Business law

1st year

UNIT -2

CONTRACT RELATING TO INDEMNITY AND GUARANTEE

The contract of indemnity and guarantee are special kinds of contracts. These contract are therefore
also required to fulfill all the essential of a valid contract.

Indemnity Contract: Indemnity contract is a type of contingent contract. The term ‘Indemnity` Simply
means ‘Making Somebody Safe` or ‘Paying Somebody back`.

Section 124 of contract Act defines that ‘‘A contract by which one party. Promises to save the other
from loss caused to him by the conduct of the promise himself by the conduct of any other person, is
called a conduct of indemnity”.

The party who gives indemnity or who promises to compensate for or to make good the loss, is called.
Indemnifier and the party for whose protection or safety the indemnity is given or the party whose loss
is made good is called ‘Indemnified’ or ‘indemnity holder’.

Important features of an indemnity contract –

1. Two party.

2. Promises for pay compensation of loss/damage.

3. Loss/damage may be the own or other person.

4. Creation of liabilities.

5. It must be faith.

6. All essential features of valid contract.

7. Compensation for actual loss/damage.

8. It may be express or implied.

Loss/damage may be caused by some event, or accident, or some natural phenomenon or disaster.

Rights of Indemnified (Indemnity-Holder) –

1. Rights to claim for all damages/losses.

2. Rights to claim for all costs which is related to contract.

3. Rights to claim for all sums which his may have paid for contract.

Liabilities/Duties of Indemnified –

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1. Liabilities to pay all damages/losses.

2. Liabilities to pay all costs related to contract.

3. Liabilities to pay all sum which is received by sell for contract from indemnified.

Purpose of Contract of Guarantee

Normally, the purpose of a contract of guarantee can be one of the following:

i) For the security of a loan given to a party,

ii) For the assurance of good conduct and honesty of an employee in service contracts and

iii) For indemnity of a third party from loss resulting from the non-payment of a debt.

Essential Features of a Contract of Guarantee

Like in a contract of indemnity, a contract of guarantee also must have all the essential elements of a
valid contract. According to Section 126, the following are the essential features of a contract of
guarantee —

1. Existence of a Principal Debt: A contract of guarantee pre-supposes the existence of a liability

enforceable at law. If no such liability exists, there can be no contract of guarantee. The surety
undertakes to be liable only if principal debtor fails to discharge his obligation.

2. Benefit to principal debtor is sufficient consideration: Section 127 clearly provides that anything
done or any promise made for the benefit of the principal debtor may be a sufficient consideration to
the surety for giving the guarantee. Thus, any benefit received by the debtor is adequate consideration
to bind the surety. There must be a fresh consideration moving from the creditor. Past consideration is
no consideration for contract of guarantee.

3. Consent of surety not obtained by misrepresentation or concealment: A contract of guarantee is not

a contract of uberrimaefidei i.e., one requiring complete disclosure of all the material facts by the
principal debtor or the creditor to the surety before the contract is entered into by him. Thus, when a
guarantee is given to a bank, it is not bound to inform the surety of matters affecting the credit of the
debtor, or of any circumstances connected with the transaction which may render the position of the
surety more onerous. The contract of guarantee is invalid in case of misrepresentation, concealment or
when co-surety does not join.

4. A contract of guarantee may be either oral or written. It may be expressed or implied from the
conduct of the parties.

5. Surety can be proceeded without proceeding against the principal debtor first.

6. A contract of guarantee can only be between at least three parties — surety, principal debtor and
creditor.

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7. Free consent of all parties is essential for a contract to be valid.

Distinction between Contracts of Indemnity and Guarantee

In both the contracts, the motive is to insure a person against the probable loss out of the deal. But
there are many points of distinction between the two which are listed below:

1. Function: In a contract of indemnity, the indemnifier promises to protect the indemnified against the
consequences of the conduct of the indemnity – holder or a third party whereas in a contract of
guarantee, the surety promises to perform the obligation or promise of a third party.

2. Parties to the Contract: In a contract of indemnity, there are only two parties to the contract — the
indemnifier and the indemnity – holder whereas in a contract of guarantee, there are three parties to
the contract — the principal debtor, creditor and the surety.

3. Object: The purpose of contract of indemnity is a safety from an uncertain future event whereas the
purpose of contract of guarantee is to assure the other party of the performance of an obligation.

4. Liability: In a contract of indemnity, the liability of the indemnifier is primary while in a contract of
guarantee, the liability of the surety is secondary and arises only on the default of the principal debtor.

5. Time of Occurrence: Ina contract of indemnity, the liability of the indemnifier arises only on the
happening of a contingency whereas in the case of a contract of guarantee, there is an existing debt or
duty the performance of which is guaranteed by the surety.

6. Scope: In a contract of indemnity, the scope is limited and does not include contracts of guarantee
whereas in a contract of guarantee, the scope is wide and includes the contracts of indemnity.

7. Nature: In a contract of indemnity, the contract is a security against loss whereas in a contract of
guarantee, the contract is an assurance to the creditor.

8. Purpose: A contract of indemnity is for the reimbursement of a loss while a contract of guarantee is
for the security of the creditor.

9. Consideration: In a contract of indemnity, the indemnifier receives a consideration from the

indemnity-holder at the beginning of the contract, whereas in a contract of guarantee, the surety does
not receive any consideration. The only consideration for the surety is the expected gain of the principal
debtor.

10. Right to Sue: In a contract of indemnity, the indemnifier cannot sue a third party for loss in his own
name, but must bring the suit on behalf of the indemnified. But in a contract of guarantee, the surety,
on discharging a debt payable by the principal debtor to the creditor, can sue the principal debtor in his
own right.

11. Number of Contracts: in a contract of indemnity, there is only one original and independent contract
between the indemnifier and the indemnity holder whereas in a contract of guarantee, there are three

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contracts — between the principal debtor and the creditor, between the creditor and the surety and an
implied contract between the principal debtor and the surety.

12. Competency to Contract: All parties in a contract of indemnity must be competent to contract. As a
special case, when a minor is a principal debtor, the contract of guarantee is still valid.

13. In the case of a contract of indemnity, it is not necessary for the indemnifier to act at the request of
the indemnified, whereas in the case of a contract of guarantee, it is necessary that the surety should
give the guarantee at the request of the debtor.

OR

DISTINCTION BETWEEN A CONTRACT OF INDEMNITY AND GUARANTEE

S.No. Different Basis Indemnity Contract Guarantee Contract

1. Nature of Contract Promises to save the other from One party promises to
loss discharge the liability of the
third party in case of his
default.
2. No. of Parties Only to parties are there There are three parties
3. No. of contracts There is only one contract There are three contract
between debtors, creditors
and surety.
4. Nature of Liability The liability of the indemnifier is The liability of the surely is
primary and independent. secondary and dependent.
5. Arising of Liability Indemnifier’s liability arises only Arises only after the default
on the happening of a contingency of debtor in payment.
6. Existence of debt or duty There is no existence debt or duty There is always some
in this contract. existing debt or duty in this
contract.
7. Request by the debtor It is not necessary for the The surely generally gives
indemnifier to act at the request guarantee to the request of
indemnified. the debtor.
8. Right to sue The indemnifier cannot sue the It surely has discharged.
third party for loss in his own The debt after the default
name. of the principal debtor, he
becomes entitled to sue
the debtor in his own
name.

Kinds of Guarantee
The function of a contract of guarantee is to enable a person to get a loan, or goods on credit, or an
employment. A guarantee may therefore be given for a) the repayment of debt, or b) the payment of

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the price of the goods sold on credit, or c) the good conduct or honesty of a person employed in a
particular office. In the last case, the guarantee is called a ‘fidelity’ guarantee.

A guarantee may be one of various kinds, such as —

a) Absolute and conditional guarantee: An absolute guarantee is one by which the guarantor
unconditionally promises payment or performance of the contract on default of the principal debtor. A
conditional guarantee is one which is not enforceable immediately on the default of the principal
debtor, but some contingency other than such default must happen.

b) General and special guarantee: A general guarantee is one for acceptance by the public generally. It
is a general promise to any one accepting it to be answerable for a debt in case of the failure of another
person. A special guarantee is one which is addressed to a particular person who alone can take
advantage of it and to whom alone the guarantor can be held responsible.

c) Limited and unlimited guarantee: A limited guarantee is ordinarily one restricted to a single
transaction and in this sense it is different from a continuing guarantee. An unlimited guarantee is one
which is unlimited either as to time or amount.

d) Retrospective and prospective guarantee: A guarantee given for an existing debtor obligation is
called a retrospective guarantee. A guarantee given for future debt or obligation is called a prospective
guarantee.

A prospective guarantee is of two types— specific guarantee and continuing guarantee

i) Specific guarantee: When a guarantee extends to a single transaction or debt, it is a specific

guarantee. Such guarantee comes to an end with the discharge of a debt or the performance of a
promise.

ii) Continuing guarantee: It means a guarantee which extends to a series of transactions. It is not limited
to a single transaction but it is generally for an indefinite time or until revoked. It is prospective in its
operation. The essence of a continuing guarantee is that it applies not to a specific number of
transactions, but to any number of them and makes the surety liable for the unpaid balance at the end
of the guarantee (Sec.129).

He salient features of a continuing guarantee are:

i) Such guarantee is valid for a series of continuing transactions provided the transactions are within the
limits of the guarantee in terms of amount and time period.

ii) Such guarantee is only applicable to specific amount of money.

iii) The surety reserves the right to be kept informed about the probable future transactions.

iv) In the absence of an agreement to the contrary, the continuing guarantee terminates in the event of
death of the guarantor.

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Revocation of a continuing guarantee

A continuing guarantee is revoked as to future transactions in the following ways:

1. By notice: A continuing guarantee may at any time be revoked by the surety as to future transactions,
by notice to the creditor (Sec. 130). In the event of revocation, the surety is not responsible to the
creditor for any future transactions, but continues to be responsible for all such transactions that have
been done till the notice of revocation of guarantee is received by the creditor.

2. By surety’s death: According to Section 131, the death of the surety operates, in the absence of any
contract to the contrary, as a revocation of a continuing guarantee, so far as regards future transactions.
The liability of the surety for the previous transactions, however, remains.

3. By other modes: A continuing guarantee is also revoked —

a) By Novation (Sec. 62): When the parties agree to substitute a new contract for the old contract or
rescind or alter the old contract of guarantee, it will amount to revocation.

b) By variance in the terms of contract (Sec. 133): If any variation has been made in the terms of
contract of guarantee between the creditor and the principal debtor without the knowledge or
concurrence of the surety, the contract of guarantee is revoked.

c) By release or discharge of the principal debtor (Sec.134): When a creditor discharges principal debtor
from the liability, the surety also gets discharged.

d) By compounding with the principal debtor (Sec. 135).

e) By creditor’s act or omission impairing surety’s eventual remedy (Sec. 139): Any act or omission by
the creditor which repairs the eventual remedy of the surety against the debtor amounts to revocation
of the contract of guarantee.

f) By loss of security (Sec. 141): When a creditor loses security under the contract, the surety gets
discharged to the extent of the value of that security.

e) Invalid guarantee: If the guarantee is not covered by the contracts of absolute faith, the surety is not
absolved of his obligation merely by proving that he was unaware of the contract between the principal
debtor and the creditor. But the surety has the right to be kept informed by the party for whom he is
giving the guarantee about the duration and amount of the guarantee. A guarantee becomes valid in the
following situations:

i) Guarantee obtained by misrepresentation (Sec. 142): Any guarantee which has been obtained by
means of misrepresentation made by the creditor, or with his knowledge and assent, concerning a
material part of the transaction, is invalid.

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ii) Guarantee obtained by concealment (Sec. 143): Any guarantee which the creditor has obtained by
means of keeping silence as to the material circumstances is invalid.

iii) Guarantee on the condition of joining co-sureties (Sec.144): Where a person gives a guarantee upon
a contract that a creditor shall not act upon it until another person has joined in it as co-surety, the
guarantee is not valid if that other person does not join. This means if the surety agrees to be only one
of several co-sureties, he will not be liable unless the other execute the guarantee.

Liability of Surety
Section 128 of the Contract Act defines the nature and extent of surety’s liability.

1. Liability of surety is of secondary nature: In a contract of guarantee, the principal debtor is primarily
liable to pay or discharge liability. It is only at his default, the liability of the surety arises and he may be
called upon to discharge it. The creditor is not required to give any notice to this effect to the surety.

2. Liability of the surety is contingent: In a contract of guarantee, the liability of the surety is contingent
or conditional in nature. It may or may not arise when the principal debtor commits default. And it is not
certain that he will default. In practice, generally he discharges his liability to the satisfaction of the
creditor.

3. Liability of the surety is immediate in nature: Once the principal debtor commits default,
immediately the creditor may proceed against the surety. It is not necessary that he should first exhaust
his remedies against the principal debtor. Thus, on default by the principal debtor, the creditor instead
of suing the principal debtor can file a suit against the surety.

4. Liability of surety is ‘co-extensive’:In a contract of guarantee, the liability of the surety is co-extensive
with that of the principal debtor. He is liable for those sums that the principal debtor is liable. His liability
cannot be more than that of the principal debtor. In case the principal debtor is scaled down or
extinguished by the creditor or by the operation of the law, either in whole or in part, the liability of the
surety would also be reduced or extinguished to the same extent.

5. Surety may limit his liability: Though the liability of the surety is co-extensive with that of principal
debtor, he has a right to limit his liability. He can do this by declaring it expressly at the time of making
the contract. In such an instance, the liability of the surety will not go beyond the limit as declared by
him.

6. Liability in continuing guarantee: In the case of continuing guarantee, the liability of the surety
extends to a series of transaction over a period of time and not to a specific number of series but to any
number of them. It makes the surety liable for unpaid balance at the end of guarantee.

7. Liability of the surety where the original contract between the principal debtor and the creditor is
void or voidable: In a contract of guarantee, there are two independent contracts, one between the
principal debtor and the creditor and another between the creditor and the surety. Since the law does

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not treat the principal debtor and the creditor is void, the surety will be liable as if he were the principal
debtor.

Discharge of Surety from Liability

A surety is said to be discharged when his liability comes to an end.The liability of a surety comes to an
end under the following circumstances:

1. Revocation by notice (Section 130): In case of continuing guarantee, a surety is discharged from
liability when he gives due notice to the creditor in respect of any future transactions. In such a case, the
surety would not be responsible for future transactions which may be made by the principal debtor after
the surety has revoked the contract of guarantee.

2. Discharge by variation in terms of contract (Section 133): If a variation is made in the terms of the
contract between the principal debtor and the creditor, without the surety’s consent, the surety is
discharged from liability as to transactions made after the variance. But the variation must be such as
materially affects the position of the surety.

3. Revocation by death (Section 131): The death of the surety operates as a revocation of the
continuing guarantee, in the absence of a contract to the contrary, so far as regards future transactions.
But such revocation does not affect transactions which were executed prior to the death of the surety.

4. Release or discharge of principal debtor (Section 134): This section provides for two kinds of
discharge from liability. a) If the creditor makes any contract with the principal debtor by which the
latter is released, the surety is discharged. But if the principal debtor is discharged in insolvency, this will
not operate as a discharge of the surety. b) The surety is also discharged by any act or omission of the
creditor, the legal consequence of which is the discharge of the principal debtor.

5. Discharge of surety on composition or extension of time or promise not to sue (Sec. 135): This
section provides three modes of discharge from liability, namely — a) Composition with principal
debtor: The liability of the surety will be discharged where a creditor in composition with his principal
debtor accepts a lesser amount in full satisfaction of his claim. b) Promise to give time: A contract
between the creditor and the principal debtor by which the creditor promises to give time to the
principal debtor discharges the surety c) Promise not to sue: Where the creditor under an agreement
with the principal debtor promises not to sue him, the surety is discharged.

6. By creditor’s act or omission impairing surety’s eventual remedy (Sec.139): A surety is discharged if
the creditor does any act which is inconsistent with the rights of the surety or omits to do any act which
his duty to the surety requires him to do and the eventual remedy of the surety himself against the
principal debtor is thereby impaired. It is the duty of the creditor not to do anything which is
inconsistent with the rights of the surety.

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7. By the creditor losing his security (Section 141): Where the creditor loses or parts with the securities
without the consent of the surety, the surety is discharged to the extent of the value of securities.

8. By concealment or misrepresentation (Section 142 and 143): Where a surety is induced to enter into
a contract of guarantee by a misrepresentation or concealment on the part of the creditor concerning a
material part of the transaction, such misrepresentation or concealment operates to discharge the
surety from his liability on the guarantee. Sections 142 & 143 will not apply if the misrepresentation or
concealment is by debtor and creditor has no knowledge of it.

9. By the failure on the part of some person or persons to join the surety (Sec.144): Where a person
gives a guarantee upon a contract that the creditor shall not act upon it until another person has joined
in it as co-surety, the guarantee is not valid if that other person does not join.

Rights of Surety
Under the Indian Contract Act, a surety has the following rights against the principal debtor, the creditor
and the co-sureties:

A. Rights against principal debtor: The surety can exercise the following two rights against the principal
debtor:

a) Right of subrogation (Sec. 140): When the principal debtor has committed the default and the surety
pays the debt to the creditor, the surety will stand in the shoes of the creditor and will be invested with
all the rights which the creditor had against the debtor.

b) Right to claim indemnity (Sec. 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 all payments properly made. After the surety makes payment under the guarantee, he becomes
a creditor of the principal debtor and can recover from the latter the amount paid, he can recover that
damage also.

B. Rights against the creditor

Section 141 provides the following rights to a surety against the creditor —

a) A surety is entitled to the benefit of every security which the creditor has at the time when the
contract of suretyship is entered into irrespective of whether the surety knows of the existence of such
security or not; and

b) If the creditor loses or without the consent of the surety parts with such security, the security is
discharged to the extent of the value of the security.

c) The surety has a right any time before the guaranteed debt has become due and before he is called
upon to pay, to require the creditor to sue the principal debtor. However, the surety will have to
indemnify the creditor for any expenses or loss resulting there from.

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d) The surety is entitled, on being sued by the creditor, to rely on any set off or counter- claim which the
debtor might possess against the creditor.

C. Rights against co-sureties

Right of contribution: When a debt is guaranteed by two or more sureties, they are called co-sureties.
The co-sureties are liable to contribute, as agreed, towards the payment of the guaranteed debt. When
one of the co-sureties makes payment to the creditor, he has a right to claim contribution from the
other co-surety or co-sureties. The doctrine of contribution applicable here is not founded on contract
but on equity i.e., there is equality of burden and benefit as between co-sureties. This rule is contained
in Secs. 146 and 147.

a) Co-sureties liable to contribute equally (Sec. 146): Where there are two or more co- sureties for the
same debt or duty and the principal debtor makes a default, the co- sureties, in the absence of any
contract to the contrary are liable to contribute equally to the extent of the default. This principle will
apply whether their liability is joint oe several, and whether their liability arises under the same or
different contracts, and whether with or without the knowledge of each other.

b) Liability of co-sureties bound in different sums (Sec.147): Where the co-sureties have agreed to
guarantee different sums, they have to contribute equally subject to the maximum amount guaranteed
by each one. The fact that the sureties are liable jointly or severally under one contract or several
contracts, or without the knowledge of each other, is immaterial. As between the co-sureties, the right
of contribution arises only when a co-surety has paid more than he is liable to pay. And if a co-surety
obtains from the creditor any security of the principal debtor, the other co-sureties have a right to share
in the proceeds of the security. To, sum up, it may be said that, between co-sureties, there is equality of
burden and benefit.

c) Release of a co-surety (Sec. 138): Where there are co-sureties, a release by the creditor of one of
them does not discharge the others, neither does it free the surety so released from his responsibility to
the other sureties.

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