The Contract of Indemnity and Contract of Guarantee are special types of contract. The specific provisions relating to these contracts are contained in Sections 124 to 147 of the Indian Contract Act, 1872. In addition to these specific provisions, the general principles of contracts are also applicable to such specific contracts.

Section 124 : The term 'indemnity' means to make good the loss or to compensate the party who has suffered some loss. It is 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”.

Example A contracts to indemnify B against the consequences of any proceedings which C may take against B in respect of a certain sum of Rs 200. This is a contract of indemnity.

This definition provides the following essential elements -

1. There must be a loss.
2. The loss must be caused either by the promisor or by any other person.
3. Indemnifier is liable only for the loss.

Thus, it is clear that this contract is contingent in nature and is enforceable only when the loss occurs.

The person who promises to make good the loss is called the 'indemnifier': In the aforesaid example, A is the indemnifier. The person whose loss is to be made good is called 'indemnity-holder'. In the aforesaid example, B is the indemnity-holder.

Whether Contract of Indemnity Covers the Cases of Loss Caused by the Events or Accidents which do not Depend upon the Conduct of the Promisor or any other Person? If the definition of contract of indemnity as per Section 124 is strictly interpreted, it would not cover the cases of loss caused by the events or accidents which do not depend upon the conduct of the promisor or any other person. In other words, contracts of insurance would be outside the purview of the contract of indemnity. Since the intention of law makers had never been to exclude the contracts of insurance from the purview of contracts of indemnity, the courts in India have decided to apply the same equitable principles that the courts in England do.

As per English law, a contract of indemnity is defined as “a promise to save another harmless from loss caused as a result of a transaction entered into at the instance of the promisor.” This definition covers a promise to make good the loss arising from any cause whatsoever. Thus, Indian courts follow the English law in respect of contract of indemnity which covers the contracts of insurance also.

A Contract of indemnity is a direct engagement between two parties thereby one promises to save the other harm. It does not deal with those classes of cases where the indemnity arises from loss caused by events or accidents which do not or may not depend on the conduct of indemnifier or any other person.

Under a contract of indemnity, liability of the promisor arises from loss caused to the promisee by the conduct of the promisor himself or by the conduct of other person.

Every contract of insurance, other than life insurance, is a contract of indemnity. The definition is restricted to cases where loss has been caused by some human agency.

A contract of indemnity may be express or implied depending upon the circumstances of the case, though Section 124 of the Indian Contract Act does not seem to cover the case of implied indemnity.

Secretary of State v Bank of India : A broker in possession of a government promissory note endorsed it to a bank with forged endorsement. The bank acting in good faith applied for and got a renewed promissory note from the Public Debt Office. Meanwhile the true owner sued the Secretary of State for conversion who in turn sued the bank on an implied indemnity.

It was held that – it is general principle of law when an act is done by one person at the request of another which act is not in itself manifestly tortious to the knowledge of the person doing it, and such act turns to be injurious to the rights of a third person, the person doing it is entitled to an indemnity from him who requested that it should be done.

Section 125: An indemnity holder is entitled to recover the following amounts from the indemnifier provided he acts within the scope of his authority.

1. Right of recovering Damages - all damages that he is compelled to pay in a suit in respect of any matter to which the promise of indemnity applies.
2. Right of recovering Costs -all costs that he is compelled to pay in any such suit if, in bringing or defending it, he did not contravene the orders of the promisor and has acted as it would have been prudent for him to act in the absence of the contract of indemnity, or if the promisor authorized him in bringing or defending the suit.
3. Right of recovering Sums -all sums which he may have paid under the terms of a compromize in any such suit, if the compromize was not contrary to the orders of the promisor and was one which would have been prudent for the promisee to make in the absence of the contract of indemnity, or if the promisor authorized him to compromize the suit.

As per this section, the rights of the indemnity holder are not absolute or unfettered. He must act within the authority given to him by the promisor and must not contravene the orders of the promisor. Further, he must act with normal intelligence, caution, and care with which he would act if there were no contract of indemnity.

At the same time, if he has followed all the conditions of the contract, he is entitled to the benefits. This was held in the case of United Commercial Bank vs Bank of India AIR 1981. In this case, Supreme Court held that the courts should not grant injunctions restraining the performance of contractual obligations arising out of a letter of credit or bank guarantee if the terms of the conditions have been fulfilled. It held that such LoCs or bank guarantees impose on the banker an absolute obligation to pay.

In the case of Mohit Kumar Saha vs New India Assurance Co AIR 1997, Calcutta HC held that the indemnifier must pay the full amount of the value of the vehicle lost to theft as given by the surveyor. Any settlement at lesser value is arbitrary and unfair and violates art 14 of the constitution.

Section 125 of the Act only lays down the rights of the indemnified and is quite silent of the rights of indemnifier as if the indemnifier has no rights but only liability towards the indemnified.

In the logical state of things if we read Section 141 which deals with the rights of surety, we can easily conclude that the indemnifier’s right would also be same as that of surety.

Simpson v Thomson: Where one person has agreed to indemnify the other, he will, on making good the indemnity, be entitled to succeed to all the ways and means by which the person indemnified might have protected himself against or reimbursed himself for the loss.

Principle of Subrogation is applicable because it is an essential part of law of indemnity and is based on equity and the Contract Act contains no provision in contravention with [Maharaja Shri Jarvat Singhji v Secretary of State for India]

The Indian Contract Act, 1872 is silent on the time of commencement of liability of indemnifier. On the basis of judicial pronouncement of courts, it can be said that the liability of an indemnifier commences as soon as the liability of the indemnity holder becomes absolute and certain. In other words, if the indemnity-holder has incurred an absolute liability even though he has himself paid nothing, he is entitled to ask the indemnifier to indemnify him.

Example:- X promises to compensate Y for any loss. that he may suffer by filing a suit against Z. The court orders Y to pay Z damages of Rs 5,000. As the loss has become certain, Y may claim the amount of loss from X and pass it on to Z.

A contract of indemnity may be express or implied.

1. A contract of indemnity is said to be express when a person expressly promises to compensate the other from loss.
2. A contract of indemnity is said to be implied when it is to be inferred from the conduct of the parties or from the circumstances of the case.

Adamson v. Jarvis: X an auctioneer, sold certain goods at the instruction of Y. Later on, it is discovered that the goods belong to Z and not Y. Z recovered damages from X for selling his goods. Here, X is entitled to recover the compensation from Y because there was an implied promise to compensate the auctioneer for any loss which he may suffer on the defective title of goods sold by auction.

In addition to the implied or express promise to indemnify, all the essentials of a valid contract must also be present.

Example :- X asks Y to beat Z and promises to indemnify Y against the consequences. Y beats Z and is fined Rs 1,000. Y cannot claim this amount from X because the object of the agreement was unlawful.