essence, a contract of indemnity is about protecting someone from financial losses, whether they are caused by actions or unforeseen events.

 Rights of Indemnity Holder 

The holder of an indemnity contract has specific rights that are important to understand:

•  Right to Claim Compensation:  The indemnity holder has the right to claim compensation from the indemnifier for any losses or damages specified in the contract. This right is the core of the indemnity agreement.
•  Right to Defend:  If a third party makes a claim against the indemnity holder for a loss covered by the indemnity, the holder has the right to defend themselves and seek reimbursement from the indemnifier for legal costs and damages.
•  Right to Mitigate Loss:  The indemnity holder has the right to take reasonable steps to mitigate or reduce the loss. For example, if the indemnity covers potential damages from a specific event, the holder should take precautions to minimize the impact of that event.
•  Right to Demand Information:  The indemnity holder can request information from the indemnifier regarding the status of the indemnity agreement and any relevant details related to potential claims.
•  Right to Enforce Terms:  The holder has the right to enforce the terms of the indemnity agreement, ensuring that the indemnifier fulfills their obligations as outlined in the contract.
•  Right to Assign:  In some cases, the indemnity holder may have the right to assign or transfer their rights under the indemnity agreement to another party, subject to the terms of the contract.

These rights provide the indemnity holder with the necessary protections and avenues for recourse in case of losses covered by the indemnity agreement. It is important for both parties to understand these rights to ensure a fair and effective indemnity arrangement.

 Commencement of the Indemnifier's Liability 

• The liability of the indemnifier in a contract of indemnity begins when the indemnified party suffers a loss that falls within the scope of the indemnity agreement.
• The indemnifier's responsibility to compensate the indemnified party starts at the point when the loss occurs, as specified in the contract.
• For example, if the indemnity agreement covers losses due to specific actions or events, the indemnifier becomes liable when such actions or events lead to a loss for the indemnified party.
• The commencement of liability is crucial in determining when the indemnified party can make a claim for compensation under the indemnity contract.
• It is important for both parties to clearly define the terms and conditions under which the indemnifier's liability begins in the contract of indemnity to avoid disputes.

 Definition of Contract of Indemnity 

• A contract of indemnity is defined in section 124 of the Indian Contract Act 1872.
• It occurs when one party promises to protect the other from losses caused by the promisor's actions or the actions of others.

 Example of Contract of Indemnity 

• A contract where party A agrees to compensate party B for any legal actions taken by party C against B regarding a specific amount of 200 rupees illustrates a contract of indemnity.

 Understanding Indemnifiers and Indemnity Holders 

 Indemnifier: 

• The indemnifier is the individual who commits to compensating for any loss. In the given example, A represents the indemnifier.

 Indemnity Holder: 

• The indemnity holder is the person whose loss is to be compensated. In the provided example, B is the indemnity holder.

 Nature of Contract of Indemnity 

• A contract of indemnity can be either express or implied based on the specific circumstances, although Section 124 of the Indian Contract Act does not explicitly address implied indemnity.
• In a case involving a broker who endorsed a government promissory note to a bank with a forged endorsement, the bank, acting in good faith, obtained a renewed promissory note from the Public Debt Office. When the true owner sued the Secretary of State for conversion, the Secretary of State, in turn, sued the bank based on implied indemnity.
• The court held that when one person performs an act at the request of another, and the act is not inherently tortious to the knowledge of the person performing it, the person performing the act is entitled to indemnity from the requester if the act harms the rights of a third party.

Essential Elements of Contract of Indemnity

The following are the essentials of the Contract of Indemnity:

•  There must be a loss. 
•  The loss must be caused either by the promisor or by any other person. 
•  Indemnifier is liable only for the loss. 

Thus, it is clear that this contract is contingent in nature and is enforceable only when the loss occurs.

Modes of Contract of Indemnity

 Express 

• A contract of indemnity is considered express when one party explicitly promises to compensate the other for any losses incurred.

 Implied 

• A contract of indemnity is deemed implied when it can be inferred from the behavior of the parties involved or the specific circumstances of the case.

 Insurance Indemnity 

In most cases, insurance policies, except for life and personal accident insurance, are based on the principle of indemnity. This means that the insurer promises to compensate the insured for any losses incurred, but within certain limits.

The promise of indemnity is not absolute. Insurers are not obligated to cover losses that exceed the actual financial impact on the insured. For example, if a policyholder suffers a loss of ₹1,00,000 but only had a policy limit of ₹50,000, the insurer would only pay ₹50,000.

Insurers are also not liable to pay for losses that the insured has not actually incurred. For instance, if a policyholder claims a loss of ₹1,00,000 but can only prove a loss of ₹30,000, the insurer will only compensate for ₹30,000.

 Key Points 

• Insurance policies, except for life and personal accident insurance, are based on indemnity.
• The promise of indemnity is not absolute; insurers have limits on compensation.
• Insurers are not obligated to cover losses that exceed the actual financial impact on the insured.
• Insurers are only liable to pay for losses that the insured has actually incurred.
• For example, if a policyholder suffers a loss of ₹1,00,000 but has a policy limit of ₹50,000, the insurer will only pay ₹50,000.

 Extent of Liability 

 Sec.125 Right of the Indemnity Holder 

• An indemnity holder, acting within their authority, is entitled to certain rights.

Rights of an Indemnity Holder

 Right to Recover Damages 

• The indemnity holder has the right to recover all damages that he might have been forced to pay in any legal action related to any matter covered by the contract.

 Right to Recover Costs 

• The indemnity holder is entitled to recover all costs associated with initiating and defending the legal action.

 Right to Recover Sums Paid Under Compromise 

• The indemnity holder can recover all amounts paid under the terms of a compromise in the legal action.
• However, the compensation must not go against the directions of the indemnifier. It must be reasonable and authorized by the indemnifier.

 Right to Sue for Specific Performance 

• The indemnity holder has the right to sue for specific performance if he has incurred absolute liability and the contract covers such liability.
• The promise in a Contract of Indemnity, acting within the scope of his authority, is entitled to recover from the promisor.

 Right of Recover Damages 

• All the damages that he is compelled to pay in a suit in respect of any mater to which the promise of indemnity applies.

 Right of Recover all Costs 

• All the costs that he is compelled to pay in such suit if in bringing or defending it he did not contravene the orders of the promisor and has acted as it would have been prudent for him to act in the absence of the contract of indemnity or if the promisor authorized him in bringing or defending the suit.

 Right of Recovery all sums 

• All the sums which he may have paid under the terms of a compromise in any such suite if the compromise was not contrary to the orders of the promisor and was one which would have been prudent for the promise to make in the absence of the contract of indemnity.

 Legal Precedent: Mohit Kumar Saha v. New India Assurance Co. 

• In this case, it was determined that the indemnifier is obligated to pay the full value of the stolen vehicle as assessed by the surveyor.
• Any settlement for a lesser amount is considered arbitrary and unfair, violating Article 14 of the Constitution.

 Conditions for Indemnity Claims 

• The right to indemnity cannot be claimed in cases of dishonesty, lack of good faith, or violation of the promisor's instructions.
• However, the right remains valid in cases of oversight.

 Rights of Indemnifier 

• Section 125 of the Act outlines the rights of the indemnified party but remains silent on the rights of the indemnifier, implying that the indemnifier has no rights and only liabilities towards the indemnified.
• However, by examining Section 141, which addresses the rights of a surety, we can infer that the indemnifier's rights are likely similar to those of a surety.
• When one person agrees to indemnify another, upon fulfilling the indemnity, the indemnifier is entitled to succeed to all the rights and means by which the indemnified party could have protected or reimbursed themselves for the loss. This principle is illustrated in the case of  Simpson v Thomson. 

 Commencement of Liability 

 When does the Indemnifier become liable to pay, or when is the indemnity-holder entitled to recover his indemnity? 

The Indian Contract Act, 1872 does not specify when the liability of the indemnifier begins. However, based on court decisions, it can be said that the indemnifier's liability starts as soon as the indemnity holder's liability becomes absolute and certain.

In simpler terms, if the indemnity holder is faced with an undeniable liability, even if they haven't made any payment yet, they have the right to ask the indemnifier to cover the loss.

Originally, under English law, indemnity was only payable after the indemnity holder had actually suffered a loss by settling the claim. The legal principle was that one had to be "damnified" before claiming indemnity. However, this principle has changed over time.

In the case of  Gajanan Moreshwar Parlekar v. Moreshwar Madan Mantri  ,Justice Chagla explained this shift in legal practice. Under English law, a legal action could not be initiated until actual loss was incurred. It was recognized that indemnity would be of little value if the indemnified party could not enforce their right to indemnity until they had made the payment. Therefore, courts of equity determined that if the indemnified party's liability was absolute, they had the right to either compel the indemnifier to settle the claim or to deposit sufficient funds in court to cover the claim whenever it arose.

This principle was further elaborated in cases such as  Richardson Re, Ex Parte The Governors of St. Thomas's Hospital  and  Osman Jamal & Sons Ltd. v. Gopal Purushottam  . It was emphasized that indemnity does not necessarily involve repayment after payment. Instead, indemnity ensures that the party to be indemnified is never obligated to make a payment.

•  Example:  X promises to compensate Y for any loss incurred by filing a lawsuit against Z. When the court orders Y to pay Z damages of Rupees 5000, Y can claim this amount from X and pass it on to Z since the loss has become certain.