CONCEPT AND COMMERCIAL UNDERSTANDING OF INDEMNITY 

Commercial agreements are fundamentally concerned with the allocation of risk between the parties. One of the most widely used tools for such allocation is an indemnity clause, which obligates that “one party to compensate the other for losses arising under certain specified conditions”. 

Indemnity operates as a contractual tool for allocating potential future liabilities between parties. In commercial relationships, parties are not merely concerned with performance of obligations, but also with the consequences of non-performance, particularly where third-party claims may arise.

Under Section 124 of the Indian Contract Act, 1872 (“ICA”), a contract of indemnity is defined as a promise to save another from loss caused by the conduct of the promisor or any other person. While the statutory definition is narrow, its application in commercial contracts has been significantly expanded through judicial interpretation.

In commercial practice, indemnity has evolved into a structured risk allocation tool designed to address complex exposures, particularly those arising from third-party claims and regulatory liabilities.

Allocation of Liability Under  Indemnity Clause

An indemnity clause specifies which party will bear financial responsibility if a defined risk occurs. This typically includes obligations to compensate for losses, cover legal expenses, and, in many cases, defend the indemnified party in legal proceedings.

An indemnity clause in commercial agreements may be structured as:

“INDEMNITY CLAUSE

The Agency shall indemnify and hold harmless the Client from and against all  actions, claims, proceedings, demands, costs, losses, damages, charges, and expenses  arising from the performance or non-performance of the services mentioned herein or in any way concerned and/ or connected with this Project to the extent that the cause thereof is the negligence, reckless conduct, breach of contractual or any other duty or willful misconduct or any of its directors, officers, employees, agents, third  party(ies) or subcontractors.

 Further, the Client shall indemnify and keep indemnified the Agency against any and all losses, costs, damages, or expenses suffered or incurred by the Client by reason of any proceedings, claims, or demands by any directors, officers, employees, agents, third party(ies) or subcontractors which have been initiated due to the Client’s  fault, negligence or breach.”

The concept of “holding harmless” further strengthens this protection by ensuring that the indemnified party is not required to bear any legal or financial consequences arising from specified events. In effect, the indemnifier assumes primary responsibility for the identified risks.

STATUTORY FRAMEFORK GOVERNING INDEMNITY UNDER INDIAN LAW

The concept of indemnity is primarily governed by Section 124 and 125 of the ICA:

1. Definition of the “Contract of Indemnity”

Section 124 defines the “contract of indemnity” as one whereby a party promises to save another from loss caused either by the conduct of the promisor or that of any other person. The definition provides three essential elements of indemnity:

• a promise to compensate for loss;
• loss arising from human conduct; 
• existence of a contractual relationship between the indemnifier and indemnified.

     2. Rights of the Indemnity Holder 

Section 125 sets the rights of the indemnity holder, when sued in respect of matters covered by the contract of indemnity. These rights include:

• recovery of all damages that the indemnity holder is compelled to pay in any suit relating to the indemnified matter;
• recovery of all costs incurred upon the indemnity holder in defending such suits; and
• recovery of all sums paid by the indemnity holder as a term of  compromise of such suits.

Limitation of the Statutory Framework:

• Narrow definition: Section 124 restricts indemnity to losses arising from human conduct and does not expressly extend to losses caused by events, accidents, or unforeseen circumstances.
• Limited recognition of Commercial Indemnities: In commercial contracts, indemnity clauses often extend to risks such as breach of representations and warranties, third-party claims, tax liabilities, and regulatory penalties, which are not explicitly covered under the statutory definition.

• Silence on the Timing of Enforcement: The statute does not expressly clarify whether indemnity can be enforced prior to actual loss. While Section 125 recognises certain rights of the indemnity holder, it does not address the timing or extent of such enforcement.

INDEMNITY V. DAMAGES

Indemnity and damages represent distinct legal concepts under the Indian Contract Act, 1872, though they are often conflated in practice.

Basis	Indemnity	Damages
Definition	Defined under Section 124, as a contract by which one party promises to save the other from loss caused by the conduct of the promisor or any other person.	Governed by Section 73, which provides that when a contract is broken, the party suffering is entitled to compensation for loss or damage caused by such breach.
Scope	Covers losses arising from conduct of third parties, in addition to the promisor.	Limited to loss arising naturally from breach or which parties knew to be likely at the time of contract.
Nature	To shift risk and allocate responsibility in advance.	To compensate for loss caused by breach.
Claim	Can be invoked once liability accrues, even before actual loss is suffered.	Arises only after breach and actual loss/damage.
Type of Loss	Covers direct, indirect, consequential, remote, and third-party losses, unless expressly excluded. (unless contract says otherwise)	Limited to losses that are natural or foreseeable at the time of contract; excludes remote and indirect losses.
Triggered	Triggered by occurrence of specified loss or liability, often involving third-party claims.	Triggered by breach of contract.
Extent of Recovery	Determined by contractual terms, may include legal costs, settlements, penalties, etc.	Determined by statutory principles of reasonable compensation.

JUDICIAL EVOLUTION AND PRINCIPLES GOVERNING INDEMNITY

The principles governing indemnity in India have been primarily developed through judicial interpretation, which has expanded the scope of indemnity beyond the statutory framework to align with commercial realities.

1. Indemnity can be triggered by liability, not just actual loss.

In Gajanan Moreshwar Parelkar v. Moreshwar Madan Mantri, the Hon’ble Bombay High Court clarified that indemnity is not confined to cases of actual loss and may be enforced once liability becomes absolute or certain. The Court emphasised the equitable principles of English law and held that an indemnity holder need not wait until actual payment is made and may call upon the indemnifier to discharge the liability. 

“If the indemnified has incurred a liability and that liability is absolute, he is entitled to call upon the indemnifier to save him from that liability and to pay it off.” 

This principle was further affirmed by the Hon’ble High Court in Khetarpal Amarnath v. Madhukar Pictures, where the expression “compelled to pay” under Section 125 was interpreted to include situations where liability is certain, even if payment has not yet been made. It clarified that a contract of indemnity is not merely about reimbursement after payment but it also includes, in a derivative sense, the obligation of the indemnifier to protect the indemnified party from a third-party claim itself.

2. Indemnity May Be Express or Implied

Indemnity is not confined to express contractual terms and may arise from the nature of the relationship between parties. In Tilak Ram v. Surat Singh, the Hon’ble Allahabad High Court recognised that indemnity may be implied where a vendee is directed to discharge a third-party liability.

Similarly, in Kadiresan Chettiar v. Ramaswami Chettiar, the Hon’ble Madras High Court held that indemnity may arise from circumstances where a request is made, and the law implies an intention that the requesting party will indemnify the other.

3. Indemnity Extends to Third-Party Liabilities

In Jet Airways India Ltd. v. Sahara Airlines Ltd., the Hon’ble Bombay High Court reaffirmed the principle laid down in Gajanan Moreshwar case, that that indemnity may be invoked once a clear and enforceable liability arises, even if payment has not yet been made. 

The Hon’ble Court clarified that “liability” includes a legal obligation or enforceable duty, thereby expanding the practical applicability of indemnity clauses in commercial contracts, held that a tax demand raised by authorities constitutes a sufficient legal liability to invoke indemnity.

4. Indemnity and Non-Indemnity Contracts

Courts have also clarified that not all contracts that involve payment upon the occurrence of an event constitute indemnity contracts. In Regional Manager, Oriental Fire & General Insurance Co. Ltd. v. Savoy Solvent Oil Extractions Ltd. The Andhra Pradesh High Court had observed that contracts such as life insurance are not contracts of indemnity, as the amount payable is predetermined and not dependent on the actual loss suffered. Unlike indemnity, where compensation is linked to loss, life insurance contracts operate independently of loss, since the value of human life cannot be quantified in monetary terms.

5. Indemnity as a Tool for Commercial Risk Allocation 

The role of indemnity in commercial contracts extends beyond traditional formulations and forms part of broader risk allocation frameworks. In West Bengal State Electricity Distribution Co. Ltd. v. Adhunik Power & Natural Resources Ltd.,  the Hon’ble Supreme Court held that contractual provisions must be interpreted in light of their commercial purpose. 

Relevant Clause from the Agreement (“PPA”):

“Coal Procurement and Tariff Escalation: Article 2.5 of the Agreement provides that if the seller procured coal from sources other than the designated captive coal block, the seller would not be entitled to claim any separate escalation in the escalable energy charges on that basis. The clause further stipulated that such coal would be deemed to have been sourced from the captive coal block for the purposes of determining the tariff.

Change in Law: Article 10 of the Agreement dealt with “Change in Law” which means occurrence of any of the events that entitle the affected party to compensate in a manner that restores such party to the same economic position as if the Change in Law had not occurred.”

The Hon’ble Apex Court recognised that clauses, though not expressly termed as indemnity, may operate as indemnity-like provisions where they effectively shift financial responsibility for defined risks. Such provisions must be interpreted harmoniously with the overall contractual structure, including pricing and risk allocation mechanisms.

Extent of Liability is Determined by Contractual Language

The extent of liability under an indemnity depends on the terms of the contract and the intention of the parties. Courts have consistently upheld clear and unambiguous indemnity clauses.

In Ramamurthi Ayyar v. Kuppuswami Ayyar,  a broadly worded clause covering “any dispute” was interpreted to extend beyond specific encumbrances and apply to all disputes resulting in loss. 

Similarly, in South Eastern Rly v. Amarendra Nath Sarkara, expressions such as “may come” and “at any time” were held to include both past and future liabilities.

Recently, the Hon’ble Supreme Court in VPS Healthcare Pvt. Ltd. v. Prabhat Kumar Srivastava held that where contractual language imposes an obligation to protect against liability, such obligation may become enforceable once a real and crystallised liability arises. 

The Hon’ble Apex Court recognised the layered nature of indemnity clauses in commercial agreements and distinguished between two categories of obligations. 

1. an absolute obligation, where the promoters undertook to “ensure that no liability” arising from the specified litigation would be recovered from VPS or the company. This was interpreted as an immediate obligation to protect the company from liability as and when it arose.
2. a contingent obligation, whereby any liability, if ultimately confirmed by the highest appellate court, was required to be discharged within a stipulated period. This obligation was dependent on the occurrence of a future uncertain event, namely final adjudication.

The Hon’ble Apex Court distinguished between an absolute obligation to prevent the recovery of liability from the promisee and a contingent indemnity obligation to reimburse such liability upon the occurrence of a specified future event.

It held that where the promisor has contractually undertaken to “ensure“ that no liability shall be recovered from the promisee, and the agreement defines the scope of such liability in broad terms, the clause creates an immediately enforceable protective obligation. Consequently, once a real and crystallised liability arises and recovery is sought against the promisee, the promisor becomes obliged to prevent such recovery, without waiting for the occurrence of any further contingent event. 

POSITION OF ENGLISH LAW ON INDEMNITY: EVOLUTION AND PRINCIPLES

English law on indemnity has evolved from a rigid, loss-based doctrine into a commercially driven principle centred on the allocation of risk and protection against liability. Modern English law treats indemnity as a primary contractual obligation, enforceable once liability becomes certain rather than only after actual loss is suffered.

Under English common law, indemnity developed as a broad equitable principle rather than a strictly defined statutory concept. It is generally understood as a promise to hold another harmless from loss arising out of a transaction undertaken at the instance of the promisor.

Old English Law: Indemnity as a Post-Loss Remedy

Historically, English law adhered to the maxim that “you must be damnified before you can be indemnified”, meaning that indemnity could only be enforced after actual loss had been suffered. This approach treated indemnity strictly as a reimbursement mechanism, requiring prior payment or damage as a condition precedent to enforcement.

Implied Indemnity 

The doctrine of implied indemnity was firmly established in Adamson v. Jarvis, where the Hon’ble Court of Common Pleas held, that when a person acts upon the instructions of another, the law implies a promise of indemnity.

In particular, where an agent acts within the scope of authority of a principal, such act would be implied as a promise of indemnity if the act, lawful in itself, leads to loss due to the principal’s lack of authority. 

Modern English law: Protection Against Liability

Modern English law has moved away from the restrictive post-loss approach and now recognises indemnity as a mechanism to protect a party against liability itself. It is no longer necessary that the indemnified party must first suffer actual loss before seeking indemnity.

This shift is reflected in re Richardson, Ex parte The Governors of St. Thomas’s Hospital, where the Hon’ble Court of Appeal observed that the essence of indemnity lies in ensuring that the indemnified party is not required to pay. 

CONCLUSION

Indemnity has emerged as a central feature of modern commercial contracting, functioning as a sophisticated tool for allocating financial risk and ensuring certainty in complex transactional relationships. 

Indian courts have progressively recognised indemnity as a flexible and commercially driven concept, capable of operating not merely as a post-loss remedy but as a mechanism to protect against liability itself. This evolution reflects a shift from a narrow statutory understanding to a broader, purposive approach that gives primacy to contractual intent and the allocation of risk between parties. The decision in VPS Healthcare Pvt. Ltd. v. Prabhat Kumar Srivastava marks an important step in this direction by recognising, the layered nature of indemnity obligations. 

However, despite this doctrinal development, a degree of uncertainty still persists. Indian indemnity law does not yet articulate a clear and consistent distinction between absolute indemnity obligations and contingent indemnity obligations. While courts interpret indemnity clauses based on expressions such as “indemnify,” “hold harmless,” and “ensure,” there remains no settled framework for determining when an obligation becomes immediately enforceable and when it remains dependent on future events, such as final adjudication or actual payment.

Against this backdrop, clarity of drafting assumes to be of critical importance. Precision in defining triggering events, coupled with a conscious allocation of risk, is essential to ensure that indemnity provisions effectively achieve their intended purpose i.e., balancing protection, responsibility, and commercial certainty between contracting parties.

Written by: Shubhangi Dengre