BUSINESS LAW (Spring Term’20)

Instructor: Misha Zaheer

CONTRACTS OF INDEMNITY & GUARANTEE

Relevant Law: The Contract Act, 1872
WHAT IS A CONTRACT OF INDEMNITY?
Section 124 of the Contract Act, 1872, 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.
E.g. All insurance contracts other than life insurance.
A contract of indemnity is meant to restore the indemnity-holder to his original financial
position, no gains can be made from such a contract.
PARTIES IN A CONTRACT OF INDEMNITY

Indemnifier: The person who promises to make good the loss; and,

Indemnity-holder: The person whose loss is to be made good.

RIGHTS OF THE INDEMNITY-HOLDER (Section 125)

An indemnity-holder is entitled to recover the following amounts from the indemnifier, provided
that he has acted within the scope of his authority:

1. All damages which the indemnity-holder may have paid in respect of any suit in respect of any
matter to which the promise to indemnify applies;

2. All costs which the indemnity-holder may have paid in bringing or defending a suit; and/or,

3. All sums which the indemnity-holder may have paid under the terms of any compromise of a
suit.

As per this section, the rights of the indemnity-holder are not absolute or unfettered. He must act
within the authority given to him by the promisor and must not contravene the orders of the
promisor. Further, he must act with normal intelligence, caution, and care with which  he would
act if there were no contract of indemnity.

Note: the liability of an indemnifier commences as soon as the liability of the indemnity-holder
becomes absolute and certain. So for instance, where X promises to compensate Y for any loss
that may be suffered by filing a suit against Z, as soon as the court orders Y to pay Z damaged
worth Rs. 5000, the loss becomes certain and Y may be entitled to claim the loss from X and
pass it onto Z.

Remember! In addition to an implied/express promise to indemnify, all essentials of a valid

contract must be present in order for a contract of indemnity to be formed. E.g. where X asks Y
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Instructor: Misha Zaheer

to kill Z and promises to indemnify Y against the consequences. Y kills Z and is then made part
of a murder trial, Y cannot claim any loss from X because the object of their contract was
unlawful, hence there was no contract and thereby no contr act of indemnity.

WHAT IS A CONTRACT OF GUARANTEE?

According to Section 126, a contract of guarantee is a contract to perform a promise or discharge

the liability of a third person in case of his default.

E.g. X takes a loan from Bank Y. Z gives the Bank Y a guarantee that in case X fails to repay the
loan, Z will pay it on his behalf. If X defaults, Y is entitled to go after Z for the payment of the
loan.

A requests B to sell him goods on credit. B agrees to do so provided C provides him a guarantee
for the payment of the goods. C provides the guarantee. A defaults. B is entitled to recover the
value of goods from C.

For instance in England when students want to rent out property, a guarantor is required whose
credit details/accounts are accordingly checked.

A contract of guarantee includes three parties, namely:

Principal debtor: the person in respect of whose default the guarantee is being given i.e. the
person defaulting (X)

Creditor: the person to whom the guarantee is given (Y), and

Surety: the person who gives the guarantee i.e. the one making the promise to pay if the
principal debtor defaults (Z).

ESSENTIALS OF A CONTRACT OF GUARANTEE

1. Tripartite agreement

Three contracts are essentially made:

A. Between the principal debtor and the creditor, out of which the debt to be guaranteed
arises;
B. Between the principal debtor and the surety; and,
C. Between the surety and the credit, by which the surety guarantees to pay the debt incase
the principal debtor fails to pay.

2. Consent of the three parties

3. Existence of a liability

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Instructor: Misha Zaheer

A liability must exist, the performance of which is to be guaranteed. Such liability must be
enforceable by law.

4. Essentials of a valid contract

This would include elements such as consideration e.g. A sells and delivers goods to B.
subsequently, C without consideration agrees to pay for them incase B defaults on his payment.
Such an agreement is void for want of consideration.

Note: a contract of guarantee may be either oral or written (Section 126) and there needn’t be
any direct consideration in the contract between the surety and the creditor (Section 127).

5. Guarantee not to be obtained by misrepresentation (Section 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.

6. Guarantee not to be obtained by concealment (Section 143)

Any guarantee which has been obtained by the creditor, by means of keeping silent as to material
circumstances, is invalid.

E.g. A is supplying iron to B. C makes a guarantee to A with regard to B’s payment for the iron.
A and B have secretly agreed that B will pay Rs. 500 extra per ton of iron and that this excess
will be applied to liquidation of an old debt. This agreement is concealed from C. C will not be
liable as a surety.

EXTENT OF SURETY’S LIABILITY

The liability of the surety is co-extensive with that of the principal debtor i.e. the liability of the
surety is equal to that of the principal debtor unless otherwise agreed.

It is important to note however, that:

 The liability of the surety can be made less than that of the principal debtor by express
agreement;

 The liability of the surety rises immediately when a default is made by the principal
debtor;

 The creditor can sue the surety without going after the principal debtor first;

 Where there is a condition precedent for the surety’s liability, the surety will only be
liable once the condition has been fulfilled e.g. where a person gives a guarantee upon a
contract that a creditor shall not act upon it until another person has joined in as a co-
surety.

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Instructor: Misha Zaheer

KINDS OF GUARANTEE

Specific guarantee: which extends to a single debt or a specific transaction. The liability of the
surety comes to an end when the guaranteed debt is duly discharged or the promise is duly
performed.

Continuing guarantee: which extends to a series of transactions. The surety’s liability continues
until the revocation of the guarantee (Section 129).
E.g. Ben recommends that Sean hire Bill for the collection of rents from his tenants. Ben makes a
guarantee that he will make good any default made by Bill. This is a contract of continuing
guarantee.
Revocation of a continuing guarantee are dealt with in Sections 130-1,133-35,139 and 141.