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The contract of indemnity as described in section 124 of the Indian Contract Act, is a contract between two parties where one party promises to indemnify the other party in case the later one suffers from any loss or to incur any kind of expenses or to protect him from any legal consequences which have been caused by the conduct of the promisor himself or caused by the third party.
Like if A states that he shall bear all the expenses or losses incurred by B which is caused by the act of the third-party with whom B has any type of contract, let it be Z in this case. The whole point of instituting the indemnity clause in the commercial contract is to exclude the affected party form any type of loss or incurring any type of liability.
This type of contract is needed especially for companies dealing with high-risk business as they enable one party to be protected against the liability arising from the act of another party. This type of contract ensures that one party is protected from any unforeseen circumstances and contract like these promote the business as companies can trade without having to worry about the incurring losses from the third parties as they are secured in that front.
Now, prior to the amendment of section 124 of the Contract Act, it previously stated that only those cases of indemnity would be taken into account which has occurred due to the conduct of the promisor or any other third party.
The essential principle was that loss has to occur only with the intervention of any human act. But if a loss occurred due to any natural act, that type of events wasn’t specified previously in the section. It also didn’t include the ambit of the contract of insurance.
Then with the suggestion of the 13th Law Commission Report, it recommended amending the provision to its present state, now the present provision as it stands states that any loss incurred which may or may not have been caused by human activity can be indemnified.
II. Contract of indemnity
Indian Contract Act, as defined in section 124 states that “A contract by which one party promises to save the other from loss caused to him by the contract of the promisor himself, or by the conduct of any other person, is called a “contract of indemnity”.
The section states that when a person enters into a contract with another party where he promises to save the first party form any losses that would arise from the contract of the promisor or from any other party.
This type of contract includes 3 parties; first is the promisor, second is the promisee and the last one is indemnifier. Now, indemnifier would choose to indemnify the promisor from any losses which he incurs in the transaction with the promisee or from any other person.
Like A promises B to indemnify him from any losses which would arise in the course of a transaction with C or from any third party, then the contract between A & B would be declared as Indemnity contract. The only restriction it provides is the loss arisen from the accidents like fire or perils of the sea.
In the famous case of Secretary of State for India v Bank of India, a forged indorsement bill was given to the bank and gave the money as per the value and then the bill was sent to the Public Debt Officer. Now the original owner of the bill recovered the amount of the bill from the state and the state sent the notice to the bank for indemnifying the transactions as the implied promise of the indemnity.
The court held that since there was a contract of indemnity with the bank and the state to indemnify the state in case of any loss was a valid contract and that bank has the duty indemnify the loss to the state.
Need for indemnity in commercial contracts
The indemnity clause is one of the most common clauses used in contractual agreements. The basic idea of importing the concept of indemnity in the contractual relationships is to limit the loss incurred by one of the party and shift it to another party with the consent of both the parties. The main aim is to protect the indemnity holder form the lawsuit filed against him by the third party and thus resolving him from any legal claims that can be raised against him.
One of the important aspects of interpreting the indemnity clause is that the scope of the indemnity agreement has to be considered within the context of the agreement as a whole. The interpretation of the meaning and language of the clause should be done taken into account contextualism of the agreement in its entirety.
Usually, the indemnity contracts are drafted in a wide manner so that it could include the third party liabilities because if whose conduct, negligence loss has been incurred by the indemnity holder there are a multitude of the reason for incorporating indemnity clause in the contracts which include the following:-
- Risk management
- Unforeseeable loss
- Extent of loss
Right of indemnity holder
Right to indemnity holder has been stated in section 125 which states that “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 in respect of any matter to which the promise to indemnify applies;
(2) 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 promisor, and acted as it would have been prudent for him to act in the absence of any contract of indemnity, or if the promisor authorized him to bring or defend the 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 one which it would have been prudent for the promisee to make in the absence of any contract of indemnity, or if the promisor authorized him to compromise the suit.”
This section states that what type of losses shall, the indemnifier shall be bound to indemnify to the indemnity-holder. It states that he is bound to indemnify all the damages indemnity holder has been compelled to pay by the court, all the costs incurred by him in defending or bringing the suits in the court and all the sums which he has to pay under the terms of compromise of such suit.
Commencement of liability
Now the important question arises when is the liability of indemnifier commences, i.e. when shall the indemnifier liable to pay, when the indemnity holder has actually suffered the loss and he had paid off the claim, then indemnifier would satisfy his liability or when indemnity holder has suffered the loss then the indemnifier pay of his liability?
So in English law, it’s the notion that “you must be damnified before you claim to be indemnified” which essentially means is that one must suffer injury, (injury in sense, by paying the all the damages, cost & sums) then one can claim indemnity from the indemnifier.
But the notion has been changed in the of Gajanan Moreshwar v Moreshwar Madan, where it was held that it indemnity would not be of much use if the indemnity holder couldn’t enforce his indemnity until and unless he has actually paid the loss amount.
It may happen that indemnity holder doesn’t have the required amount or in a position to pay and if the indemnity couldn’t be enforced at that point of time then the whole point of having indemnity contract gets vitiated.
III. Insurance contract
All the insurances contracts are indemnity contract except for the life insurance and personal accident insurance. The insurer’s promise to indemnify is an absolute one and suit can be file if the insurer failed to indemnify irrespective of the fact whether an actual loss has been incurred or not.
The basic premise is that insurance contract is undertaken so that if any untoward incident happens then policyholder doesn’t have to pay as his losses are covered by the insurer. Like in case of fire insurance, before policyholder had to pay for his loses; the insurer has the duty to pay all the claims after duly assessing the damage of the property.
The main aim of the insurance contract is to put the policyholder back to place before such an incident took place. Now before insurer indemnifies the policyholder, certain conditions have to be proved, which are as follows:-
a. Compensation amount
It’s the settled principle and contract is drafted in such a way to ensure that amount of compensation that can be claimed in the event of such loss takes place shall be equal to the amount of the insurance taken by the policyholder.
For example, if the policyholder takes the insurance of 10 Lakh and the damage is of 20 lakhs he shall have the claim from the insurer only up to 10 lakhs only and he has to bear for the rest of the amount.
b. Excess amount
This one is in direct relation with the previous one, as per which of the policyholder receives the amount in excess of the damage then the insurer has the right to claim the rest of the amount. Like if A has suffered the loss of 5 Lakh and he gets the claim of 10 Lakhs then the insurer has the right to reclaim the rest of the amount.
The idea behind this principle is that policyholder can’t have an income out of the insurance contract. This was held in the case of Castellain v Preston, where Brett LJ held that “Every contract of Marine or Fire insurance is a contract of indemnity, and of indemnity only, the meaning at which is that the assured in case of a loss is to receive of full indemnity but is never to receive more.
Every rule of insurance law is adopted in order to carry out this fundamental rule, and if any proposition is bought forward, the effect of which is opposed to this fundamental rule, it will fond to be wrong.”
c. Exclusionary principle
As already discussed this principle of indemnity doesn’t apply to the insurance and personal accident claims as the idea behind it is that section 124 of the Act basically states that indemnifier is bound to indemnify the indemnity holder if he suffers any losses due to the promisor or due to any act of the third person.
It doesn’t cover the promise to indemnify the loss not arising out of the human agency. So fire or life insurance contract doesn’t come under the ambit of section 124, though they are valid and shall come under the contingent contract. But the motor or marine insurance contracts are considered valid indemnity contract under section 124 of the Act provided the loss arise out of the act of human agency.
In the case of United India Insurance Co v Aman Singh, certain goods where to be transported from one to another and because of which the goods were stored in the godown. When the goods wherein the godown, it caught fire and the entire stock was destroyed. So the plaintiff asked the insurer to indemnify the loss incurred by him.
It was held that since the destroying of the goods happened not because of any human agency but because of natural event remedy was not available under section 124 of the Act, but the plaintiff can claim compensation through other statues.
Law Commission of India has also stated about the discrepancy between the indemnity principle and insurance contract in its 13th Report and stated that, its high time that the understanding of the indemnity must be expanded so that insurance contract can also be included in its aspect as both deals with the same issue, indemnifying the indemnity-holder. It was suggested to include those cases of insurance which occurred not because of the human agency but because of the natural event.
d. Third-party consideration
this principle states that if the policyholder receives any amount over and above the amount given by the insurer, then the insurer shall have the right to such amount
After thoroughly analyzing various case laws and section 124 of the Act, in it can be stated that both the understanding of the indent contract and insurance contract are restricted and limited to the understanding that if loss happens only because of the human agency then only the claim of the indemnity holder shall be applicable.
Now it has to be understood that it’s an old enactment and now a day’s destruction of property happening because of the natural event is more likely than the destruction of property because of human agency. It’s a very limited analysis that only when human agency is involved then only the claim can succeed.
So, to avoid this vice, the parliament has enacted separate provisions dealing with insurance contract separately because of its special nature. But that doesn’t mean that insurance contract can’t come under the ambit of section 124 of the Act. Time will only tell whether separate legislations for insurance will suffice or it needs the help of the indemnity principle after widening its scope.
 Indian Contract Act 1872, section 124.
 Avtar Singh, Contract & Specific Relief (12th edn, Eastern Book Company, 2017).
 13th Law Commission Report, ‘Contract Act, 1872’ <http://lawcommissionofindia.nic.in/1-50/Report13.pdf> accessed 11 July 2019.
 Secretary of State for India v Bank of India AIR 1938 PC 191
 Gajanan Moreshwar v Moreshwar Madan Mantri AIR 1942 Bom 302
 New India Assurance Co ltd v State Trading Corporation of India AIR 2007 NOC 517 (Guj)
 Castellain v Preston  11 QBD380
 United India Insurance Co v Aman Singh AIR 1994 P&H 206