Contract of Indemnity

In a contract of indemnity, protection is provided to the party who has suffered a loss or injury because of the non-performance or breach of contract. The term indemnity is derived from the Latin term,’indemnis’ which means free from injury or loss. Mostly the contract of indemnity is used for business purposes for loss incurred. Businesses depend on the contacts of indemnity to play it safe and to avoid loss and damages from non-performance of any party or refusal to perform.

CLAT 2025: 10 Free Mock Tests | Legal Maxims | Landmark Judgements | PYQs

CUET BA LLB 2025:  Legal Studies ebook | 5 Free Mock Tests

MH CET LAW 2025: 10 Free Mock Tests | Legal Reasoning Practice Questions

Monthly Legal Current Affairs:  August’24 | July’24 | June’24

Overview of the Contract of Indemnity

According to section 124 of the Indian Contract Act, 1872 contract of indemnity is used by a party to save themselves from loss incurred due to non-performance by another party to a contract. This indemnity clause acts as a remedy or security against damages and injury.

Illustration-

X comes into a contract with Y to indemnify Y from the loss that Y is going to face because of the consequences of any court proceeding which amounts to Rs. 1000. In this case it can be said that the contract of indemnity.

In a contract of indemnity, one party promises to save the other party from loss caused due to firstly, by the misconduct of the promisor himself and secondly, by the misconduct of any othe person to the contract.

Parties involved in a Contract of Indemnity

The contract of indemnity consists of two parties the one party who promises to compensate the other party for the loss incurred is known as indemnifier and the other party who is indemnified or has sustained the loss is called indemnity holder. The indemnifier takes the responsibility to protect the rights of the indemnity holder and compensates for the loss incurred.

Essential elements to constitute a Contract of Indemnity

In a contract of indemnity, the indemnifier who is the one who compensates the party who has sustained loss is called the indemnity holder. A contract of indemnity occurs when a party suffers a loss due to the non-performance of either party to a contract. Here, are the essential conditions required to constitute a contract of indemnity-

1. There should be two parties involved in a contract to constitute the contract of indemnity.

2. There should be a valid offer that should be made by the offerer and a valid acceptance to constitute a contract of indemnity.

3. To constitute a contract of indemnity the contract should be expressed or implied in nature.

4. The contract should be on a legal object and should be according to the law.

5. To constitute a contract of indemnity the parties involved in the contract should be competent enough to enter into a contract.

6. The purpose of a contract of indemnity is to protect the party who has sustained loss or damages.

7. One of the important elements of a contract of indemnity is that the other party is only liable when another party sustains a loss.

8. The indemnity holder has all the right to compel the indemnifier to pay for the loss that he has sustained.

Different Types of Indemnity

1. Express indemnity

Express indemnity also known as written indemnity. As the name goes is a written contract, not an oral one. In an express indmenity, all the rules and conditions are mentioned in a contract. The contract of express indemnity consists of all the rights obligations and duties of the parties. An indemnity Attorney needs to be present while drafting a contract of expressed indemnity.

2. Implied Indemnity

Implied indemnity is opposite to that of expressed authority as in an expressed authority all the terms and conditions are written down in a contract whereas in an implied indemnity contract the terms and conditions are not written down. The facts, actions and conduct of the parties lead to obligation in an implied indemnity contract. The master-servant relationship is one example of an implied indemnity contract.

Rights Of The Indemnity Holder

The indemnity holder is the one who has sustained the loss due to the non-performance of the other party to a contract. Section 125 of the Indian Contract Act 1872 deals with the right of the indemnity holder. The rights of the indemnity holder are mentioned below-

1. He may be compelled to pay all the damages as promised in the contract.

2. The cost and damages which he has to pay in a suit if it is filed against him while defending it. He cannot contravene his duties.

3. The damages he has to pay under the terms and conditions if a suit is filed against him or if there is any provision of compromise in the contract. And if the compromise does not match the orders laid down by the promisor he has to pay if there were no provision of contract of indemnity.

Rights of the Indemnifier

Indminifer is the one who pays for the damages or loss sustained due to breach of contract to the indemnifier who has sustained the loss. The indemnifier is liable to pay the damages to the indemnity holder for the loss that he has sustained. Here, are the rights of the indemnifier-

1. After the indemnifier has done with his duties which means once he has paid for the damages to the aggrieved party that is the indemnity holder then the indemnifier has all the right to protect the indemnity holder’s rights. Once the indemnifier pays the damages to the indemnity holder the compensator has all the rights that can save the indemnity holder from damages

2. The contract of indemnity will only work if the indemnity holder has sustained any loss or injury.

3. The indemnifier is bound to indemnify the indemnity holder within a period.

4. The Bombay High Court In the case of Gajanan Moreshwar v. Moreshwar Madan (1942) it was held that the liability is on the indemnifier to indemnify the indemnity holder within a certain period. And the indemnity holder can compel the indemnifier to pay the damages.

When Can an Indemnifier be made liable to pay damages?

As given in the English common law an indemnifier cannot be made liable unless and until the indemnity holder suffered any loss or damages. In many cases, such a situation arrived when the indemnity holder was not in a position where the indemnity holder couldn't pay the damages. This makes it clear that it is the responsibility of an indemnifier to compensate the indemnity holder only when the indemnity holder has sustained a loss or damage due to a breach of contract.

According to a decision of the Lahore and Nagpur High Court, an indemnity holder can only be indemnified if he has sustained a loss.

In the case of State Bank of India v. Mula Shakari Sakhar Karkhana Ltd.

In this case, the respondent a cooperative society entered into a contract with M/s Pentagon Engineering Pvt. Ltd for the establishment of a paper plant. As per the conditions of the agreement the Pentagon Engineering Company set a bank for the release of the indemnity. The operative section of the bank guarantee documents is written as ‘to indemnify the Mula Shakari Sakhar Karkhana Ltd. from the losses and damages sustained and the supplier will be liable for the damages incurred.

Disputes arose between the party and as the dispute arose the respondent as a result terminated the contract made to establish a paper plant and invoked the guarantee provided by the bank against the Pentagon Engineering Company. Saying that it was the contract of indemnity not a contract of guarantee.

The apex court in this case held that the claim made in exchange for the termination of the contract needed to be paid by the bank without any loss occurring or not.

The Indian view of Contract of Indemnity

Section 124 of the Contract Act 1872 that the sole objective of the contract of indemnity is to indemnify the indemnity holder against the loss or damage sustained by the the indemnity holder. According to Indian law, a contract of guarantee is not included in the contract of indemnity. Thus the contract of insurance does not come under the purview of section 124 of the Indian Contract Act 1872 which is a contract of indemnity.

The Indian view of the contract of Indemnity is narrower compared to the English view of the contract of indemnity. Thus under Indian law, the indemnifier is liable to pay compensation to the indemnity holder for the damages and the loss incurred due to breach of contract.

The English view of Contract of Indemnity

The English view of the contract of indemnity is broader than the Indian view of the contract of indemnity. Under English law, the contract of indemnity can be implied or expressed. Under English law, a person who is in a contract of indemnity or is about to enter into a contract of indemnity will be saved from any loss or damages that occur. Thus, according to English law contract of indemnity means saving the indemnity holder from all harmful consequences of a breach of a contract.

Under English law, the indemnity clause has been given a wider meaning, in which an indemnifier will be liable to indemnify the indemnity holder from loss or damages incurred due to an act by human agency which is not in the case of Indian law. Also under English law, a contract of insurance comes under the contract of indemnity.

Contract of Guarantee

Section 126 of the Indian Contract Act deals with the contract of Guarantee. The contract of guarantee might be different from the contract of indemnity but both are governed by the Indian Contract Act 1872.

According to the definition of contract of guarantee incorporated under section 126 of the Indian Contract Act 1872 a contract of guarantee is a contract where a promise is performed to discharge the liability of a third person in case the third person does any default.

Illustration-

X takes a loan from a bank. And X promises the bank to repay the loan amount. Y is a friend of X and he promises to the bank that if X fails to repay the loan Y will repay the loan on X’s behalf. According to this X is the principal debtor, who takes the loan, and Y is the surety who does not have any primary liability his liability is secondary. Later if X fails to repay the loan amount to bank Y the surety will repay the loan on X’s behalf hence protecting the right of X. In this case, the bank is the creditor.

In a contract of guarantee, there are three parties involved, at first, comes the principal debtor who makes a promise to the creditor to perform the promise he has made. Secondly, comes the surety who undertakes the liability to perform the promise if the principal debtor fails to do so. Thirdly, the surety discharges the promise and the principal debtor has to indemnify the surety for the same.

Features of the Contract of Guarantee

1. A contract of guarantee might be written or oral-

Section 126 of the Indian Contract Act 1872 says that a contract of guarantee can be a written contract or an oral contract. According to English law, a contract of guarantee will only be considered valid if it is in writing and signed by both the party on the other hand in India a contract of guarantee can be written or oral.

2. Presence of a principal debtor is necessary-

In a contract of guarantee a principal debtor is essential to be present. The surety will be liable if the principal debtor fails or refuses to discharge the obligation. In cases where there is no such principal debtor, one party promises to compensate the other party in a situation where the other party cannot pay it.

3. The Benefit to the principal debtor is of sufficient consideration

Consideration is an important essential in any contract formed, consideration is also essential in a contract of guarantee. In a contract of guarantee, there must be a direct consideration between the surety and the creditor. To constitute a sufficient consideration the creditor must benefit the principal debtor.

4. The surety’s consent shouldn't be obtained by misrepresentation

In a contract of Guarantee, the creditor should not obtain a guarantee with the help of misinformation or misorientation of documents or facts related to the transaction. A guarantee which is obtained through unfair means is invalid.

Difference between a Contract of Guarantee and a Contract of Indemnity

Case laws on Contract of Indemnity

In the case of United India Insurance Co. v. Ms Annan Singh Munshilal (1994)

• In the following case, there was a consignment that was to be stored at a godown which was the route to the final destination. As the goods were stored in the godown a fire took place at the godown and the fire destroyed the goods. The goods said that it was lost in transit, and the insurance company on which the insurance of the goods was made was held liable to pay compensation for the loss.
• The court in this case held that the remedy of the contract of indemnity would not apply in this situation as the goods got destroyed due to fire and this comes under the provisions of the contingent contract.

In the case of Chand Bibi v. Santosh Kumar Pal.

• In the following case, the father of the defendants while acquiring rights of a property had made a promise to indemnify the plaintiff if the plaintiff is proven to be accountable for the debt. Later on, the plaintiff filed a suit against the father of the defendant as the father failed to pay the obligation of a mortgage. However, the suit was only against the non-perfromance of the obligations as the plaintiff did not sustained any loss.
• The court in this case held that as the plaintiff did not sustain any loss the contract of indemnity is not applicable here.

Conclusion

In a contract of indemnity, protection is provided to the party who has suffered a loss or injury because of the non-performance or breach of contract. The term indemnity is derived from the Latin term,’indemnis’ which means free from injury or loss. Mostly the contract of indemnity is used for business purposes for loss incurred. Businesses depend on the contacts of indemnity to play it safe and to avoid loss and damages from non-performance of any party or refusal to perform. To conclude this it can be said that the contract of indemnity acts as a remedy for the loss incurred by the indemnity holder.