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Indemnity and guarantee

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Sagnik Saha

Editor’s note:

While the concept of indemnity and guarantee differ on several issues, they both remain modes of compensation with overlapping principles. This paper analyses both the similarities and the differences between the two. Indemnity, under S. 124 of the Indian Contract Act, is a contract to keep a party indemnified against loss. Guarantee enables a person to get a loan on goods, or an employment, and requires a valid consideration. While a contract of guarantee has 3 parties, with varying liabilities, a contract of indemnity has two parties with primary liability. There exist several such differences, with an guarantee having a far-reaching principle, unlike an indemnity, which emerges on occasion.

Introduction

‘Indemnity and Guarantee are two sides of the same coin’- It means that indemnity and guarantee differ on a lot of issues while being similar on the issue that they are both modes of compensation and that they are similar on certain principles like unjust enrichment and matters of good faith. In spite of their basic similarities, contracts of indemnity are inherently different from contracts of guarantee. First we will go about explaining what indemnity and guarantee means. Then we will go into the differences and the similarities between guarantee and indemnity.

Indemnity[i]

Section 124 of the Indian Contract Act 1872, defines Indemnity. According to Halsbury, as indemnity is a contract, express or implied to keep a person, who has entered into or who is about to enter into, a contract or incur any other liability, indemnified against loss, independently of the question whether a third person makes a default[ii]. Chitty says the term, indemnity, is used in the law in several different times and cases. In its widest sense, it means recompense for any loss or liability which one person has incurred, whether the duty to indemnify comes from an agreement or not. Section 126 of the Indian Contract Act 1872, talks about the rights conferred on the indemnity holder and the essential conditions for him to claim these rights. It was held in Adamson vs. Jarvis, that Adamson has to indemnify Jarvis as Jarvis was asked to follow the orders of Adamson, and if anything went amiss Jarvis would be indemnified. The indemnity holder can call upon the indemnifier to save him from loss even before the actual loss is incurred.

Rights of Indemnified or Indemnity Holder:

  • All damages for which he may be forced to pay in any suit subjected to any matter to which the promise to indemnify is applicable;

  • All costs which he may be forced to pay in any such suit if, in carrying or protecting it, he didn’t negate the commands of the promisor, and went about as it might have been judicious for him to act without any agreement of reimbursement, or if the promisor commissioned him to carry or defend a suit;

  • Every sum which he may have paid under the terms of any bargain of any such suit, if the bargain was not in spite of the requests of the promisor, and was one which it might have been reasonable for the promisee to make without any agreement of indemnity, or if the promisor sanctioned him to bargain the suit.

Rights of Indemnifier:

  • After compensation of the indemnity holder, indemnifier reserves the right to all the ways and means by which the indemnifier could have safeguarded himself from the loss.

Guarantee[iii]

Guarantee is constituted with the concurrence of the principle debtor, the creditor and the surety, but that does not mean that there must be evidence showing that the principle-debtor undertook his obligation at the express request of the principle-debtor as implied request will be quiet sufficient to satisfy this requirement. The function of a contract of guarantee is to enable a person to get a loan on goods on credit, or an employment. A contract of guarantee is rendered void without valid consideration[iv].

The Essentials of a Contract of Guarantee are:

  • Tripartite Agreement: A contract of guarantee entails three parties, principal creditor, creditor and surety. In a successful contract of guarantee, there must be three separate contracts between the three parties and each and every contract must be consenting.

  • Liability: Here the main liability lies with the principal debtor. Secondary liability lies with the surety which can only be invoked once the principal debtor defaults on its payment.

  • Essentials of a Valid Contract: Like any other general contract, it maintains free consent, consideration, lawful object and competency of contracting parties as the essentials of a valid contract.

  • Medium of Contract: The Indian Contract Act, 1872, does not strictly mention the need for any written form of contract of guarantee. Both oral and written form will suffice.

Rights of a surety:

As against the Creditor:

According to the Indian Contract Act, 1872,

  • Sec. 133 – The creditor ought not fluctuate terms of the agreement between the creditor and the principal debtor without the surety’s assent. Any such fluctuation releases the surety as to transactions ensuing to the difference. However in the event that the change is for the profit of the surety or does not prefer him or is of an irrelevant character, it might not have the impact of releasing the surety.

  • Sec. 134 – The creditor ought not discharge the principal debtor from his liability under the agreement. The impact of the release of the principal debtor is to release the surety too. Any enactment or exclusion from the creditor which in law has the impact of releasing the principal debtor puts a close to the liability of the surety.

  • Sec. 135 -In the event that an agreement is made between the Creditor and Principal debtor for intensifying the last’s liability or making a guarantee to him growth of time for doing the commitments or swearing up and down to not to beyond any doubt, releases the surety unless he consents to such an agreement.

  • Sec. 139 – the surety is released if the creditor debilitates the surety’s possible remedy against the principal debtor.

As Against the Principal Debtor

  • Right of subrogation – The surety on making good of the debt obtains a right of subrogation.

  • Sec. 140 – the surety can’t assert the right of subrogation to the creditor’s securities in the event that he has agreed as a security for a part of the contract and security has been procured by the creditor for the complete debt.

Differences between guarantee and indemnity[v]

A contract of guarantee always has three parties; they are, the creditor, the principal debtor and the surety; whereas a contract of indemnity has two parties, the indemnifier and the indemnity holder. In a contract of indemnity, the indemnifier assumes primary liability, whereas in a contract of guarantee, the debtor is primarily liable and the surety assumes secondary liability. In indemnity, the contingency present is that of the possibility or risk of suffering loss to which the indemnifier agrees to indemnify; while in guarantee, there is an existing debt or duty whose performance is guaranteed by the surety. In case of indemnity contract, indemnifier’s interest lies in earning a commission and a premium whereas in a contract of guarantee, the only interest is guarantee itself. In a contract of indemnity, the indemnifier cannot sue a third party. Surety is entitled to file a suit against the principal debtor in his own name if only he has paid the debt. In a contract of indemnity, there is a single promise or contract; a promise to pay if there is a loss. In a contract of guarantee, by contrast, there are multiple promises, including the original promise to pay or perform and the guarantor’s promise to pay or perform in the event of default.

In a case study between, Punjab National Bank Ltd. v. Bikram Cotton Mills and Anr[vi] and Gajan Moreshwar vs. Moreshwar Madan, the difference between guarantee and indemnity is clearly visible. There are three parties here, in the Punjab National Bank case where as only two parties in Gajan Moreshwar. Here Moreshwar Madan was the indemnifier and hence he was the only one liable to make good of the money, whereas in the Punjab National Bank case, the debtor, which is the first respondent company, is the primary liability holder and the secondary liability belongs to the surety which is the respondent. The Privy Council in Gajan Moreshwar case held that the indemnity holder has rights other than those mentioned in the sections mentioned. If the indemnity holder has incurred any liability, he can ask the indemnifier to do well of the liability and Moreshwar Madan was directed by the Privy Council to do well of the indemnity holder, Gajan Moreshwar’s, liability. In Punjab National Bank case, there was no risk involved, but there is an existing duty to pay off debts as mentioned in the sections governing guarantee. Hence irrespective of the presence of risk, the principal debtor and surety has to do well of the debts of the creditor. In Gajan Moreshwar case, Gajan Moreshwar can’t sue K.D. Mohan, as it is a contract of indemnity. He can only sue Moreshwar Madan. But in Punjab National Bank case, along with the principal debtor, the surety can also be sued.

Similarities[vii]

Guarantees and indemnities have numerous similar attributes. By and large likewise, similar obligations and rights

emerge between the parties. This will have impact particularly throughout the time of looking to authorize the agreement. Contracts of indemnity and contracts of guarantee impart certain central commonality. In every contract, one party consents to pay in the interest of another. Also each of these categories of contracts is utilized as a safeguard against misfortunes by people and organizations. One more point of similarity worth mentioning is that they cannot be used to make unjust enrichments. In a comparative study between Punjab National Bank Ltd. v. Bikram Cotton Mills and Anr and Gajan Moreshwar vs. Moreshwar Madan, it can be seen, that both guarantee and indemnity are used to compensate the creditor and indemnity holder respectively and the principal debtor and surety in the Punjab National Bank case s well as the indemnifier had consented to pay to make good of the debt.

Conclusion[viii]

An indemnity, by contrast, accommodates simultaneous obligation with the principal although and there is no compelling reason to “look first” at the principal. Generally it is an agreement that the surety will hold the lender innocuous against all misfortunes emerging from the agreement between the principal and the lender. Generally, a guarantee accommodates an obligation far-reaching with that of the principal. At the end of the day, the guarantor can’t be at risk for much more than the client. The document will be understood as a guarantee if, on its actual development, the commitments of the surety are to “remained behind” the principal and just go to the fore once a commitment has been broken as between the principal and the lender. The commitment is an auxiliary one, reflexive in character. An indemnity emerges on event of an occasion, whereas a guarantee emerges on default by a third party. Hence we have explained what indemnity and guarantee means and on what grounds they differ on like the number of parties involved and the nature of risks involved and we have also worked upon the small but significant differences both in working and in principal between guarantee and indemnity. Therefore, though guarantee and indemnity have a few similarities, they are inherently different in nature.

Edited by Neerja Gurnani

[i] Contract of Indemnity available at http://www.lawnotes.in/Contracts_of_Indemnity#ixzz2sqefMeVf (Last Visited on February 21, 2014)

[ii] Adamson v. Jarvis, (1827) bing 66: 5 LJ OS 68: The plaintiff, an auctioneer, sold certain cattle on the instruction of the defendant. It subsequently learned out that the livestock did not belong to the defendant, but to another person, who made the auctioneer liable and the auctioneer in his turn sued the defendant for indemnity for the loss he had thus suffered by acting on the defendant’s directions.

[iii] Contract of Guarantee available at   http://www.lawnotes.in/Contract_of_Guarantee#ixzz2uGPMTPeF (Last Visited on February 22,2014)

[iv] Janaki Paul v. Dhokar Mall Kidarbux, (1935) 156 IC 200

[v] Difference between Indemnity and Guarantee available at http://www.ehow.com/info_8094382_differences-contract-indemnity-contract-guarantee.html#ixzz2swbr3ui2 (Last Visited on February 12, 2014)
[vi] The Differences between Contract of Indemnity & Contract of Guarantee available at http://www.ehow.com/info_8094382_differences-contract-indemnity-contract-guarantee.html#ixzz2swdShgGT (last visited on February 24, 2014)

[vii] GUARANTEE AND INDEMNITY AS SUBJECTS OF SECURITY, Ale-Daniel Olaoluwa, Jonathan Julius Iyieke, Udeogu Chijioke
[viii] Difference between Indemnity and Guarantee available at http://judicially-yours.blogspot.in/2010/02/difference-between-indemnity-and.html (Last visited on February 21, 2014)

2 thoughts on “Indemnity and guarantee”

  1. Guarantor is entitled to benefit of discharge as mortgagor…..How we illustrate and under which section….

    Reply

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