Indeminity and Guarantee
A contract of indemnity is “a contract by which one party promises to save the other from the loss caused to him by the conduct of the promisor himself, or by the conduct of a third party” (Sec.123).
Example : A contracts to indemnify B against consequences of any proceedings which C may take against B in respect of a certain sum of 200 rupees. This is a contract of indemnity. A will be termed as “Idemnifier” and B as the “Idemnity-holded”.
Definition is not very exhaustive:
According to the definition given by Sec. 124 of the Contract Act, contract of indemnity includes (i) only express promise to idemnify and (ii) cases where loss is caused by the conduct of the promisor himself or by the conduct of any other person. It does not include (a) implied promise to indemnify and (b) cases where the loss is caused by accident or by the conduct of the promises.
According to English law, a contract of indemnity is “a promise to save another harmless from loss caused as a result of a transaction entered into at the instance of the promisor”. It thus, includes the loss caused by events or accidents also. The definition of a contract of indemnity as per Indian Law is thus very restrictive. If it is strictly applied, even the contracts of insurance would fall outside the purview of contract of indemnity. But Indian Courts apply the English definition to contracts of indemnity. As was observed by Justice Chagla, “Sections 124 and 125 of the Contract Act are not exhaustive of the law of indemnity and the courts here would apply the same principles that the courts in England do”. (Gajanan Moreshwar V. Moreshwar Madras, 1942 Bomb. 302).
Indian courts, in a large number of cases, have also observed that contracts of indemnity also include implied promise to indemnify.
Example: A is the owner of an article. It is lost and found by B. B sends it to an auctioner for selling it. The auctioner sells the article. A recovers damages from the auctioner for selling away his article. The auctioner can recover the loss from B. There is an implied promise by B to save the auctioner from any loss that may be cuased to him on account of any defect in B’s authority to let the article sold.
Commencement of Indemnifier’s Liability
High Courts have differed in their judgements regarding commencement of indemnifier’s liability. According to High Courts of Calcutta, Madras, Allahabad and Patna indemnity holders when asked to meet a liability, can compel the indemnifiers to put him (indemnity-holder) in a position to meet the liability without waiting until he (indemnity-holder) has actually discharged it. High Courts of Bombay, Lahore and Nagpur have, however, held that idemnifier can be made liable only when indemnity-holder has incurred an actual loss, i.e., discharged the liability. The former view seems to be more correct and is also in consonance with the English view “to indemnity does not merely mean to reimburse in respect of moneys paid, but to save from loss in respect of liability against which the indemnity has been given…if it be held that payment is a condition precedent to recovery, the contract may be of little value to the person to be indemnified, who may be unable to meet the claim in the first instance.” (Kennedy L.J.) in Liverpool Insurance Co. case 84
Thus, we can conclude that if the indemnity holder had incurred an absolute liability, he has the right to call upon the indemnifier to save him from that liability and pay it off.
Rights of the indemnity-holder when sued
The indemnify holder is entitled to the following rights:
1. Indemnity-holder is entitled to recover all damages which he might have compelled to pay in any suit in respect of a matter covered by the contract.
2. Indemnity holder is entitled to recover all costs incidental to the institution or defending of the suit. But the party indemnified can not recover costs when he has not acted as a prudent man in defending the action against him or has not been authorised by the indemnifier to defend the suit or where the costs incurred have been unreasonable in amount.
3. Indemnity holder is entitled to recover all sums paid under any compromise of any such suit, provided the compromise was not contrary to the directions of the promisor and it has been made on the best available terms. Promisee must have acted prudently in making such a promise. (Sec. 125).
It is to be noted that a contract of indemnity being a specie of the general contract and therefore, must satisfy all essentials of a valid contract such as competent parties, free consent, lawful object etc., otherwise it will not be valid.
Example: A agrees to indemnity B for all consequences which may arise as a result of his (B) giving a good beating to C. The object being unlawful the agreement is also void.
CONTRACTS 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 deault. The person who gives the guarantee is called the ‘surety’; the person in respect of whose default the guarantee is given is called ‘the principal debtor’ and the person to whom the guarantee is given is called the ‘creditor’. The contract of guarantee may be either written or oral (Sec. 126).
Purpose: Contracts of guarantee are usually entered into
(a) to secure the performance of something which may be immediately related to a mercantile agent, or
(b) to secure the honesty and fidelity of someone who is to be appointed to some offce, or
(c) to secure some one from injury arising out of some wrong committed by another.
Essentials of a valid contract must be present
A contract of guarantee like other ordinary contrary must satisfy all the essentials of a contract but it has two distinctive features.
(a) Something done or any promise made for the benefit of the principal debtor is presumed by law to be a sufficient consideration for the contract of guarantee. It is not necessary that the surety himself must be benefited.
Example: A sells and delivers goods to B. C afterwards requests A to forbear to sue B for the debt for a year and promises that if he does so, C will pay for them in default of payment by B. A agrees to forbear as requested. This is a sufficient consideration for C’s promise.
(b) In a contract of guarantee, the creditor and surety must be competent to enter into a contract but principal debtor may be a minor or a person incapable of entering into a contract. In such a case the surety will be taken as the principal debtor and will be liable to pay.
(c) In a contract of guarantee, the liability of the surety is condition. It arises only when the principal debtor makes a default. A liability which arises independently of a ‘default’ is not within the definition of guarantee. (Punjab National Bank V. Sri Vikram Cotton Mills, (1970) ISCC 60).
Following are a few of those cases when the guarantee given by the surety will be invalid and cannot be enforced against him:
(i) Guarantee obtained by misrepresentation (Sec. 142): Any guarantee which has been obtained by means of misrepresentation made by the creditor, or with his knowledge and assent, concerning a material part of the transaction, is invalid.
(ii) Guaranttee obtained by concealment (Sec. 143): Any guarantee which the creditor has obtained by means of keeping silence as to material circumstances is invalid.
(iii) In case co-surety does not join (Sec. 144): Where a person gives a guarantee upon a contract that the creditor shall not act upon until another person has joined in it as co-surety, the guarantee will be invalid if that other person does not join.
Example (i) A agrees with B to stand as a surety for C for a loan of Rs. 1000 provided D also joins him as surety. D refuses to join. A is not liable as a surety.
(ii) A guarantees to C payment for iron to be supplied by him to B to the amount of 2,000 tons.
B and C have privately agreed that B should pay five rupees per ton beyond the market price, such excess to be applied in liquidation of an old debt. This agreement is concealed from A. A is not liable as a surety.
Distinction between a Contract of Idemnity and a contract of gurantee:-
CONTRACT OF IDEMNITY CONTRACT OF GUARANTEE
Only two parties-
‘indemnifier & indemnified.
| There are three parties–
‘Creditor’ ‘principal debtor’ and ‘surety’.
The liability of the indemnifieris ‘primary’
|The liability of the surity is secondary, i.e., the surety’s is liable only if the principal debtor fails. The liability of the principal debtor is primary.|
The liability of the idemnifier
arises only on the happening of a contingency.
|There is an existing debt or duty the performance of
which is guaranteed by the surety.
There is only one contract
between the indemnifer and
|Three contracts; one between the creditor and principal debtor; second, between the surety and the creditor, and third, between the surety and the principal debtor.|
The indemnity contract is for reimbursement of loss. It provides ‘security’.
|The contract of guarantee provides ‘surety’ to the creditor.|
|6.||Right to sue–
Indemnifier cannot sue a third party for the loss suffered.
|Surety can sue the principal debtor.|
Kinds of Guarantee
Contracts of guarantee may be
(i) Specific, or (2) Continuing.
1. Specific guarantee: Specific guarantee means a guarantee given for one specific transaction. In this case the liability of the surely extends only to a single transaction.
Example: A guarantee payment to B of the price of 5 sacks of flour to be delivered by B to C and to be paid in a month. B delivers sacks to C. C pays for them. Afterwards B delivers four sacks to C, which C does not pay. The guarantee given by A was only a specific guarantee and accordingly he is not liable for the price of the four sacks.
2. Continuing guarantee (Sec. 129): A continuing guarantee is that which extends to a series of transactions (Sec. 129). It is not confined to a single transaction. Surety can fix up a limit on this liability as to time or amount of guarantee, when the guarantee is a continuing one. The fact that the guarantee is continuing can also be ascertained from the intentions of the parties and the surrounding circumstances.
Example: (i) A, in consideration that B will employ C in collecting the rents of B,s zamindari, promises B to be responsible, to the amount of 5,000 rupees, for the due collection any payment by C of those rents. This is continuing guarantee.
(ii) A gurantees payment to B, a tea/dealer to the amount of £ 100, for tea he may from time to time supply to C.B supplies C with tea to the extent of the agreed value i.e., £ 100 and C pays B for it. Afterwards B supplies C with tea to the value of £ 200. C fails to pay. The guarantee given by A was a continuing guarantee, and he is accordingly liable to B to he extent of £ 100.
Revocation of continuing guarantee
A continuing guarantee is revoked by any of the following ways.
1. By notice (Sec. 130). A continuing guarantee may at any time be revoked by the surety as to future transactions, by giving a distinct notice to the creditor.
Example: A in consideration of B’s discounting at A’s request, bills of exchange, for C guarantees to B, for twelve months, the due payment of all such bills to the extent of 5,000 rupees, B discounts bills for C to be extent of 2,000 rupees. Afterwards at the end of three months, A revokes the guarantee. This revoation discharges A from all liability to B for any subsequent discount. But A is liable to B for 3,000 rupees, on the default of C.
2. By Death (Sec. 131): Death of the surety will operate as a revocation of the continuing guarantee with regard to the future transactions unless the contract provides otherwise. No notice of death need be given to the creditor. Heirs of the surety will not be liable forany fresh transactions entered into by the creditor with the principal debtor after the death of the surety without knowledge of such death.
Nature of surety’s liability
Where the parties do not specifically agree as to the extent of he liability or the surety does not put up any limit on his ability at the time of entering into the contract, the liability of the surety will be co-extensive with that of the principal debtor. In other words, whatever amount of money a creditor can legally realise from the principal debtor including interest, cost of litigation, damages etc., the same amount he can recover from the surety.
Example: A guarantees to B the payment of a bill of exchange by C, the acceptor. The bill is dishonoured by C. A will be liable not only for the amount of the bill also for any interest and charges which have become due on it.
The liability of the surety arises immeidiately on the default of the principal debtor but the creditor is not bound to give any notice of the default of the principal debtor to the surety or it exhaust all the remedies open to him as against the debtor before proceeding against the surety. Besides that, creditor is free to release the debt when it becomes due to either from the debtor or the surety. It is not necessary for him to proceed against the debtor first. He may sue the surety without suing the principal debtor. It is surety’s duty to see that the principal debtor pays or performs his obligation.
Rights of the Security
Rights of the surety can be classified under three heads: (i) Against the principal debtor.
(ii) Against the creditor.
(iii) Against the co-sureties.
1. Rights of the surety against the principal debtor
(a) Rights to be subrogated: When the principal debtor had committed the default and the surety pays the debt to the creditor, surety will stand in the shoes of the creditor and will be invested with all the rights which the creditor had against the debtor (Sec. 140).
(b) Right to claim indemnity: In every contract of guarantee, there is an implied promise by the principal debtor to indemnify the surety and the surety is to recover from the principal debtor whatever sum he has rightfully paid under the guarantee but no sums which he has paid wrongfully, e.g., cost of fruitless litigation (Sec. 145).
Examples : (i) B is indebted to C, and A is surety for the debt. C demands payments from A, and on his refusal sues him for the amount. A defends the suit, having reasonable grounds for doing so, but is compelled to pay the amount of the debt with costs. He can recover from B the amount paid by him for costs, as well as the principal debt.
(ii) A guarantees to C, to the extent of 2000 rupees, payment for rice to be supplied by C to B. C supplies rice to a less amount than 2000 rupees, but obtains from A payment of the sum of 2,000 rupees in respect of the rice supplied. A cannot recover from B more than the price of the rice actually supplied.
2. Rights of the surety against the creditor
A surety is entitled to the benefit of every security which the creditor has against the debtor at the time when the contract of suretyship is entered into, whether the surety knows of the existence of such security or not and if the creditor loses or without the consent of the surety parts with such security, the surety is discharged to the extent of the value of the security (Sec. 141). But a surety, however, cannot claim the benefit of the securities only on the payment of a part of the debt.
3. Right against co-sureties
When two or more persons stand as sureties for the same debt or obligation they are termed as co-sureties. The position of co-sureties is as follows.
Co-sureties liable to contribute equally (Sec. 146): Where two or more persons are co-sureties for the same debt or duty, either jointly or severally, and whether under the same or different contract, and whether with or without the knowledge of each other, the co-sureties in the absence of any contract to the contrary, are liable, as between themselves, to pay each an equal share of the whole debt, or of that part of it which remains unpaid by the principal debtor.
Example: A, B and C are sureties to D for the sum of 3,000 rupees lent to E.E makes default in payment. A, B and C are liable, as between themselves, to pay 1,000 rupees each.
Liability of co-sureties bound in different sums (Sec. 147)
Co-sureties who are bound in different sums are liable to pay equally as far as the limits to their respective obligations permit.
Example: (i) A, B and C, as sureties for D, enter into three several bonds, each in a different penalty, namely, A in the penalty of 10,000 rupees, B in that of 20,000 rupees, C in that of 40,000 rupees, conditoned for D’s duly accounting to E. D makes default to the extent of 30,000 rupees. A, B and care each liable to pay 10,000 rupees.
(ii) A, B and C, as sureties for D, enter into three several bonds, each in a different penalty, namely, A in the penalty of 10,000 rupees, B in that 20,000 rupees and C in that of 40,000 rupees, conditioned for D’s duly accounting to E, D makes default to the extent of 40,000 rupees. A is liable to pay 10,000 rupees, and B and C 15,000 rupees each.
Discharge of surety
Surety will be discharged from his liability in the following cases:
1. By notice or death (Secs. 130 & 131): A contract of continuing gurantee may be terminated at any time by notice to the creditor. The death of the surety brings an end to continuing gurantee. No notice of death need to given to the creditor. The surety will not be responsible for acts done after his death.
2. Variations in terms of the original contract between the principal debtor and the creditor (Sec. 133): If the contract between the creditor and the principal debtor is materially altered without the consent of the surety, the surety is discharged as to transactions subsequent for the alteration.
Example (i) : A becomes surety to C for B’s conduct as a manager in C’s bank. Afterwards, B and C contract, without A’s consent that B’s salary shall be raised, and that he shall become liable for one-fourth of the losses on overdrafts B. allows a customer to overdraw, and the bank loses a sum of money. A is discharged from his suretyship by the variance made without the consent, and is not liable to make good this loss.
(ii) C contracts to lend B Rs. 5,000 on first March. A guarantees repayment. C pays the amount to B on first January. A is discharged from the liability, as the contract has been varied in as much as C might sue B for the money before the 1st March.
3. By release or discharge of the principal debtor (Sec. 134). The surety is discharged by any contract between in creditor and the principal debtor, by which the principal debtor is released or by any act or omission of the creditor, the legal consequence of which is the discharge of a surety on one agreement will not release the other surety bound for the same debtor by a separate agreement from his engagement, unless the effect of such release is to adversly affect the others right to contribution.
Example (i) : A gives a gurantee to C for goods to be supplied by C to B. C supplies goods to B, and afterwards B becomes embrassed and contracts with his credtiors (including C) to assign to them his property in consideration of their releasing him from their demands. Here B is released from his debt by the contract with C, and A is discharged from his suretyship.
(ii) A contracts with B fro to grow crop of indigo on his (A’s) land and to deliver it to B at a fixed rate. C guarantees A’s performance of his contract. B diverts a stream of water which is necessary for irrigation of A’s land and thereby prevents him from raising the indigo. C is no longer liable on his guarantee.
Compounding by creditor with the principal debtor (Sec. 135). A contract between the creditor and the principal debtor by which the creditor makes a composition with, or promise to give time to, or not sue to the principal debtor discharges the surety unless the surety assents to such contract.
But where a contract to give time to the principal debtor is made by the creditor with a third person, and not with the principal debtor, the surety is not discharged (Sec. 136).
Example: C, the holder of an overdue bill of exchange drawn by as surety for & and accepted by B, contracts with A to give time to B, is not discharged.
Similarly, mere forbearance on the part of the creditor to sue the principal debtor within the limitation period or to enforce any other remedy against him does not in the absence of any provision in the guarantee to the contrary discharge the surety (Sec. 137).
Example: B, owes to C a debt guaranteed by A. The debt becomes payable. C does not sue
B for a year after the debt has become payable. A is not discharged from the suretyship.
Where there are co-sureties a release by the creditor of one of them does not discharge the other;
neither does it free the surety so released from his responsibility to other sureties (Sec. 138).
5. Creditor’s act or omission imparing surety’s eventual remedy (Sec. 139). If the creditor does any act which is inconsistent with the rights of the surety, or omits to do any act which his duty to the surety requires him to do, any the eventual remedy of the surety himself against the principal debtor is thereby impaired, the security is discharged.
Example: (i) B contracts to build a ship for C for a given sum to be paid by instalments as the work reaches certain stages. A becomes surety to C for B’s performance of the contract. C without the knowledge of A, prepays to B the last two instalments. A is discharged by his pre-payments.
(ii) A puts M as apprentice to B, and gives a guarantee to B for M’s fidelity. B promises on his part that he will, at least once a month, see M to make up the cash. B omits to see M as promised, and M embezzles. A is not liable to B on his guarantee.
6. Loss of security (Sec. 141). If the creditor losses on, without the consent of the surety, parts with any security given to him at the time of the contract of guarantee, the surety is discharged from liability to the extent of the value of security.
Example: C advances to B, his tenant Rs. 2,000 on the gurantee of A. C has also further a security of Rs. 2,000 by a mortage of B’s furniture. C cancells the mortage. B becomes insolvent, and C sues A on his guarantee. A is discharged from his liability to the amount of the value of the furniture.
7. By invalidation of the contract of guarantee (Secs. 142, 143 and 144). A contract of guarantee becomes invalid if guarantee was obtained by fraud or concealment etc. about meterial facts as discussed before. Surety in such a case will be discharged from his liability.