Section 124-147 of the Indian Contract Act, 1872 lays the terms and conditions of these contracts of indemnity and guarantee. First, this article will discuss indemnity, scope, nature, validity, the commencement of liability, and rights of indemnity holders. Then we will also discuss a guarantee, its main features, types of guarantees, discharge and liability of surety, and the differences and similarities between the contract of indemnity and guarantee.
What is Indemnity?
Indemnity means security against the loss suffered by one person due to the actions of another person. Indemnity is defined in Section 124, Indian Contract Act, 1872. In a contract of indemnity, one person promises to make good, harmless, or compensate for the loss suffered by the other person due to an act of one person.
The person making the promise to compensate is called an ‘indemnifier.’ The person to whom the promise is made is called an ‘indemnified person’ or ‘indemnity holder.’
Scope of Indemnity
The scope of indemnity contract is restricted to the losses caused due to:
- Act of the promisor himself or
- Act of any other person.
Therefore, any loss that occurred due to an act of God, accident (e.g., fire, flood), or conduct of the promise is not covered under a contract of indemnity.
Nature of Indemnity
The nature of indemnity could be expressed (expressly written under the agreement) or implied (implied by the person’s actions).
- Express Indemnity can be understood from the following example:
ABC Insurance Company entered into a contract with XYZ Ltd. to reimburse the company’s stock of products up to Rs. 60,00,000 for a premium of Rs. 1,00,000 for damages incurred by an accidental fire.
- Implied indemnity has been clearly put forward in Adamson Vs Jarvis (1882).
In this case, the plaintiff (an auctioneer) had sold certain cattle under the defendant’s instruction. The cattle did not belong to the defendant. When the true owner of the cattle came to know about this, he sued the plaintiff for conversion; the auctioneer, in turn, sued the defendant for indemnity. The court had held that, since the plaintiff had acted under the defendant’s instruction, he was entitled to assume that the plaintiff would be indemnified by the defendant in the event of any wrongful act.
Validity of Contract of Indemnity
The principle that applies for a valid contract of indemnity is the same as the principle of valid contracts in general such as, free consent, lawful object, competent to enter into a contract, etc. when consent is backed by undue influence, coercion, fraud or misrepresentation, the agreement said to be voidable at the option of the person giving consent.
Rights of Indemnity-holder
Section 125, Indian Contract Act, 1872 lays down the extent of liability of the indemnifier. The indemnity-holder is entitled to the following amount of compensation if he is acting within the scope of his authority:
- The indemnifier will be compelled to pay all damages in any suit or proceedings to which the promise to indemnify applies.
- All the costs involved in bringing and defending the suit
- All the sums payable under the terms of any settlement of any suit.
- Commencement of Liability
- The indemnity-holder can claim indemnity only if he has incurred the actual loss in the original English rule. However, this rule has been transformed now; in Gajanan Moreshwar Vs. Moreshwar Madan AIR 1942 Bom 302, 304, the court had laid down that indemnifier commences as soon as the loss of the indemnity-holder becomes absolute, imminent, or inevitable. The indemnity-holder was entitled to get the indemnifier to pay off the claim or pay a certain amount of money to the court so that it would act as a pay-off fund that the indemnity-holder can claim when its due.
What is a Contract of Guarantee?
Section 126, Indian Contracts Act, 1872 states that a contract of guarantee means a contract to execute a promise made or relieve the liability of a third person in case of a default. In other words, a guarantee is a promise to repay the debt owed by a third person if the third person does not pay.
There are three parties in the Contract of Guarantee:
- Surety: person or guarantor who gives a guarantee,
- Principal debtor: a person for whose default the guarantee is given, or the person to takes the debt,
- Creditor: person to whom the guarantee is given or the person who provides credit.
Example:
A request B to lend Rs. 20,000 to C and guarantees that C will repay the amount within six months. In C’s failure to repay within the specified time, A will refund the said amount.
In this example, A is the surety, B is the creditor, and C is the principal debtor.
Validity of Guarantee
A valid contract fulfills the following essential conditions:
- There must be a principal debt.
- Sufficient consideration should be paid to the surety.
- Free consent, without any misrepresentation or concealment of material facts.
- It can be either oral or written
Types of contracts in Guarantees
There are three types of contracts in a guarantee, namely;
- Principal contract: Between the creditor and the principal debtor;
- Secondary contract: Between the surety and creditor and
- Implied contract: Between the principal debtor and surety, whereby the principal debtor has agreed to indemnify or repay the loan amount to the surety, in case of default.
Consideration for Guarantee
Consideration is an essential aspect of guarantee. Section 127 of the Indian Contract Act, 1872 lays down that the surety should receive sufficient consideration from the principal debtor for giving the guarantee or anything done or promise made on behalf of the principal debtor. Therefore, one should always keep in mind that any contract without consideration is void.
Liability of Surety
Section 128 of the Indian Contract Act, 1872 lays down the fundamental principle of surety’s liability.
- Co-extensive – the surety’s liability is co-extensive to that of the principal debtor, i.e., the surety is liable only to the amount of guarantee agreed and not more than that.
- Condition Precedent – when the surety gives a guarantee on the condition that if the co-surety does not join the contract, the creditor will not take any action. Therefore, if the co-surety does not join, the contract of guarantee is not valid.
- Proceeding against surety without exhausting remedies against the debtor in case of unconditional liability.
- Action against principal debtor alone, it is not necessary for the principal debtor to join the guarantor.
Suit against surety alone without even impleading the principal debtor. The creditor has the option to use the surety alone or along with the principal debtor. - Death of Principal debtor – when the principal debtor dies before any suit is initiated against him, then such suit is void ab initio. However, the surety is not discharged of his liability.
- Impossibility of performance – where the performance of a contract becomes impossible, the surety does not escape the liability.
Continuing Guarantee
Where series of transactions is guaranteed, it is called continuing guarantee. The continuing guarantee extends to all transactions that the principal debtor enters into before the surety revokes it. The surety can withdraw a continuing guarantee for future transactions at any time by giving notice to the creditor. However, the surety is not discharged of his liability for completed transactions before revoking the guarantee.
Rights of Surety
The surety has a right to limit his liability or make it conditional. In case the surety undertakes to be liable for the entire debt amount, the surety has an option to limit his liability to a certain amount or attach a certain condition to his liability.
Discharge of Surety from liability
When the liability of the surety comes to an end, the surety is discharged of his liability.
- Section 130 the surety can revoke a continuing guarantee for future transactions by giving a notice of revocation to the creditor.
- Section 131 the surety is discharged of liability of future transactions in the event of surety’s death.
- Section 133 surety’s liability is discharged if there is any variation or changes in terms between the creditor and principal debtor in the contract without surety’s consent.
- Section 134 surety is discharged of liability if the principal debtor is released by any contract between the creditor and the principal debtor or on the creditor’s non-performance or omission of any act.
- Section 135, when the creditor agrees with the principal debtor to extend the time for payment of a debt or not to sue the principal debtor without the consent of the surety, then the liability gets discharged.
- Section 139 any act done by the creditor that is inconsistent with the surety’s rights or omits to do any act, thereby impairs the surety’s remedy against the principal debtor.
An exception to the discharge of surety
The surety’s liability is not discharged in the following cases:
- The creditor has extended the time for payment of the debt; the surety is not discharged of his liability.
- The creditor has forgiven to sue the principal debtor or forbade to enforce any remedy that does not discharge the surety’s liability.
- Where there is co-surety, if the creditor releases one of the co-sureties, then the other surety does not stand discharged.
Having looked into the concept of indemnity and guarantee, we will now look into the similarities and the differences between the contract of indemnity and guarantee.
Similarities and Difference between Contract of Indemnity and Contract of Guarantee
Indemnity and guarantee have the following standard features namely;
- Both the contract provides security against probable losses,
- In both the contract, the loss may arise due to human action,
- One of the essential features of both the contract is free consent and consideration.
- These contracts cannot be used to make unjust enrichments.
Now let us discuss the difference between the contract of indemnity and the contract of guarantee.
Following are the point of difference between both the contract:
Points of difference |
Contract of Indemnity |
Contract of Guarantee |
Number of Parties |
Contract of Indemnity is a two-party agreement, i.e., indemnity holder and indemnifier, | in the contract of guarantee, if one of the parties to the contract is a minor, it is a valid contract |
Competency to contract |
both the parties should be competent to the contract | if one of the parties to the contract is a minor, it is a valid contract. |
Time of Liability |
the liability arises only after happening of the contingent event | the liability is already existing and is exercised when the principal debtor fails to perform. |
Time to act |
the indemnifier may not act at the request of the indemnity-holder | the surety must act at the request of the principal debtor in the event of extending the guarantee. |
Right to sue the third party |
there is no right to sue a third party on behalf of an indemnifier | the surety can sue the principal debtor to enforce his rights. |
Conclusion
The contract of indemnity is a contract where one person promises to indemnify the other for the loss suffered by that person due to the act of the third person. In a guaranteed contract, a promise to perform or discharge the liability of a third person in case of a default. The indemnity contract is only between the indemnity-holder and indemnifier, and a guarantee is a contract between the creditor, principal debtor, and surety. For a valid contract of indemnity and guarantee, it has to comply with the rules of a valid contract.
