1)INTRODUCTION

When we are discussing about the Contracts of Indemnity and Guarantee, the first thing we have
to do is to define the both types of Contracts. Contract of Indemnity means enact to compensate
or protect somebody from the loss or make good to the loss. When one person promises to
another person that in case another person suffers from some loss the first person will
compensate the loss. An indemnity is a sum paid by party A to party B by way of compensation
for a particular loss suffered by B. The indemnitor (A) may or may not be responsible for the
loss suffered by the indemnitee (B). Forms of indemnity include cash payments, repairs,
replacement, and reinstatement. In the same context Contract of Guarantee means an act to
perform the promise, or discharge the liability, of a third person in case of his default. The person
who gives the guarantee is called “surety”, the person in respect of whose default the guarantee
is given is called the “principal debtor” and the person to whom the guarantee is given is called
the “creditor”.

2) Indemnity as per Indian Contract Act, 1872.

Indemnity literally means,

(1) Payment for damage, a guarantee against losses.

(2) A bond protecting the insured against losses caused by others failing to fulfill their
obligations.
(3) The granting of exemption from prosecution.
(4) an option to buy or sell a specific quantity of stock at a stated price within a given period
of time.

It is entered into with the object of protecting the promises against anticipated loss. The
contingency upon which the whole contract of indemnity depends is the happening of loss.

ILLUSTRATIONS: A lost his share certificate. He applied to the company for the issue of a
duplicate certificate. The Company asked A to furnish an ‘indemnity bond’ in its favour to
protect it against any claim that may be made by any person on the original certificate. A,
accordingly executed the ‘indemnity bond’. It is a contract of indemnity between A and the
Company. A is the ‘indemnifier’ and the Company is the ‘indemnified’ or ‘indemnity-holder.
A contract of indemnity is one whereby a person promises to save the other from loss caused to
him by the conduct of the promisor himself or of any third person. For example, a shareholder
executes an indemnity bond favoring the company thereby agreeing to indemnify the company
for any loss caused as a consequence of his own act. The person who gives the indemnity is
called the 'indemnifier' and the person for whose protection it is given is called the 'indemnity-
holder' or 'indemnified'. A contract of indemnity is restricted to cover the loss caused by the
promisor himself or by a third person. The loss must be caused by some human agency. Loss
arising from accidents like fire or perils of the sea are not covered by a contract of indemnity.

As per Section 124 of the Indian Contract Act, the contract of indemnity is defined as, “a
contract by which one party promises to save other from loss caused to him by the conduct of the
promisor himself, or by the conduct of any other person.”

Well, this section is not so difficult to understand when you relate it to practical house. Suppose
you are hired by a newspaper to write articles for them as a freelancer. Typically, your contract
would have an indemnity clause so that if you write something against a very important person
and that person files a suit against the newspaper for defamatory material, the newspaper can
show the indemnity clause that you signed, protecting them from any form of loss caused due to
your conduct.

Then, the onus of fighting the defamation suit becomes your responsibility. That’s not all about
the contract of indemnity as it is incorporated in most contracts, particularly in real estate
purchase and bank loans. A person who promises to bear the loss is known as indemnifier and
the person whose loss is covered is known as indemnified. These types of contracts are mainly
formed between insurance companies and their customers.

3)RIGHTS OF INDEMNITY HOLDERS

In a suit against the indemnity holder, he may have been compelled to pay damages, and incurred
costs, etc. in his own turn, he can bring an action against the promisor (indemnifier) to recover
damages and costs, etc. paid by him, if the indemnifier has promised an indemnity in such a case.
The provision in this regard is contained in Section 125, which reads as under:

124. Rights of Indemnity holder

The promisee in a contract of indemnity, acting within the scope of his authority, is entitled to
recover from the promisor:-

(1) All damages which he may be compelled to pay in any suit in respect of any matter to which
the promise to indemnify applies;

(2) all costs which he may be compelled to pay in any such suit, if in bringing of defending it, he
did not contravene the orders of the promisor, and acted as it would have been prudent for him to
act in the absence of any contract of indemnity, or if the promisor authorised him to bring or
defend the suit;

(3) all sums which he may have paid under the terms of any compromise of any such suit, if the
compromise was not contract to the orders of the promisor, and was one which it would have
been prudent for the promise to make in the absence of any contract of indemnity, or if the
promisor authorised him to compromise the suit.

The indemnity-holder, acting within the scope of his authority, is entitled to recover the
following amounts-

(1) All damages which he may be compelled to pay in any suit in respect of any matter to
which the promise of indemnity applies;

(2) All costs which he may be compelled to pay in such suits if, in bringing or defending it,
he did not contravene the order of the promisor, and acted as it would have been prudent for him
to act in the absence of any contract of indemnity, or, if the promisor authorised him to bring or
defend the suit;

(3) All sums which he may have paid under the terms of any compromise of any such suit, if
the compromise was not contrary to the orders of the promisor, and was one which it would have
been prudent for the promise to make in the absence of any contract of indemnity, or if the
promisor authorised him to compromise the suit.

A person who encashes an indemnity bond which is in nature of a bank guarantee can retain only
that part of the amount of the bond which represents the damage or loss suffered by the bond-
holder as a result of the contracting party’s breach. Anything more would be undeserved windfall
for one party and penalty of the other.

Where a motor vehicle (truck) was under indemnity insurance for Rs.2,00,000 and it was stolen
with no chances of recovery, it was held that the proper amount of indemnity was as fixed by the
surveyor at Rs. 1,87,492 and that it was payable with 18% interest for the delay period. The
settlement of claim at a lesser amount by insurance authorities was arbitrary and unfair under
Article 14 of the Constitution.

4) RIGHTS AND DUTIES OF INDEMNIFIER

4.1) Rights of the indemnifier:
The rights of the indemnity-holder are the duties of indemnifier, and duties of the indemnity-
holder are the rights of the indemnifier. There are not prescribed any specific rights of the
indemnifier either in Nepalese law or in Indian law. However, he is not liable for indemnity.

(i) If indemnity-holder acts negligently.

(ii) If indemnity-holder is acting with the intention of causing any loss or damage.

(iii) If he is acting against the instructions of the other party (promisor).

4.2) Duties of indemnifier:

The duties of an indemnifier arise in the following circumstances:

(i) There must be a loss in accordance with the contract to make the indemnifier liable.

(ii) There must be an occurrence of the anticipated event. Without any occurrence of the
prescribed event, there is no indemnity by the indemnifier.

(iii) Where the right of indemnity is used by the indemnity-holder prudently and the instruction
of the indemnifier is not contravened or when there is no breach of contract.

(iv) If the costs demanded by the indemnifier are not caused by negligence.

Definition of Guarantee
Contract of guarantee is defined in section 126 of Indian contract act.
“Contract of guarantee “, surety, principal debtor and creditor – 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 person who gives the guarantee is called the surety, the person in respect of whose
default the guarantee is given is called the principal debtor and the person to whom guarantee is
given is called creditor a guarantee may be either oral or written.

For example: A takes a loan from a bank A promises to the bank to repay the loan B also makes
the promise to the bank saying that if A does not repay the loan then I will pay .in this case A is a
principal debtor who undertakes to repay the loan B Is the surety, who’s liability is secondary
because he promises to perform the same duty in case there is default on the on part of A. the
bank in who’s favors the promise has been made is the creditor.

The object of a contract of guarantee is to provide additional security to the creditor in the form
of the promise by the surety to fulfill a certain obligation in case the principal debtor fail to do
that in every contract of guarantee there are three parties the creditor the principal debtor and the
surety there are three contracts in contract of guarantee .firstly the principal debtor himself
makes a promise in favors of creditor to perform a promise, secondly the surety undertakes to be
liable towards to the creditor if the principal debtor makes a default. 1 Thirdly an implied promise
by the principal debtor in favor of the surety that in case the surety has to discharge the liability
of the default of the principal debtor, the principal debtor shall indemnify the surety 2. The
contract of guarantee is no doubt tripartite in nature 3 but it is not necessary or essential that the
principal debtor must expressly be a party to that document. In a contract of guarantee, the
principal debtor may be a party to the contract by implication. Thus, there is a possibility that a
person may become a surety without the knowledge and consent of the principal debtor. The
function of contract of guarantee is to enable a person to get a loan, or goods on credit, on an
employment. Some person comes forward and tells the lender, or the supplier or the employer
that he (the person in need) may be trusted and in case of any default .for e.g. in old case of
Birkmy vs Darnell4 the court said

1
Ibid1
2
Section 145also see NS bank Vs Union of India, AIR 1991 AP 153,at 158
3
Mahabir shum sher vs Lloyds bank, air 1969 cal 371
4
(1709) 91 ER 27:1 Salk 27.
“if two comes to a shop and one buys, and other to give him credit, promises the seller, ‘if he
does not pay you, I will pay’.

This type of collateral undertaking to be liable for the default of another is called a “contract of
guarantee”. In English law a guarantee is defined as “a promise to answer for the debt, default or
miscarriage of another”5

Essentials of Guarantee
1.The contract may be either oral or in writing

According to sec 126, a guarantee may be either oral or written. On this point, the position in
India is different from that in England. According to English law, for a valid contract of
guarantee, it is necessary that it should be in writing and signed by party to be charged therewith.
In English law under the provisions of statutes of fraud a guarantee is not enforceable unless it is
“in writing and signed by the party to be charged’’

2.There should be a principal debt

A contract of guarantee pre supposes a principal debt or an obligation to be discharged by the

principal debtor. The surety undertakes to be liable only if the principal debtor fails to discharge
his obligation. If there is no such principal debt, but there is a promise by one party in favor of
another for compensating in a certain situation, and the performance of this promise is not
dependent upon the default of somebody else, it is a contract of indemnity. The purpose of a
guarantee being to secure a payment of debt, the existence of a recoverable debt is necessary.

3.Consideration

Like every other contract, a contract of guarantee should also be supported by some
consideration. A guarantee without consideration is void. For surety’s promise, it is not
necessary that there should be a direct consideration between the creditor and surety; it is enough
that the creditor had done something for the benefit of the principal debtor. Benefit to the
principal debtor constitutes a sufficient consideration to the surety for giving the guarantee. This
is clear from sec 127 which read as under

5
S.4, statute of frauds 1677, 29 II. C 3
“Anything done, or any promise made for the benefit of the principal debtor may be a sufficient
consideration to the surety for giving the guarantee.”

Illustrations

(a)B requests A to sell and deliver to him goods on credit. A agrees to do so, provided C
promises will guarantee the payment of the prices of the goods .C promises to guarantee the
payment in consideration of A’s promise to deliver the goods. this is a sufficient consideration
for C’s promise

4.Consent of the surety should not have been obtained by misrepresentation or

concealment

The creditor should not obtain guarantee either by any misrepresentation or concealment of any
material facts concerning the transaction. If the guarantee has been obtained that way, the
guarantee is invalid. The position is explained by section 142 and 143 which are as under

“142. Guarantee obtained by misrepresentation invalid. -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.”

“143. Guarantee obtained by concealment invalid. - Any guarantee which the creditor has
obtained by means by means of keeping silence as to material circumstances is invalid”

DIFFERENCE BETWEEN CONTRACT OF INDEMNITY &

GUARANTEE.
There are distinguishing differences between Indemnity and Guarantee in the Indian Contract
Act.

 Section 124 of the Indian Contract Act, 1872 defines the "Contract of Indemnity". It is
contract by which one party promises to save the other from loss caused to him by the
contract of the promisor himself, or by the conduct of any other person. 'A' contract to
indemnify B against the consequences of any proceedings which C may take against B in
respect of a certain sum of 20000 rupees. This is a contract of indemnity.
  A contract of guarantee is defined in Section 126 of the Act. It is a contract to perform
the promise, or discharge the liability, of a third person in case of his default. The person
who gives the guarantee is called the surety; the person in respect of whose default the
guarantee is given is called the principal debtor and the person to whom the guarantee is
given is called the creditor.
 In contract of indemnity there are only two parties viz the indemnifier or promisor and
the indemnity holder or promisee. In contract of guarantee there are three parties viz the
creditor, principal debtor and surety.
 In indemnity, there is primary and independent liability. In guarantee the surety has
collateral liability.
 There is no existing debt generally in the case of contract of indemnity where there is
existing debt in the case of guarantee.
 There are two contracts in a contract of indemnity where there are three contracts in the
case of guarantee.
 In Indemnity the promisor is discharged by payment. In guarantee the surety is
discharged by payment made by principal debtor.
 Indemnifier may have some interest in the transaction where the surety will not have any
connection with the transaction.

CONCLUSION
Indemnity is a special contract under the Indian Contract Act, 1872. The legislation is a very well
drafted one, but has given a very narrow definition of indemnity, due to which the Indian Courts
have time and again held that certain documents do not come under the purview of the definition
of indemnity contained in the Act. Such decisions have not created a problem, since the courts
covered the liability under other provisions of the same Act, mainly under Section 31of the Act
dealing with contingent contracts. Therefore, it would suffice to say that though the definition of
indemnity under the Indian Contract Act is narrow, the principles regarding indemnities which
have been laid down by common law are definitely addressed by other provisions of the Act.

The main purpose of construction and interpretation of a contract of indemnity is to ascertain and
give effect to the intention of the parties. While interpreting the indemnity clause in a business
contract, care should be taken so as to give the meaning to the terms and phrases according to the
common parlance used in that business rather than resorting to other means of interpretation,
unless such construction leads to absurdity. The extent of liability under a contract of indemnity
depends on the nature and terms of the contract and each case must be governed by its own facts
and circumstances. Interpretation of the contract or clause of indemnity thus plays a crucial role
in fixing the liability.