MS EDUCONZ PVT. LTD.

LAW& AUDIT

SPECIAL CONTRACT

Contract of Indemnity
1. INTRODUCTION TO CONTRACT OF INDEMNITY

¾ Indemnity Meaning –
• To make good the loss incurred by another person
• To compensate the party who has suffered some loss
• To protect a party from incurring a loss

¾ ‘Contract of indemnity Definition

A contract is called as a ‘contract of indemnity’ if –
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.

¾ Modes of contract of indemnity

Expressed:
When a person expressly promises to compensate the other from loss.
Implied :
When the contract is to be inferred from the conduct of the parties or from the
circumstances of the case.

¾ Essential elements of a contract of indemnity

Contract :
All the essentials of a valid contract must also be present in the contract of indemnity
Example:- X asks Y to beat Z and promises to indemnify Y against the consequences. Y
beats Z and is fined Rs.1,000. Y cannot claim this amount from X because the object of
the agreement was unlawful.
Loss to one party
A person can indemnify another person only if such other person incurs some loss or it
has become certain that he will incur some loss.
Indemnity by the promisor
The purpose of contract of indemnity is to protect the indemnity holder from any loss
that may be caused to the indemnity holder.
Reason for loss
The contract of indemnity must specify that indemnity holder shall be protected from the
loss caused due to –
• Action of the promisor himself; or
• Action of any other person; or
• Any act, event or accident which is not in the control of the parties.

2. RIGHTS OF INDEMNITY HOLDER (Sec. 125)

¾ Right to recover damages

The indemnity holder has the right to recover all the damages which he is compelled to
pay in any suit in respect of any matter covered by the contract of indemnity.

¾ Right to recover costs

SUJEET JHA 61 9213188188
MS EDUCONZ PVT. LTD. LAW& AUDIT

The indemnity holder has the right to recover all the costs which he is compelled to pay
in bringing or defending such suit.
Condition:
(a) The indemnifier authorised him to bring or defend the suit; or
(b) The indemnity holder did not contravene the orders of the indemnifier; and The
indemnity holder acted as it would have been prudent for him to act in the absence of
any contract of indemnity.

¾ Right to recover sums paid

The indemnity holder has the right to recover all the sums which he has paid under the
terms of a compromise of such suit.
(a) The indemnifier authorised him to compromise the suit; or
(b) The indemnifier holder did not contravene the orders of the indemnifier; and the
indemnity holder acted as it would have been prudent for him to act in the absence of
any contract of indemnity.

Contract of guarantee
3. MEANING OF CERAIN TERMS (Sec. 126)

¾ Meaning 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.

¾ Meaning of ‘surety’
The person who gives the guarantee is called as ‘surety’

¾ Meaning of ‘principal debtor’

The person in respect of whose default the guarantee is given is called as ‘principal
debtor’.

¾ Meaning of ‘creditor’
The person to whom the guarantee is given is called as ‘creditor’.
GUARANTEE

ON MONEY
ON PERSON
Nature of payment Effective time of payment

Specific/Simple Continuing Retrospective Prospective Fidelity

Guarantee Guarantee Guarantee Guarantee Guarantee
Guarantee is for Guarantee is for Guarantee is for Guarantee is for Guarantee is on
a single a series of an existing debt a future debt or the good conduct
transaction. It transactions. or obligation. obligation. or honesty of a
ends when debt Liability extends person employed
is discharged or till the in a particular
promise is revocation of organizations.
performed. guarantee.

SUJEET JHA 62 9213188188

MS EDUCONZ PVT. LTD. LAW& AUDIT

4. ESSENTIALS AND LEGAL RULES FOR A VALID CONTRACT OF GUARANTEE.

¾ Must have all the essentials of a valid contract

• All the essentials of a valid contract must be present in the contract of guarantee.
• Exceptions:
(a) Consideration received by the principal debtor is a sufficient consideration to the
surety for giving the guarantee.
(b) Even if principal debtor is incompetent to contract, the guarantee is valid. But, if
surety is incompetent to contract, the guarantee is void.

¾ Primary liability of some person

• The principal debtor must be primarily liable. However, even if the principal debtor
is incompetent to contract the guarantee is valid.
• The debt must be legally enforceable.
• The debt must not be a time barred debt.

¾ The contract must be conditional

• The liability of surety is secondary and conditional.
• The liability of surety arises only if the principal debtor makes a default.

¾ No misrepresentation
• The creditor should disclose all the facts which are likely to affect the surety’s
liability.
• There must not be any concealment of facts.

¾ Form of contract
A contract of guarantee may be either oral or written.

¾ Joining of other co-sureties

The guarantee by a surety is not valid if –
• A condition is imposed by a surety that some other person must also join as a co-
surety; but
• Such other person does not join as a co-surety.

5. NATURE AND EXTENT OF SURETY’S LIABILITY

¾ Surety’s liability is coextensive with liability of principal debtor

General rule –
• Surety is liable for all the debts payable by the principal debtor to the creditor.
• Accordingly, interest, damages, costs etc. may also be recovered from the surety.
Exception:-
The contract of guarantee may provide otherwise.

¾ Commencement of surety’s liability

• The liability of surety arises immediately on default by the principal debtor.
• The creditor is not required to –
(a) first sue the principal debtor; or
(b) first give a notice to the principal debtor.

¾ Surety’s liability may be limited

SUJEET JHA 63 9213188188

MS EDUCONZ PVT. LTD. LAW& AUDIT

The surety may fix a limit on his liability up to which the guarantee shall remain
effective.

¾ Surety’s liability may be continuous

• The surety may agree to become liable for a series of transactions of continuous
nature.
• However, the surety may fix –
- a limit on his liability upto which the guarantee shall remain effective;
- a time period during which the guarantee shall remain effective.

¾ Surety’s liability may be conditional

The surety may impose certain conditions in the contract of guarantee. Until those
conditions are met, the surety shall not be liable.

6. CONTINUING GUARANTEE

¾ Meaning
A guarantee which extends to a series of transactions is called as continuing guarantee.

¾ Revocation (Sec.130)
Continuing guarantee may be revoked, at anytime, by the surety by giving a notice to the
creditor. However, revocations shall be effective only in respect of future transactions
(i.e. the liability of the surety with regard to previous transactions remains unaffected)

¾ Death of surety (sec. 131)

Death of the surety operates as a revocation of a continuing guarantee as to future
transaction.

7. RIGHTS OF SURETY (Sec.140, 141, 145, 146 and 147)

I. Rights against principal debtor

¾ Right of indemnity
• There is an implied promise by the principal debtor to indemnity the surety.
• The surety is entitled to claim from the principal debtor all the sums which he has
rightfully paid.
• The surety cannot recover such sums, which the he has paid wrongfully.

¾ Right of subrogation
On payment of a debt, the surety shall be entitled to all the rights which the creditor
could claim against the principal debtor.

II. Rights against the creditor

¾ Right of subrogation
• The surety can claim all the securities which the creditor had at the time of giving of
guarantee
• It is immaterial as to whether the surety had knowledge of such securities or not.
• If the securities are returned by the creditor to the principal debtor the surety is
discharged to the extent of value of the securities so returned.

¾ Right of set off

• Any amount recoverable by the principal debtor may be claimed as deduction.
• Any amount recoverable by the surety may be claimed as deduction.
SUJEET JHA 64 9213188188
MS EDUCONZ PVT. LTD. LAW& AUDIT

¾ Rights to share reduction

If the principal debtor becomes insolvent, the surety may claim proportionate reduction
in his liability.

III. Rights against co-sureties

¾ Rights to contribution
General Rule
All the co-sureties shall contribute equally
Exceptions
• Under the contract of guarantee, the co-sureties may fix limits on their respective
liabilities. Even in such a case, the co-sureties shall contribute equally, subject to
maximum limit fixed by the co-sureties.
• The contract of guarantee may provide that the co-sureties shall contribute in some
other proportion.

¾ Right to share benefit of securities

If one co-surety receives any security, all the other co-sureties are entitled to share the
benefit of such security.
8. DISTINCTION BETWEEN INDEMNITY AND GUARANTEE

Basis Contract of indemnity Contract of guarantee

Meaning A contract by which one party A contract of guarantee is a
promises to save the other from contract to perform the promise,
loss caused to him is called as a or discharge the liability of a third
contract of indemnity. person in case of his default.
Parties There are only two parties, viz, the There are three parties, viz., the
indemnifier and the indemnity principal debtor, creditor and the
holder. surety.
Nature of liability The liability of the indemnifier is The liability of the surety is
primary and independent. secondary and conditional.
Number of contract In a contract of indemnity there is In the contract of guarantee, there
only one contract. are three contracts; first between
principal debtors and creditor,
second between creditor and
surety, and third between surety
and principal debtor.
Nature of contract The contract of indemnity is for the The contract of guarantee is for
reimbursement of the loss. the security of the creditor.

9. DISCHARGE OF SURETY FROM LIABILITY (Sec.130 to 144)

DISCHARGE OF SURETY

Revocation of contract of Invalidation of contract of Conduct of Creditor

guarantee guarantee

¾ Notice of revocation by surety

• Specific guarantee
A specific guarantee can be revoked only if liability of principal debtor has not
arisen.
• Continuing guarantee
SUJEET JHA 65 9213188188
MS EDUCONZ PVT. LTD. LAW& AUDIT

A continuing guarantee can be revoked only in respect of future transactions.

¾
¾
¾ Death of surety
In case of death of surety, a continuing guarantee is automatically revoked in respect of
future transactions.

¾ Variance in terms
If –
• Any variation is made subsequent to formation of contact of guarantee; and
• Such variation is made without the consent of surety;
Then –
• The surety shall be released for such transactions as take place after such variation.

¾ Release or discharge of principal debtor

If –
• The creditor makes a fresh contract with the principal debtor whereby the principal
debtor is relieved from his liability; or –
• The creditor does any act or omission resulting in discharge of the principal debtor;
Then –
The surety is discharged.
¾ Composition with principal debtor
The surety is discharged if the creditor makes a composition with the principal debtor
without obtaining the consent of surety.

¾ Giving extension of time to principal debtor

The surety is discharged if the creditor extends the time for repayment of the debt by the
principal debtor without obtaining the consent of the surety.

¾ Loss of security by a creditor

The surety is discharged to the extent of security lost by the creditor.

SUJEET JHA 66 9213188188