Subject: Business law

Chapter No 05
Contract of Indemnity & Guarantee
 This Chapter contains

1. Definition and Nature of indemnity

2. Essentials of contract of indemnity
3. Nature and definition of Guarantee
4. Legal rules regarding contract of Guarantee
5. Kinds of Guarantee
6. Difference between the Contract of Indemnity and contract of
Guarantee
7. Rights of Surety
8. Liabilities of Surety
9. Discharge of surety from liabilities

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CONTRACT OF
INDEMNITY

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 Definition and Nature of indemnity

 The term ‘Indemnity’ literally means protection against possible

damage or loss.

 Contract of Indemnity is defined as ‘a contract by which one party

promises to save the other from the loss caused to him by the conduct of
the promisor himself or by the conduct of any other person’.

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 Cont…

 In the contract of indemnity, the person who promises promisor to make

good the loss to compensate is called ‘Indemnifier’ and the person whose
loss is to be made good is called as ‘Indemnity Holder’ or
‘Indemnified’.

 A contract of indemnity is made to protect the promisee against

anticipated expected loss. It depends upon the happening of loss.

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 Example

 Mustafa parked a car at Gulbahar Car parking. He lost his token

given by Zakeem the guard of parking. The Guard refuses to
return the car but Mustafa pomises to compensate Zakeem ‘the
guard’ against any loss he may suffer, if any other person claims
the car from him.

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 Essentials of valid Contract of
indemnity

 The Valid of indemnity must contain and fulfill all the essentials
of valid contract

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CONTRACT OF
GUARANTEE

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 Definition and Nature of Guarantee

 The term ‘Guarantee’ literally means ‘the assurance that a contract

or legal action will be duly carried out.’

 Whereas the ‘Contract of Guarantee’ is a contract in which

someone promises to perform the liabilities of third person in case
his default.

 It is a promise to perform the promise of the other, on his failure to

do so.

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 Cont…

 The person who gives the guarantee is called the ‘Surety’ or

‘Guarantor’, and to whom the guarantee is given is called the
‘Creditor’ and in respect of whose default the guarantee is given is
called ‘Principal Debtor’.
Example
 Khadim requests Faridoon to lend him Afs. 5,000. Jalaluddin gives
assurance that if Khadim fails to return that he willl pay to Faridoon.
It is a contract of Guarantee. In this example Khadim is Principal
Debtor, Faridoon is a Creditor and Jalaluddin is a Surety or
Guarantor.

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Kinds of Guarantee

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 Kinds of Guarantee
 Guarantee has two kinds i) Specific Guarantee and ii) Continuing
Guarantee

1. Specific Guarantee: a guarantee which extends to a single debt or

transaction is called specific guaranty. It is also called ordinary or simple
guarantee. It comes to an end as soon as the liability under transaction
comes to an end.

 Example: Sulaiman guarantees the payment of 10 bags of wheat

purchased by Haider from Hameed, Haider again purchased 10 bags
form Hameed but didn’t pay. Hameed sued Sulaiman, held that
Sulaiman’s guarantee was specific and he is not liable.
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 Kinds of Guarantee cont…

2. Continuing Guarantee: a guarantee which extends to a series of

transactions is called as continuing guarantee. In other words a
guarantee which covers number of transactions over a period of
time is called continuing guarantee.

 It is like a ‘Standing Offer’ which is accepted by the creditor every

time when a subsequent transaction takes place.

 “Standing offer” is an offer of continuous nature, which remains

open for specified time period on specified terms and conditions.

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 Example
1. ‘A’ contracts to purchases goods from B on credit. ‘C’
guarantees the payment of ‘A’ up to 50,000 (fifty thousand
Afghanis) for one year. Now and onwards every subsequent
transaction, not exceeding 50,000 is guaranteed by ‘C’ for
one year. It is continuing Guarantee.

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Legal Rules regarding
Contract of Guarantee

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 Legal Rules
1. Contract of Guarantee is a Tripartite/Three - way contract.
Tripartite contract is the one which has three parties. Thus it
has three parties i.e. the Principal Debtor, Creditor and surety.
There exists three separate contracts between them, one
between the principal debtor and the creditor which is called
“Principal Contract” and second between creditor and surety,
and third between surety and principal debtor, they are called
“secondary Contract”.

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 Example Cont…

 X takes loan of Afs. 30000 from Y on the guarantee of Z. the

agreement between X and Y is Principal Contract and the
contract between Y and Z is the contract of guarantee and is
also known as secondary contract. The liability of Z will arise
when x fails to repay the loan.

 In the contract of guarantee the principal debtor is liable to

perform the promise, and the surety will be only when
principal debtor fails to perform.

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 Legal rules cont…

2. A contract of a guarantee like other contracts must fulfill

essentials of a valid contract. It must be supported by
consideration. It is not necessary that there must be direct
consideration between the surety and creditor. The
consideration received by the principal debtor is sufficient for
surety.

3. Consent of the guarantor must be free, If the consent of surety

(guarantor) is obtained by misrepresentation or fraud, or by
concealing facts, the surety is discharged from his liability.

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 Example
1. Kareem was invited to give a guarantee for the honesty
of Farhad’s servant. The employer had already
dismissed him for dishonesty. But didn’t disclosed this
fact to the surety (Kareem). The servant committed
embezzlement. The surety was held not liable.

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 Difference between
the contracts of Indemnity
and Guarantee

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 Difference between the contracts of
Indemnity and Guarantee

1. Number of parties: In a contract of indemnity there are two

parties indemnifier and indemnity holder. Whereas in
contract of guarantee there are three parties i.e. the creditor,
surety, and principal debtor.

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 Difference cont …

2. Number of contracts: in a contract of indemnity there is only

contract i.e. between the indemnifier and indemnity holder
whereas in the contract of guarantee there are three contracts
i.e. one between the creditor and principal debtor, second
between the principal debtor and surety, and third between the
surety and creditor.

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 Difference cont …

3. Nature of liability: In a contract of indemnity the liability

of indemnifier is primary and independent, but in case of
guarantee the liability of surety is secondary, he is liable
when principal debtor fails to perform his promise.

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 Difference cont …

4. Extent of liability: in a contract of indemnity the liability of

indemnifier arises on the happening of event, whereas in
contract of guarantee the liability already exists and its
performance is guaranteed by the surety.

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 Difference cont …

5. Purpose: the purpose of indemnity is reimbursement

(compensation) of loss, whereas the purpose of guarantee is to
secure the repay of debt or performance of promise (contract)

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Rights of Surety

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 Rights of Surety
 A surety has the following rights

1. Rights against creditor

a) Right to security
b) Right to claim set-off

2. Rights against the Principal debtor

a) Right of subrogation
b) Right of indemnity
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 1 – Rights against creditor
 A surety has the following rights against creditor

1. Rights to Security: the surety at the time of payment can

demand the securities which creditor has received from the
principal debtor at the time of creation of a contract, whether the
surety is aware of such securities or not. If the creditor by
negligence losses any security held by him, the surety is
discharged to that extant from the payment of guaranteed sum.
But if security is lost due to unavoidable act, the surety would
not be discharged.

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 Example
‘C’ gives loan of US $ 15,000 to ‘B’ on the guarantee of X.
‘C’ also pledges B’s car. B fails to pay and X pays US $
15,000 to ‘C’. X can get the car from C.

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 Rights against creditor continues …

2. Rights to Set – off : set-off means ‘counterclaim’ or

‘counter-demand’ by defendant against the
plaintiff/applicant.

If the principal debtor has some claim against the creditor,

the debtor can ask for adjustment of his debts to the extent of
his claims. If creditor sues surety for repayment; then surety
can claim set-off (adjustment), which principal debtor had
against the creditor.

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 Example
‘A ’ supplies furniture of Afs. 2 lacks to ‘B’ on the
guarantee of ‘C’. ‘B’ claims that some furniture was
defective and refuses to pay Afs. 20,000. ‘C’ can ask for
set-off (adjustment) of Afs. 20,000.

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 Rights against principal Debtor

A surety has the following rights against principal Debtor

1. Rights of Subrogation: Subrogation means substitution of

one person for another, and the person succeeds to the rights
of other.

When surety has paid the guaranteed debt the default of

principal debtor, then he is entitled to all rights, which the
creditor has against the principal debtor. The surety is entitled
to all remedies available to creditor against the debtor.

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 Example
Khan borrowed money form Ghaffoor on the guarantee of
Ghanni and mortgaged his house to Ghaffoor. Khan failed
to pay, then Abdul Ghanni paid. Now Abdul Ghani has got
a right over the house against Khan.

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 Rights cont…

2. Rights of Indemnity: In every contract of guarantee there

is an implied promise by principal debtor to indemnify
surety. The surety is entitled to recover from the principal
debtor whatever sum he has paid under the guarantee.

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 Example
Shahab owes to pay Afs. 50,000 to Ayyub and Fahim is a
surety. Shahab refuses to pay, Ayyub sues Fahim for the
money. Fahim defends himself but loses and then pays debt
to Ayyub. Fahim can recover the whole amount from
Shahab.

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Liabilities of Surety

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 Surety’s Liability
1. The liability of surety is secondary. It arises on the default or
failure of principal debtor.

2. The liability of surety is of con-extensive type, which means

that it is same as that of Principal Debtor.

3. The surety’s liability can be made less than that of the principal
debtor, but never greater.

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Discharge of Surety
Form Liabilities

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 Discharge of surety from Liability
A surety can be discharged from liabilities by following ways.

1. By notice of revocation
2. By death of Surety
3. By change in terms of contract without the consent of surety
4. By release or discharge of principal debtor.
5. By arrangement without surety’s consent
6. Creditor’s act or omission/error.
7. By invalidation/Cancelation of contract of guarantee.

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