Unit-II Contract of indemnity and guarantee.docx

Meaning (Section 124 of the Indian Contract Act, 1872)
A contract of indemnity is a contract by which one party promises to save the other from loss caused:
• by the conduct of the promisor himself, or
• by the conduct of any other person.
Example:
A contracts to indemnify B against the consequences of any proceedings which C may take against B in respect of a certain sum of money.
→ A is the indemnifier, and B is the indemnified or indemnity-holder.

1. UNIT II – CONTRACT OF INDEMNITY AND GUARANTEE
1. CONTRACT OF INDEMNITY
Meaning (Section 124 of the Indian Contract Act, 1872)
A contract of indemnity is a contract by which one party promises to
save the other from loss caused:
by the conduct of the promisor himself, or
by the conduct of any other person.
Example:
A contracts to indemnify B against the consequences of any proceedings
which C may take against B in respect of a certain sum of money.
→ A is the indemnifier, and B is the indemnified or indemnity-holder.
2. ESSENTIALS OF A VALID CONTRACT OF INDEMNITY
1.Two Parties:
oIndemnifier (promisor) and Indemnity-holder (promisee).
2.Promise to Save from Loss:
oThe main object is protection from loss.
3.Loss Must Be Caused:
oLoss should arise due to the conduct of the promisor or a third
person.
4.Express or Implied:
oThe contract may be express (written/oral) or implied from the
circumstances.
5.All Essentials of a Valid Contract:

2. oOffer, acceptance, lawful object, consideration, free consent,
and capacity to contract.
3. RIGHTS OF THE INDEMNITY HOLDER (Sec. 125)
The indemnity holder is entitled to recover from the indemnifier:
1.All Damages –
All damages he may be compelled to pay in any suit relating to the
matter.
2.All Costs –
All costs incurred in defending such suit, provided he acted prudently
and with the authority of the indemnifier.
3.All Sums Paid Under Compromise –
All sums paid under any compromise of such suit, if the compromise
was made prudently and with the consent of the indemnifier.
Example:
A indemnifies B against the consequences of a case. B, acting prudently,
defends the case and pays damages of ₹10,000 and costs ₹2,000.
→ B can recover ₹12,000 from A.
4. RIGHTS OF THE INDEMNIFIER
Although not expressly stated in the Act, the indemnifier has certain
equitable rights:
1.Right to Control or Defend Proceedings:
The indemnifier can take over the defense in the name of the
indemnified.

3. 2.Right to Recover from Indemnity-holder:
If the indemnifier has paid for a loss that the indemnity-holder caused
by his own fault, he may recover it.
3.Right of Subrogation:
Once the indemnifier pays for the loss, he steps into the shoes of the
indemnified and can exercise his rights against third parties.
5. CONTRACT OF GUARANTEE
Meaning (Section 126 of the Indian Contract Act, 1872)
A contract of guarantee is a contract to perform the promise or discharge
the liability of a third person in case of his default.
Parties:
1.Surety – The person who gives the guarantee.
2.Principal Debtor – The person whose default is guaranteed.
3.Creditor – The person to whom the guarantee is given.
Example:
A lends ₹10,000 to B and C promises to pay the amount if B fails to pay.
→ A = Creditor, B = Principal Debtor, C = Surety.
6. ESSENTIALS OF A VALID CONTRACT OF GUARANTEE
1.Existence of a Principal Debt:
There must be a liability or debt of the principal debtor.
2.Consideration (Sec. 127):
Anything done for the benefit of the principal debtor is sufficient
consideration for the surety.

4. Example: A gives a loan to B; C guarantees repayment. Here, the loan to B is
the consideration for C’s promise.
3.Consent of All Three Parties:
There must be agreement among creditor, principal debtor, and
surety.
4.Written or Oral:
A contract of guarantee may be oral or written (unlike in English law,
which requires it to be written).
5.Free Consent:
Consent must not be obtained by misrepresentation or concealment of
material facts.
6.Lawful Object:
The purpose must not be illegal or immoral.
7. KINDS OF GUARANTEE
1.Specific (Simple) Guarantee:
oGiven for a single debt or transaction.
oComes to an end when the debt is paid or obligation discharged.
Example: C guarantees B’s loan of ₹10,000 from A.
2.Continuing Guarantee (Sec. 129):
oExtends to a series of transactions.
oRemains in force until revoked.
Example: C guarantees A that B will supply goods up to ₹50,000
each month to A.
3.Revocable Guarantee:
oCan be revoked by notice or death of surety.

5. 8. REVOCATION OF GUARANTEE
A guarantee may be revoked in the following ways:
1.By Notice (Sec. 130):
oA continuing guarantee may be revoked for future transactions
by giving notice to the creditor.
2.By Death of Surety (Sec. 131):
oAutomatically revoked for future transactions unless agreed
otherwise.
3.By Discharge of Principal Debt:
oWhen the principal debtor’s liability ends, the surety is also
discharged.
4.By Mutual Agreement:
oAll parties may agree to revoke the contract.
9. RIGHTS OF SURETY
(A) Rights Against the Principal Debtor
1.Right of Subrogation (Sec. 140):
After paying the debt, the surety gets all the rights of the creditor
against the principal debtor.
2.Right of Indemnity (Sec. 145):
Surety can recover from the principal debtor all sums paid under the
guarantee.
(B) Rights Against the Creditor

6. 1.Right to Security (Sec. 141):
Surety is entitled to benefit of every security which the creditor has
against the debtor at the time of the contract.
Example: If the creditor releases or loses a security, the surety is discharged
to that extent.
2.Right to Set-off:
Surety can claim any set-off or counterclaim available to the debtor.
(C) Rights Against Co-sureties
1.Right to Contribution (Sec. 146–147):
If there are several sureties for the same debt, they must share the
liability equally, unless otherwise agreed.
Example: A, B, and C are co-sureties for ₹60,000. A pays the entire sum → A
can recover ₹20,000 each from B and C.
10. LIABILITIES OF SURETY
1.Co-extensive Liability (Sec. 128):
The surety’s liability is equal to that of the principal debtor unless
otherwise stated in the contract.
Example: If B owes ₹10,000 to A, C (surety) is liable for the same amount.
2.Immediate Liability:
The creditor can sue the surety directly without first proceeding
against the principal debtor.
3.Liability Arising from Valid Contract Only:
The contract of guarantee must be valid; otherwise, the surety is not
liable.

7. 4.Extent of Liability:
The surety’s liability may be limited by terms of the guarantee (e.g.,
limited to ₹50,000).
11. DISCHARGE OF SURETY FROM LIABILITY
A surety is discharged from his liability under the following circumstances:
(A) By Revocation
By notice (Sec. 130) or death (Sec. 131).
(B) By Conduct of Creditor
1.Variance in Terms (Sec. 133):
Any change in the terms of contract without surety’s consent
discharges the surety.
Example: C guarantees B’s employment as manager at ₹20,000 salary. A
increases it to ₹25,000 without C’s consent → C is discharged.
2.Release or Discharge of Principal Debtor (Sec. 134):
When the creditor releases the debtor, the surety is discharged.
3.Creditor’s Act or Omission (Sec. 139):
If creditor’s action impairs surety’s remedy against debtor, the surety
is discharged.
4.Loss of Security (Sec. 141):
If the creditor loses or parts with security without consent of the
surety, he is discharged to that extent.
(C) By Invalidation of Contract
1.Misrepresentation (Sec. 142):
If the guarantee is obtained by misrepresentation, it is invalid.

8. 2.Concealment (Sec. 143):
Concealment of material facts discharges the surety.
3.Failure of Consideration:
If no consideration exists, the surety is not bound.
12. DISTINCTION BETWEEN INDEMNITY AND GUARANTEE
Basis Contract of Indemnity Contract of Guarantee
Number of
Parties
Two parties (Indemnifier
& Indemnified)
Three parties (Creditor, Debtor,
Surety)
Nature of
Liability
Primary Secondary
Purpose To protect from loss
To ensure performance or
payment
Number of
Contracts
One contract
Three contracts (Creditor-
Debtor, Debtor-Surety, Surety-
Creditor)
Right to Sue
Third Party
Indemnifier cannot sue
third party until payment
Surety can sue principal debtor
after payment
Example Insurance contract Bank guarantee, suretyship
13. IMPORTANT CASE LAWS
Case Principle Established
Adamson v. Jarvis (1827)
Indemnity-holder entitled to recover for loss
suffered while acting on behalf of indemnifier
Gajanan Moreshwar v.
Moreshwar Madan (1942)
Indemnifier’s liability arises as soon as loss
becomes absolute

9. Case Principle Established
Bank of Bihar v. Damodar
Prasad (1969)
Surety’s liability is co-extensive and immediate
State Bank of India v.
Premco Saw Mill (1983)
Release of principal debtor discharges the
surety
London General Omnibus
Co. v. Holloway (1912)
Variation in contract without surety’s consent
discharges him
14. SUMMARY TABLE
Topic Key Points
Indemnity
Protection from loss; 2 parties; rights under Sec.
125
Indemnity-holder
Rights
Recover damages, costs, sums paid
Guarantee Promise to perform liability of third person
Parties Creditor, Debtor, Surety
Kinds Specific, Continuing, Revocable
Rights of Surety Against debtor, creditor, and co-sureties
Liability of Surety Co-extensive with principal debtor
Discharge Revocation, variance, release, loss of security, etc.