Contracts of indemnity work towards saving a party from incurring a loss. One party makes good the loss suffered by another party. In this blog, we have discussed the meaning of indemnity contracts and the rights of the person who has been indemnified against a loss (rights of the indemnity holder). The timing when the liability under a contract of indemnity arises is also relevant.
What is a contract of indemnity?
Section 124 of the Indian Contract Act, 1872 defines a contract of indemnity.
It says that a contract of indemnity is one in which one party promises to safeguard the other party from any loss caused to him by the promisor’s own conduct himself or by the conduct of another person. For example, when A promises to indemnify B against the loss that may be suffered by him due to any legal proceedings that C may take against him for a certain sum of Rs. 30,000, this is a contract of indemnity.
The contract of indemnity can be expressed or implied. The latter can be inferred from the facts of a specific situation, such as an act performed by A at the request of B. If A incurs any losses, he can recover them from B.
Who is the indemnifier and who is the indemnified?
The individual who agrees to indemnify or make good the loss is referred to as the indemnifier, and the person whose loss is compensated or made good is referred to as the indemnified or indemnity holder.
Contract of indemnity under English law
According to English law, a contract of insurance is an example of an indemnity contract. In exchange for the premium, the insurer undertakes to make good the loss suffered by the insured on account of the destruction of his property by fire.
On the other hand, if we go by the literal meaning of the contract of indemnity under the Indian Contract Act, it is restricted to such circumstances only where the loss promised to be compensated is caused by the conduct of the promisor himself or any other person. It appears that losses caused by incidents or accidents that are unrelated to the conduct of any individual cannot be sought to be reimbursed under a contract of indemnity.
However, the fact is that all contracts of insurance (excluding life insurance) are also considered to be contracts of indemnity. The objective of lawmakers was never to exclude insurance contracts from the scope of contracts of indemnity. As a result, if we adhere to the English definition, it reads “a promise to save another harmless from loss caused as a result of a transaction entered into at the instance of the promisor”. This definition includes a promise to make good any loss caused by any reason whatsoever, such as fire, perils of the sea, accidents, and so on.
What are the Rights of Indemnity Holder?
Section 125 deals with the rights of an indemnity holder. When the indemnity holder has been sued due to the conduct of the promisor or by a third party in respect of any matter to which the contract of indemnity applies, he can recover damages from the indemnifier. This is so because the indemnifier has to make good losses borne by the person who has been indemnified.
For example, A and B may agree that if C sues B in a specific matter, A will indemnify B. Suppose C has now filed a case against B, and B has been compelled to settle and pay an amount. In terms of the contract of indemnity, A would hence be liable for all payments made by B to C in connection with that matter.
Let us discuss these rights further in detail.
Rights of Indemnity Holder when sued
As per Section 125 of the Indian Contract Act, the promisee (or the indemnity holder) in a contract of indemnity who acts within the scope of his authority is entitled to recover the following amounts from the promisor or indemnifier:
1. The indemnity holder is entitled to recover the damages that he may be required to pay in any lawsuit relating to any matter to which the promise to indemnify applies.
2. He is entitled to recover from the indemnifier any costs that he may be obliged to pay in any such lawsuit. However, in bringing or defending such a lawsuit, it must be ensured that the indemnity holder did not violate the directions of the promisor and that he acted in the same way as a prudent person would act if there was no contract of indemnity. Moreover, he is also entitled to this right if the promisor authorized him to bring or defend the lawsuit.
3. He is entitled to recover from the indemnifier the entire sum that he paid under the conditions of the compromise of such a lawsuit. However, it is important that the compromise must not be contradictory to the directions of the indemnifier, and he must act prudently in settling or compromising the claim. This right is also available to the indemnity holder if he paid any money under any compromise entered into by him and authorized by the indemnifier.
There are some crucial conditions that the indemnity holder must observe here according to this provision. He must act within the authority granted to him by the promisor and must not deviate from the promisor’s orders. Also, he must act with the same intelligence, caution, and care as he would if there was no contract of indemnity.
Further, this section is not exhaustive and does not list all of the reliefs available to an indemnity holder who has been sued. Certain equitable reliefs that he may be entitled to remain untouched. The rights of the indemnity holder are not limited to those listed in this section. Even if no damage has been caused yet, he has the right to sue for the specific execution of the contract of indemnity if it can be demonstrated that he has incurred an absolute liability and that the indemnity contract covers the said liability.
When does the indemnifier’s liability commence?
A crucial concern in this regard is: When does the indemnifier become obligated to pay, or when is the indemnity holder entitled to recover his indemnity? The indemnity holder is entitled to the aforementioned rights as soon as his liability becomes certain, even though he has paid nothing. Indemnity is not always provided by repayment after payment.
The contract of indemnity essentially requires that the party to be indemnified should never be called upon to pay. As a result, if the indemnity holder has incurred an absolute liability, he has the right to ask the indemnifier to save him from it and pay it off. To put it another way, the liability of the indemnifier begins as and when the indemnity holder’s liability becomes absolute.
Relevant case laws on Indemnity Holder’s rights
Indemnifier’s liability: Osman Jamal & Sons Ltd. v Gopal Purushottam (1928 ILR 56 Cal 262)
In the case of Osman Jamal & Sons v. Gopal (1928), the plaintiff was held entitled to recover the sums from the indemnifier before even actually discharging his liability. It was decided that indemnity need not necessarily be given by repayment after the payment is made. Indeed, indemnity requires that the party to be indemnified (i.e., the promisee) shall never be called upon to pay.
Insurance contracts: The New India Assurance Co. Limited vs. State Trading Corporation of India
In ‘The New India Assurance Co. Limited vs. State Trading Corporation of India’ – A.I.R. 2007 (NOC) 517 (Gujarat), it was held that almost all insurance contracts other than life and personal accident insurances are contracts of indemnity.
Wrapping up: What are the rights of an indemnity holder?
Under indemnity contracts, the indemnity holder, when sued, has a right to recover from the promisor (i.e., indemnifier): (a) all damages that he may be compelled to pay, (b) all costs of suit that he may have to pay, and (c) all sums that he may have paid under the terms of the compromise of such lawsuit. He can recover all of these sums as soon as his liability has become certain. There is no need to pay the amounts first and then recover them from the indemnifier.
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