Introduction
The concept of indemnity forms a crucial part of the law of contracts, particularly in commercial transactions, insurance, and employment relationships. The word indemnity literally means security against loss or compensation for damages suffered. Under the Indian Contract Act, 1872, it is defined and governed by Sections 124 and 125, which lay down the foundation for protecting one party from loss caused by the conduct of another.
The purpose of a contract of indemnity is to make good a loss that one party may suffer due to the acts of the promisor or any other person. It is based on the equitable principle of “ubi jus ibi remedium” — where there is a right, there must be a remedy.
Definition of Contract of Indemnity (Section 124)
Text of Section 124
“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.”
This definition limits indemnity to loss caused by human conduct — either by the promisor or a third person. It does not, strictly speaking, include loss caused by natural events such as fire, flood, or accident; however, courts have interpreted the concept liberally to include such cases under equitable principles.
Illustrations
- Example 1: A contracts to indemnify B against the consequences of any proceedings that C may take against B in respect of a certain sum. This is a contract of indemnity.
- Example 2: A agrees to compensate B if B suffers any loss due to A’s negligence while transporting goods. This is also a valid contract of indemnity.
Nature and Scope of Indemnity
A contract of indemnity may arise in various forms — express or implied. The express contract clearly defines the terms, while an implied indemnity may be inferred from the nature of the relationship between parties.
It is primarily used in:
- Insurance contracts, where the insurer indemnifies the insured against loss.
- Agency contracts, where the principal indemnifies the agent for lawful acts done in good faith.
- Guarantee and employment contracts, to safeguard against potential risks or losses.
Indemnity is thus a risk-transfer mechanism, ensuring that losses fall on the person who agreed to bear them.
Rights of the Indemnity Holder (Section 125)
Text of Section 125
“The promisee in a contract of indemnity, acting within the scope of his authority, is entitled to recover from the promisor—
(1) all damages which he may be compelled to pay in any suit,
(2) all costs which he may be compelled to pay in bringing or defending such suit,
(3) 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 prudent or necessary.”
These rights ensure that the indemnity holder is not left uncompensated for losses suffered while acting lawfully within the terms of the contract.
When the Indemnifier’s Liability Arises
Indian courts have held that the indemnifier’s liability arises as soon as the loss becomes imminent, not only after the actual loss is paid. This liberal interpretation protects the indemnity holder from financial hardship and legal uncertainty.
Leading Case: Gajanan Moreshwar v. Moreshwar Madan (1942) 44 Bom LR 703
The Bombay High Court held that the indemnifier’s obligation begins when the loss becomes absolute or certain, even if the indemnity holder has not yet paid for the loss.
This case expanded the narrow scope of Section 124 and recognized equitable indemnity, aligning Indian law with English principles.
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Essentials of a Valid Contract of Indemnity
- Existence of Loss:
There must be an actual or potential loss against which protection is sought. - Promise to Compensate:
One party must expressly or impliedly promise to make good the loss. - Lawful Object and Consideration:
The agreement must fulfill all essentials of a valid contract under the Act. - Loss Caused by Human Conduct:
The loss must arise from the conduct of the promisor or any other person (though courts have extended this to natural causes).
Types of Indemnity
- Express Indemnity:
Clearly stated in written or oral form, defining the terms and extent of protection.
Example: Insurance policies. - Implied Indemnity:
Arises from the circumstances or nature of the relationship.
Example: Principal indemnifying agent for lawful acts done in good faith (Section 222).
Extent of Liability of Indemnifier
The indemnifier is bound to:
- Pay for all losses or damages suffered by the indemnity holder.
- Cover all legal costs or expenses incurred during litigation.
- Fulfill any compromise obligations made prudently and within the contract’s scope.
However, if the indemnity holder acts negligently, illegally, or beyond the authority granted, the indemnifier is not liable.
Distinction between Indemnity and Guarantee
| Basis | Indemnity | Guarantee |
|---|---|---|
| Parties | Two parties – Indemnifier and Indemnified | Three parties – Surety, Principal Debtor, Creditor |
| Nature of Liability | Primary | Secondary |
| Purpose | To compensate for loss | To ensure performance of an obligation |
| Existence of Debt | No pre-existing debt | Pre-existing debt or duty exists |
| Number of Contracts | One | Three separate contracts |
Important Judicial Decisions
1. Osman Jamal & Sons Ltd. v. Gopal Purshottam (1928) ILR 52 Bom 13
The Court held that the indemnifier’s liability extends to all damages and costs suffered by the indemnity holder, provided they are incurred within the authority of the contract.
2. Adamson v. Jarvis (1827) 4 Bing 66
An agent, acting on the principal’s instructions, sold certain goods that did not belong to the principal. The court held that the principal was bound to indemnify the agent for all losses incurred while acting in good faith.
3. Secretary of State v. Bank of India Ltd. (1938) 5 MLJ 186
The Privy Council recognized that a right of indemnity may exist even outside Section 124, emphasizing equitable interpretation.
Relationship with Insurance Contracts
Contracts of insurance are the most common examples of indemnity, particularly in fire, marine, and accident insurance. However, life insurance is not a contract of indemnity because the value of human life cannot be quantified or restored through compensation.
Conclusion
A Contract of Indemnity is a vital legal instrument ensuring fairness, justice, and protection against unforeseen loss. It embodies the principles of equity, compensation, and good faith, ensuring that the party suffering a loss is made whole. Indian courts have evolved the concept beyond the literal text of Section 124 to include implied and equitable indemnities, making it a flexible and essential feature of modern contract law.