Contracts of Indemnity and Guarantee

Introduction
 The contract of indemnity and the contract guarantee are the special
contracts under the Indian Contract Act, 1872. The contract of indemnity is the
contract where one person compensates for the loss of the other.
 Contract of guarantee is a contract between three people where the third
person intervenes to pay the debt if the debtor is at default in paying back.
 The contract of guarantee and contract of indemnity perform similar commercial
functions in providing compensation to the creditor for the failure of a third party to
perform their obligation.
 Chapter VIII of the Indian Contract Act, 1872 contains the legal provisions
governing a contract of indemnity and a contract of guarantee in India.
Contract of Indemnity
 The term indemnity is derived from the Latin word “indemnis” which
denotes uninjured or suffering no damage or loss. It is a sort of security or
protection against loss.
 Indemnity is to indemnify one person by bearing his losses incurred to him by
the conduct of promissory or by any other party.
 Section 124 of the Indian Contract Act, 1872 defines a contract of indemnity as a
contract wherein 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.
 In an indemnity contract, there are only two parties i.e.,
o The Indemnifier: The promisor, who agrees to make up the damage caused to
the other group.
o The Indemnified: The person who is assured of compensation for the damage
incurred (if any) is referred to as the indemnity holder or the indemnified.
Essentials in the Contract of Indemnity
 Valid contract: An indemnity contract must have all parts of a valid contract.
The Indian Contract Act of, 1872 applies to indemnity contracts.
 Loss protection: The indemnity contract is for loss protection. The indemnifier is
bound to recover the losses.
 Parties: The indemnity contract shall have two parties. The indemnifier and the
holder.
 Contracts: There is one contract only between the holder and the indemnifier.
 Express or implied: The indemnity contract can either be spoken or written. The
parties can also imply it.
Types of Indemnity
 Express Indemnity:
o This is also known as written indemnity. Under this, all the terms and
conditions of the indemnity are mentioned specifically in the contract.
o The rights and the liabilities of both parties are clearly set out in the
agreement.
o This type of agreement includes insurance indemnity contracts,
construction contracts, agency contracts, etc.
 Implied Indemnity:
o It refers to that indemnity wherein the obligation arises from the facts and
the conduct of the parties involved. This is not a written contract.
o The core example of this type of indemnity is the master-servant
relationship.
o The master is liable to indemnify his servant for the losses that he incurred
while working as per his instruction.
Dugdale v. Lovering (1827)
Facts
In this case, the plaintiff was in possession of certain trucks, which were claimed both by the
defendant and K.P. Colliery. The defendant demanded delivery of the trucks. As the plaintiff
was aware that the ownership of the trucks was claimed by both the defendant and K.P.
Colliery, the plaintiff, asked for an indemnity bond from the defendant. A reply was received
by the plaintiff, which only demanded delivery and did not mention an indemnity bond. After
which, the plaintiff delivered the trucks to the defendant. A suit of conversion was filed
against the plaintiff by K.P. Colliery, as per the verdict, for which the plaintiff had to
compensate K.P. Colliery. Another suit for indemnity was filed by the plaintiff against the
defendant.
Judgment
It was held that, though there is no express contract of indemnity, there is an implied contract
of indemnity. As per the facts of the case, by demanding the indemnity bond, the plaintiff
showed his intention that he would not deliver the trucks without indemnity. Having
knowledge of this fact, the defendant accepted the delivery of trucks. By accepting, the
defendant impliedly promised the plaintiff indemnification. It was held that the defendant was
liable to indemnify the plaintiff as the indemnity bond led to the creation of an implied
promise.
Rights of an Indemnity Holder
Section 125 of Indian contract Act, 1872 deals with rights of an indemnity holder.
The promisee in a contract of indemnity, acting within the scope of his authority, is entitled
to recover from the promisor:
  All damages which he may be compelled to pay in any suit in respect of any matter
to which the promise to indemnify applies.
 All costs which he may be compelled to pay in any such suit if, in bringing or
defending it, he did not contravene the orders of the promisor, and acted as it would
have been prudent for him to act in the absence of any contract of indemnity, or if
the promisor authorized him to bring or defend the suit;
 All sums which he may have paid under the terms of any compromise of any such
suit, if the compromise was not contrary to the orders of the promisor, and was one
which it would have been prudent for the promisee to make in the absence of
any contract of indemnity, or if the promisor authorized him to compromise the suit.
Rights of the Indemnifier
 After the indemnity holder is paid for the damage incurred, the compensator shall
have all the rights to all the methods and services which can save the compensator
from the damage.
 Indemnification can only be done if the loss to the other party is incurred, or if it is
certain that the loss will be incurred.
 The Indian Contract Act of, 1872 does not provide for the time to commence
the liability of the indemnifier under the contract.
 In Gajanan Moreshwar vs. Moreshwar Madan, (1942), the Bombay High
Court held that if the indemnified has incurred liability and the liability is absolute,
he is entitled to call upon the indemnifier to save him from the liability and pay it off.
 In Lala Shanti Swarup vs Munshi Singh & Others, (1967), the Supreme
Court held that a conveyance which contains a covenant whereby the
purchaser promises to pay off encumbrances on the sold property is nothing but
an implied contract of indemnity, whose cause of action arises when
actually indemnified. (Mortgage decree being passed does not amount to actual
indemnification).
Contract of Guarantee
 Guarantee means to give surety or assume responsibility. It is an agreement to
answer for the debt of another in case he makes default.
 Section 126 of the Indian Contract Act, 1872 provides that a "contract of
guarantee" is a contract to perform the promise, or discharge the liability, of
a third person in case of his default.
 Three parties are involved in the contract of guarantee.
o Surety: The person who gives the guarantee is called the surety. The liability
of the surety is secondary, i.e., he has to pay only if the principal debtor fails to
discharge his obligation to pay.
o Principal debtor: The person in respect of whose default the guarantee is
given is the principal debtor.
 o Creditor: The person to whom the guarantee is given called the creditor.
 A guarantee is either in the format of writing or of oral.
 This contract lets the principal debtor to avail employment, loan or goods on
credit and the surety would ensure repayment in case of any default in the part of
the debtor.
 Example
o Mohan takes loan of Rs. 5 lakhs from the UCO Bank of Lucknow University
Branch. Sohan promises to UCO Bank that if Mohan fails to rupee the loan
timely then, Mohan will pay. This is a contract of guarantee and Mohan is
Principal debtor UCO Bank is creditor and Sohan is surety.
Essentials of Contract of Guarantee
1. The contract can be either oral or in writing. Nevertheless, the assurance contract
can only be in writing in English law.
2. The guarantee contract presumes a principal liability or a discharge duty on the
part of the principal debtor. Even if there is no such principal liability, one party
agrees to pay another under such situations, and the enforcement of this obligation is
not contingent on anyone else's default, it is an indemnity contract.
3. Sufficient consideration is to support the principal debtor. It is not necessary to
have clear consideration between the creditor and the assurance that it is
appropriate that the creditor has done anything for the good of the principal debtor.
4. Assurance consent cannot be obtained by misrepresentation or cover of any
material information relating to the transaction.
Liability of Surety
 Section 128 of the Indian Contracts Act, 1872 states the liability of the surety is
co-extensive with that of principal debtor, unless it is otherwise provided by the
contract.
 Surety's liability is the same as that of the principal debtor. A creditor can move
directly against the surety. Without suing the principal debtor, a creditor may sue the
surety directly. Surety is liable to make payment immediately after the default of
any payment by the principal debtor.
 Primary responsibility for making payment, however, is from the principal debtor,
and the responsibility of the surety is secondary. In fact, if the principal debtor cannot
be held liable for any payment due to any document error, then surety is not
responsible for such payment as well.
Rights of Surety
A. Rights against the principal debtor

 o Right to give notice.
o Rights of sub-rogation.
o Right of indemnity.
o Right to get securities.
o Right to ask for relief.
B. Rights against the creditor


o Right to get securities.

o Right to ask for set-off.
o Rights of sub-rogation.
o Right to advice to sue principal debtor.
o Right to insist on termination of services.
C. Rights against co-sureties


o Right to Ask for Contribution: Surety can ask its co surety to add the sum
when the principal debtor defaults. If they have issued commitments for equal
quantities, they would have to make equivalent contributions.
o Right to claim share in securities.
Continuing Guarantee
 One form of guarantee that extends to a series of transactions is a continuing
guarantee. A continuing guarantee extends to all transactions that the principal
debtor enters into before the surety revokes it.
 A continuing guarantee for future transactions may be withdrawn at any time by
notice to the creditors. However, the responsibility of a surety for transactions
completed prior to such revocation of guarantee is not diminished.
Difference between Contract of Indemnity and Contract of Guarantee

Contract of Indemnity Contract of Guarantee

There are three parties in a contract of

There are two parties in a contract of indemnity, namely
guarantee, namely the principal debtor, the
the indemnifier and the indemnity holder.
creditor, and the surety.

It consists of only one contract between the indemnifier There are three contracts.
and the indemnity holder. The indemnifier promises to
indemnify the indemnified/indemnity holder in event of a

  Between the principal
debtor and the creditor to
fulfill the liability and pay
dues
 Between the creditor and
surety, where the surety will
pay off dues if the principal
certain loss.
debtor defaults
 Between the principal
debtor and surety, where the
principal debtor makes
good the losses of the surety
incurred to fulfill the
guarantee

The liability of the surety is a secondary

one, i.e., his obligation to pay arises only
when the principal debtor defaults.
Liability in a contract of guarantee is
The liability of the indemnifier is primary. The liability in
continuing in the sense that once the
a contract of indemnity is contingent in the sense that it
guarantee has been acted upon, the liability
may or may not arise.
of the surety automatically arises.
However, the said liability remains in
suspended animation until the debtor
makes default.

Liability of surety is conditional on the

The liability of an indemnifier is not conditional on the
default of the principal debtor. For
default of somebody else. For example, Mrinal promises
example, Anil buys goods from a seller and
the shopkeeper to pay, by telling him that, “Let Anil have
Mrinal tells the seller that if Anil doesn’t
the goods, I will be your paymaster”. This is a contract of
pay you, I will. This is a contract of
indemnity as the promise to pay by Mrinal is not
guarantee. Thus, the liability of Mrinal is
conditional on default by Anil.
conditional on non-payment by Anil.

No requirement of the principal debt Principal debt is necessary.

After the surety has made the payment, he

Once the indemnifier indemnifies the indemnity holder, he steps into the shoes of the creditor and can
cannot recover that amount from anybody else. recover the sums paid by him from the
principal debtor.

Gajanan Moreshwar v. Moreshwar Madan (1942)

Facts
In this case, the municipal corporation of Bombay leased the plaintiff a piece of property in
Bombay. In response to the defendant's request, the plaintiff granted him possession of the
land and built a structure on it, thus rendering the plaintiff to mortgage the land twice for Rs.
5,000. In exchange for the plaintiff being released from all obligations related to the land, the
lease of the plot was also transferred into the defendant's name. However, the defendant did
not release the plaintiff from the obligations for which the plaintiff had filed a suit. The
plaintiff stated that the defendant shall indemnify him with respect to all liabilities under the
mortgage deed.
Judgment
It was held that if the indemnity holder had to wait until he had paid the actual loss, the value
of the indemnification clause would be lost. According to the court's application of the equity
principle, the indemnifier might be required to pay the court a sufficient amount of money
that is used to build a fund and pay the claim whenever it is made.
United India Insurance Co. v. Ms. Annan Singh Munshilal (1994)
Facts
In this case, the cover note had the consignee's address. Additionally, before being carried to
the destination, the products had to be dropped off at a godown on the route there. When the
products were in the godown, they were destroyed by fire. The items were seen as having
been lost in transit, and the insurance policy's provisions held the insurer accountable.
Judgment
It was decided that an indemnification agreement would not apply in the event of a fire or
other disaster. This case held that in cases of fires, etc., it is called a contingent contract and
not a contract of indemnity.
Secretary of State v. Bank of India (1938)
Facts
In this case, a lady was the holder and endorsee of a 5000 rupee government promissory note.
An agent in possession of such a promissory note forged the lady's signature on the note in
his favour and endorsed it for value to the respondent. In accordance with the Indian
Securities Act, 1920, the respondent applied to the public debt office in good faith. When the
woman became aware of the deception, she filed a conversion lawsuit against the Secretary
of State and was awarded damages. After this, a lawsuit was filed by the appellant against the
bank, citing implied indemnity.
Judgment
It was held that the appropriate amount of the claim should be recovered by the appellant
from the respondent. Additionally, an express indemnity clause is not required for the pre-
existing implied right to indemnity provided by Indian law.
Lala Shanti Swarup v. Munshi Singh (1967)
Facts
In this case, the plaintiff-respondent mortgaged a piece of land to Bansidhar and Khub Chand
for Rs.12,000/- The appellant purchased half of the land from the rightful owner for
Rs.16,000/- Shanti Saran promised to pay the due money, i.e., 13500, to Bansidhar and Khub
Chand. Shanti Saran did not pay, thus Bansidhar and Khub Chand filed a lawsuit. The issue
was whether there existed an indemnity contract.
Judgment
It was held that Shanti Saran failed to discharge the encumbrance, which caused a loss to the
vendor, and the plaintiff-respondent could sue under the contract of indemnity.
Chand Bibi v. Santosh Kumar Pal (1933)
Facts
In this case, the defendant's father, while acquiring specific property, promised to pay off the
plaintiff's mortgage obligation and indemnify him if they were proven accountable for the
debt. The plaintiff sued the defendant's father to enforce the agreement when the defendant's
father failed to pay off the mortgage obligation. The Court took into consideration the fact
that the plaintiff had not yet suffered any loss for which he should be compensated.
Judgment
It was held that the plaintiff had not suffered any losses and that the suit was premature so far
as the cause of action on indemnity was concerned. Moreover, one of the essential conditions
of a contract of indemnity is 'there must be a loss incurred.'
Conclusion
Both the contract of indemnity and contract of guarantee are similar in the sense that they
provide protection against loss. However, as mentioned above, there is an important
distinction between the two. Whether a contract is a contract of indemnity or a contract of
guarantee is a question of construction in each case.