Definition of Indemnity

A form of contingent contract, whereby one party promises to the other party that he will
compensate the loss or damages occurred to him by the conduct of the first party or any
other person, it is known as the contract of indemnity. The number of parties in the
contract is two, one who promises to indemnify the other party is indemnifier while the
other one whose loss is compensated is known as indemnified.

The indemnity holder has the right to reimburse the following sums from the indemnifier:

 Damages caused, for which he was compelled.

 The amount paid for defending the suit.
 The amount paid for compromising the suit.

One more common example of indemnity is the insurance contract where the insurance
company promises to pay for the damages suffered by the policyholder, against the
premiums.

In an insurance contract, the insurance company promises to pay a specific amount to the
insured for losses or damages if the latter pays the premium (the contract condition) and if
the damages or losses are not listed as exclusions in the contract.
The contract is valid for a specific period of time. Past that period, all of the parties involved
are relieved from their contractual obligations. In the case of insurance, this means that the
company is no longer obliged to pay the insured if they incur a loss.

Example

Indemnity

Mr. Joe is a shareholder of Alpha Ltd. lost his share certificate. Joe applies for a duplicate
one. The company agrees, but on the condition that Joe compensates for the loss or
damage to the company if a third person brings the original certificate.

Right of the indemnity holder – (Section 125)

An indemnity holder (i.e. indemnified) acting within the scope of his authority is entitled to
the following rights –

1.       Right to recover damages – he is entitled to recover all damages which he might have
been compelled to pay in any suit in respect of any matter covered by the contract.

2.       Right to recover costs – He is entitled to recover all costs incidental to the institution
and defending of the suit.

3.      Right to recover sums paid under compromise – he is entitled to recover all amounts
which he had paid under the terms of the compromise of such suit. However, the   
compensation must not be against the directions of the indemnifier. It must be prudent and
authorized by the indemnifier.

4.      Right to sue for specific performance – he is entitled to sue for specific performance if
he has incurred absolute liability and the contract covers such liability. 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 or 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
authorized 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

Right of Indemnifier –
 Section 125 of the Act only lays down the rights of the indemnified and is quite silent of the
rights of indemnifier as if the indemnifier has no rights but only liability towards the
indemnified.

In the logical state of things if we read Section 141 which deals with the rights of surety, we
can easily conclude that the indemnifier’s right would also be same as that of surety.

Where one person has agreed to indemnify the other, he will, on making good the
indemnity, be entitled to succeed to all the ways and means by which the person
indemnified might have protected himself against or reimbursed himself for the loss.

No Indemnity for Illegal Activities

A person can attempt to be indemnified (held harmless) for doing their duty or acting
within the scope of their job. But indemnity doesn't carry over into illegal acts, like theft,
harassment, and fraud. For example, a corporate financial officer may have made a mistake
in an important financial report. The officer may be protected from being sued for this
mistake. But if the financial officer embezzles money from the company, this is a crime and
there's no indemnity protection. 

What Is the Importance of Indemnity?

Indemnity is common in agreements between individuals and businesses. But it also applies
to businesses and governments as well as governments in different countries. Indemnity
offers financial protection to cover costs that result from accidents, negligence, mistakes, or
circumstances that could not be avoided.
Indemnity insurance provides protection against claims or lawsuits. It protects the
policyholder from having to pay the full amount of a settlement, even if he or she is at fault.
Most businesses require their directors and executives to have indemnity because lawsuits
are so prevalent. It ensures court costs, lawyer's fees, and potential settlements are all
covered.
Surety Rights
Rights against Creditors-
1. Rights in Case of Fidelity Guarantee
In case of fidelity guarantee i.e., guarantee as to good behaviour, honesty, etc., of the
principal debtor, the surety can ask the employer to dispense with the services of the
employee if the latter is proved to be dishonest.

2. Before the Payment of the Debt Guaranteed

A surety may, after the debt has become due but before he is called upon to pay, require
the creditor to sue the principal debtor to recover the debt. But, in such cases, the surety
must undertake to indemnify the creditor for any risk, delay or expense resulting there
from.

3. Right to Claim Securities

After payment of the debt to the creditor or the performance of the promise of the
principal debtor, the surety can recover all the securities which the creditor had with him
either before or after the contract of guarantee was entered into. This right is available to
the surety whether or not he knows about the existence of such security. He is entitled to
all of them.

4. Right of Equities
After paying the amount due to the creditor, the surety is entitled to all equities of the
creditor that he had against the debtor as well as any other person with regard to the debt.

5. Right of Set-off
Sometimes, the principal debtor is entitled to certain counter claim or deductions from the
loan obtained from the creditor. In such cases, the surety is entitled to the benefit of such
counter claim or deductions, if the creditor files a suit against the surety.

Rights of Surety against the Principal Debtor

1. Right of Subrogation
After the payment of the debt to the creditor, the surety is subrogated to the rights of the
creditor i.e., he has the same rights as those of the creditors. Therefore, he can sue the
principal debtor to exercise those rights. Thus if the surety has performed his promise
towards the creditor, all the rights of the principal debtor against the creditor devolve upon
him.
2. Right of Indemnity
In every contract of guarantee, there is an implied promise by the principal debtor to
indemnify the surety i.e., to compensate the surety. Therefore, upon the payment of debt
of the principal debtor, the surety becomes entitled to recover from the principal debtor,
all the amount including interest plus costs rightly paid to the creditor under the guarantee.
The reason is that the surety is entitled to full indemnification.

3. Right to be Relieved Earlier

A surety can, even before making any payment, compel the debtor to relieve him from
liability by paying off the debt. But, before doing so, the debt should be ascertained.

Rights of Surety against Co-sureties

When two or more persons give a guarantee for the same debt, they are called as co-
sureties. All of them are equally liable to the creditor for the payment of the debt to the
creditor. The rights of one co-surety against the other co-sureties are as follows:

1. Right to Contribute Equally

If two or more persons are co-sureties for the same debt either jointly or severally, or
whether under the same or different contracts and whether with or without the knowledge
of each other, the co-sureties in the absence of any contract to the contrary, are liable as
between themselves, to pay each, an equal shares of the whole debt, or that part of it
which remains unpaid by the principal debtor.

Sometimes, one co-surety discharges the entire obligations. In such cases, he can obtain
equal contribution from the other co-sureties.

2. Liability of Co-sureties bound in Different Sums

If the co-sureties are bound in different sums, they are liable to pay equally but not more
than the maximum amount guaranteed by each one of them.

Example: A, B and C are sureties for D, enter into three several bonds, each in a different
penalty, such as A in the penalty of Rs.5,000, B in that of Rs.10,000, C in that of Rs.20,000,
conditioned for D’s duly accounting to E. D failed to the extent of Rs.15,000, A, B and C are
each liable to pay Rs.5,000 each.
Discharge of a Surety (Sec.130 – 141)

A surety is discharged from his liability on:

1. The death of a surety as regards future transactions in case of a continuing guarantee in

the absence of a contract to the contrary.
2. Notice of revocation as regards future transactions in case of a continuing guarantee.
For example, Anu gives a guarantee to Bela to the extent of ₹50000, that Freida will pay
all the bills that Bela will draw upon her. Bela draws bills on Freida and she accepts the
bill. Anu gives notice of revocation. Freida dishonors the bill at maturity. Anu is liable as
it was a transaction before the notice of revocation.
3. Any variation in the terms of the contract between the principal debtor and the creditor
without surety’s consent.
4. If the creditor releases the principal debtor, the surety also automatically discharges.
5. When the creditor makes an arrangement for composition or promises to give time or
not sue the principal debtor without surety’s consent, the surety will be discharged.
6. Any act or omission to do an act by the creditor which results in harming the rights of
the surety, and also impairs the eventual remedy of the surety himself against the
principal debtor, discharges the surety.
7. Where the creditor loses or parts with any security which he receives from the principal
debtor without the consent of the surety, this discharges the surety to the extent of the
value of such security.
Comparison Chart

BASIS FOR
INDEMNITY GUARANTEE
COMPARISON

Meaning A contract in which one A contract in which a party

party promises to another
that he will compensate him
for any loss suffered by him
by the act of the promisor or
the third party.
promises to another party that
he will perform the contract or
compensate the loss, in case of
the default of a their person, it
is the contract of guarantee.

Defined in Section 124 of Indian Section 126 of Indian Contract

Contract Act, 1872 Act, 1872

Parties Two, i.e. indemnifier and Three, i.e. creditor, principal

indemnified debtor and surety

Number of One Three

Contracts

Degree of Primary Secondary

liability of the
promisor

Purpose To compensate for the loss To give assurance to the

promisee

Maturity of When the contingency Liability already exists.

Liability occurs.

Definition of Guarantee

When one person signifies to perform the contract or discharge the liability incurred by the
third party, on behalf of the second party, in case he fails, then there is a contract of
guarantee. In this type of contract, there are three parties, i.e. The person to whom the
guarantee is given is Creditor, Principal Debtor is the person on whose default the
guarantee is given, and the person who gives a guarantee is Surety.

Three contracts will be there, first between the principal debtor and creditor, second
between principal debtor and surety, third between the surety and the creditor. The
contract can be oral or written. There is an implied promise in the contract that the
principal debtor will indemnify the surety for the sums paid by him as an obligation of the
contract provided they are rightfully paid. The surety is not entitled to recover the amount
paid by him wrongfully.

Guarantee

Mr. Harry takes a loan from the bank for which Mr. Joesph has given the guarantee that if
Harry default in the payment of the said amount he will discharge the liability. Here Joseph
plays the role of surety, Harry is the principal debtor and Bank is the 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 the guarantee is given is called the ” creditor “. A guarantee may
be either oral or written.

Consideration for guarantee.-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.

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