INDEMNITY

The word indemnity has been derived from the Latin term “indemnis” which means unhurt or
free from loss. As we all know, the fundamental idea behind an indemnity or indemnification
is to transfer some or all of the liability from one party to another. This means that one party
to the contract, referred to as the “indemnifier” or “indemnifying party”, promises to protect
another party, referred to as the “indemnity holder” or “indemnified party”, from not only
loss, cost, expense, and damage but also from any legal consequences resulting from an act or
omission by either the indemnifier or a third party or any other event. Section 124 of the
Indian Contract Act, 1872.
As per the Oxford dictionary, “Security from damage, loss, or penalty.” The definition of the
word “indemnify” is to compensate someone for harm, loss, or damage. Indemnity contracts
and contracts for insurance are extremely similar. In an insurance contract, the insurer
pledges or promises to make up in the form of compensation for the insured’s losses. In
return, he receives consideration in the form of a premium. These kinds of transactions are
not governed by the Contract Act. This is so because legislation like the Insurance Act has
provisions specifically for insurance contracts.
As per Section 124 of the Indian Contract Act, an agreement by which one party promises to
save the other from loss caused to him by the conduct of the promisor himself or by the lead
of someone else is classified as “Contract of Indemnity”.
The term (Indemnity) means to make good the loss or to compensate for the losses. To
protect the promisee from unanticipated losses, parties enter into the contract of Indemnity. It
is a promise to save a person without any harm from the consequences of an act.
There are two parties involved in the Contract of Indemnity. The two parties are:
1. Indemnifier: Someone who protects against or compensates for the loss of the damage
received.
2. Indemnified/Indemnity-holder: The other party who is compensated against the loss
suffered.
Example- A contracts to indemnify B against the consequences of any proceedings which C
may take against B in respect of a certain sum of 200 rupees. This is a contract of indemnity.

Insurance Indemnity
All insurances except and personal accident insurance come in the scope of Indemnity. It is
an absolute promise to indemnify the insured. Upon the failure of performance, a suit can be
filed immediately, irrespective of the actual loss. If the liability is incurred by the Indemnity
holder and is absolute, he/she would be entitled to call upon the indemnifier to save him from
that responsibility by taking care of it. An insurance policy that compensates a party for any
accidental damages or losses up to a certain limit—usually the value of the loss of itself —is
known as indemnity insurance.

Meaning of Indemnity
According to the definition given by Halsbury, the term “indemnity” is a contract that
expressly or impliedly protects a person who entered into a contract or is about to enter from
any losses, irrespective of the fact that those losses were due to the actions of a third party. As
mentioned above, the word indemnity is derived from the Latin word “indemnis”, which
means freedom from loss. According to Longman’s dictionary, it is protection against any
kind of loss, expense, etc., in the form of a promise to pay for those losses.
Essentials to a contract of indemnity
For the purpose of a contract of indemnity, the following conditions must be satisfied:
 There must be two parties.
 One of the parties must promise the other to pay for the loss incurred.
 The contract may be expressed or implied.
 It must satisfy the essentials of a valid contract.

Conditions for the contract of indemnity

 Parties to the contract of indemnity- There must essentially be two parties in a

contract of indemnity: the indemnity holder and the indemnifier. Moreover, no
individual can enter into a contract with themselves, and the minimum requirement
for any contract to be legally valid is for two parties. Additionally, these parties must
have the capacity to contract. However, depending on the circumstances, there may be
more than two parties.
 The promisor or indemnifier- An indemnifier is a person who promises to compensate
for a loss but does not bear the loss.
 The promisee or the indemnified or indemnity holder- An indemnity holder is a
person whose losses are compensated by an indemnifier.

Illustration

There is a contract between A and B in which A promises to deliver certain goods to B for
Rs. 7,000 every month. C comes and makes a promise to indemnify B’s losses if A fails to
deliver the goods.

Here,

 C is the indemnifier or promises as he promises to bear the loss; and

 B is the indemnity-holder or promisee or indemnified as his losses are compensated
for.

Promise to pay losses

Promise
A contract of indemnity is one in which one party promises to protect the other party from
harm brought on by the actions of the other party.
One party must present a condition to another party, and the other party must accept it.
Acceptance occurs when another party accepts the offer on the same terms. After accepting
the offer, it becomes a promise. The party that made the promise is now known as the
promisor, and the person who accepted it is now known as the promisee.
It is an important part of the contract of indemnity that “the promise must be made by the
promisor to pay the losses of the promisee.” A contract of indemnity is one in which one
party promises to protect the other party from harm brought on by the actions of the other
party.
Expressed or implied
As stated above, a contract for indemnity may be expressed or implied. In other words,
parties may directly impose their own conditions in such a contract. The nature of
circumstances may also create indemnity obligations impliedly. Express contracts are those
that are created orally or in writing, whereas implied contracts are those that are made as a
result of the conduct of the parties.
There must be a loss incurred
The condition of the contract of indemnity is that “the loss must be incurred by the
promisee.” The promisor is not required to make any payments if the promisee suffers no
loss.
Lawful object and consideration
A contract for indemnity can only be executed for a valid purpose and a lawful consideration.
A contract of indemnity cannot be construed as a contract to engage in unlawful behaviour or
conduct that is against public policy.
As stated above, indemnity in India has been defined under Section 124 of the Indian
Contract Act, 1872. According to the Section, it is a contract in which a party makes a
promise to save others from any kind of loss due to the actions of the promisor himself or any
third person. This definition is only limited to the losses caused by the actions of humans or
agencies and does not include losses that are caused due to events that cannot be controlled or
foreseen by any person, as stated in the case of Gajanan Moreshwar v. Morehswar Madan
(1942).

GUARANTEE
What is a contract of guarantee?
Section 126 of the Indian contract act defines a contract of guarantee as a contract to perform
the promise or discharge the liability of the defaulting party in case he fails to fulfill his
promise.
Thus here we can infer that there the 3 parties to the contract
Principal Debtor – The one who borrows or is liable to pay and on whose default the
guarantee is given
Creditor – The party who has given something of value to borrow and stands to receive the
payment for such a thing and to whom the guarantee is given
Surety/Guarantor – The person who gives the guarantee to pay in case of default of the
principal debtor
Also, we can understand that a contract of guarantee is a secondary contract that emerges
from a primary contract between the creditor and the principal debtor.
Illustration
Ankita advances a loan of INR 70000 to Pallav. Srishti who is the boss of Pallav promises
that in case Pallav fails to repay the loan, then she will repay the same. In this case of a
contract of guarantee, Ankita is the Creditor, Pallav the principal debtor and Srishti is the
Surety.
A contract of guarantee may either be oral or written. It may be express or implied from the
conduct of parties.

Essentials of a Contract of Guarantee

1) Must be made with the agreement of all three parties

All the three parties to the contract i.e the principal debtor, the creditor, and the surety must agree to
make such a contract with the agreement of each other. Here it is important to note that the surety
takes his responsibility to be liable for the debt of the principal debtor only on the request of the
principal debtor. Hence communication either express or implied by the principal debtor to the surety
is necessary. The communication of the surety with the creditor to enter into a contract of guarantee
without the knowledge of the principal debtor will not constitute a contract of guarantee.
Illustration
Sam lends money to Akash. Sam is the creditor and Akash is the principal debtor. Sam
approaches Raghav to act as the surety without any information to Akash. Raghav agrees. This
is not valid.
2) Consideration
According to section 127 of the act, anything is done or any promise made for the benefit of the
principal debtor is sufficient consideration to the surety for giving the guarantee. The consideration
must be a fresh consideration given by the creditor and not a past consideration. It is not necessary
that the guarantor must receive any consideration and sometimes even tolerance on the part of the
creditor in case of default is also enough consideration.
In State Bank of India v Premco Saw Mill(1983), the State Bank gave notice to the debtor-defendant
and also threatened legal action against her, but her husband agreed to become surety and undertook
to pay the liability and also executed a promissory note in favor of the State Bank and the Bank
refrained from threatened action. It was held that such patience and acceptance on the bank’s part
constituted good consideration for the surety.
3) Liability
In a contract of guarantee, the liability of a surety is secondary. This means that since the primary
contract was between the creditor and principal debtor, the liability to fulfill the terms of the contract
lies primarily with the principal debtor. It is only on the default of the principal debtor that the surety
is liable to repay.
4) Presupposes the existence of a Debt
The main function of a contract of guarantee is to secure the payment of the debt taken by the
principal debtor. If no such debt exists then there is nothing left for the surety to secure. Hence in
cases when the debt is time-barred or void, no liability of the surety arises. The House of Lords in the
Scottish case of Swan vs. Bank of Scotland (1836) held that if there is no principal debt, no valid
guarantee can exist.
5) Must contain all the essentials of a valid contract
Since a contract of guarantee is a type of contract, all the essentials of a valid contract will apply in
contracts of guarantee as well. Thus, all the essential requirements of a valid contract such as free
consent, valid consideration offer, and acceptance, intention to create a legal relationship etc are
required to be fulfilled.
6) No Concealment of Facts
The creditor should disclose to the surety the facts that are likely to affect the surety’s liability. The
guarantee obtained by the concealment of such facts is invalid. Thus, the guarantee is invalid if the
creditor obtains it by the concealment of material facts.
7) No Misrepresentation
The guarantee should not be obtained by misrepresenting the facts to the surety. Though the contract
of guarantee is not a contract of Uberrima fides i.e., of absolute good faith, and thus, does not require
complete disclosure of all the material facts by the principal debtor or creditor to the surety before he
enters into a contract. But the facts, that are likely to affect the extent of surety’s responsibility, must
be truly represented

Kinds of guarantee
Contracts of guarantees may be classified into two types: Specific guarantee and continuing
guarantee. When a guarantee is given in respect of a single debt or specific transaction and is to come
to an end when the guaranteed debt is paid or the promise is duly performed, it is called a specific or
simple guarantee. However, a guarantee which extends to a series of transactions is called a
continuing guarantee (Section129). The surety’s liability, in this case, would continue till all the
transactions are completed or till the guarantor revokes the guarantee as to the future transactions.
Illustrations
a) S is a bookseller who supplies a set of books to P, under the contract that if P does not pay for the
books, his friend K would make the payment. This is a contract of specific guarantee and K’s liability
would come to an end, the moment the price of the books is paid to S.

Continuing guarantee
A continuing guarantee is defined under section 129 of the Indian Contract Act,1872. A continuing
guarantee is a type of guarantee which applies to a series of transactions. It applies to all the
transactions entered into by the principal debtor until it is revoked by the surety. Therefore Bankers
always prefer to have a continuing guarantee so that the guarantor’s liability is not limited to the
original advances and would also extend to all subsequent debts.
The most important feature of a continuing guarantee is that it applies to a series of separable, distinct
transactions. Therefore, when a guarantee is given for an entire consideration, it cannot be termed as a
continuing guarantee.
Revocation of Continuing Guarantee
So far as a guarantee given for an existing debt is concerned, it cannot be revoked, as once an offer is
accepted it becomes final. However, a continuing guarantee can be revoked for future transactions. In
that case, the surety shall be liable for those transactions which have already taken place.
A contract of guarantee can be revoked in the following two ways-

1) By giving a notice (Section 130)

Continuing guarantees can be revoked by giving notice to the Creditor but this applies only to future
transactions. Just by giving a notice the surety cannot waive off his responsibility and still remains
liable for all the transactions that have been placed before the notice was given by him. If the contract
of guarantee includes a clause that a notice of a certain period of time is required before the contract
can be revoked, then the surety must comply with the same as said in Offord v Davies (1862).
Illustration
A guarantees to B to the extent of Rs. 10,000, that C shall pay for all the goods bought by him during
the next three months. B sells goods worth Rs. 6,000 to C. A gives notice of revocation, C is liable for
Rs. 6,000. If any goods are sold to C after the notice of revocation, A shall not be, liable for that.
2) By Death of Surety(Section 131)
Unless there is a contract to the contrary, the death of surety operates as a revocation of the continuing
guarantee in respect to the transactions taking place after the death of surety due to the absence of a
contract. However, his legal representatives will continue to be liable for transactions entered into
before his death. The estate of deceased surety is, however, liable for those transactions which had
already taken place during the lifetime of the deceased. Surety’s estate will not be liable for the
transactions taking after the death of surety’even if the creditor had no knowledge of surety’s death.

Period of Limitation
The period of limitation of enforcing a guarantee is 3 years from the date on which the letter of
guarantee was executed. In State Bank Of India vs Nagesh Hariyappa Nayak And Ors, against the
advancement of a loan to a company, the guarantee deed was executed by its directors and
subsequently a letter acknowledging the load was issued by same directors on behalf of the company.
It was held that the letter did not have the effect of extending the period of limitation. Recovery
proceedings instituted after three years from the date of the deed of guarantee were liable to be
quashed.

Rights of a Surety
After making a payment and discharging the liability of the principal debtor, the surety gets various
rights. These rights can be studied under three heads:
(i) rights against the, principal debtors.
(ii) rights against the creditor, and
(iii) rights against the co-sureties.

(i) Rights against the Principal Debtor

1) The right of surety on payment of debt or the Right of

subrogation(Section 140)
The right of subrogation means that since the surety had given a guarantee to the creditor and the
creditor after getting the payment is out of the scene, the surety will now deal with the debtor as if he
is a creditor. Hence the surety has the right to recover the amount which he has paid to the creditor
which may include the principal amount, costs and the interest.

2) The right of Indemnity(Section 145)

In every contract of guarantee, there is an implied promise by the principal debtor to indemnify the
surety, and the surety is entitled to recover from the principal debtor whatever sum he has rightfully
paid under the guarantee. This is because the surety has suffered a loss due to the non-fullfillment of
promise by the principal debtor and therefore the surety has a right to be compensated by the debtor
Illustration
Luthra and co has taken a loan from Khaitan and co where Amarchand acts as security on
behalf of Luthra. Khaitan demands payment from Amarchand and on his refusal sues him for
the amount, Amarchand defends the suit having reasonable grounds for doing so, but he is
compelled to pay the amount of the debt with costs. He can recover from Luthra the amount
paid by him for costs, as well as the principal debt.

(ii) Rights against the Creditor

1) Right to securities given by the principal debtor(section 141)

On the default of payment by the principal debtor, when the surety pays off the debt of the principal
debtor he becomes entitled to claim all the securities which were given by the principal debtor to the
creditor. The Surety has the right to all securities whether received before or after the creation of the
guarantee and it is also immaterial whether the surety has knowledge of those securities or not.
Illustration
On the guarantee of Priya, Anita lent rs 100000 to Sita. This debt is also secured by security for
the debt which is the lease of Sita’s house. Sita defaults in paying the debt and Priya has to pay
the debt. On paying off Sita’s liabilities Priya is entitled to receive the lease deed in her favor.

2) Right to set off

When the creditor sues the surety for the payment of principal debtor’s liabilities, the surety can claim
set off, or counterclaim if any, which the principal debtor had against the creditor.

(iii) Rights against the Co-sureties

1) Release of one co-surety does not discharge others (Section 138)

When the repayment of debt of the principal debtor is guaranteed by more than one person they are
called Co-sureties and they are liable to contribute as agreed towards the payment of guaranteed debt.
The release by the creditor of one of the co-sureties does not discharge the others, nor does it free the
released surety from his responsibility to the other sureties. Thus when the payment of a debt or
performance of duty is guaranteed by co-sureties and the principal debtor has defaulted in fulfilling
his obligation and thus the creditor compels only one or more of the co-sureties to perform the whole
contract, the co-surety sureties performing the contract are entitled to claim contribution from the
remaining co-sureties.

2) Co-sureties to contribute equally (Section 146)

According to Section 146, in the absence of any contract to the contrary, the co-sureties are liable to
contribute equally. This principle will apply even when the liability of co-sureties is joint or several,
and whether under the same or different contracts, and whether with or without the knowledge of each
other.
Illustration
A, B, C, and D are co-sureties for a debt of Rs. 2,0000 lent by Z to R. R defaults in repaying the
loan. A, B, C, and D are liable to contribute Rs. 5000 each.

3) Liability of co-sureties bound in different sums(Section 147)

When the co-sureties have agreed to guarantee different sums, they have to contribute equally subject
to the maximum of the amount guaranteed by each one.
Illustration
A, B and C, sureties for D, enter into three separate bonds, each in a different penalty, A for Rs.
10,000, B for Rs. 20,000 and C for Rs. 40,000. D makes default to the extent of Rs. 30,000. A B
and C are liable to pay Rs. 10,000 each. Suppose this default was to the extent of Rs. 40,000.
Then A would be liable for Rs. 10,000 and B and C Rs. 15,000 each.

Discharge of Surety from Liability

Under any of the following circumstances a surety is discharged from his liability:
i) by the revocation of the contract of guarantee,
ii) by the conduct of the creditor, or
iii) by the invalidation of the contract of guarantee

Conduct of the Creditor

1) Variance in terms of the contract(Section 133)

When a contract of guarantee has been materially altered through an agreement between the creditor
and principal debtor, the surety is discharged from his liability. This is because a surety is liable only
for what he has undertaken in the guarantee and any alteration made without the surety’s consent will
discharge the surety as to transactions subsequent to the variation.
Illustration
A becomes surety to C for B’s conduct as a manager in C’s bank. Afterward, B and C contract,
without A’ s consent, that B’ s salary shall be raised, and that he shall become liable for one-fourth of
the losses on overdrafts. B allows a customer to over-draw, and the bank loses a sum of money. A is
discharged from his suretyship by the variance made without his consent and is not liable to make
good this loss.

2) Release or discharge of the principal debtor(Section 134)

A surety is discharged if the creditor makes a contract with the principal debtor by which the principal
debtor is released, or by any act or omission of the creditor, which results in the discharge of the
principal debtor.
Illustration
A supplies goods to B on the guarantee of C. Afterwards B becomes unable to pay and contracts
with A to assign some property to A in consideration of his releasing him from his demands on
the goods supplied. Here, B is released from his debt, and C is also discharged
from his suretyship. But, where the principal debtor is discharged of his debt by operation of
law,
say, on insolvency, this will not operate as a discharge of the surety.

3) Arrangement between principal debtor and creditor

According to section 135 when the creditor, without the consent of the surety, makes an arrangement
with the principal debtor for composition, or promise to give him time to, or not to sue him, the surety
will be discharged.
However, when the contract to allow more time to the principal debtor is made between the creditor
and a third party, and not with the principal debtor, the
surety is not discharged (Section 136).
Illustration
C, the holder of an overdue bill of exchange drawn by A as surety for B, and accepted by B,
contracts with M to give time to B, A is not discharged.

4) Loss of security(Section 141)

If the creditor parts with or loses any security given to him at the time of the guarantee, without the
consent of the surety, the surety is discharged from liability to the extent of the value of the security.
Illustration
A, as surety for B, makes a bond jointly with 3 to C to secure a loan from C to B. Later on, C
obtains from B further security for the same debt. Subsequently, C gives up further security. A
is not discharged.

By Invalidation of the Contract

A contract of guarantee, like any other contract, may be avoided if it becomes void or voidable at the
option of the surety. A surety may be discharged from liability in the following cases:

1) Guarantee obtained by misrepresentation(Section 142)

When a misrepresentation is made by the creditor or with his knowledge or consent, relating to a
material fact in the contract of guarantee, the contract is invalid

2) Guarantee obtained by concealment(Section 143)

When a guarantee is obtained by the creditor by means of keeping silence regarding some material
part of circumstances relating to the contracts, the contract is invalid

3) Failure of co-surety to join a surety(Section 144)

When a contract of guarantee provides that a creditor shall not act on it until another person has joined
in it as a co-surety, the guarantee is not valid if that other person does not join.E

Extent of a surety’s liability

In the absence of a contract to the contrary, the liability of a surety is co-extensive with that of the
liability of the principal debtor. It means that the surety is liable to the same extent to which the
principal debtor is liable.
Illustration
A guarantees to B the payment of a bill of exchange by C, the acceptor. On the due date, the bill
is dishonored by C. A is liable, not only for the amount of the bill but also for any interest and
charges which may have become due on it.