In this article, we shall discuss the Contract of Indemnity and Guarantee. This topic is contained in the Contracts Law.
Definition of “Contract of Indemnity”:
Contract of Indemnity means “to save against loss” or in other words, it is a special type of contract wherein security or protection against the loss is reserved so as to indemnify or compensate.
Special contracts are contained in Section 124 to Section 238 of the Indian Contract Act,1872. These special contracts are Indemnity, Guarantee, Bailments, pledge, and Agency.
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.
In a contract of indemnity, Mr. A (promisor) promises to pay Mr. B (promisee) if any loss happens by the conduct of Mr. A. or any third party then all the loss will be compensated by Mr. A.
The English law definition of a contract of indemnity is – “it is a promise to save a person harmless from the consequences of an act”.
Thus it includes within its ambit losses caused not merely by the human agency but also those caused by accident or fire or other natural calamities.
The definition provided by the Indian Contract Act confines itself to the losses occasioned due to the act of the promisor or due to the act of any other person.
Section 124 of the Indian Contract Act 1872, defines Indemnity, like all contracts the ‘contracts of Indemnity’ fulfill all its essentials of a valid contract including an agreement enforceable by law with consideration.
Unlike every contract there must be two parties, the indemnifier ( more or likely a promisor) and the ‘indemnity holder’ or ‘indemnified’ ( more or likely a promisee).
According to Halsbury a British lawyer, “an indemnity is a contract, express or implied to keep a person, who has entered into or who is about to enter into, a contract or incur any other liability, indemnified against loss, independently of the question whether a third person makes a default.”
The above definition provides the following essential elements-
- There must be a loss; the claim for indemnity does not hold if there’s no loss suffered.
- The loss must be caused either by the promisor or by any other person.
- Indemnifier is only liable for the loss.
Here it is clear that this contract is contingent in nature which means where the promisor performs his obligation only when certain conditions are met and it is only enforceable only when there is any loss occurred.
Some more illustrations:
(a) Mr. A holds some shares in a company and wants the company to register him as a shareholder. At the company’s request, he fills an indemnity bond promising to save the company from any loss which it may suffer in case some person other than Mr. A is proved to be the owner of those shares. Mr. A has made a contract of indemnity.
(b) B contracts to indemnify C against the consequences of any proceedings which C may take against C in respect of a certain sum of R. 2,500. This is a contract of indemnity.
(c) X insured his his house from Y , that in case if X’s house get destroyed or set fire, then by Y will compensate for X through the contracts of indemnity.
Types of Contract of indemnity:
There are two type of Contract of Indemnity:
- express contract: An express contract is a contract whose terms the parties have explicitly set out. This contract is made either written or oral.
- implied contract: An implied contract is created when two or more parties have no written contract, but the law creates an obligation in the interest of fairness based on the parties’ conduct or circumstances.
An express indemnity clause is not necessary for the face of the implied right to indemnity:
Section 124 of Indian Contract Act 1872, set out an case of an express contract of indemnity but there is are implied contracts too. Implied indemnity was recognized for sure by the Privy Council in the case of Secretary of State v. The Bank of India Ltd.
A Contract of Insurance is a contract of indemnity (although not clearly mention on Section 124).
Relevant English Case :
Can an indemnity holder make a Contract of Indemnity to an indemnifier for illegal work?
That is less likely to happen because contract of indemnity can only be made on something that is legal.
Indemnity and Guarantee are two sides of the same coin’- It means that indemnity and guarantee differ on a lot of issues while being similar on the issue that they are both modes of compensation and that they are similar on certain principles like unjust enrichment and matters of good faith. In spite of their basic similarities, contracts of indemnity are inherently different from contracts of guarantee
Rights of Indemnified or Indemnity Holder:
Rights of Indemnity Holder or Indemnifier is defined on section 125 of Indian Contract Act. Defined into three sections
- All damages for which he may be forced to pay in any suit subjected to any matter to which the promise to indemnify is applicable;
- All costs which he may be forced to pay in any such suit if, in carrying or protecting it, he didn’t negate the commands of the promisor, and went about as it might have been judicious for him to act without any agreement of compensating, or if the promisor commissioned him to carry or defend a suit;
- Every sum which he may have paid under the terms of any bargain of any such suit, if the bargain was not in spite of the requests of the promisor, and was one which it might have been reasonable for the promisee to make without any agreement of indemnity, or if the promisor sanctioned him to bargain the suit.
Rights of Indemnifier:
- After compensation of the indemnity holder, indemnifier reserves the right to all the ways and means by which the indemnifier could have safeguarded himself from the loss.
Definition of “Contract of Guarantee”:
A contract of guarantee” is a contract to perform the promise, or discharge the liability, of a third person in case of his default. The person who gives the guarantee is called the “surety”, the person in respect of whose default the guarantee is given is called the “principal debtor”, and the person whom the guarantee is given is called the “creditor.”A guarantee may be either oral or written.
Contract of Guarantee will be mentioned in Section 126 of an Indian Contract Act,1872 also with three other terms namely:
1. surety : who gives the guarantee,
2. principal debtor : in respect of whose default the guarantee is given. and
3. creditor : to whom the guarantee is given.
A contract of guarantee is a contract is a contract to perform the promise, or discharge the liability of a third person in case of its default. The person who gives the guarantee is called the Surety, the person for whom the guarantee is given is called the Principal Debtor; and the person to whom the guarantee is given is called the ‘Creditor’.
Mr. A takes a loan from the bank for which Mr. B has given the guarantee that if A default in the payment of the said amount he will discharge the liability. Here B plays the role of surety, A is the principal debtor, and Bank is the creditor.
Essentials of a Contract of Guarantee:
There are mainly 8 essential features of Contract of Guarantee:
- The concurrence of All the Parties. …
- Liability. …
- Existence of a Debt. …
- Consideration. …
- Writing not Necessary. …
- Essentials of a Valid Contract. …
- No Concealment of Facts. …
- No Misrepresentation.
Rights of a surety:
As against the Creditor:
According to the Indian Contract Act, 1872,
- Sec. 133 – The creditor ought not to fluctuate terms of the agreement between the creditor and the principal debtor without the surety’s assent. Any such fluctuation releases the surety as to transactions ensuing to the difference. However in the event that the change is for the profit of the surety or does not prefer him or is of an irrelevant character, it might not have the impact of releasing the surety.
- Sec. 134 – The creditor ought not to discharge the principal debtor from his liability under the agreement. The impact of the release of the principal debtor is to release the surety too. Any enactment or exclusion from the creditor which in law has the impact of releasing the principal debtor puts a close to the liability of the surety.
- Sec. 135 -In the event that an agreement is made between the Creditor and Principal debtor for intensifying the last’s liability or making a guarantee to him the growth of time for doing the commitments or swearing up and down to not to beyond any doubt, releases the surety unless he consents to such an agreement.
- Sec. 139 – the surety is released if the creditor debilitates the surety’s possible remedy against the principal debtor.
As Against the Principal Debtor:
- Right of subrogation – The surety on making good of the debt obtains a right of subrogation (meaning: substitution).
- Sec. 140 – the surety can’t assert the right of subrogation to the creditor’s securities in the event that he has agreed as security for a part of the contract and security has been procured by the creditor for the complete debt.
Kinds of Guarantee:
A guarantee may be given in two ways:
- Specific Guarantee
- Continuous guarantee.
A guarantee, given for only one specific transaction between the debtor and the creditor, is called a specific guarantee. It is intended to come to an end with the completion of the transaction.
Illustration: Mr. A sells goods to Mr. B on credit for Rs.5,00, 000. Mrs. C gives a guarantee for Mr. B for timely payment. Mr.B pays in time. The guarantee comes to an end. If Mr.A again sells goods to Mr. B on credit, a fresh guarantee shall be required for this and the earlier guarantee will provide no protection to Mr. A.
In continuing guarantee a guarantee extends to a series of transactions. The guarantee is not limited to only one transaction but to many transactions. Section 129 deals with Continuing guarantee in detail.
Mr. X enters into a contract with Mr. Y, a shopkeeper, to allow Mrs. X to take whatever goods she may need from his shop up to the amount of Rs. 25,000/-. Mr. A will be liable for the debts incurred by Mrs. X up to the given amount. A continuing guarantee may at any time be revoked by the surety, as to future transactions, by notice to the creditor. Say Mr. X and his wife are now living separately; Mr. X only, has to inform Mr. Y that the guarantee stands revoked from that point on. Thus, any debts incurred by Mrs. X after such a revocation would not be payable by Mr. Y.
Difference between Indemnity and Guarantee:
Contracts of Indemnity:
- Section contract of indemnity as a contract by which one party 124 defines 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.
- In the contract of indemnity, the indemnifier to save merely undertakes the indemnity-holder from the loss caused by the conduct of indemnifier or of a stranger.
- In a contract of indemnity, there are only two parties to the promisor or indemnifier and the promisee or indemnified or indemnity holder.
- In a contract, of indemnity, there is only one contract and that is always between the indemnifier and indemnity-holder.
- In a contract of indemnity, the indemnifier is primary and the liability of independent.
- In the case of indemnity, the possibility of any loss happening is the only contingency against which the indemnified undertakes to indemnity.
- The liability of indemnifier is contingent and comes into being on the happening of a contingency.
- The reimbursement of loss, if any, to the indemnity- holder is the main aim.
- An indemnifier has no right to file a suit against the third party for any loss. An indemnifier can do so only when there is an assignment right in his favor.
- In a contract of indemnity, it is not necessary for the indemnifier to act upon the request of the indemnity-holder.
- Indemnity is promised generally as a compensation for a loss.
Contract of guarantee:
- Section 126 defines a contract of guarantee as a contract to perform the promise or discharge the liability, of a third person in case of his default.
- In a contract of guarantee. there is a guarantee for a promise or a debt upon the default of the principal debtor.
- In a contract of guarantee, there are three parties to their principal debtor, the creditor, the surety also called guarantor or there may be co-sureties
- In a contract of guarantee, there are three contracts, viz. (i) between the principal debtor and creditor, (ii) between the surely and the creditor and (i) between the principal debtor and the surety which is the implied contract whereby the surety is entitled to recover from the rightful amounts he has paid the contract principal debtor all the under of guarantee.
- In a contract whereby the surety is entitled to recover from the principal debtor all the rightful amounts, he has paid under the contract of guarantee.
- In a contract of guarantee the liability of the surely is secondary or collateral. The principal debtor’s liability is always primary.
- In the case of a guarantee, there is an existing debt or duty, the performance of which guaranteed by the surety.
- To give security to the creditor in respect of debt or duty is the aim in the Contract of Guarantee.
- When a surety pays off the debt due to the principal debtor under a contract of guarantee, the surety gets the right to bring a suit against the principal debtor in order to recover the amount he has paid to the creditor. Even the certain rights surety gets against the creditor and co- sureties.
- In a contract of the guarantee, the surety should be given guarantee only at the request of the principal debtor.
- The guarantee is given to secure a loan or acquire a job.
Similarities between Indemnity and Guarantee:
Guarantees and indemnities have many similar characteristics. And also have, similar kind of agreements and rights.
appear between the parties. This will have an impact particularly throughout the time of looking to authorize the agreement. Contracts of indemnity and contracts of guarantee have certain common features. Contracts of Indemnity represent a Contract in which one party promises to save the other from loss caused to him by the conduct of the promisor/ contractor, himself, or by the conduct of any other person. One more point of similarity worth mentioning is that they cannot be used to make unjust enrichment. In a relative case study between Punjab National Bank Ltd. v. Bikram Cotton Mills and Gajan Moreshwar vs. Moreshwar Madan, it is seen, that both guarantee and indemnity have to indemnify the creditor and indemnity-holder respectively. And in the principal debtor and surety in the Punjab National Bank case, the indemnifier had consented to pay the debt.
A contrast of n indemnity, have similar obligations with the principal although and there is no necessary reason to “look first” at the principal. Generally it is an agreement that the surety will hold the agent harmless, against all misfortunes emerging from the agreement between the principal and the agent.
Similarly, in a contract of guarantee, there has an obligation far-reaching with that of the principal. The one who is a guarantor can’t be at risk for much more than the client. The document is useful to guarantee if, on its actual development, the commitments of the surety are to “remained behind” the principal and just go to the fore once a commitment has been broken as between the principal and the agent. The commitment is an auxiliary one, reflexive in character.
An indemnity emerges on the event of an occasion, whereas a guarantee emerges on default by a third party. Hence we have explained what contract of indemnity and guarantee mean and on what grounds they differ on like the number of parties involved and the nature of risks involved and we have also worked upon the small but significant differences both in working and in principal between the contact of guarantee and indemnity. Therefore, though the contract of guarantee and indemnity have a few similarities, they are immanently different in nature.
Relevant Cases link:
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I am a 23-year old Mathematics (Hons.) graduate who has taken up law because it’s my choice :3
Currently Pursuing my 3 years L.l.b degree from Indian Institute of Legal Studies, Siliguri