Contract of Indemnity under Sections 124 and 125 of the Indian Contract Act, 1872: Essentials, Express and Implied Indemnity, When the Indemnifier's Liability Commences, and Indemnity Compared with Guarantee and Insurance

Section 124 defines a contract of indemnity more narrowly than the expression is used in practice. It covers only a promise to save another from loss caused by the conduct of the promisor himself or of any other person, which leaves out loss caused by an accident or by an event nobody brought about. English law is wider, treating indemnity as a promise to save harmless from loss however caused, and Indian courts have held that Sections 124 and 125 are not exhaustive, so the wider cases are dealt with on general principles. The other question of practical importance is when the indemnity-holder may call on the indemnifier, and the answer given by the Indian courts is more generous than the section suggests.

1. The Definition

Sections 124 and 125, Indian Contract Act, 1872

124. Contract of indemnity defined. 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.

Illustration. A contracts to indemnify B against the consequences of any proceedings which C may take against B in respect of a certain sum of two hundred rupees. This is a contract of indemnity.

125. Rights of indemnity-holder when sued. 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 authorised 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 authorised him to compromise the suit.

Two parties or three, and the consequences that follow from the difference

2. Essential Elements

Two parties. The indemnifier, who promises to make good the loss, and the indemnity-holder or indemnified, who is to be saved from it.
A promise to save from loss. The undertaking must be to protect against loss, and not merely to answer for another's default, which is a guarantee.
The loss must be caused by the conduct of the promisor or of some other person, on the language of Section 124.
All the requirements of a valid contract must be satisfied, since a contract of indemnity is a contract: free consent, capacity, lawful consideration and object under Section 10.
The object must be lawful. An indemnity against the consequences of a criminal act, or against a liability the claimant knows to be unlawful, is void under Section 23.

2.1 Express and implied indemnity

An indemnity may be express, in words, or implied from the relationship or the circumstances. Section 9 applies to indemnities as to any other contract. The commonest implied indemnities are the agent's right to be indemnified by his principal under Section 222, the right of a person who acts on another's instructions in circumstances where both believe the act to be lawful, and the indemnity implied in favour of a person who pays another's liability at his request.

📖 Adamson v. Jarvis, (1827) 4 Bing 66

Facts: An auctioneer sold cattle on the instructions of a person who represented himself to be the owner but was not. The true owner sued the auctioneer in conversion and recovered. The auctioneer then sought to be indemnified by the person on whose instructions he had sold.

Held: The auctioneer was entitled to be indemnified. A person who does an act at another's request, which is not manifestly unlawful to his own knowledge, is entitled to assume that the person requesting it is indemnifying him against the consequences, and the law implies a promise to that effect. The auctioneer having acted innocently on the defendant's representation, the defendant had to make good the loss.

Ratio: Where a person acts on another's request in circumstances where the act is not manifestly wrongful to his knowledge, the law implies a promise by the person requesting it to indemnify him against the consequences.

3. When the Indemnifier's Liability Commences

Section 125 speaks of what the indemnity-holder may recover, and on a literal reading it suggests that he must first have been made to pay. That was the older English rule and it produced an obvious injustice: an indemnity-holder without the means to pay would have to be ruined before his indemnity became worth anything. The Indian courts have rejected it.

📖 Gajanan Moreshwar Parelkar v. Moreshwar Madan Mantri, AIR 1942 Bom 302

Facts: The plaintiff had obtained a lease of a plot and, at the defendant's request, transferred the benefit of it to him. The defendant began construction and obtained materials on credit, and at his request the plaintiff executed a mortgage of the plot in favour of the supplier to secure the price and interest. The defendant agreed to pay the mortgage amount and to get the plaintiff released from liability, but did not do so. The plaintiff, who had not yet paid anything, sued to compel him to discharge the liability.

Held: Chagla J held that the plaintiff was entitled to relief although he had suffered no actual loss. Sections 124 and 125 are not exhaustive of the law of indemnity in India, and the courts follow the same equitable principles as the English courts of equity. If the indemnity-holder has incurred a liability which is absolute, he is entitled to call on the indemnifier to put him in a position to meet it before he is actually called on to pay. To hold otherwise would make an indemnity worthless to a person who cannot pay first.

Ratio: The indemnity-holder need not wait until he has actually paid. Once his liability is absolute, he may compel the indemnifier to discharge it or to place him in funds, and Sections 124 and 125 do not exhaust the law of indemnity.

⚠ Section 124 is narrower than indemnity in commercial usage

Two limits are built into the definition and both are routinely encountered. The loss must be caused by the conduct of the promisor or of some other person, so on a literal reading a promise to make good loss caused by fire, flood or an accident is outside Section 124. And the definition speaks of a promise to save from loss, which on one view requires loss to have been suffered. Indian courts have resolved both difficulties by holding that the sections are not exhaustive and by applying equitable principles, as Gajanan Moreshwar shows. In practice a commercial indemnity clause is construed on its own terms, and the section serves as a starting point rather than a boundary.

4. Rights of the Indemnity-Holder

What may be recovered	Condition attached by Section 125
Damages he is compelled to pay in a suit	The matter must be one to which the promise to indemnify applies, and he must have acted within the scope of his authority
Costs he is compelled to pay	He must not have contravened the promisor's orders, and must have acted as a prudent person would have acted with no indemnity, or with the promisor's authority
Sums paid under a compromise	The compromise must not be contrary to the promisor's orders, and must be one a prudent person would have made without an indemnity, or authorised by the promisor
To be put in funds before paying	Not in Section 125, but available on equitable principles once the liability is absolute, per Gajanan Moreshwar

Three points run through the section. The indemnity-holder must have acted within the scope of his authority; he must not have contravened the indemnifier's orders; and where there were no orders, he must have acted as a prudent person would have acted in the absence of an indemnity, which prevents him from defending or compromising extravagantly at the indemnifier's expense.

5. Rights of the Indemnifier

To be informed of any claim to which the indemnity applies, and to be given the opportunity to give directions, although the Act does not say so expressly; a failure to notify may affect the reasonableness of what the indemnity-holder then does.
To give orders as to the conduct of the litigation, which the indemnity-holder contravenes at his own risk under clauses (2) and (3) of Section 125.
To take over the defence where the contract so provides, which most commercial indemnity clauses expressly permit.
To the benefit of securities and rights, on the principle that on making good the loss he stands in the position of the indemnity-holder as against the person whose conduct caused it. The Act contains no provision equivalent to Section 140 for indemnities, and the right rests on general principles and on the terms of the contract.
To resist a claim beyond the scope of the indemnity, since the promise covers only the matters it describes.

6. Indemnity and Guarantee Compared

Point of difference	Indemnity, Sections 124 to 125	Guarantee, Sections 126 to 147
Number of parties	Two: indemnifier and indemnity-holder	Three: surety, principal debtor and creditor
Number of contracts	One	Three: between creditor and principal debtor, creditor and surety, and surety and principal debtor
Nature of the liability	Primary and independent	Secondary and collateral; it arises on the principal debtor's default
Existence of a prior debt	None. The liability arises on the event indemnified against	There must be an existing or contemplated debt or obligation of the principal debtor
Request of the third party	Not required	The surety undertakes at the request, express or implied, of the principal debtor
Right of subrogation	Not conferred by the Act; rests on general principles and the contract	Expressly conferred by Section 140 on payment
Right of indemnity against another	None as of right	Section 145 implies a promise by the principal debtor to indemnify the surety
Typical use	Insurance, commercial risk allocation, agency	Bank guarantees, personal guarantees for loans, performance guarantees

7. Indemnity and Insurance Compared

Insurance is a species of indemnity, and contracts of fire, marine and general insurance are contracts of indemnity in the wider sense, though not all fall within the narrow words of Section 124 because the loss is often caused by an event rather than by anyone's conduct.
Life insurance is not a contract of indemnity at all. It is a contract to pay a fixed sum on a specified event, which is why the insurable interest need exist only at inception and why the sum assured is payable regardless of the actual loss.
Insurance is a contract uberrimae fidei, requiring disclosure of every material fact, subject in life insurance to Section 45 of the Insurance Act, 1938. A commercial indemnity is not ordinarily a contract of utmost good faith.
Insurance requires an insurable interest, failing which the arrangement is a wager void under Section 30. An indemnity requires no such interest.
Insurance is regulated by the Insurance Act, 1938 and by the Insurance Regulatory and Development Authority; a commercial indemnity is governed by the general law of contract.
Subrogation is a standard incident of indemnity insurance, the insurer stepping into the assured's rights against the wrongdoer on payment.

8. Indemnity Clauses in Commercial Contracts

Scope. The clause should identify precisely the losses, claims, liabilities and expenses covered, and whether it extends to third-party claims only or also to direct losses between the parties.
Trigger. Whether the indemnity responds on the indemnity-holder incurring a liability or only on his making a payment. Gajanan Moreshwar allows recovery before payment where the liability is absolute, but an express provision removes the argument.
Conduct of claims. Notice requirements, the indemnifier's right to take over the defence, and restrictions on settling without consent, which correspond to the conditions in clauses (2) and (3) of Section 125.
Caps and exclusions. Financial limits and exclusions of indirect and consequential loss. Where a sum is named as payable on breach, Section 74 caps recovery at reasonable compensation not exceeding it.
Lawfulness. An indemnity against the consequences of a criminal or otherwise unlawful act is void under Section 23, while an indemnity against the consequences of an act innocently done which turns out to be tortious is enforceable, as Adamson v. Jarvis shows.

9. The Position Stated Shortly

Section 124 covers a promise to save from loss caused by the conduct of the promisor or of any other person, which is narrower than indemnity in commercial usage.
Sections 124 and 125 are not exhaustive, and Indian courts apply equitable principles to cases outside them.
An indemnity may be express or implied, and Adamson v. Jarvis shows the implied indemnity where a person acts on another's request.
Section 125 permits recovery of damages, costs and compromise payments, subject to acting within authority, not contravening orders, and acting prudently.
Gajanan Moreshwar: the indemnity-holder need not pay first; once his liability is absolute he may compel the indemnifier to discharge it.
Indemnity creates a primary liability between two parties; guarantee creates a secondary liability among three.
A guarantee presupposes an existing or contemplated obligation of a principal debtor; an indemnity does not.
Sections 140 and 145 give the surety subrogation and an implied indemnity; the Act gives the indemnifier no equivalent, and his rights rest on general principles and the contract.
Insurance is a species of indemnity, except life insurance, which is a contract to pay a fixed sum and is not an indemnity at all.

10. Related Topics and Provisions

Topic or provision	Connection
Contract of Guarantee under Section 126	The three-party comparison in full
Rights of the Surety under Sections 140 to 147	Subrogation and indemnity, which the Act gives a surety and not an indemnifier
Wager vs Insurance Contract	Insurable interest and why life insurance is not an indemnity
Contingent Contracts under Sections 31 to 36	Indemnity as a contingent contract
Sections 124 and 125, Indian Contract Act	The definition and the rights of the indemnity-holder
Section 222, Indian Contract Act	The agent's statutory right to be indemnified
Section 23, Indian Contract Act	Indemnity against an unlawful act
Section 74, Indian Contract Act	Caps on recovery where a sum is named
Insurance Act, 1938	Regulation of insurance and Section 45