Contents of Article
Introduction
A contract of indemnity is a type of contract where one party promises to save the other party from any loss caused to them by the conduct of the promisor or any other person. Under Section 124 of the Indian Contract Act, 1872, a contract of indemnity is defined as “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 contracts are designed to protect a party from losses arising from specific circumstances. Understanding the contract of indemnity and its significance in commercial dealings is essential for law students and professionals.
This article explores what is the contract of indemnity in Indian Contract Act, the principles of indemnity, the scope, and the difference between contract of indemnity and guarantee. Additionally, we will discuss relevant case laws and the latest judicial interpretations.
What is a Contract of Indemnity?
A contract of indemnity is essentially an agreement where one party agrees to compensate another party for any losses they may suffer due to a specific event. In this contract, the indemnifier agrees to protect the indemnified party from any financial loss. This type of contract is frequently used in insurance policies, construction contracts, and business dealings.
Indemnity Meaning
- To make good the loss incurred by another person
- To compensate the party who has suffered some loss
- To protect a party from incurring a loss
Types of Indemnity
There are primarily two types of indemnity contracts:
-
Express Indemnity:
In this type, the terms and conditions of indemnity are explicitly mentioned in the contract. Both parties know exactly what events are covered, and the indemnifier’s liability is clearly defined.
Example: A contractor indemnifies a client for any damages or losses caused by construction delays in a written contract. -
Implied Indemnity:
Implied indemnity arises from the conduct of the parties or the nature of the relationship, even if it is not expressly mentioned in a contract.
Example: A company hires an employee to act on its behalf, implicitly agreeing to indemnify the employee for any losses incurred while performing their duties.
Essential elements of a contract of indemnity
Contract : All the essentials of a valid contract must also be present in the contract of indemnity. Example:- X asks Y to beat Z and promises to indemnify Y against the consequences. Y beats Z and is fined Rs.1,000. Y cannot claim this amount from X because the object of the agreement was unlawful.
- Loss to one party: A person can indemnify another person only if such other person incurs some loss or it has become certain that he will incur some loss.
- Indemnity by the promisor: The purpose of contract of indemnity is to protect the indemnity holder from any loss that may be caused to the indemnity holder.
- Reason for loss: The contract of indemnity must specify that indemnity holder shall be protected from the
- Loss caused due to –
- Action of the promisor himself; or
- Action of any other person; or
- Any act, event or accident which is not in the control of the parties.
- Loss caused due to –
Scope of Indemnity
The scope of indemnity is generally broad, covering any loss, damage, or liability suffered by the indemnified party due to the specific event mentioned in the contract. The contract may be limited to certain types of losses, such as financial losses, legal liabilities, or other specific damages.
- Financial Loss: The most common type of indemnity covers financial loss, where the indemnifier agrees to reimburse the indemnified party for any monetary loss suffered.
- Legal Liabilities: Some indemnity contracts also cover legal liabilities, where the indemnifier agrees to compensate the indemnified for legal costs, damages, or judgments.
- Third-Party Actions: The indemnity can extend to losses caused by the actions of a third party, as allowed under Section 124.
Principle of Indemnity
The principle of indemnity is based on the idea that the indemnified party should be restored to the same financial position they were in before the loss occurred. The indemnity contract is not meant to provide profit to the indemnified party, but to compensate them for actual losses.
Key Principles:
- Compensation for Actual Loss: The indemnified party can only claim the actual loss suffered, not more.
- Event-Specific: The indemnity is applicable only for losses arising from the specific event or cause mentioned in the contract.
- Legal Protection: The indemnity also provides legal protection to the indemnified party by covering legal expenses and liabilities arising from third-party claims.
Rights and Duties under a Contract of Indemnity
Rights of the Indemnified:
- Right to recover damages
The indemnity holder has the right to recover all the damages which he is compelled to pay in any suit in respect of any matter covered by the contract of indemnity.
- Right to recover costs
The indemnity holder has the right to recover all the costs which he is compelled to pay in bringing or defending such suit.
Condition:- The indemnifier authorised him to bring or defend the suit; or
- The indemnity holder did not contravene the orders of the indemnifier; and The indemnity holder acted as it would have been prudent for him to act in the absence of any contract of indemnity.
- Right to recover sums paid
The indemnity holder has the right to recover all the sums which he has paid under the terms of a compromise of such suit.- The indemnifier authorised him to compromise the suit; or
- The indemnifier holder did not contravene the orders of the indemnifier; and the indemnity holder acted as it would have been prudent for him to act in the absence of any contract of indemnity.
Duties of the Indemnifier:
- Duty to Compensate: The indemnifier is obligated to pay for the losses as per the contract.
- Duty to Act in Good Faith: The indemnifier must act in good faith and take steps to minimize the indemnified’s losses.
Difference Between Contract of Indemnity and Contract of Guarantee
The terms contract of indemnity and contract of guarantee are often confused, but they are distinct legal concepts under Indian contract law.
| Aspect | Contract of Indemnity | Contract of Guarantee |
|---|---|---|
| Parties Involved | Two parties: Indemnifier and Indemnified | Three parties: Creditor, Principal Debtor, and Surety |
| Nature of Contract | The indemnifier promises to compensate for a loss. | The surety guarantees the performance of the principal debtor. |
| Liability | Liability arises only after the indemnified suffers a loss. | Liability is secondary, and arises only if the principal debtor defaults. |
| Purpose | To protect the indemnified from loss. | To ensure that the creditor is repaid if the principal debtor defaults. |
| Example | A promises to indemnify B if C files a lawsuit against B. | A guarantees to repay B’s loan if C fails to do so. |
Latest Case Law on Contract of Indemnity
- Gujarat State Petroleum Corporation Ltd. v. Hindustan Petroleum Corporation Ltd. (2021)
In this case, the court ruled in favor of the indemnified party, reiterating the obligation of the indemnifier to compensate for legal costs incurred due to third-party actions. The court clarified that the indemnifier must honor the contract as long as the losses fall within the scope of the indemnity clause. - SBI General Insurance Co. Ltd. v. Raja Rammohan Roy Hospital (2020)
This case involved an insurance indemnity contract where the insured sought compensation for losses arising from a fire. The court held that the insurer (indemnifier) was liable to compensate the insured for actual losses under the principle of indemnity.
Conclusion
The contract of indemnity is a critical legal tool for protecting parties from unforeseen losses arising from specific events. As per Section 124 of the Indian Contract Act, 1872, the indemnifier is obligated to compensate the indemnified for any loss caused due to the actions of the indemnifier or a third party. This contract plays a vital role in commercial transactions, insurance policies, and business operations. Understanding the principles of indemnity, its scope, and the distinction between contract of indemnity and guarantee ensures that parties are protected from financial losses.
Recommended Books For Law of Contract
- Law of CONTRACT & Specific Relief by Dr. Avtar Singh
- Law of Contract I & II by Dr. S.S. Srivastava
- Law of Contract by Dr. Ashok K. Jain
Read more Article