The Empty Provisions of Indemnity in the Indian Contract Act

Prem Vinod Parwani |

---

In the Indian Contract Act (‘ICA’ or ‘the Act’), the law of indemnities is one of those fields which has received very little scholarly attention. Besides Wayne Courtney’s scholarship (here and here), no authoritative literature has discussed the scope of the law on indemnities in India.

Unlike the law of agency or bailment, it has only two dedicated provisions in the Act – which as this piece shall unpack, are themselves of little to no help to understand the scope of indemnity in India. This piece traces the scope and judicial interpretation of indemnity provisions in the ICA, arguing that these are essentially defunct. It demonstrates how this is a curious anomaly in the ICA, which has otherwise laid down (or at least attempted to) the legal framework for other fields of law.

The English Law Lifeboat that ‘Rescued’ the ICA’s Provisions

The ICA contains two provisions on indemnity – s.124 and s.125.

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”. 

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 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.

From a plain reading of the ICA provisions, it is clear that they resemble very little of the indemnities agreed upon and entered into in modern-day commercial contracts. After all, indemnities are claimed not merely for the ‘conduct of the promisor or any other person’, but for events outside the scope of their conduct - such unforeseen or contingent events. In fact, this is the foundation of insurance contracts. Thus, every prevalent exposition of this provision begins with the observation that the scope of indemnities in this provision much narrower than in English law.

Further, indemnity-holders can surely claim even if they are not sued – indeed, that is often the preventive purpose of most contractual indemnities. However, the express words of s.125 provide for the rights of the indemnifier only “when sued.” If restricted strictly to the words of the provisions, many indemnities in commercial contracts would have little value if the claims of indemnity could not be instituted before a legal suit is brought.

Another conspicuous absence is the rights of the indemnifier, since s.125 only prescribes what the rights of the indemnified party are. To make matters worse, the right in s.125 is cast in exhaustive terms; “the promisee in a contract of indemnity… is entitled to recover from the promisor”. On its face, it does not permit reading in other rights by, for instance, using the phrases ‘may recover’ or ‘include’. Thus, if the provisions are taken as they are, one could see how they would become essentially inoperable. Wayne Courtney says has called this narrow definitional choice ‘puzzling’ and ‘untidy’. While analysing the ICA, even Lord Burrows dedicated a mere two paragraphs to the subject of indemnities. While he recognized this limited scope, he simply concluded “this is all the extent of the provisions of the Act as they apply to contracts of indemnity; all other issues will be governed by the general principles of the Act.” What these ‘general principles’ are – one can only guess.

However, Indian Courts have come up with a solution. To remedy this limited scope, Chalga J. held in Gajajan Moreshwar (the locus classicus of the law on indemnities in India) that “the ICA is not exhaustive on the subject of indemnity.” In doing so, he opened the door for Courts to reference English law where the ICA was silent. No one has taken issue with this – in fact, it has been accepted that the oddity of the ICA’s provisions on indemnity are remedied by opening the window to English law. This dictum has also been followed as in recent case law. 

All seems well so far – where the rights in s.125 are of use, one may resort to those. Where the Act provides no guidance, English law can cover those bases. However, this piece will show that throwing open the window to English law has resulted in an anomaly in the ICA - that the provisions are now of no use!

The Lifeboat that Sank the Ship

It is settled that the ICA’s provisions on indemnity are not exhaustive. As a result, extensive reference has been made to English law in deciding Indian cases on indemnities. By itself, this is fairly routine in the scheme of the ICA. The scope of doctrines in English law (say for instance, in agency) are used extensively to inform the words of the ICA. 

However, something more occurs with indemnities. Here, English law does not merely supplement or inform the ICA provisions – it supplants them altogether. This piece will show how this is so, and how it is a result of the odd framing of the provisions. 

To begin with, the words of s.125(3) have been effectively ignored. This sub-section provides for an indemnity against a compromise in pursuance of a claim. Note that a plain reading shows that the rights in s.125 would trigger only after a suit has been brought against the indemnified party – after all, the text of s.125 reads “rights…when sued….”, “sums….he may have paid under…any compromise of any such suit.” In other words, the indemnified party can invoke his indemnity only when he is sued. Despite this, the Allahabad HC held in Kali Charan (1913) that an indemnity could be claimed for a compromise without waiting for a suit to be filed. 

Similarly, judicial interpretation has also articulated rights for the indemnifying party, even though the Act is silent on such rights – for instance, the right to be indemnified before actual loss is suffered is derived not from s.125, but as we will see below in Osman Jamal, from English law. Even the Law Commission noted that “the indemnified [party] has other rights besides those mentioned in s.125.”

Most importantly, s.124 clearly limits the scope of a contract of indemnity to those events concerning the conduct of the promisor or a third party. However, this limited scope has been ignored altogether. Most recently, in Jet Airways, the Bombay HC granted an indemnity for income tax paid by Jet Airways to the tune of Rs. 37 crore – a loss that has nothing to do the promisor’s or a third party’s conduct. In doing so, the limited scope of s.124 is effectively nullified.  Similarly, the Punjab HC allowed the allottee of a flat to pursue indemnification in pursuance of a force majeure event as per the terms of the contract.

In all these cases, Courts use the principles of English law not just to go over and above the provisions in the Act – but even to contradict them. In other words, several operative portions of the ss.124 and 125 have been hollowed out. Instead, as it stands, the body of indemnity in India consists of these general principles borrowed from English law. A simple section search of s.124 or s.125 on legal databases will also support the conclusion that these provisions are essentially defunct - no more than a handful of results turn up.[1]

The clearest indication of the disuse of the provisions can be observed from the fact that the most-oft cited judgement on indemnities in India did not even apply the provisions! J. Chagla unequivocally rules out the applicability of these provisions in Gajanan:

3. Section 124 …… does not deal with those classes of cases where the indemnity arises from…… liability incurred by something done by the indemnified at the request of the indemnifier. In the present suit the indemnity arises because the plaintiff has become liable owing to something which he has done at the request of the defendant and therefore, in my opinion, Section 124 does not apply at all to the facts of this case.

4. Further, Section 125, as the marginal note indicates, only deals with the rights of the indemnity-holder in the event of his being sued. Section 125 is by no means exhaustive of the rights of the indemnity-holder as I shall presently point out. The indemnity-holder has other rights besides those mentioned in Section 125.

If not the provisions, what did J.Chagla apply? He applied the Calcutta High Court’s precedent in Osman Jamal, which was authority for the principle that actual loss need not be suffered for a claim of indemnity to succeed. Lord Williams in Osman Jamal in turn made no reference to the ICA provisions – he only referred to English precedents such as Richardson [1911] 2 K.B. 705 and Liverpool Mortgage Insurance Company [1914] 2 Ch. 617 to cull out the principle that the liability to indemnify is triggered before the indemnifier makes the actual payment. Thus, even the case deciding the ‘settled law’ on indemnities in India made no resort to the provisions in the ICA. Rather, it borrowed principles from English law.

This window to English law seems to have been opened out of necessity[2] – without this, several important indemnity stipulations would become inoperable. To stay afloat, courts launched a lifeboat by turning to English law. In doing so, we have obliterated any need to refer to the provisions in the ICA. Indeed, several judgements often cited as ‘laying down the principles for the law of indemnity in India’ make no or very sparse reference to the provisions themselves (see here, and here). In other words, in launching the lifeboat of English law, the very ship of the ICA’s indemnity provisions has been left to sink. What began as a rescue mechanism has now rendered the statutory vessel obsolete!

An Anomaly in the Act

We have seen that while ss.124 and 125 define indemnities and the rights that flow from it, settled judicial interpretation has effectively supplanted these with principles from English law. This is an oddity in the scheme of the Act. To appreciate this, we may begin with the definition provision. As it is interpreted, the definition of a contract of indemnity in s.124 is unlike any other provision governing different areas of law – it is neither dispositive, nor does it provide a validity condition for a contract of indemnity. If the definition were interpreted dispositively, the words of s.124 ought to disqualify any contract as one of indemnity if it covered losses beyond the promisor or a third party’s conduct.

Take for instance, the definition provision on bailments. Courts consider the definition of a contract of bailment in s.148 to be dispositive – In other words, if the ICA’s definition of such a contractual relationship is not met, then the contractual relationship would not fall within that definition. If a contract does not fit in the four corners of the s.148 definition which requires ‘delivery’ of the goods and their ‘return or disposal’, it is held to not be a contract of bailment.

The broader point being made here is that the words of the provisions on indemnities are ignored entirely, and this is not the case elsewhere in the ICA. Expanding the scope of a contract of indemnity beyond the events for which they are provided for in the Act does exactly that. The same point applies to s.125 with equal force – there seems to be no reason why the rights are treated as inexhaustive, or whether any justification exists for articulating rights that are not already covered in the ambit of the Act. Indeed, one does not need to navigate each provision of the Act to appreciate the simple point that to ignore (and even contradict) the words of a provision does violence to the statute!

Contrast this with statutory laws on indemnity internationally. These do not limit the scope of indemnities in the odd manner that the ICA does. Further, they also provide for dispositive conditions or obligations. For instance, the only stipulation on indemnity in s.2710 of the US Code is that no indemnity can be entered into for events relating to the ‘discharge of oil.’ On the other hand, s.79(1) of the Conveyancing Act 1919 of New South Wales provides for an implied covenant of indemnity where a property with an encumbrance is conveyed. Neither of these statutes venture to define the ‘scope’ of an indemnity like s.124, leaving them entirely to contract. The ICA is peculiar in that it treads into the realm of what ordinarily ought to be determined by contract.

All said and done, supplanting the statute is the most sensible thing the Courts could have done. The reason is clear – it would result in absurdity if the Courts were to limit contractual indemnities to only the scope and rights laid down in the provisions of the Act. Several known forms of indemnity (such as insurance contracts, which are ordinarily considered to be a subset of indemnity contracts) would be unable to avail the rights and obligations attached to indemnities. Thus, the fault seems to be not in our Courts, but in our drafters.

But what could the drafters possibly have meant in drafting the provisions on indemnities in this manner? After all, there is no English law (or for that matter, any practical reason) to restrict its scope only to the conduct of promisors and third parties.

My answer is that the provisions seem to serve two limited purposes. First, s.125(1) clarifies that the ‘conclusiveness’ principle, i.e., that the promise of indemnity is conclusive in any suit in which the indemnified party is liable to pay damages. This is important since it was a confused and unsettled field in English law. There were conflicting authorities on whether the indemnifying party would be liable for the indemnity in a suit to which he is not party. Some English authorities held that a liability would be conclusive only on notice or knowledge of the indemnifying party. s.125 clarifies the conclusiveness of this liability, since the indemnifier be liable for the indemnity in a suit ‘in respect of which the promise to indemnify applies.’ The second point of the provisions is that they provide a conceptual framework for the concept of indemnities, allowing Courts to distinguish indemnities from other special contracts such as those of guarantees and damages. In Ultratech Cement, the Bombay HC did exactly this. It held that the contract in question was one of indemnity and not of damages, thereby averting the need to prove loss. But even these do not explain several oddities - the limited scope of the definition, the limited rights stipulated (which are further limited only when a suit is brought), or the absence in stipulating the manner of enforcement – a gap that the Law Commission recommended be filled via the insertion of s.125A.

One may find an explanation by digging into the arcane drafting history of the Act or conducting a comprehensive survey of the pre-1872 English law on indemnities. But from everything we know about the way the ICA has developed today, the empty provisions of ss.124 and 125 remain a curious anomaly.

[1] The SCC Search on s.124 produces 12 results.

[2] More on this is said later in the piece while discussing why it is sensible for the Courts to have interpreted the provisions in this manner.