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.,
  • The Indemnifier: The promisor, who agrees to make up the damage caused to the other group.
  • 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:
  • This is also known as written indemnity. Under this, all the terms and conditions of the indemnity are mentioned specifically in the contract.
  • The rights and the liabilities of both parties are clearly set out in the agreement.
  • This type of agreement includes insurance indemnity contracts, construction contracts, agency contracts, etc.
• Implied Indemnity:
  • 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.
  • The core example of this type of indemnity is the master-servant relationship.
  • The master is liable to indemnify his servant for the losses that he incurred while working as per his instruction.

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.
  • 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.
  • Principal debtor: The person in respect of whose default the guarantee is given is the principal debtor.
  • 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
  • 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

1. Rights against the principal debtor

• • Right to give notice.
  • Rights of sub-rogation.
  • Right of indemnity.
  • Right to get securities.
  • Right to ask for relief.

B. Rights against the creditor

• • Right to get securities.
  • Right to ask for set-off.
  • Rights of sub-rogation.
  • Right to advice to sue principal debtor.
  • Right to insist on termination of services.

C. Rights against co-sureties

• • 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.
  • 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

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.