All you need to know about Indemnity

Meaning, Definition and Scope:

To provide indemnity means to save an individual from loss. In a promise of indemnity one party promises to save another from loss and this is the core concept behind a contract of indemnity between two parties. The party to be saved from incurring loss is refereed to as the ‘indemnity holder’ and the party who is saving the other from loss is called the ‘indemnifier’. It is this promise between the indemnity holder/promisee and the indemnifier/promisor that forms a contract of indemnity.

Section 124 of the Indian Contract Act, 1872 defines a contract of indemnity 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, is called a "contract of indemnity.”[1] The section limits the scope by mandating that the loss must be caused by either the promisor or by a third party thereby excluding losses caused bereft of human agency such as natural disasters, loss at sea, fire and other such accidents.

It is also important to note here that even though a literal interpretation of the section might point towards the need for contracts of indemnity to be in written form, however flowing from general principles governing contract law, a contract for indemnity can be either express or implied. This view was upheld Secy of Sate for India in Council v. Bank of India Ltd.[2] , a case where it was held that there was an implied promise between the State and the Bank which made it possible for the State to recover money from the Bank when it was discovered that the endorsement sent by the Bank in good faith to the Public Debt Office was actually forged.

Extent of Liability:

Section 125 then goes on to define the extent of liability for the indemnifier which in other words translates to the rights that the indemnity holder can enforce against the indemnifier.[3] This section establishes the conclusive liability of the indemnifier to pay all costs, damages and sums that arise with respect to the matters regarding which the contract of indemnity was agreed upon. However, there are still certain conditions mentioned within the Section itself as well as principles established through precedents that must be kept in mind while awarding damages, costs, and sums.

The case of Duffield v. Scott[4] originally established that in order to recover damages it is necessary to prove that the indemnity holder was compelled by law to pay such damages.[5]The court in Nallappa Reddi v. Virdhachala Reddi[6] further elucidated that the right to claim damages ensues from the date of passing of the decree. While claiming damages it is also important to keep in mind the difference between damage due to breach of contract and damage covered under a promise of indemnity, the latter being a wider concept.[7] This is primarily because " ‘Indemnity’ may refer to all loss suffered which is attributable to a specified cause, whether or not it was in the reasonable contemplation of the parties”.[8] There is also no need to prove that the loss incurred is direct in nature and is not remote or indirect.[9]

The case of Gopal Singh v. Bhawani Prasad [10] in consonance with sub-section (2) of Section 125 establishes that in order to recover costs incurred due to litigation, the indemnity holder must be able to show that they acted with prudence while defending a suit or that they acted after being authorized to do so by the by the indemnifier. The indemnity holder can only claim an amount from the indemnifier that is equivalent to the loss suffered and is within the extent agreed upon as any amount higher would lead to the indemnity holder benefiting form undue gain.[11]

Sub-section (3) of Section 125 deals with sums paid in leu of a compromise. A strict interpretation of the section would enable the indemnity holder to recover only those sums brought after the initiation of a suit thereby excluding sums paid in a compromise entered into prior to the initiation of the suit. However, the court in the case of Kali Charan v. Durga Kunwar[12] did not view the Section in a strict and literal manner and broadened the extent of sums recoverable to include a prior compromise as well, as long as it had been made prudently or after receiving due authorization from the indemnifier. It is also important to remember that a promise to indemnify only extends to existing dues and retrospectively imposed dues cannot be claimed against subsequently.[13] The indemnifier while agreeing to pay the amount may also validly impose a condition upon the indemnity holder requiring them to pursue legal remedies available against the third party in order to recover the amount lost and reimburse them if successful.[14]

Commencement of Liability

After discussing the meaning of indemnity and the scope of liability that arises due to it, the next thing one needs to understand is when does the liability commence. In other words when can the indemnity holder demand to be saved from loss or when can the indemnifier be called upon to pay. These questions have not been clearly answered by statutory law but instead, the answer has been developed through judicial precedents.

At the very outset it is necessary to point out that the law established in this regard is different in Indian law as opposed to the original concept developed under English law. According to the original rule, the indemnity holder would only be able to recover money after actual loss had been suffered. Actual loss here refers to payment made by the indemnity holder in leu of claims arising.[15]But the Indian law deviated from this position in the landmark judgement of Gajanan Moreshwar Parelkar v. Moreshwar Madan Mantri[16] where the court changed the emphasis from when the occurrence of actual loss takes place to instead, the moment when the liability becomes absolute.

Justice Chagla while pronouncing the judgement explained that ‘an intolerable burden’ is placed on the indemnity holder if they are required to wait till a judgement has been pronounced, suffer actual loss by paying off the liabilities and only thereafter can they ask the indemnifier to reimburse them.[17] This would lead to an inequitable result where the indemnity holder does not have the ability to repay his dues and cannot enforce the promise of indemnity till he does. Hence the Court held that the indemnifier is required to pay as soon as the liability becomes absolute. Absolute here means that it has become certain and clear that loss will occur.

Indeed, as expounded by LJ Buckley, "Indemnity is not necessarily given by repayment after payment. Indemnity requires that the party to be indemnified shall never be called upon to pay.”[18] This interpretation moves away from the concept of actual loss thereby absolving the indemnity holder to pay at the first instance. If loss becomes absolute in nature, then the indemnifier can either pay off the liabilities or create a fund by depositing money with the court from which the claims can be paid off in the future.[19] This principle was followed in Osman Jamal & Sons Ltd. v. Gopal Purshttam[20] where actual loss had not occurred as the company had not yet paid its dues to the vendor but it was clear that the liability existed which made it an absolute liability and so the court directed for a fund to be created which would be used to settle the dues.

Period of Limitation and Notice:

Contracts of indemnity are also subject to Limitation. The period of limitation is governed by The Limitation Act, 1963 which requires that the indemnity holder must bring a suit calling for the indemnifier to pay within three years.[21] But from when does this period of three years start running was a contentious question. This was answered by the court in the case of Lala Shanti Swarup v. Munshi Singh[22] where there was an implied contract of indemnity between the parties to pay off the original mortgages which stood as an encumbrance upon the property. It was held that the period of limitation should run not from the date when the mortgage was undertaken but instead when the mortgage became repayable and its execution had been called for. [23]

A contract for indemnity may require the indemnity holder to notify the indemnifier that loss has occurred immediately. The word immediately implies that it should be done in a reasonably quick manner.[24] Notice should be given promptly by avoiding delay unnecessarily. It is important to look at whether the indemnity holder had a Bonafede intention to provide notice immediately. For example, if theft has been committed then filing a police report immediately displays genuine intention on the part of the indemnity holder and the indemnifier cannot deny liability even if there was a delay of one month in providing notice.[25]

Conclusion:

A contract for indemnity is a promise between two parties[26] where one party promises to save the other from incurring loss by undertaking any liabilities that may arise on the matter agreed upon. The rights of the indemnity holder and the scope of liability of the indemnifier have been analyzed with respect to damages, costs and sums paid during the course of a compromise. The law on indemnity in India has developed along the principle of liability commencing when it becomes absolute instead of relying on the concept of actual loss which would have made it much more difficult to realize any amount through a contract of indemnity. While the statute is more focused on the rights of the indemnity holder, provisions regarding period of limitation and providing notice exist to look after the interest of the indemnifier as well. The law regarding indemnity in India has been laid down within Sections 124 and 125 of the Indian Contract Act, 1872. However, the statute is not exhaustive on all matters regarding indemnity. The judiciary has the power to interpret the law in an equitable manner.[27]

[1] Indian Contract Act, 1872.

[2] AIR 1938 PC 191.

[3] Indian Contract Act, 1872.

[4] Duffield v. Scott, (1789) 3 TR 374 : 100 ER 628.

[5] Courtney, W., 2015. Indemnities and the Indian Contract ACT 1872. National Law School of India Review, [online] 27, pp.66-88.

[6] ILR (1914) 37 Mad 270.

[7] Osman Jamal v. Gopal Purshottam, (1928) SCC OnLine Cal 131.

[8] Total Transport Corporation v. Arcadia Petroleum Limited, (1997) EWCA Civ 2754.

[9] Hindustan Petroleum Corporation Ltd. v. M3nergy Sdn. Bhd., (2019) SCC OnLine Bom 2915.

[10] ILR (1888-90) 10 All 531.

[11] Cargill International SA v. Bangladesh Sugar and Food Industries Corpn., (1996) 4 All ER 563 (CA).

[12] Kali Charan v. Durga Kunwar, ILR (1913) 35 All 168.

[13] Bishal Chand Jain v. Chattur Sen, AIR (1967) All 506.

[14] Raigad Concrete Industries v. ICICI Bank Ltd., (2009) 4 Mah LJ 923.

[15] Singh, A., 2017. Textbook on Law of Contract and Specific Relief. 12th ed. Lucknow: Eastern Book Co, pp.591-599.

[16] AIR (1942) Bom 302.

[17] Ibid

[18] Richardson, re, (1911) 2 KB 705 CA.

[19] Supra note 16.

[20] Supra note 7.

[21] Article 83 of the Limitation Act, 1963.

[22] AIR (1967) SC 1315.

[23] Ibid.

[24] Praful Kumar Mohanty v. Oriental Insurance Co Ltd., (1997) AIHC 2822 (Ori).

[25] Ibid.

[26] Nagpur Nagarik Sahakari Bank Ltd. v. Union of India, (1981) SCC OnLine AP 19. An agreement between three parties may be a contract of guarantee. A contract for indemnity must be between only two parties.

[27] Supra note 16.