CONTRACT OF INDEMNITY

This Article is written by Mushkan Pandey, during the internship at LeDroit India.

INTRODUCTION

The term “Indemnity” derives from the Latin “indemnis” meaning “unhurt” or free from loss. In its broadest sense, indemnity means security, protection or coverage for any loss incurred.

Indemnity typically occurs in the form of a contractual agreement between two parties, where one party agrees to compensate the other party for any loss or damages they may suffer, usually as a result of specific event, action, or circumstances.

A contract of indemnity is defined under section 124 of Indian Contract Act, 1872, which states that one party promises to compensate another for losses incurred due to the promisor’s action or those of a third party. To be valid such contracts must comply with the essential’s conditions mentioned in section 10 of Indian Contract Act, 1872, which includes:

Competent parties
Free consent
Lawful consideration
Certainty and clarity
Legality and adherence to public policy

There are two parties involved in the contract of indemnity. The two parties are:

Indemnifier: Someone who protects against or compensates for the loss of the damage received.

Indemnified/Indemnity-Holder: The other party who is compensated against the loss suffered.

ILLUSTRATION: –

Mr. A co-signs a lease agreement with Mr. B for property rented by Mr. C. If Mr. C fails to pay rent, Mr. A is liable to pay the rent to Mr. B is a contract of indemnity.

In this case, Mr. A promises to indemnify Mr. B to pay the rent, So Mr. A is indemnifier, Mr. B is creditor and Mr. C is indemnity-holder.

The case law of Gajanan Moreshwar Parelkar Vs Moreshwar Madan Mantri (1942) is a significant judgement that interprets the principles of indemnity contracts in India.

FACTS: –

Gajanan Moreshwar (indemnity-holder) and Moreshwar Madan (indemnifier) entered into an indemnity contract. The indemnity-holder incurred a liability (absolute in nature) due to a decree passed against him. The indemnity-holder sought reimbursement from the indemnity-holder, as per their indemnity contract.

JUDGEMENT: –

The court held that the indemnifier was liable to indemnify the indemnity-holder. The judge observed that if the indemnity-holder incurs an absolute liability, they can call upon the indemnifier to save them from the liability and pay it off.

KEY POINTS OF THE JUDGEMENT: –

Absolute Liability: The court emphasized that the indemnified party’s liability must be absolute, meaning it is certain and unconditional.

Indemnifier’s Obligation: The indemnifier is obligated to save the indemnified party from the absolute liability and pay it off.

Entitlement to Call: The indemnified party has the right to call upon the indemnifier for assistance when they incur an absolute liability.

Timing of Indemnification: The court implied that the indemnifier’s obligation arises as soon as the indemnified party’s liability becomes absolute.

IMPLICATIONS: –

Protection for Indemnified Parties: The case law provides robust protection for indemnified parties, ensuring they are absolved of absolute liabilities.

Indemnifier’s Responsibility: The judgement emphasizes the indemnifier’s responsibility to actively discharge or pay off the indemnified party’s absolute liabilities.

Clarity on Indemnity Contracts: The case law provides clarity on the principles of indemnity contracts, guiding future interpretations and applications.

PROVISIONS UNDER ENGLISH LAW

The concept of contract of indemnity in English law originated from the landmark case Adamson Vs Jarvis (1827). This case established that an auctioneer, acting on instructions, could assume indemnity from the defendant for any wrongful actions. The court ruled in favour of the plaintiff(auctioneer) whom the true owner of the cattle sued for wrongful sale. The plaintiff sought indemnity from the defendant who instructed them to sell the cattle without disclosing lack of ownership. The court held that:

The plaintiff acted in good faith, assuming the defendant’s authority.

The defendant is liable for the plaintiff’s losses due to their own actions.

The plaintiff is entitled to indemnity for losses incurred due to the defendant’s wrongdoing.

The Court decision emphasizes the importance of indemnity in protecting agents who act in good faith on behalf of principals. It also highlights the principal’s responsibility to ensure their agents are not exposed to unnecessary risks.

The General rule of contract of indemnity in English Law are:

The indemnifier compensates the indemnity-holder only when they incur a loss.

The indemnity-holder must follow the indemnifier instruction.

The indemnity-holder incurs coasts during legal proceedings or pays a compromise amount.

Initially, courts required the indemnity-holder to incur a loss before claiming indemnity. However, courts of equity later removed this requirement, allowing indemnity-holders to claim indemnity for the promise itself, even if no actual loss occurred. This shift in approach now holds indemnifiers liable for indemnity even if no loss has happened.

INDEMNITY INSURANCE

The Contract of Indemnity is foundational to the insurance industry. Insurance operates on seven fundamental principles, and Indemnity is one of them.

The Seven Principles of Insurance are:

Utmost Good Faith
Insurable Interest
Indemnity
Contribution
Subrogation
Loss Minimization
Proximate Cause

In fact, the entire insurance industry is built on the concept of indemnity. Indemnity is core principles that ensures policyholders restore their pre-loss financial position, without making a profit or facing a loss.

Indemnity is the foundation of insurance contracts, and all insurance product including:

Life Insurance
Health Insurance
Property Insurance
Liability Insurance
Marine Insurance

Are designed to provide indemnity to the policy-holders. Insurers promise to compensate policy-holders for losses or damages, up to the policy’s limits, to put them back in the same financial position they were in before the loss.

Indemnity is the underlying principles that allows insurance companies to:

Assess risks
Calculate premiums
Set policy limits
Process claims
Provide coverage

Without Indemnity, Insurance as we know it wouldn’t exist. It is the backbone of the Insurance Industry, and all insurance products and services revolve around this core principle.

The case of Oriental Insurance Company Ltd Vs Meena Variyal & Others (2007) decided by the Supreme Court of India, dealt with issues concerning the liability of an Insurance Company under a motor insurance policy.

FACTS: –

The dispute arose from a fatal accident involving a vehicle owned by the insured company and driven by an employee (the deceased). The family of the deceased (Meena Variyal and others) claimed compensation from Oriental Insurance Company, the insurer, under the terms of the insurance policy taken out by the employer. The issues were whether the insurance company was liable to indemnify the insured for this claim.

In this case, the policy primarily provided third-party liability coverage, which indemnifies the insured for legal liabilities to third parties in the event of accidents. The Policy did not automatically extend to cover liabilities toward the insured’s employees unless explicitly stated.

LEGAL ISSUES: –

Whether the insurance policy covered the death of the insured’s employee (the driver). The family of the deceased argued that the insurer was liable to pay compensation. The insurance company, however, contended that their indemnity obligation under the policy did not extend to employees, as the policy only provided third-party coverage, not employee indemnification.

JUDGEMENT: –

The Supreme Court examined the policy terms to determine the scope of the indemnity. The court ruled that:

Indemnity is governed by the contract: The insurance company’s obligation to indemnify arises only if the loss falls within the scope of the risks covered by the contract.

Third-party Vs employee coverage: Since the policy was designed to cover third-party liabilities, the insurer’s indemnity obligation did not extend to employees unless a separate provision for such coverage was included in the contract. In this case there was no such provision.

No liability to indemnify: As the employee’s death was not covered under the policy, the insurance company was not contractually obligated to indemnify the insured for claims arising from the employee’s death.

The court held that the insurance company was not liable to indemnify the insured because the claim did not fall within the scope of the risk covered by the insurance contract. The contract of indemnity between the insured and the insurer was limited to third-party liabilities, and there was no provision for indemnifying the employer for the death of an employee.

The case of The Oriental Insurance Company Ltd Vs Meena Variayal & Others underscores the principle that an insurance contract, as a contract of indemnity, limits the insurer’s liability to the risks explicitly covered by the policy. Without specific coverage for employee-related incidents, the insurer is not obligated to indemnify the insured for such claims.

ESSENTIALS OF CONTRACT OF INDEMNITY

The essentials elements of Contract of Indemnity are:

Parties To a Contract: There must be two parties, namely, indemnifier and indemnified or indemnity-holder.

Protection of Loss: A contract of indemnity is entered into for the purpose of protecting the indemnifier from the loss. The loss may be caused due to the conduct of the indemnifier or any other person.

Express or Implied: The contract of indemnity may be expressed or implied unreformed from the conduct of parties or circumstances of the particular case.

Essentials of Valid Contract: A contract of indemnity is a special kind of contact that falls under the Indian Contract Act, 1872. As such, it must satisfy all the essential elements of a valid contract in section 10 of the Act. These essentials include: –

Offer and Acceptance
Consideration
Intention to create legal relations
Capacity to Contract
Legality of Object
Possibility of Performance
Certainty of terms
Free Consent (absence of coercion, undue influence or misrepresentation)

TYPES OF INDEMNITY

There are two types of Indemnity:

Express Indemnity: –

An indemnity agreement is a written contract that mentions the terms and conditions of indemnification, specifying the obligations and responsibilities of the parties involved. Indemnity Agreement include:

Insurance indemnity contracts: Between an insurer and policyholder, outlining coverage and claims procedures.

Construction contracts: Between contractors and clients, specifying liabilities and responsibilities for project-related risk.

Agency contract: Between agents and principles, defining the scope of agency and indemnification for agent actions.

Leases agreements: Between landlords and tenants, outlining responsibilities for property damage or liability.

Service contracts: Between service providers and clients, specifying indemnification for service-related risks.

Indemnity agreements provide clarity and protection for parties involved, ensuring that risks and liabilities are allocated and managed appropriately.

Implied Indemnity: –

The obligation to indemnify arises from the circumstances or conduct of the parties involved, rather than a written agreement. This is called implied indemnity.

Implied indemnity is based on the principles of fairness, justice and equity. It recognizes that the agent acted on behalf of the principal and incurred losses due to the principal’s actions.

This concept applies to various situations, including:

Agency relationship
Employment contract
Partnerships
Trust relationship

Implied indemnity ensures that parties are held accountable for their actions and that losses are fairly distributed. It promotes trust, good faith, and fair dealing in business and personal relationships.

RIGHTS OF THE INDEMNIFIED/INDEMNITY-HOLDER

As per sec – 125 of Indian Contract Act, 1872 the following rights were available to indemnify or indemnity-holder against the indemnifier, provided he has acted within the scope of his authority:

Rights to recover damages paid in a suit [sec – 125 (i)]: –

The Indemnity-Holder is held or liable for loss or damage that falls within the scope of indemnity contract, they can recover the amount they paid from the indemnifier. This includes:

Damages or losses awarded by the courts
Settlement amounts paid to resolve a dispute
Costs and expenses incurred in defending the suit

The Indemnifier is liable to indemnify the indemnity-holder for all such damages or losses ensuring that the indemnity-holder is not left with any financial burden.

Rights to recover costs incurred in defending a suit [sec – 125 (ii)]: –

An Indemnity-Holder has right to recover from the indemnifier all costs which he may be compelled to pay in any such suit if, in bringing or defending it, he did not contravene the orders of the indemnifier, and acted as it would have been prudent for him to act in absence of any contract of indemnity, or if the indemnifier authorized him to bring or defend the suit.

It states that the Indemnity-Holder can recover costs from the indemnifier if:

They dint’s disobey the indemnifier instruction
They acted prudently, as if there was not indemnity contract
The promisor authorized them to bring or defended the suit

This provision ensures the indemnity-holder is protected from financial losses when acting in accordance with the indemnity contract.

Rights to Sue for Specific Performance:

Specific performance is a legal remedy where the court orders the indemnifier to perform their obligations under contract, rather than paying damages.The indemnity-holder can seek specific performance if:

They have incurred absolute liability (strict liability for a product defect).
The contract explicitly covers such liability.
The indemnifier has failed to fulfil their indemnification obligations.

The indemnity-holder can ensure that the indemnifier fulfils their contractual obligations, providing the promised indemnifications and protection against losses.

CONCLUSION

The concept of indemnity has a dual application, being both broad and narrow simultaneously. On one hand, the English definition of indemnity is comprehensive, covering the promise to indemnify against losses from any cause. On the other hand, the Indian Contract Act’s definitions are more restrictive, providing a narrower scope of indemnity. This contrast highlights the complexity of Indemnity’s application across different legal frameworks.

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