Rights Of Indemnity Holder – Section 125 of Indian Contract Act

Introduction:

Indemnity is a legal concept, entered in the form of a contract, or mentioned as a clause in commercial contracts, wherein a party promises to the indemnified party to do good the losses arising as a consequence of the acts of the promisor or any third party.  It can also be invoked in cases where the indemnified person gets sued by a third party, and so, is used to cover expenses incurred in law suits. Thus, it is a contract, contingent on the occurring of losses. This can be explained with an illustration: “A agrees to compensate B for the consequences of any legal action taken by C against B in relation to a specific sum of rupees. This is an indemnification agreement.”

What is “Indemnity”?

The concept of indemnity originated in Adamson v. Jarvis[1] case in 1827. In this case, Jarvis, the principal, represented to Adamson, an auctioneer, that he was the owner of cattle and other goods, and allowed the auctioneer to sell them. The auctioneer was ignorant about the fact that Jarvis did not have rights over the goods and cattle.  Adamson merely followed the instructions and sold it. However, he was sued for conversion. Adamson was ordered to recover damages and other expenses from Jarvis and compensate it to the true owner.[2]

Contracts of indemnity in India are governed under the Indian Contract Act, 1872. Section 124 of the Indian Contract Act, 1872 discusses about the 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 conduct of any other person.” Within the meaning of the definition, indemnity is a term, which can be vastly and flexibly interpreted to mean any express or implied promise by one party to not let the other party suffer losses. The loss referred should be caused exclusively by conduct of a ‘human agency’. In other words, it must not include any loss accruing to unforeseeable circumstances or inevitable accident or Act of God. As such, the indemnified or protected party is the sole beneficiary and is also vested with certain rights.

The English law definition of a contract of indemnity states, “It is a promise to save a person harmless from the consequences of an act”. Under English Law, indemnity encompasses a wider meaning compared to the Indian Law definition. It includes a contract to protect the promisee from any loss, irrespective of whether it was caused by human agency, or any other event like fire, accident, earthquake and other natural calamities. Moreover, under English law, insurance (other than Life Insurance) also comes under the contract of indemnity.

Rights of Indemnity Holder

An indemnity holder holds the right to sue the promisor for specific performance if the liability incurred is absolute and the contract of indemnity covers it.

Section 125 of the Indian Contact Act, 1872 highlights three rights conferred upon the indemnity holder when sued. According to it,  

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 (or she) 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 (or she) 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 (or she) 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.

Note: Although only three express statutory rights are mentioned in the Act, these are not exhaustive. An indemnity holder has the option to seek recourse to other equitable remedies.

These rights can be invoked only when the indemnity holder is sued. These three rights can be elaborated as:

1. Damages

The indemnity holder has the right to claim damages which he was compelled to pay in a lawsuit proceeding. The indemnifier then becomes liable to pay those damages which were agreed upon bona fide. Moreover, all the damages paid by the indemnity-holder to any third person or the indemnifier himself can be recovered by the indemnifier

In Parker vs. Lewis[3], the court held that “…if a person has agreed to indemnify another against a particular claim or a particular demand, and an action is brought on that demand, [indemnified] may then give notice to the [indemnifier] to come in and defend the action, and if he does not come in, and refuses to come in, [indemnified] may then compromise at once on the best terms he can, and then bring an action on the contract of indemnity. On the other hand, if [indemnifier] does not choose to trust the [indemnified] with the defence to the action, he may, if he pleases, go on and defend it, and then, if the verdict is obtained against him, and judgment signed upon it…at law that judgment, in the case of express contract of indemnity is conclusive”.

However, this dictum directed the defendant to be liable to indemnify as regards express indemnity contract.[4] In simple words, the court opined that if the indemnified brought an action to claim damages from the indemnifier, or agrees to compromise the suit, the indemnifier would be absolutely liable to compensate irrespective of whether the case was decided in his favour or not. Even when the suit is appealed further, the indemnifier would still be liable to pay as per the contract.

In Nallappa Reddi v. Vridhachala Reddi[5], the court clearly stated that the defendant (in this case, the indemnifier) cannot escape liability to indemnify the indemnified by alleging any contentions.[6]

2. Costs

The indemnified has the right to claim costs incurred while defending a law suit, given that he/she acts in a prudent manner, and not against the order of the promisor, or with the authority of the promisor.

In Alla Venkataramanna vs. Palacherela Manqamma[7], the court stated that the indemnifier is liable to indemnify the promisee for losses incurred while defending lawsuits by third parties, in spite of not being a party to the contract.

In Pepin vs. Chunder Seekur Mookerjee[8], it was held that costs reasonably incurred (by indemnified) in resisting or reducing or ascertaining the claim may be recovered (from the indemnifier).[9]

3. Sums

Amount paid in case of compromise of the suit can also be recovered, without contravening the orders of indemnifier. For this arrangement, the indemnifier must act in good faith and his/her aim must not be to deceive the indemnifier.  The bargain must also be reasonable and not immoral. In other words, anything more would be undeserved windfall for one party and penalty of the other.[10] For instance, in Anwar Khan vs. Gulam Kasam[11], the court stated, “The measure of damages would depend upon the extent to which the person has been indemnified, if more than the amount, the indemnifier may refuse as well.”[12] Likewise, in Gopal Singh v. Bhawani Prasad[13], the court maintained that only those costs can be recovered that are supposed to be incurred by a reasonable person.[14]

Duties of Indemnity Holder

Rights always come hand-in-hand with duties. The indemnity holder has some implied duties, for instance, to comply with the terms and conditions of the contract. It must be noted that these duties of the indemnified are the ‘rights’ of indemnifier. Thus, unless otherwise specified in the contract, the indemnifier will not be responsible for damage in the following conditions:

1. Duty to act prudently– The indemnity-holder must act reasonably. If the indemnity-holder acts negligently, the indemnifier shall not be liable to indemnify.

2. Duty not to act to cause harm or loss– The indemnity-holder must not intend to deceive or cause harm to the indemnifier, and thus, must act in good faith.

3. Duty to comply with the orders of Promisor– If the indemnity-holder acts in contravention of the orders of the Promisor, the indemnifier will not be responsible for such losses which arise due to non-compliance of instructions.

When can an indemnifier be made liable?  

This is a significant question which follows these rights and duties of Indemnity Holder. There is a difference of opinion among the High Courts in India as to whether the indemnified can be demnified before incurring actual losses. The Nagpur[15] and Lahore[16] HCs have held that no indemnity can be claimed until the indemnified suffers actual loss. The HCs of Bombay[17], Calcutta[18], Patna[19], Madras[20] and Allahabad[21] have upheld the position of the Courts of Equity in England, according to which an indemnified can compel the promisor to obtain the indemnity, even before suffering actual damage.[22] This has largely been recognized so as to ensure that the indemnified holds enough funds to afford lawsuits for claims.

What is the Limitation Period to enforce the Rights of Indemnity Holder in India?

Normally, the limitation period is 6 years, commencing from the date of the breach of the indemnity contract. However, depending on the terms and conditions, and clauses stated in a contract, it is crucial to note that the limitation period may start from the date on which the indemnified refuses to comply with the orders of the indemnifier, or dishonours the indemnity contract.[23]

Conclusion

To sum up, the contract of indemnity is an effective tool to protect and secure a party from losses. The indemnified party is given an advantage to the extent that they need not prove the causation of event, or its proximity to the default of the promisor or any third-party, but simply its occurrence is enough to claim damages. The party is also entitled to claim damages suffered as a result of breach of contract. All this has ensured that the indemnified party comes out unaffected from the consequences of any event bringing harm.

As evident, the provision on rights is not exhaustive, and allows scope for wider interpretation in the interests of equity and justice. The Law Commission in its recommendation (in 13^th Report, 1958) has maintained that “the rights of the indemnity holder should be more fully defined and the remedies of an indemnity holder should be indicated even in cases where he has not been sued.” Thus, redefining and incorporating more rights in favour of the indemnity holder can go a long way in securing their interests, and easing the burden of costs and risks resulting out of lawsuits and other acts of third-parties.

Reference

[1] [1827] 4 BING 66

[2] Case Summary: ADAMSON V. JARVIS (1827) 4 BING. 66:29 R.R 503, available at: https://www.ejusticeindia.com/case-summary-adamson-v-jarvis-1827-4-bing-6629-r-r-503/ (last visited on June 30, 2021).

[3] (1873) 8 Ch App 1035

[4] Gray vs. Lewis AND Parker vs. Lewis, available at: https://indiancaselaw.in/gray-vs-lewis-and-parker-vs-lewis/  (last visited on June 30, 2021).

[5] (1914) 37 Mad 270

[6] Nallappa Reddi vs. Vridhachala Reddi and Anr., 6^th October 1914, available at: https://advocatespedia.com/Nallappa_Reddi_vs._Vridhachala_Reddi_and_Anr,_6th_October_1914 (last visited on June 30, 2021).

[7] AIR 1944 Mad 457.

[8] ILR (1880) 5 Cal 811

[9] Pepin vs. Chunder Seekur Mookherjee and Anr. On 1^st April 1880, available at: https://advocatespedia.com/Pepin_vs._Chunder_Seekur_Mookerjee_and_Anr._On_1st_April_1880  (last visited on June 30, 2021).

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

[11] AIR 1919 Nag 126

[12] Rights of Indemnity-Holder, available at: https://www.legalbites.in/rights-of-indemnity-holder/  (last visited on July 1, 2021).

[13] (1888) ILR 10 All 531

[14] Section 125: Rights of Indemnity Holder, available at: https://thefactfactor.com/facts/law/civil_law/contract_laws/indian_contract_act/section-125-rights-of-indemnity-holder/11746/  (last visited on June 30, 2021).

[15] Ranganath v. Pachusao, A.I.R. 1935 Lahore 974.

[16] Sham Sunder v. Chandu Lal, A.I.R. 1935 Lahore 947

[17] Gajanan Moreshwar v. Moreshwar Madan, A.I.R. 1942 Bom. 302.

[18] Prafulla Kumar v. Gopee Ballabh Sen, I.L.R. (1944) 2 Cal. 318.

[19] Chunibhai Patel v Natha Bhai Patel, AIR 1944 Pat 185;

[20] Ramalingathudayar v Unnamalai Achi, (1915)38 Mad 791

[21] Shiam Lai v Abdul Salam, AIR 1931 All 754

[22] Dr. R.K. Bangia, Contract-II (Allahabad Law Agency, Haryana, 7^th edition, 2017).

[23] Importance of the Indemnity Clause in a Commercial Contract, available at: https://www.indialawoffices.com/legal-articles/importance-of-the-indemnity-clause-in-a-commercial-contract  (last visited on July 1, 2021).

Also Read – Types of Damages in Contract Law (Section 73 of Indian Contract Act)

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