CONTRACT OF INDEMNITY

To,
Dr.Silla Ramsundar
Dean, Faculty
NMIMS Hyderabad

From,
Parvathi PK
B.B.A LL.B
NMIMS Hyderabad
81021319018

Abstract
As a legal concept, Indemnity has a more specific meaning. For
instance, compensation connotes merely a sum paid to make good the
loss of another without regard to the payer's identity, or their reasons
for doing so. Indemnities form the basis of many insurance contracts;
for example, a car owner may purchase different kinds of insurance as
an indemnity for various kinds of loss arising from operation of the
car, such as damage to the car itself, or medical expenses following an
accident. In an agency context, a principal may be obligated to
indemnify their agent for liabilities incurred while carrying out
responsibilities under the relationship. While the events giving rise to
an indemnity may be specified by contract, the actions that must be
taken to compensate the injured party are largely unpredictable, and
the maximum compensation is often expressly limited. Objectives of
the paper are to define Indemnity, to explain the nature and scope of
indemnity to distinct between Indemnity and other Specific contracts.

Introduction

As per section 124 of the Indian contract Act 1872- 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”.
Indemnities form the basis of many insurance contracts; for example,
a car owner may purchase different kinds of insurance as an
indemnity for various kinds of loss arising from operation of the car,
such as damage to the car itself, or medical expenses following an
accident. In an agency context, a principal may be obligated to
indemnify their agent for liabilities incurred while carrying out
responsibilities under the relationship. While the events giving rise to
an indemnity may be specified by contract, the actions that must be
taken to compensate the injured party are largely unpredictable, and
the maximum compensation is often expressly limited. In the old
English law, Indemnity was defined as “a promise to save a person
harmless from the consequences of an act. Such a promise can be
expressed or implied from the circumstances of the case”. This view
was illustrated in the case of Adamson vs Jarvis 1872. In this case,
the plaintiff, an auctioneer, sold certain goods upon the instructions of
a person. It turned out that the goods did not belong to the person and
the true owner held the auctioneer liable for the goods. The
auctioneer, in turn, sued the defendant for indemnity for the loss
suffered by him by acting on his instructions. It was held that since
the auctioneer acted on the instructions of the defendant, he was
entitled to assume that if, what he did was wrongful, he would be
indemnified by the defendant. This gave a very broad scope to the
meaning of Indemnity and it included promise of indemnity due to
loss caused by any cause whatsoever. Thus, any type of insurance
except life insurance was a contract of Indemnity.
The definition provides the following essential elements
1. There must be a loss.
2. The loss must be caused either by the promisor or by any other
person (in Indian context loss is to be caused by only by a
human agency.)
3. 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.
Rights of Indemnifier

After compensating the indemnity holder, indemnifier is entitled to

all the ways and means by which the indemnifier might have
protected himself from the loss.
Relevant Case Laws

Rights of the indemnity holder

Section 125, defines the rights of an indemnity holder. These are as

follows - The promisee (Indemnity holder) in a contract of indemnity,
acting within the scope of his authority, is entitled to recover from the
promisor (Indemnifier). These are:
1. Right of recovering Damages - all damages that he is compelled
to pay in a suit in respect of any matter to which the promise of
indemnity applies.
2. Right of recovering Costs -all costs that he is compelled to pay
in any 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.
3. Right of recovering Sums -all 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 promisee to
make in the absence of the contract of indemnity, or if the
promisor authorized him to compromise the suit.
 Some of the important conditions which he ought to follow here
are viz; that as per this section, the rights of the indemnity
holder are not absolute or unfettered. He must act within the
authority given to him by the promisor and must not contravene
the orders of the promisor. Further, he must act with normal
intelligence, caution, and care with which he would act if there
were no contract of indemnity. Therefore, at the same time, if he
has followed all the conditions of the contract, he is entitled to
the benefits. This was held in the case of United Commercial
Bank vs Bank of India AIR 1981. In this case, Supreme Court
held that the courts should not grant injunctions restraining the
performance of contractual obligations arising out of a letter of
credit or bank guarantee if the terms of the conditions have been
fulfilled. It held that such LoCs or bank guarantees impose on
the banker an absolute obligation to pay. In the case of Mohit
Kumar Saha vs New India Assurance Co AIR 1997, Calcutta
HC held that the indemnifier must pay the full amount of the
value of the vehicle lost to theft as given by the surveyor. Any
settlement at lesser value is arbitrary and unfair and violates art
14 of the constitution.

When does the Commencement of liability arises

In general, as per the definition given in section 124, it looks like an

indemnity holder cannot hold the indemnifier liable until he has
suffered an actual loss. This is a great disadvantage to the indemnity
holder in cases where the loss is imminent and he is not in the
position to bear the loss. In the celebrated case of Gajanan
Moreshwar vs Moreshwar Madan, AIR 1942, Bombay high court
observed that the contract of indemnity held very little value if the
indemnity holder could not enforce his indemnity until he actually
paid the loss. If a suit was filed against him, he had to wait till the
judgement and pay the damages upfront before suing the indemnifier.
He may not be able to pay the judgement fees and could not sue the
indemnifier. Thus, it was held that if his liability has become absolute,
he was entitled to get the indemnifier to pay the amount.

Contract of Guarantee

Apart from indemnity contracts, the Contract Act also

governs contracts of guarantee. These contracts might appear similar
to indemnity contracts but there are some differences between them.
In guarantee contracts, one party contracts to perform a promise or
discharge a liability of a third party. This will happen in case the third
party fails to discharge its obligations and defaults. However, the
burden of discharging the burden will first lie on the defaulting third
party.
The person who gives the guarantee is the Surety. On the other hand,
the person for whom the Surety gives the guarantee is the Principal
Debtor. Similarly, the person to whom he gives such a guarantee is
the Creditor.

Distinction between a contract of Indemnity and a contract of

Guarantee.

Contract of Indemnity (Section 124) Contract of Guarantee (Section 126)

It is a bipartite agreement between the It is a tripartite agreement between the

indemnifier and indemnity-holder. Creditor, Principal Debtor, and Surety.
Liability of the indemnifier is Liability of the surety is not
contingent upon the loss. contingent upon any loss.
Liability of the indemnifier is primary Liability of the surety is co-extensive
to the contract with that of the principal debtor
although it remains in suspended
animation until the principal debtor
defaults. Thus, it is secondary to the
contract and consequently if the
principal debtor is not liable, the
surety will also not be liable.
The undertaking in indemnity is The undertaking in a guarantee is
original. collateral to the original contract
between the creditor and the principal
debtor.
There is only one contract in a There are three contracts in a contract
contract of indemnity between the of guarantee - an original contract
indemnifier and the indemnity holder. between Creditor and Principal
Debtor, a contract of guarantee
between creditor and surety, and an
implied contract of indemnity between
the surety and the principal debtor.
The reason for a contract of indemnity The reason for a contract of guarantee
is to make good on a loss if there is is to enable a third person get credit.
any.
Once the indemnifier fulfills his Once the guarantor fulfills his liabilty
liability, he does not get any right over by paying any debt to the creditor, he
any third party. He can only sue the steps into the shoes of the creditor and
indemnity-holder in his own name. gets all the rights that the creditor had
over the principal debtor.

Historical Development of Principle of Indemnity

1. Indemnity was restricted only to the loss occured by human

agency only.
In Gajanan Moreshwar vs. Moreshwar Madan. It is stated
:This definition covers indemnity for loss caused by human
agency ONLY. It does not deal with those classes of cases
where the indemnity arises from loss caused by events or
 accidents which do not or may not depend upon the conduct of
the indemnifier or any other person, or by reason of liability
incurred by something done by the indemnified at the request of
the indemnifier.

2. Contractual document must state clearly the terms and

conditions of indemnity.
In State Bank of India and another vs. Mula Sahkari Sakhar
Karkhana Ltd. It is stated : A document, as is well known,
must be construed on the basis of the terms and conditions
contained therein. It is also trite that while construing a
document the court shall not supply any words which the author
thereof did not use. The document in question is a commercial
document.

It does not on its face contain any ambiguity. The High Court
itself said that ex facie the document appears to be a contract of
indemnity. Surrounding circumstances are relevant for
construction of a document only if any ambiguity exists therein
and not otherwise.

The said document as per Supreme Court, constitutes a

document of indemnity and not a document of guarantee as is
clear from the fact that by reason thereof the appellant was to
indemnify the co-operative society against all loses, claims,
damages, actions and costs which may be suffered by it.

The document does not contain the usual words found in a bank
guarantee furnished by a Bank as, for example, "unequivocal
condition", "the co-operative society would be entitled to claim
the damages without any delay or demur" or the guarantee was
"unconditional andabsolute" as was held by the High Court. It is
 beyond any cavil that a bank guarantee must be construed on its
own terms. It is considered to be a separate transaction.

Contract of Insurance

Insurance may be defined as a contract between two parties whereby

one party called insurer undertakes, in exchange for a fixed sum
called premiums, to pay the other party called insured a fixed amount
of money on the happening of a certain event. It means protection
against loss. It is the process of safeguarding the interest of people
from loss and uncertainity. It is based on the contract. It is a valid
agreement that incorporates certain terms and conditions.

It may be describes as a Social device to reduce or eliminate a risk of

loss to life and property. Insurance business and the need for the
insurance cover are growing with the growing complexity of life,
trade and commerce, and consequently, there is now bewildering
variety of insurance covers.

Principle of Indemnity

As a rule, all insurance contracts except personal insurance are

contracts of indemnity.

According to this principle, the insurer undertakes to put the insured,

in the event of loss, in the same position that he occupied immediately
before the happening of the event insured against, in a certain form of
insurance, the principle of indemnity is modified to apply.
For example: in marine or fire insurance, sometimes, a certain profit
margin which would have earned in the absence of the event, is also
included in the loss. In a true sense of the indemnity, the insured is
not entitled to make a profit from his loss.

To discourse over insurance the principle of indemnifying it an

essential feature of an insurance contract, in the absence of which this
industry would have the hue of gambling, and the insured would tend
to affect over-insurance and then intentionally cause a loss to occur so
that a financial gain could be achieved.

So, to avoid this international loss, only the actual loss becomes
payable and not the assured sum (which is higher in over-insurance).
If the property is under-insured, i.e., the insured amount is less than
the actual value of the property insured, the insured is regarded his
insurer for the amount if under insurance and in case of loss one shall
share the loss himself.

To avoid an Anti-social Act; if the assured is allowed to gain more

than the actual loss, which is against the principle of indemnity, he
will be tempted to gain by the destruction of his property after getting
it insured against risk. He will be under constant temptation to destroy
the property.

Thus, the whole society will be doing only anti-social acts, i.e., the
persons would be interested in gaining after the destruction of the
property. So, the principle of indemnity has been applied where only
the cash-value of his loss and nothing more than this, though he might
have insured for a greater amount, will be compensated.

To maintain the Premium at Low-level; if the principle of indemnity

is not applied, the larger amount will be paid for a smaller loss, and
this will increase the cost of insurance, and the premium of insurance
will have to be raised. If the premium is raised two things may happen
first, persons may not be inclined to ensure and second, unscrupulous
persons would get insurance to destroy the property to gain from such
an act. Both things would defeat the purpose of insurance. So, a
principle of indemnity is here to help them because such
temptation’ is eliminated when only actual loss and not more than
the actual financial loss is compensated provided there is insurance up
to that amount.

Conditions For Indemnity Principle

The following conditions should be fulfilled in full application of the

principle of indemnity.

 The insured has to prove that he will suffer a loss on the insured
matter at the time of happening the event and the loss is an
actual monetary loss.

 The amount of compensation will be the amount of insurance.

Indemnification cannot be more than the amount insured.

 If the insured gets more amount than the actual loss, the insurer
has the right to get the extra amount back.

 If the insured gets some amount from the third party after being
fully indemnified by the insurer, the insurer will have the right
to receive alt the amount paid by the third party.

 The principle of indemnity does not apply to personal insurance

because the amount of loss is not easily calculable there.
Conclusion

Indian Contract Act does not specifically provide that there can be an
implied contract of indemnity. The Privy Council has, however,
recognized an implied contract of indemnity also Secretary of State
vs. The Bank of India Ltd.

The Law Commission of India in its Report (13th Report, 1958, on

Indian Contract Act, 1872) has recommended the amendment of
section 124. According to its recommendation, the definition of the
Contract of Indemnity in section 124 be expanded to include cases of
loss caused by events which may or may not depend upon the conduct
of any person. It should also provide clearly that the promise may also
be implied.

To conclude, logically it is also true that indemnity has been

embedded in the concept of insurance and as well as concept of
guarantee. Insurance and Guarantee are the species of a same genus
.i.e., indemnity or in other words the contract of insurance and the
contract of Guarantee are the development on contract of indemnity.
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