LAW OF CONTRACT

(week 6)

by
Shan Ali
LL.M (Gold Medalist)

BS (A & F)-4 (A) Morning

Credit Hours # 3
INDEMNITY AND GUARANTEE
(Sec 124-147)
 CONTRACT OF INDEMNITY
 The term indemnity means to compensate the party who suffers a loss.
 A contract of indemnity is an obligation by one person to provide
compensation to the other party for a particular loss suffered by him.
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. [section 124].

A contract of indemnity is made to protect the promisee against

anticipated (predictable) loss. It depends upon happening of loss. Contract
of insurance is example of indemnity.
Exp; A parked his cycle at a cycle stand. A lost the token issued by B. B
refused to return the cycle. To get his cycle, A promised to compensate B
against any loss he may suffer if any other person claims the cycle from B.
 PARTIES TO CONTRACT OF INDEMNITY:

INDEMNIFIER (Promisor): The person who promises to indemnify.

INDEMNITY HOLDER (Promisee): The person whose loss is to be
indemnified.

• Examples:
Motor insurance
Marine insurance
Fire insurance

• Life insurance is not the contract of indemnity.

 Essentials of a valid contract of indemnity

• It must contain all the essentials of a valid contract.

• It is a contract between two parties. One person promises to save the
other from any loss which he may suffer.
• The loss may be caused by the conduct of the promisor himself or any
other person.
• The contract of indemnity may be expressed or implied.
RIGHTS OF INDEMNITY-HOLDER WHEN SUED
The following are rights of indemnity holder (sec 125)

1. Right to Recover Damages

• Indemnity holder can recover from indemnifier all damages which he may be
compelled to pay in respect of any suit filled against him
2. Right to Recover Cost of Suit
• Indemnity holder can recover from indemnifier expenses in respect of any suit
filed by him with the authority of indemnifier.
3. Right to Recover Sums
• The indemnity holder can recover from indemnifier all amount which he has paid
as a result of any compromise of the suit.
 Rights of Indemnifier
There is no provision in the law about the rights of indemnifier.
However, the rights of indemnifier are the same as the rights of a
guarantor. It is a principle of law that where one person has agreed to
indemnify another, his rights will be similar to the rights of guarantor.
 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. A guarantee may be either oral or
written. [section 126].

A guarantee is a contract to pay the amount due from another person, in case the
later fails to pay. It is made to enable a person to get loans, goods on credit,
employment etc.

A contract of guarantee is made to enable a person to get a loan or goods on credit

or an employment etc. it may be oral or written. It is promise to perform the
promise of the other, on his failure to do so.
a. A requests B to lend Rs. 5 Lac to C. A guarantees that if C fails to return the loan, A will pay to B. This is a contract of guarantee.
b. On the request of B, A promises to the employer of B that if B commits a fraud, A shall be liable. This is a contract of guarantee.
PARTIES TO CONTRACT OF GUARANTEE
SURETY: The person who gives the guarantee is called the “surety”.
Person giving guarantee is also called as ‘guarantor’.

PRINCIPAL DEBTOR: the person in respect of whose default the

guarantee is given is called the “principal debtor”, and

CREDITOR: the person to whom the guarantee is given is called the

“creditor”.
 Essentials
1. Tripartite Contract
It is an agreement between the principal debtor, creditor and surety. Three
separate contracts exist among them. In a tripartite contract, the liability of
the surety arises if the promise by principal debtor is not fulfilled.
In a contract of guarantee, the principal debtor is liable and the surety
becomes liable on the default of principal debtor. The principal contract exists
between the principal debtor and creditor and the secondary contract exists
between the creditor and surety.
Exp; X takes a loan of Rs. 5000 from Y on the guarantee of Z. The agreement
between X and Y is the principal contract and the contract between Y and Z is
a contract of a guarantee. The liability of Z will arise if X fails to repay the
loan.
 Essentials
2.Consideration
Like other contracts, a contract of guarantee must fulfill essentials of a
valid contract. It must be supported by some consideration. It is not
necessary that there is direct consideration between the surety and
creditor. The consideration received by the principal debtor is sufficient
for the surety. (Sec.127)

a. A sells goods on credit to B on C's guarantee. C's promise to

guarantee is the consideration for As promise to sell the goods.
b. A sells goods to B. X requests A not to sue B for a week, and
promises to pay if B does not pay. It is consideration for X's promise.
 Essentials
3. Misrepresentation
A guarantee obtained by means of misrepresentation made by the
creditor, or with his knowledge and assent, concerning the material part
of a transaction is invalid. If the consent of surety is obtained by
misrepresentation, the surety will be discharged from his liability.
(Sec.142)
Exp; H was invited, to give a guarantee for the honesty of N's servant.
N had previously dismissed his servant for dishonesty but did not
disclose this fact to H. Later, the servant committed embezzlement. H
was held not liable. (LGO Co. vs. Holloway)
 Essentials
4. Concealment
Any guarantee which the creditor obtains by means of keeping silence to
material circumstances is invalid. The expression 'keeping silence' means
intentional concealment of the facts. The creditor should disclose to the surety
the facts which are likely to affect the surety's liability. (Sec.143)
Exp; A employs B to recover money. B misappropriates the money. Later, A asks C for surety. C being unaware of B's
previous record gives guarantee for B. B again misappropriates. C's guarantee is invalid because A concealed the facts.

5. Primary Liability
Under contract of guarantee, the primary liability is of the principal and
secondary liability is of the surety. The liability of surety arises only when
the principal debtor defaults. The liability must be enforceable at law.
 Essentials
6. Writing not Necessary
It is not necessary that the contract of guarantee be in writing. The contract may
be either oral or written. It may be express or implied from the conduct of
parties. (Sec.126)
Exp; A sells and delivers goods to B on the verbal guarantee of C. It is a valid
guarantee.
7. Capacity of Parties
The parties to a contract of gurantee must be competent to contract. Incapacity of
principal debtor does not does not affect the validity of a contract of gurantee.
However the other parties must be competent to contract.
Exp; F a minor takes a loan from G. W gives gurantee to G for the repayment of
loan if F refuses to pay. It is a valid contract.
 Surety’s Liability
Extent of Surety's Liability
The liability of surety is co-extensive with that of the principal debtor -
unless it is otherwise provided by the contract. The phrase 'co-
extensive with that of principal debtor' shows the quantum of the
surety's liability. It means that the liability of a surety is the same as that
of a principal debtor unless there is a contract to the contrary. The
surety's liability can be made less than that of the principal debtor but
never greater. (Sec.128)
Example; A guarantees to B for the payment of a bill accepted by C.
The bill is dishonored. A is liable for the payment.
 Nature of surety's liability

The following are rules regarding the nature of surety's liability:

 The liability of surety is secondary. It arises on the default of principal debtor.
 The liability of surety arises immediately on the default of principal debtor; unless there is a
provision in the contract that creditor must file a suit against principal debtor or give notice
of default to surety.
 Where a creditor holds securities from principal debtor for his debt, the creditor should first
sue the surety before resorting to securities unless agreed otherwise.
 The surety is not liable where the creditor has obtained guarantee by misrepresentation.
 The law does not treat the principal debtor and surety as one person. It is not necessary that
surety will be liable only if principal debtor is liable.
 The discharge of principal debtor by operation of law does not discharge the surety, e.g.
material alteration.
 Liability of surety does not come to an end on the death of principal debtor.
 KINDS OF GUARANTEE
 ABSOLUTE GUARANTEE (Unconditional guarantee by surety)
 CONDITIONAL GUARANTEE (Enforceable when contingency along with
default happens)
 RETROSPECTIVE GUARANTEE (Given for existing debt)
 PROSPECTIVE GUARANTEE (Given for future debt)
 LIMITED GUARANTEE (For a single transaction)
 UNLIMITED GUARANTEE (Unlimited as to time or amount)
 GENERAL GUARANTEE (For acceptance by the public generally)
 SPECIAL GUARANTEE (For acceptance by the particular person)
 CONTINUING GUARANTEE (Extends to series of transactions)
 Kinds of Guarantee
1. Simple/ Specific guarantee
A guarantee which extends to a single debt or transaction is called ordinary, simple or specific
guarantee. It comes to an end as soon as the liability under the transaction ends.
Expample; G guarantees K for the payment of 5 bags of wheat purchased by C. C makes the
payment. Later, C again purchases 5 bags of wheat but did not pay. K sued G. Held, G's
guarantee is specific guarantee and G is not liable. (Kyk vs. Groves)
2. Continuing guarantee
A guarantee which extends to a series of transactions is called continuing guarantee. In other
words, a guarantee which covers a number of transactions over a period of time is called
continuing guarantee. It is like a standing offer which is accepted by the creditor every time a
subsequent transaction takes place. (Sec.129)
Example; D guarantees C for B's purchases from C to the extent of Rs. 5,000 for the next
one year. This is a continuing guarantee.
 Rights of Surety

a. Right to Securities
• At the time of payment, the surety can demand the securities which
creditor has received from principal debtor at the time of creation of
contract, whether surety is aware of such securities or not. If creditor
by negligence loses any security held by him, the surety is discharged
to that extent from the payment of guaranteed sum. But if security is
lost due to unavoidable act, the surety would not be discharged.
(Sec.141)
C gives a loan of Rs. 2 Lac to B on the guarantee of X. C also pledges
B's car. B fails to pay the loan and X pays Rs. 2 Lac to C. X can get the
car from C.
 Rights of Surety
b. Right to Claim Set-off
If the principal debtor has some claims against the creditor, the debtor
can ask for adjustment of his debts to the extent of his claims. If creditor
sues surety for repayment, the surety can claim set off, if any, which
principal debtors had against creditor.
Example; A supplies furniture worth Rs. 2 Lac to B on the guarantee of
C. B claims that some furniture is defective and refuses to pay Rs.
20,000. C can ask for adjustment of Rs. 20,000.
 Rights against Principal Debtor
a. Right of Subrogation
When surety has paid the guaranteed debt on default of principal debtor, he is entitled
to all the rights which creditor had against the principal debtor. The' surety is entitled to
all the remedies which are available to creditor against principal debtor. (Sec.140)
Example; X borrowed money from Y on the guarantee of W and mortgaged his house to W X
failed to pay and W. paid. Now, W can enforce the mortgage of the house against X .
b. Right of indemnity
In every contract of guarantee, there is an implied promise by principal debtor to
indemnify the surety. The surety is entitled to recover from principal debtor whatever
sum he has rightfully paid under the guarantee, but no sums which he has paid
wrongfully. (Sec 145)
Example; B owes Rs. 1 Lac to C, and A is the surety. B fails to pay. C demands payment
from A. A refuses to pay. C sues A for the money. A defends the suit on reasonable grounds
but loses and pays debts with cost of suits. A can recover the whole amount from B.
 Rights against Co-sureties
Where a debt is guaranteed by more than one surety, they are called co-sureties.
In such a case, all the sureties are liable to make the payment to creditor
according to the agreement among them. If there is no agreement and one of the
co-sureties is compelled to pay the entire debt, he has a right to contribution
from the co-sureties. Following are the rules in this regard: (Sec.146147)
a. Similar amount
When there are sureties for the same debt and the principal debtor has
committed a default, each party is liable to contribute equally to the extent of the
default.  
A, B and C are sureties to D for the sum of Rs. 3000 lent to E. E makes default
in payment. A, B and C are liable to pay Rs. 1000 each. If C becomes insolvent
and only pays Rs. 500, then A and B will contribute equally.
 Rights against Co-sureties
b. Different amount
When there are sureties for the same debt for different sums, they are bound
to contribute equally subject to the limit fixed by their guarantee. They will
not contribute proportionately.
A, B and C are sureties for D. A, B and C guarantee for Rs. 10,000, 20,000
and 40,000 respectively.
a. If D makes default in payment to the extent of Rs. 30,000 then liability of
A, B and C is Rs. 10,000 each.
b. If D makes default to the extent of Rs. 40,000 then liability of A is Rs.
10,000, B is Rs. 15,000 and. C is Rs. 15,000.
c. If D makes default to the extent of Rs. 70,000 then A, B and C will pay Rs.
10,000, Rs. 20,000 and Rs. 40,000 respectively.
 Discharge of Surety from Liability

A surety is discharged from his liability in the following ways:

1. Notice of Revocation
A specific guarantee can be revoked by notice if the liability has not arisen. But a continuing
guarantee may be revoked anytime by the surety as to future transactions by giving a notice
to the creditor. The surety remains liable,for transactions entered into prior to the notice. (Sec.
130)
A lends B a certain sum on the guarantee of C. C cannot revoke the guarantee. But if A has not yet given the
sum to B, then C may revoke the guarantee by giving a notice.
2. Death of Surety
In specific guarantee, the surety is not discharged from liability on his death if the liability
has already occurred. But in a continuing guarantee, the death of surety discharges him from
liability regarding the transactions which take place after his death, unless there is a contract
to the contrary. The estate of deceased surety will remain liable for past transactions. (Sec.
131)
A sells goods to B for Rs. 1 Lac. C guarantees payment. A delivers goods worth Rs. 50,000. Later, C dies. Cs
property is liable up to Rs. 50,000.
3. Change In Terms of Contract
When any change is made in the terms of the contract by principal debtor and creditor
without the surety's consent, the surety stands discharged with respect to transactions
subsequent to the change. (Sec. 133
M contracts to lend Rs.1 Lac to Non 1st March. S guarantees payment. M pays the amount on 1 Jan. S is
discharged from his liability.

4. Release or discharge of Principal Debtor

The surety is discharged by any contract between the creditor and principal debtor by which
principal debtor is released, or by an act or omission of the creditor which discharges the
principal debtor. (Sec.134)
a. A contracts to build a house for B. C guarantees for the performance. If B releases A from the performances
of the contract, the surety is discharged.

b. A contracts to build house for B. B is liable to supply wood. C guarantees As performance of the contract. B
fails to supply the wood. C is discharged from his liability.
5. Arrangement without Surety's consent
Where the creditor, without the consent of surety, makes an arrangement
with principal debtor for composition or promises to give him time or not to
sue him, the surety will be discharged. (Sec.135)
Where a contract to give time to principal debtor is made by the creditor
with a third person and not with principal debtor, the surety is not
discharged. (Sec.136)
a. P purchased a car from C on guarantee of S. C gave P more time for payment. Held,
the giving of time to P for payment discharged S from his liability. (M.M Showroom Ltd
vs. Newman)'
b. A lends Rs. 10 Lac to B for 1 year on the guarantee of C. A promises X, a friend of
B, to give more time to B to return the loan. C is not discharged from his liability.
6. Creditor's-act or omission
If the creditor does any act which is inconsistent with 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 against the principal debtor is thereby impaired,
the surety is discharged. (Sec.139)
a. B contracts to build a ship for C for Rs. 90 Lac to be paid by installments as
the work reaches certain stages. A guarantees C for B's performance. Without telling A, C
prepays the last two installments to B. A is discharged by this prepayment.
b. A employs B as a cashier on the guarantee of M. A promises to count the
cash at least once a month. A does not count the cash. B commits fraud. M is not liable to A.
7. Loss of Security
If the creditor loses or without the consent of the surety, parts with
the security given by the principal debtor against the debt, the
surety is discharged from liability to the extent of the value of
security. If the security is lost due to an act of God, the surety will
not be discharged. (Sec 141)
Example; A advances Rs. 2 Lac to B on the guarantee of X. A gets
an additional security of Rs. 50000 by pledge of B's car. A cancels
the pledge and returns the car. B becomes insolvent. X is
discharged from the liability to the extent of value of car.
Invalidation of Contract of Guarantee
A surety is discharged from liability when the contract of guarantee (between creditor and
surety) is invalid. A contract of guarantee is invalid in the following cases: (Sec.142-144)
a. Where the guarantee is obtained by misrepresentation.
b. Where the guarantee is obtained by concealment of material facts.
c. Where guarantee is obtained under the impression that co-sureties will join
and if, no body joins.
d. Where it lacks some essentials of a valid contract, e.g. surety is incompetent to contract or
the object is illegal.
a. A employs B as a clerk. B commits fraud. Later, A asks C for guarantee without informing C about B's
previous conduct. C gives guarantee for B's conduct. B again commits fraud. The guarantee is invalid.
b. B signed a guarantee under the impression that three other persons would
also sign it. One of them died without signing. The guarantee is not enforceable. (NP Bank of England vs.
Brackenbury)
 Distinguish between Contract of Indemnity and Contract of
Guarantee.
BASIS CONTRACT OF INDEMNITY CONTRACT OF GUARANTEE

1. No. of parties There are two parties to the contract viz. There are three parties to the viz.
indemnifier (promisor) and the Indemnified creditor, principal debtor and the surety
(promise).
2. Liability of Liability of the indemnifier to the Liability of the surety to the creditor is
parties indemnified is primary and independent. collateral or secondary, the primary
liability being that of the principal
debtor.
3. No. of contracts There is only one contract in case of a In a contract of guarantee there are three
contract of indemnity, i.e., between the contracts, between principal Debtor and
indemnifier and the indemnified. Creditor; between creditor and the surety
and between surety and principal debtor.
4. Liability is due The liability of the indemnifier arises only There is usually an existing debt or duty,
on the happening of a contingency. the performance of which is guaranteed
by the surety.
BASIS CONTRACT OF INDEMNITY CONTRACT OF GUARANTEE

5. Liability of An indemnifier cannot sue a third party for A surety, on discharging the debt due
third party loss in his own name, because there is no by the principal debtor, steps into the
privity of contract. He can do so only if shoes of the creditor. He can proceed
there is an assignment in his favour. against the principal debtor in his own
right
6. Request In a contract of Indemnity, the indemnifier In a contract of guarantee, the surety
promises without the request of the debtor. gives the guarantee on the request of
debtor.

7. Filing of Suit In a contract of indemnity, the indemnifier In a contract of guarantee, the surety
cannot sue the third party for loss in his after paying to creditor can sue
own name. He can sue if the claim is principal debtor in his own name.
assigned in his favour.
8. Purpose A contract of indemnity is for A contract of guarantee is for security
reimbursement of loss. of a debt or performance of promise.