CONTRACT OF INDEMNITY & GUARANTEE,,,REVOCATION OF THE CONTRACT OF GUARANTEE,,RIGHTS AND LIABILITIES OF SURETY,,DISCHARGE OF SURETY:

PRELIMINARY NOTE:

The Contract of Indemnity and Contract of Guarantee are two important types of special contracts recognized under Chapter VIII of the Contract Act, 1872 (Sections 124 to 147). These contracts are widely used in commercial dealings, insurance, financial services, and other transactions requiring legal assurance and protection against losses or defaults. Understanding the definitions, essentials, rights, and liabilities arising under these contracts is crucial for legal professionals, students, and business persons.

RELEVANT LAW AND PROVISIONS:

Chapter VIII (Indemnity and Guarantee) & Section 124-174 of Contract Act, 1872

 

WHAT IS A CONTRACT OF INDEMNITY:

In ordinary parlance, the term indemnity means to make good any loss or to compensate any person who has suffered some loss.

Section 124 of the Act defines a contract of indemnity as:

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.

• The person who makes the promise to make good the loss is called the indemnifier.

• The person whose loss is to be made good is called the indemnity holder.

 

ESSENTIALS OR CHARACTERISTICS OF INDEMNITY:

Following are the essentials of the contract of indemnity; which are as follows:

1. Contract of indemnity has two parties namely the indemnifier who makes a promise to indemnify loss and the indemnity holder whose losses are made good by the indemnifier.

2. Contract of indemnity includes losses arising out of the conduct of the party and happening of an event or accident. It may include express or implied promise for compensating the losses.

3. Contract of indemnity is made primarily for compensating losses of another party which may be caused either by the conduct of the party or by any event or accident.

 

RIGHTS OF INDEMNITY HOLDER: (SECTION 125)

In a contract of indemnity, the indemnity holder who is to be compensated for the loss has the following rights:

a) Right to recover the amount of damages that he has been compelled to pay to another party.

b) Right to claim all the costs which he has incurred for defending himself in a suit to which the promise of indemnity is applicable.

c) Right to recover the payment from indemnifier.

 

CONTRACT OF GUARANTEE:

Section 126 of the Contract Act defines contract of guarantee as:

“A contract of guarantee is a contract to perform the promise, or discharge the liability, of a third person in case of his default.”

The contract of guarantee is made to ensure performance of a contract or discharge of obligation by the promisor. In case he fails to do so, the person giving assurance or guarantee becomes liable for such performance or discharge.

In a contract of guarantee, there are three parties, namely, the principal debtor, creditor, and surety. The principal debtor is liable to pay, and the surety is the person who gives the guarantee.

For Example:

If A borrows a sum of Rs. 10,000 from B, and C gives guarantee that in case A defaults in repayment, he will repay the amount, then this is an example of a contract of guarantee. Here, A is the principal debtor, B is the creditor, and C is the surety.

 

ESSENTIALS OF CONTRACT OF GUARANTEE:

• a) Contract of guarantee must possess the essentials of a valid contract.
• b) There must be three parties in a contract of guarantee i.e., principal debtor, creditor and surety.
• c) Contract of guarantee must be supported by lawful consideration. But under section 127, any promise made for the benefit of the principal debtor may be a sufficient consideration to the surety for giving the guarantee.
• d) In a contract of guarantee there is a primary liability on a principal debtor to repay or to discharge obligation.
• e) In every contract of guarantee there is an implied indemnity.
• f) Validity of the contract of guarantee depends upon the mutual trust and good faith on the part of the creditor (section 142 and 143).
• g) The contract of guarantee may be made in writing or by the words of mouth (section 126).

 

KINDS OF GUARANTEE:

Guarantee may be:

1) SPECIFIC GUARANTEE:

A specific guarantee is a contract of guarantee made for a particular transaction. It covers only that single particular transaction.

2) CONTINUING GUARANTEE:

Under section 129, a continuing guarantee is a contract made for a particular transaction having many series or parts thereof. In case of continuing guarantee, the liability of the surety extends to all those series which are involved in that transaction.

 

REVOCATION OF THE CONTRACT OF GUARANTEE/ CONTINUING GUARANTEE:

A continuing guarantee may be revoked in any one of the following manners:

1) BY NOTICE: (SECTION 130)

After having completed some series of transactions for which guarantee has been given, the surety may, by giving notice of revocation to the creditor, revoke a contract of guarantee. In such a case, the surety will be liable for all those series which have been completed till that notice.

2) BY DEATH OF SURETY: (SECTION 131)

A continuing guarantee may also be revoked in the case of death of the surety. However, for the series completed prior to the death of the surety, the estate of the surety will be liable.

3) BY OTHER MODE:

In addition to notice by the surety, or his death, a contract of continuing guarantee will be revoked under all circumstances in which the surety is discharged from his liability.

 

RIGHTS AND LIABILITIES OF SURETY:

RIGHTS OF SURETY:

In a contract of guarantee, the surety is considered as a ‘favoured debtor’ with rights against:

• The principal debtor

• The creditor

• The co-sureties (if any)

1. Rights against principal debtor:

• i. Right of Subrogation:  The surety will get the right of subrogation when he fulfills the obligation of the principal debtor fully. In other words, if the principal debtor commits default and the surety pays the debt to the creditor.

Example:
A has borrowed Rs. 50,000 from B. C stands surety to the bank for the repayments. On the due date, A defaults and B calls upon C to repay. C makes repayments to B. B was also holding certain assets worth Rs. 10,000 as a security for this loan. On repayment, C (the surety) is entitled to recover the assets held by B as security and can further proceed against A for the balance.

• ii. Right of Indemnity:  In every contract of guarantee, there is an implied promise by the principal debtor that any loss caused to him will be indemnified by the principal debtor. Thus, the surety is entitled to recover from the principal debtor whatever sum he has rightfully paid under the contract of guarantee. In other words, indemnity is applicable only on those payments made by the surety in connection with the guarantee, which are just and equitable. It covers principal amount, interest thereon, legal expenses if any and the cost of any suit.

2. Rights against creditor:

• i. Right to claim securities: In case where surety becomes liable to pay the debt on non-payment by the principal debtor, the surety is entitled to claim all those securities which the principal debtor has given as securities to the creditor in addition to the guarantee of the debt. If the creditor loses or, without the consent of the surety, discharges the debtor, the surety is discharged to that extent.

Example:
A borrows a sum of Rs. 10,000 from B for three months. C stands surety, in addition to securities worth Rs. 5,000. Without the consent of C, B returns securities worth Rs. 2,000 to A. In case A defaults and C makes repayments, he is entitled to get back security of Rs. 5,000 from B.

• ii. Right of Set-Off : If the principal debtor has a claim against the creditor, the surety is entitled to that claim and may use it to set off the amount due.
• iii. Right to share reduction:If there has been some reduction in the amount of debt being guaranteed by the surety, the surety is entitled to such reduction and his liability will also be reduced to that extent.
• iv. Right to demand termination of employee: In a contract of fidelity guarantee regarding the honest behavior of the employment, the surety has a right to demand dismissal of the employee if he defaults in his behavior.

3. Right against co-sureties:

• i. Right of Contribution:Where two or more persons stand sureties for the same debt either jointly or severally, the co-sureties are liable to pay equal share of the whole debt. If any one of them is compelled to pay the whole debt, he is entitled to get contribution in equal ratio from other co-sureties.
• ii. Co-sureties giving guarantee for different amounts: Where the same debt is guaranteed by two or more co-sureties, offering guarantee for different amounts, they will be liable in equal ratio subject to the maximum of the amount of guarantee given by them.

 

DISCHARGE OF SURETY:

In a contract of guarantee, the surety has a liability parallel to that of the principal debtor, which arises in case of default of the principal debtor. The surety is said to be discharged from his liability when his liability comes to an end, i.e., he is no more liable to the creditor. The liability of the surety comes to an end in the following manner:

1) BY REVOCATION:

The surety gets released from his liability in a contract of guarantee by revocation under the following situations:

i. By notice of revocation:
In a contract of continuing guarantee, the liability of surety extends to various series of a transaction. In such a case, the surety, by giving notice to the creditor, may revoke the contract for remaining series, but he will be liable for the series which have been completed before such notice.

ii. By death of surety:
A contract of continuing guarantee is also revoked at the death of the surety for the remaining series of that transaction. The legal representatives of the surety will be liable for the series which have been completed by the time of death of the surety.

iii. By novation:
By mutual consent of all parties, the original contract of guarantee may be replaced by a new contract. In such a case, the surety will be discharged from his liability in the original contract.

 

2) BY CONDUCT OF CREDITOR:

The surety will be discharged from his liability in a contract of guarantee by the conduct of the creditor under the following circumstances:

i. By variation in the terms of contract:
Any material variation or change regarding the terms of a contract of guarantee by the creditor and principal debtor without the consent of the surety will discharge him from his liability as to the transaction subsequent to such a change.

ii. By release or discharge of principal debtor:
The liability of the surety is secondary in nature. Thus, if the principal debtor is released or discharged from his liability by any act or omission of the creditor, the liability of the surety will also come to an end.

iii. By compounding surety’s remedy:
A contract between the creditor and the principal debtor whereby the creditor extends the time of payment or makes a promise not to sue the principal debtor in case of his default, the surety will be discharged from his liability in that contract of guarantee.

iv. By impairing surety’s remedy:
Any act or omission of the creditor which infringes the right of the surety would lead to his discharge from liability, i.e., if the creditor does any act which is inconsistent with the rights of the surety or omits to do any act which is his duty to do and the eventual remedy of the surety against the principal debtor is impaired, the surety is discharged.

v. By loss of security:
While making a contract of guarantee, in addition to guarantee, some security has also been given to the creditor. In case the creditor loses that security or parts with it without the consent of the surety, the surety will be discharged from his liability to that extent.

 

3) BY INVALIDATION OF CONTRACT OF GUARANTEE:

The surety will be discharged from his liability in the following cases on account of a contract being invalid:

i. Guarantee obtained by misrepresentation:
Where the guarantee has been obtained by the creditor by using misrepresentation or fraud, a contract of guarantee will be invalid and the surety will be discharged.

ii. Guarantee obtained by concealment:
Where the creditor obtains guarantee by means of keeping silent or concealing material facts, a contract of guarantee is invalid and provides sufficient ground for the surety to get discharged.

iii. Failure of consideration:
Lawful consideration is required in a contract of guarantee. In case of failure of such consideration, a contract becomes invalid and leads to discharge of surety from his liability.

iv. Failure of co-surety to join:
Where a person agrees to be surety in a contract on a condition that the creditor shall not act upon unless a co-surety joins, in case such a person does not join as a co-surety, the surety will be discharged from his liability.

 

LIABILITIES OF SURETY:

i. Liability of the surety is secondary:
In a contract of guarantee, the principal debtor is primarily liable to pay or discharge liability. It is only at his default, the liability of the surety arises and he may be called upon to discharge it.

ii. Liability of the surety is contingent:
It may or may not arise when the principal debtor commits default.

iii. Liability of surety is immediate in nature:
Once the principal debtor commits default, immediately the creditor may proceed against the surety.

iv. Liability of surety is co-extensive:
In a contract of guarantee, the liability of the surety is co-extensive with that of the principal debtor.

v. Surety may limit his liability:
Though the liability of the surety is co-extensive with that of the principal debtor, he has a right to limit his liability.

vi. Liability in continuing guarantee:
Makes the surety liable for unpaid seller.

vii. Liability of the surety where the original contract between the principal debtor and the creditor is void or voidable:
The law does not treat the principal debtor and the surety as one person. If a contract between the principal debtor and the creditor is void, the surety will be liable as if he were the principal debtor.

 

DIFFERENCE BETWEEN CONTRACT OF INDEMNITY AND GUARANTEE:

The contract of indemnity can be distinguished from the contract of guarantee in a number of ways, which are as follows:

Basis	Contract of Indemnity	Contract of Guarantee
1) Number of parties	There are two parties: the indemnifier and the indemnified.	There are three parties: the principal debtor, the creditor, and the surety.
2) Number of contracts	There is only one contract between the indemnifier and the indemnified.	There are three contracts: one between the principal debtor and the surety, the next between the creditor and the surety, and one between debtor and creditor.
3) Liability	The liability of the indemnifier is primary and unconditional. The liability arises only on the happening of the contingency.	The primary liability rests with the principal debtor and that of the surety is secondary and conditional. The liability arises only on the non-performance of the promise or non-payment of an existing debt.
4) Right to sue	The indemnifier cannot sue a third party in his own name, due to lack of privity of contract.	The surety can, on the discharge of the debt of the principal debtor, sue in his own name.

 

CONCLUSION:

The Contract of Indemnity and Contract of Guarantee are essential legal instruments in commercial law and financial security. While both aim to protect against loss or default, their legal nature, parties involved, scope of liability, and structure differ significantly.

A contract of indemnity primarily deals with compensation for a loss incurred, arising from the conduct of the promisor or a third party. On the other hand, a contract of guarantee ensures that an obligation or liability of a third party will be fulfilled and if not, the surety will be held responsible.

Both contracts are legally enforceable under the Contract Act, 1872, and their proper understanding is crucial for lawyers, judges, law students, and those involved in financial dealings. Legal awareness of the rights and liabilities under these contracts enables parties to secure their interests and avoid legal complications in case of breach or default.