What is Contract of Indemnity?
As per the Contract Act, “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”.
Table of Contents
- 1 What is Contract of Indemnity?
- 2 What is Contract of Guarantee?
- 3 Parties to Contract of Indemnity and Guarantee
- 4 Difference Between a Contract of Indemnity and a Contract of Guarantee
- 5 Kinds of Guarantee
- 6 Rights of Creditor
- 7 Obligations of Creditor
- 8 Rights of Surety Against Principal Debtor and Creditor
- 9 Liability of Surety
- 10 Discharge of Surety
- 11 Rights of Indemnified
- 12 Rights of the Indemnifier
- 13 Commencement of Indemnifier’s Liability
Contract of Indemnity Example
Person A and B go to a shop. B says to the shopkeeper “Let A have the goods, I will promise that you are paid if you sustain any loss due to the transaction”. The person who promises to make good the loss is called the ‘Indemnifier’ (promisor), and the person whose, loss is to be made good is called the ‘Indemnified or Indemnity.
Contract of Indemnity Definition
It is a contract wherein one party (promisor) assures and promises to indemnify or make good the losses caused to the promisor due to the act or omission or conduct of the promisor or any third party acting on behalf of the promisor. The contract of indemnity arises either by the operation of law or by express promises.
Section 124 of the Act applies to the contract of indemnity. The section says that a contract of indemnity is a type of contract in which a party promises the other party to save the other party from the breach caused by the promisor himself or from the conduct of any other person. This is a type of typical contingent contract.
There are two parties in this contract. The party that provides the promise to safeguard the other party is known as the indemnifier. The party to whom the security is given is known as indemnified.
What is Contract of Guarantee?
A contract of guarantee is a contract to perform the promise or dis- charge the liability of a third person in case of his default”.
Contract of Guarantee Example
A and B go to a shop. A says to the shopkeeper, C, “Let B have the goods, and if he does not pay, I will”. This is called a contract of guarantee.
Contract of Guarantee Definition
It is a contract in which one party promises to perform the promise or to discharge the liability incurred by the third party in case of his default. In this case, there are three parties. The person who gives the guarantee is known as a surety. The person in default whose guarantee is given is known as the principal debtor. The person to whom the guarantee is given is known as a creditor
Parties to Contract of Indemnity and Guarantee
There are basically two parties in the contract of indemnity. The person who promises is referred to as the indemnifier and the other party is said to be indemnified.
In the case of a contract of guarantee, there are three parties. The person who provides the guarantee is known as a surety. The person for whom the guarantee is given is known as the principal debtor. The third party is known as the creditor.
Difference Between a Contract of Indemnity and a Contract of Guarantee
The main difference between the contract of indemnity and the contract of the guarantee are as follows:
Number of Parties
In the case of a contract, there are only two parties. However, in the case of a contract of guarantee, there are three parties. The surety in this case is an additional party as compared to the contract of indemnity.
Extent of Liability
In the contract of indemnity, the liability of the promisor or the indemnifier is unlimited. However, in the case of guarantee, the liability of the surety arises only when the principal debtor is at default.
Time of Liability
The liability of the indemnifier arises only at the time of default. However, in the case of a guarantee the liability is already in existence but is applicable only when the principal debtor is in default.
Time to Act
The indemnifier need not act at the request of the indemnifier. But, in the case of guarantee, the surety must act at the request of the principal debtor.
Table 2.1 distinguishes between the contract of indemnity and the contract of guarantee:
| Contract of Indemnity | Contract of 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 or any other person | A contract of guarantee is a contract to perform the promise or discharge the liability of the third person in case of his default. |
| The liability of the promisor is primary, there is no secondary liability. | The liability of the principal debtor is primary and the liability of the surety is secondary. |
| The contract is express and specific. | The debtor and debtor and the creditor are specific and the contract between the principal debtor and surety is implied. |
| There are two parties involved and only one agreement. | There are three parties involved and three agreements. |
| The promisor cannot file suit against the third person until and unless the promisor subrogates his rights for filing of the suit. | The surety does not require any subrogation for filing the suit. |
Kinds of Guarantee
The different kinds of guarantees are discussed as follows:
Oral or Written Guarantee
A contract of guarantee can be verbal or in written form. Although a creditor always prefers a written contract of guarantee in order to avoid any dispute in the future. In the case of an oral agreement, the existence of the agreement itself is very difficult to prove and thereby enforce.
Specific and Continuing Guarantee
The scope of a contract of guarantee can be specific or continuing. A specific guarantee is intended to be applicable to a particular debt and thus it ceases with the repayment of the debt. For example, A guarantees the repayment of a loan of ₹10,000 to B by C (a banker). The guarantee, in this case, is for a specific purpose or debt.
On the other hand, a guarantee that extends to a series of transactions is called a continuing guarantee.
For example, A guarantees payment to B, a tea dealer, to the amount of ₹10,000 for any tea he may supply to C. B supplies C with tea of a value above ₹10,000 and C pays B for it. Afterward, B supplies C with tea to the value of ₹15,000 and C fails to pay. The guarantee given by A was a counting guarantee and he is accordingly liable to B to the extent of ₹10,000.
A guarantee regarding the conduct of another person is a continuing guarantee. Unlike a specific guarantee which is irrevocable, a continuing guarantee can be revoked regarding further transactions. However, continuing guarantee cannot be retrospectively revoked regarding transactions that have ready taken place.
For example, X guarantees the repayment of advances made to A within 6 months subject to a maximum of ₹20,000. If ₹10,000 has been advanced by the end of 2 months, the guarantee is irrevocable as far as this advance of ₹10,000 is concerned.
Rights of Creditor
The rights of creditors are as follows:
- The creditor is entitled to demand payment from the surety as soon as the principal debtor refuses to pay or makes defaults in payment. The liability of the surety cannot be postponed till all other remedies against the principal debtor have been exhausted.
In other words, the creditor cannot be asked to exhaust all other remedies against the principal debtor before proceeding against the surety. The creditor also has a right of general lien on the securities of the surety in his possession. This right, however, arises only when the principal debtor has made a default and not before that. - Where the surety is insolvent, the creditor is entitled to proceed with the surety’s insolvency and claim the pro rata dividend.
Obligations of Creditor
The obligations of a creditor in a contract of the guarantee are:
- Not to Change Any Terms of the Original Contract
- Not to Release or Discharge the Principal Debtor
- Not to Compound, Give Time to, or Agree Not to Sue the Principal Debtor
- Not to Do Any Act Inconsistent With the Rights of the Surety. (Section 139)
Not to Change Any Terms of the Original Contract
The creditor should not change any terms of the original contract without seeking the consent of the surety. According to Section 133 of the Companies Act, “any variance made, without the surety’s consent, in the terms of the contract between the principal debtor and the creditor, discharges the surety as to the transactions subsequent to the variance”.
For example, a banker contract to lend X ₹5,000 on March 4. A guarantee of the repayment of the amount. The banker pays ₹5,000 on January 1. A in this case is discharged from his liability as the contract has been varied as much as the banker might sue X before March 4, but it cannot sue A as the guarantee is from March 4.
Not to Release or Discharge the Principal Debtor
The creditor is under an obligation not to release or discharge the principal debtor. According to Section 134 of the Companies Act, “The surety is discharged by a contract between the creditor and 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 the principal debtor”.
For example, A gives a guarantee to banker C for the repayment of the debt granted to B. B later contracts with his creditors (including C, the banker) 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.
Not to Compound, Give Time to, or Agree Not to Sue the Principal Debtor
According to Section 135 of the Companies Act, “A contract between the creditor and the principal debtor, by which the creditor makes a composition with or promises to give time to, or not to use the principal debtor, discharges the surety unless the surety assents to such contract”.
If the time for repayment is extended, the debtor may die or become insane or insolvent or his financial position may become weaker in the meanwhile, with one effect that the surety’s remedy to recover the money in case the principal debtor defaults, may be impaired.
However, there are certain exceptions to this obligation.
- Section 136 states that if the creditor makes an agreement with a third party, but not with the principal debtor, to give an extension of time to the principal debtor, the surety is not discharged even if his consent has not been sought.
For example, C the holder of an overdue bill of exchange, drawn by A as surety for B and accepted by B, contracts with M to give time to B. A is not discharged. - According to Section 137 of the Companies Act, mere forbearance on the part of a creditor to sue the principal debtor, or to enforce any other remedy against him, does not, in the absence of a provision to the contrary, discharge the surety (Section 137).
For example, B owes C (a banker) a debt guaranteed by A and the debt becomes payable, but C does not sue B for a year after the debt becomes payable. A is not discharged from his suretyship. - If the creditor releases one of the co-sureties, the other co-surety (or co-sureties) thereby is not discharged. The co-surety released by the creditor is also not released from his liability to the other sureties (Sec.138).
Not to Do Any Act Inconsistent With the Rights of the Surety. (Section 139)
Where C lends money to B on the security of a joint and several promissory notes made in C’s favor by B and by A as surety for B, together with a bill of sale of B’s furniture, which gives power to C to sell the furniture and apply the proceeds in the discharge of the note.
Subsequently, C sells the furniture, but owing to his misconduct and wilful negligence, only a small price is realized, then A is discharged from the liability on the note.
Rights of Surety Against Principal Debtor and Creditor
The rights of a surety are classified under three heads:
Rights Against the Creditor
In the case of fidelity guarantee, the surety can direct the creditor to dismiss the employee whose honesty he has guaranteed, in the event of proven dishonesty of the employee. The creditor’s failure to do so will exonerate the surety from his liability.
Rights Against the Principal Debtor
It includes the following:
Right of Subrogation
Section 140 lays down that where a surety has paid the guaranteed debt on its becoming due or has performed the guaranteed duty on the default of the principal debtor, he is invested with all the rights which the creditor has against the debtor. In other words, the surety is subrogated to all the rights which the creditor had against the principal debtor.
So, if the creditor loses, or without the consent of the surety parts with any securities (whether known to the surety or not) the surety is discharged to the extent of the value of such securities ( Section 141). Further, the creditor must hand over to the surety, the securities in the same condition as they formerly stood in his hands
Right to be Indemnified
The surety has a right to recover from the principal debtor the amounts which he has rightfully paid under the contract of guarantee.
Rights Against Co-Sureties
paid more than his share or a decree has been passed against him for more than his share, he has a right of contribution from the other sureties who are equally bound to pay with him.
For example, A, B, and C are sureties to D for the sum of ₹3,000 lent to E. E defaults in making payment. A, B, and C are liable, as between themselves to pay ₹1,000 each, and if any one of them has to pay more than his share, i.e., ₹1,000 he can claim contribution from the others, for the amount paid in excess of ₹1,000. If one of the sureties becomes insolvent, the solvent co-sureties shall have to contribute the whole amount equally.
Where the co-sureties have guaranteed different sums, they are bound under Section 147 to contribute equally, subject to the limit fixed by their guarantee and not proportionately to the liability undertaken.
For example, A, B, and C as sureties for D, enter into three several bonds, each with a different penalty, namely, A in the penalty of ₹10,000, B in that of 20,000, C in that of ₹40,000, conditioned for D’s duly accounting to E. E makes default to the extent of ₹30,000. A, B, and C are each liable to pay ₹10,000.
Liability of Surety
According to section 128 of the Companies Act, “unless the contract provides otherwise, the liability of the surety is co-extensive with that of the principal debtor.”
In other words, the surety is liable for all those amounts the principal debtor is liable for. It is also called secondary or contingent, as his liability arises only on default by the principal debtor. But as soon as the principal debtor defaults, the liability of the surety begins and runs co-extensive with the liability of the principal debtor, in the sense that the surety will be liable for all those sums for which the principal debtor is liable.
The creditor may file a suit against the surety without suing the principal debtor. Further, where the creditor holds securities from the principal debtor for his debt, the creditor need not first exhaust his remedies against the securities before suing the surety, unless the contract specifically so provides. The creditor is even not bound to give notice of the default to the surety unless it is expressly provided for.
For example, A guarantees to B the payment of a bill of exchange by C, the acceptor. The bill is dishonored by C. A is liable not only for the amount of the bill but also for any interest and charges which may have become due on it.
Discharge of Surety
The liability of surety can be discharged under any of the conditions shown in Table:
| Condition | Explanation |
|---|---|
| Notice of revocation (Section 130) | A continuing guarantee may at any time be revoked by the surety, as to future transactions, by notice to the creditor. For 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. B discounts the bill for C to the extent of ₹2,000. Afterward, at the end of the three months, A revokes the guarantee. The revocation discharges A from liability to B for any subsequent discount. But A is liable to B for ₹2,000 on default of C |
| Death of surety (Section 131) | The death of the surety operates, in the absence of any contract to the contrary, as a revocation of a continuing guarantee, so far as regards future transactions. |
| Variance in terms of the contract (Section 133) | Any variance, made without the surety’s consent, in the terms of the contract between the principal debtor and the creditor, discharges the surety as to transactions subsequent to the variance. For example, A becomes surety to C for B’s conduct as a manager in C’s bank. Afterward 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 his consent and is not liable to make good this loss |
| Release or discharge of principal debtor (Section 134) | The surety is discharged by any contract between the creditor and 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 the principal debtor. For example, A gives a guarantee to C for goods to be supplied by C to B. C supplies goods to B, and afterward B becomes embarrassed and contracts with his creditors (including C) to assign to them his property in consideration of their releasing him from their demands. Here A is released from his debt by the contract with C and A is discharged from his suretyship. |
| Compounding with, or giving time to, or agreeing not to sue, a principal debtor (Section 135) | A contract between the creditor and the principal debtor by which the creditor makes a composition with, or promises to give time to, or not to sue the principal debtor, discharges the surety. The surety shall, however, be not discharged if (a) he assents to such contract, (b) the contract to give time to the principal debtor is made by the creditor with a third person and not with the principal debtor. For example, C, the holder of an overdue bill of exchange drawn by A as surety for B and accepted by B, contracts with M to give time to B. A is not discharged. |
| Creditor’s act or omission impairing surety’s eventual remedy (Section 139) | If the creditor does any act which is inconsistent with the right of the surety or omits to do any act which his duty to the surety requires him to do and the eventual remedy of surety himself against the principal debtor is thereby impaired, the surety is discharged. For example, B contracts to build a ship for C for a given sum to be paid in installments as the work reaches certain stages. A becomes a surety of B’s due performance of the contract. C, without the knowledge of A, repays to B the last two installments. A is discharged by this prepayment. |
| Loss of security (Section 141) | If the creditor loses or parts with any security given to him by the principal debtor at the time the contract of guarantee was made, the surety is discharged to the extent of the value of the security, unless the surety consented to the release of such security. For example, C advances to B, his tenant ₹2,000 on the guarantee of A. C has also further security for the ₹2,000 by a mortgage of B’s furniture. C cancels the mortgage. B becomes insolvent and C sues A on his guarantee. A is discharged from liability to the amount of value of the furniture |
Rights of Indemnified
According to Section 124, “a contract of indemnity is a contract whereby one party promises to save the other from loss caused to him (the promisee) by the conduct of the promisor himself or by the conduct of any other person.” An example of a contract of indemnity is an insurance contract.
A contract of indemnity may arise either by (i) an express promise or (ii) operation of law, e.g., the duty of a principal to indemnify an agent from consequences of all lawful acts done by him as an agent. The contract of indemnity, like any other contract, must have all the essentials of a valid contract.
These are two parties in a contraction of identity indemnifier and indemnified. The indemnifier promises to make good the loss of the indemnified (i.e., the promisee). For example, A contracts to indemnify B against the consequences of any proceeding that C may take against B in respect of a certain sum of ₹200. This is a contract of indemnity.
An indemnified person is entitled to recover the following 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 of suit which he may have to pay to such third party provided in bringing or defending the suit (a) he acted under the authority of the indemnifier or (b) if he did not act in contravention of orders of the indemnifier and in such a way as a prudent man would act in his own case.
- All sums which may have been paid under the terms of any compromise of any such suit, if the compromise was not contrary to the orders of the indemnifier and was one which it would have been prudent for the promisee to make.
Rights of the Indemnifier
The Act makes no mention of the rights of the indemnifier. However, his rights, in such cases, are similar to the rights of a surety under Section 141, viz., he becomes entitled to the benefit of all the securities which the creditor has against the principal debtor whether he was aware of them or not.
Commencement of Indemnifier’s Liability
Indemnity requires that the party to be indemnified shall never be called upon to pay. Indemnity is not necessarily given by repayment after payment. The indemnified may compel the indemnifier to place him in a position to meet a liability that may be cast upon him without waiting until the promisee (indemnified) has actually discharged it.
