The liability of an insurer begins only after the encashment of the cheque and not before ruled a Bench of the Supreme Court comprising Justices S.B. Sinha and Lokeshwar Singh Panta in the case of National Insurance Co. Ltd. v. Yellamma & Anr. on May 5, 2008.

In this case, the owner of a Mini Bus sought an insurance policy in respect of the vehicle. To this end, he issued a third party cheque towards payment of insurance premium. Once the Development Officer of the insurance company realised this, he contacted the vehicle owner and asked him to pay the premium which was apparently not done.

The said insurance cover was issued for the period 3.9.1991 to 2.9.1992. On or about 12.9.1991, the vehicle met with an accident. Yellama who was injured therein filed a claim petition in terms of the provisions contained in Section 166 of the Motor Vehicles Act, 1988 (the Act). An award for a sum of Rs.43,000/- was made.

The High Court increased the amount of compensation to Rs.1,50,000/-. The insurance company then appealed to the Supreme Court which held that a contract of insurance like any other contract is a contract between the insured and the insurer. The amount of premium is required to be paid as a consideration for arriving at a concluded contract. If the insurer insists that a cheque should be issued only by the insured and not by a third party, no exception thereto can be taken. The fact remains that the cheque was not encashed. Concededly, the insured did not make any payment.

Section 64VB of the Insurance Act, 1938 mandates that before a contract of insurance comes into being, the premium should be received by the insurer in advance, stating :

No risk to be assumed unless premium is received in advance:
(1) No insurer shall assume any risk in India in respect of any insurance business on which premium is not ordinarily payable outside India unless and until the premium payable is received by him or is guaranteed to be paid by such person in such manner and within such time as may be prescribed or unless and until deposit of such amount as may be prescribed, is made in advance in the prescribed manner.
(2) For the purposes of this section, in the case of risks for which premium can be ascertained in advance, the risk may be assumed not earlier than the date on which the premium has been paid in cash or by cheque to the insurer.
Explanation: Where the premium is tendered by postal money order or cheque sent by post, the risk may be assumed on the date on which the money order is booked or the cheque is posted, as the case may be.

The question came up for consideration before the Supreme Court in Deddaooa & Ors. v. Branch Manager, National Insurance Co. Ltd. [(2008) 2 SCC 595], wherein upon noticing the precedents which were operating in the field, it was clearly held :

“18. The ratio of the said decision was, however, noticed by this Court in New India Assurance Co. Ltd. v. Rula and Ors. [(2003) 3 SCC 195]. It was held that ordinarily a liability under the contract of insurance would arise only on payment of premium, if such payment was made a condition precedent for taking effect of the insurance policy but such a condition which is intended for the benefit of the insurer can be waived by it.”

The dicta laid down therein clarifies that if on the date of accident the policy subsists, then only the third party would be entitled to avail the benefit therof.

In National Insurance Co. Ltd. v. Seema Malhotra and Ors. [(2001) 3 SCC 151], a Division Bench noticed both the aforementioned decisions and analysed the same in the light of Section 64-VB of the 1938 Act. It was held:

’17. In a contract of insurance when the insured gives a cheque towards payment of premium or part of the premium, such a contract consists of reciprocal promise. The drawer of the cheque promises the insurer that the cheque, on presentation, would yield the amount in cash. It cannot be forgotten that a cheque is a bill of exchange drawn on a specified banker. A bill of exchange is an instrument in writing containing an unconditional order directing a certain person to pay a certain sum of money to a certain person. It involves a promise that such money would be paid.

18. Thus, when the insured fails to pay the premium promised, or when the cheque issued by him towards the premium is returned dishonoured by the bank concerned the insurer need not perform his part of the promise. The corollary is that the insured cannot claim performance from the insurer in such a situation.

19. Under Section 25 of the Contract Act an agreement made without consideration is void. Section 65 of the Contract Act says that when a contract becomes void any person who has received any advantage under such contract is bound to restore it to the person from whom he received it. So, even if the insurer has disbursed the amount covered by the policy to the insured before the cheque was returned dishonoured, the insurer is entitled to get the money back.

20. However, if the insured makes up the premium even after the cheque was dishonoured but before the date of accident it would be a different case as payment of consideration can be treated as paid in the order in which the nature of transaction required it. … A contract is based on reciprocal promise. Reciprocal promises by the parties are condition precedents for a valid contract. A contract furthermore must be for consideration.”

In today’s world payment by cheque is ordinarily accepted as valid tender but the same would be subject to its encashment. A distinction, however, exists between the statutory liability of the insurance company vis-à-vis the third party in terms of Sections 147 and 149 of the Motor Vehicles Act and its liability in other cases but it is clear that if the contract of insurance had been cancelled and all concerned had been intimated thereabout, the insurance company would not be liable to satisfy the claim.

In this case, there cannot be any doubt or dispute whatsoever that no privity of contract came into being between the insurance company and the owner of the vehicle and as such the question of enforcing the purported contract of insurance while taking recourse to Section 147 of the Motor Vehicles Act did not arise.

Being of the opinion that the interest of justice would be subserved by the exercise of its jurisdiction under Article 142 of the Constitution of India, the Supreme Court directed that the awarded amount be paid by the insurance company to Yellama with liberty to it to recover the same from the owner of the vehicle by initiating an appropriate proceeding in this behalf.

(This article is an edited extract of the judgment.)