Contracts of Indemnity | PAPER II – PRINCIPLES & PRACTICES OF BANKING | MODULE B: FUNCTIONS OF BANKS

Contracts of Indemnity

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Definition of Contract of Indemnity

According to Section 124 of the Indian Contract Act, 1872: "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."

Distinctive Features of Indemnity and Guarantee

• Parties: Indemnity involves two parties (Indemnifier and Indemnity Holder); Guarantee involves three (Creditor, Principal Debtor, and Surety).
• Liability: Indemnifier's liability is primary; Surety’s liability is secondary in a guarantee.
• Trigger: Indemnity is for loss; Guarantee is for the default of a third party.

Rights of an Indemnity Holder

As per Section 125 of the Indian Contract Act, the indemnity holder is entitled to recover:

• All damages he is compelled to pay in a suit.
• All costs incurred in such suits if acted prudently.
• All sums paid under a compromise, if done in good faith.

Implied Contracts of Indemnity

Not all indemnity contracts are explicitly written. Courts recognize implied indemnity where the conduct of parties or nature of transaction implies protection from loss. Examples include agents acting on behalf of principals.

Enforceability of Indemnity Contracts

An indemnity contract becomes enforceable when the indemnity holder suffers a loss. Courts in India have supported enforcement even at the time of potential liability, subject to jurisdictional interpretation.

Scope and Application of Indemnity in Banking

In banking, indemnity contracts are widely used:

• Loss of Fixed Deposit Receipts (FDRs)
• Discharge of Guarantees and Bonds
• Safe Custody Articles
• Disputed Title Loans

Example of Indemnity

Suppose A agrees to indemnify B against consequences of a legal case C may file. If C sues B and B incurs Rs. 1,00,000 in legal expenses and damages, A must reimburse B the full amount if the case fits the indemnity terms.

Mathematical Illustration

Let:

• Legal Damages (LD) = Rs. 70,000
• Legal Fees (LF) = Rs. 20,000
• Settlement Costs (SC) = Rs. 10,000

Total Indemnity = LD + LF + SC = Rs. 70,000 + Rs. 20,000 + Rs. 10,000 = Rs. 1,00,000

Multiple Choice Questions (MCQs)

1. Which section of the Indian Contract Act defines indemnity?
   • a) Section 124
   • b) Section 125
   • c) Section 126
   • d) Section 127
   Answer: a
2. How many parties are involved in a contract of indemnity?
   • a) One
   • b) Two
   • c) Three
   • d) Four
   Answer: b
3. What type of liability does the indemnifier bear?
   • a) Secondary
   • b) Joint
   • c) Primary
   • d) None
   Answer: c
4. Which of the following is NOT a right of an indemnity holder?
   • a) Claim for damages
   • b) Claim for costs of suits
   • c) Claim for interest on loan
   • d) Claim for compromise payments
   Answer: c
5. When does an indemnity contract become enforceable?
   • a) On signing
   • b) On breach
   • c) On occurrence of loss
   • d) On demand
   Answer: c
6. Which of the following is a banking application of indemnity?
   • a) FDR loss coverage
   • b) Credit card issuance
   • c) NEFT transactions
   • d) ATM withdrawals
   Answer: a
7. Which is a key distinction between indemnity and guarantee?
   • a) Number of parties
   • b) Contract duration
   • c) Amount involved
   • d) All of the above
   Answer: a
8. Implied indemnity often arises in which type of relationship?
   • a) Banker and depositor
   • b) Agent and principal
   • c) Creditor and debtor
   • d) Landlord and tenant
   Answer: b
9. Under indemnity, what happens if there is no actual loss?
   • a) Contract is void
   • b) Payment must still be made
   • c) No obligation arises
   • d) Depends on court
   Answer: c
10. Legal enforceability of indemnity in Indian law includes which condition?
    • a) Only express contracts are valid
    • b) Indemnity can be implied or express
    • c) Must be notarized
    • d) Must be registered
    Answer: b