Understanding Contract of Indemnity and Guarantee
A contract of indemnity involves a direct promise to save one party from harm caused by another, focusing on losses specifically attributable to the promisor or another person. Meanwhile, a contract of guarantee entails a promise to fulfill the obligations of a third party in case of default. Essential elements, rights of indemnity holders, and the roles of principal debtors, creditors, and sureties are outlined in these contracts.
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CONTRACT OF INDEMNITY & GUARANTEE SAMIUDDIN __CONTRACT II
CONTRACT OF INDEMNITY S. 124 Security against loss Involvement of Human agency A Contract of indemnity is a direct engagement between two parties thereby one promises to save the other harm. It does not deal with those classes of cases where the indemnity arises from loss caused by events or accidents which do not or may not depend on the conduct of indemnifier or any other person. (New India Assurance Company Ltd. Vs Kusumanchi Kameshwra Rao & Others) SAMIUDDIN __CONTRACT II
ESSENTIAL ELEMENTS There must be a loss. The loss must be caused either by he promisor or by any other person. Indemnifier is liable only for the loss. SAMIUDDIN __CONTRACT II
Right of the indemnity holder (Section 125) 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. Right to recover costs He is entitled to recover all costs incidental to the institution and defending of the suit. 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. 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- SAMIUDDIN __CONTRACT II
CONTRACT OF GUARANTEE A contract of guarantee is a contract to perform the promise, or discharge the liability, of a third person in case of his default. PARTIES TO CONTRACT OF GUARANTEE Principle debtor Creditor and Surety. SAMIUDDIN __CONTRACT II
Principal Debtor [Section 126] The person in respect of whose default the guarantee is given is called the 'Principal debtor . Creditor [Section 126] The person to whom the guarantee is given, is called the 'creditor . Surety [Section 126] The person who gives the guarantee is called the 'Surety'. SAMIUDDIN __CONTRACT II
A guarantee may be either oral or written. Consideration for guarantee [Section 127] As per Section 127 of the Act, 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. SAMIUDDIN __CONTRACT II
ESSENTIAL FEATURES OF A CONTRACT OF GUARANTEE All the essentials of a valid contract. (i)The principal debtor need not be competent to contract. In case the principal debtor is not competent to contract, the surety would be regarded as the principal debtor and would be personally liable to pay. (ii) Surety need not be benefited. According to Section 127, "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." (iii) A guarantee need not be in writing. According to Section 126, a guarantee may be either oral or written. SAMIUDDIN __CONTRACT II
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. Guarantee not to be obtained by concealment [section 143] Any guarantee which the creditor has obtained by means of keeping silence as to material circumstances is invalid. Tripartite agreement A contract of guarantee is a tripartite agreement between the principal debtor, creditor and surety. There are three contracts as under: (i)Contract between creditor and the principal debtor out of which the guaranteed debt arises. (ii) Contract between surety and the principal debtor by which the principal debtor undertakes to indemnity the surety if surety is required to pay. (iii) Contract between surety and the creditor by which the surety guarantees to pay the principal debtor's debt if the principal debtor fails to pay. SAMIUDDIN __CONTRACT II
There must be an existing liability or a promise whose performance is guaranteed. Such liability or promise must be enforceable by law. Hence, guarantee can be given only for liability or promise which is enforceable by law. But there is an exception to this rule. The exception is a guarantee given for minor's debt. Though minor's debt is not enforceable by law, yet the guarantee given for minor's debt is valid. There must be consent of all the three parties. Existence of a liability SAMIUDDIN __CONTRACT II
Nature of suretys liability [Section 128] (i) The liability of the surety is co-extensive with that of the principal debtor unless it is otherwise provided by the contract. The term co-extensive with that of principal debtor means that the surety is liable for what the principal debtor is liable. The liability of a surety arises only on default by the principal debtor. But as soon as the principal debtor defaults, the liability of the surety co-extensive with the liability of the principal debtor, in the sense that the surety will be liable for all those sums for which the principal debtor is liable. Where a debtor cannot be held liable on account of any defect in the document, the liability of the surety also ceases. Surety s liability continues even if the principal debtor has not been sued or is omitted from being sued. In other words, a creditor may choose to proceed against a surety first, unless there is an agreement to the contrary. Surety s liability may be conditional. The surety may impose certain conditions in the contract of guarantee. Until those conditions are met, the surety shall not be liable. (ii) (iii) (iv) (v) SAMIUDDIN __CONTRACT II
Important cases on Sureties liability Bank of Bihar Ltd. v. Damodar Prasad The Supreme Court held that the liability of the surety is immediate and cannot be defended until the creditor has exhausted all his remedies against the principal debtor. Maharashtra Electricity Board Bombay v. Official Liquidator and Another under a letter of guarantee the bank undertook to pay any amount not exceeding Rs.50000/- to the Electricity Board. It was held that the Bank is bound to pay the amount due under the letter of guarantee given by it to the Board. Kellappan Nambiar v. Kanhi Raman In this case that if the principal debtor happens to be a minor and the agreement made by him is void, the surety too cannot be made liable in respect of the same because the liability of the surety is co-extensive with that of principal debtor. It has been held that the guarantee of the loan or an overdraft to an infant is void because the loan to the infant itself is void. State Bank of India v. V.N. Anantha Krishnam that in view of the provision of section 128 of Act the Presiding officer was not correct in giving directions to the Bank to proceed against the property because cash credit facility and the liability of surety was co-extensive with that of principal debtor. Industrial Financial Corporation of India v. Kannur Spining & Weaving Mills Ltd. It was held that the liability of surety does not cease merely because of discharge of the principal debtor from liability. In a case of Harigobind Aggarwal v. State Bank Of India It was held that the principal debtor liability is reduced e.g. after the creditor has recovered a part of the sum due from him out of his property the liability of the surety is also reduced accordingly. SAMIUDDIN __CONTRACT II
Continuing Guarantee A Guarantee which extends to a series of transactions is called a 'continuing guarantee'. A surety's liability continues until the revocation of the guarantee. REVOCATION OF CONTINUING GUARANTEE 1. By notice of revocation [section 130] A continuing guarantee may at any time be revoked by the surety as to the future transactions by notice to the creditor. However, the surety remains liable for the past transactions which have already taken place. 2. By death of surety [section 131] In the absence of any contract to the contrary, the death of surety operates as a revocation of a continuing guarantee as to the future transactions taking place after the death of surety. However, the surety's estate remains liable for the past transactions which have already taken place before the death of surety. Meaning of Continuing Guarantee [Section 129]: SAMIUDDIN __CONTRACT II
Modes of discharging the surety By notice of revocation [Section 130] By the death of surety [Section 131] Novation [Section 62] Variance in terms of contract [Section 133] Release or discharge of principal debtor [Section 134] When the creditors enter into an arrangement with the principal debtor [Section 135] Creditor's act or omission impairing surety's eventual remedy [Section 139] Loss of security [Section 141] SAMIUDDIN __CONTRACT II
A contract of guarantee is said to be discharged by novation when a fresh contract is entered into either between the same parties or between other parties, the consideration being the mutual discharge of the old contract. The original contract of guarantee comes to an end and the surety under original contract is discharged. By Variance In Terms Of Contract [Section 133] Any variance, made without the surety's consent, in the terms of the contract between the principal debtor and the creditor, discharges the surety as to transactions subsequent to the variance. By Release Or Discharge Of Principal Debtor [SECTION 134] The surety is discharged by any contract between the creditor and the principal debtor, by which the principal debtor is released, or by any act or omissions of the creditor, the legal consequence of which is the discharge of the principal debtor. . By Arrangement [SECTION 135] A contract between the creditor and principal debtor, by which the creditor makes a composition with, or promises to give time to, or not to sue the principal debtor, discharges the surety, unless the surety assents to such contract. By Novation [SECTION 62] SAMIUDDIN __CONTRACT II
If a creditor does any act which is inconsistent with the rights of the surety, or omits to do an act which is his duty to the surety requires him to do, and the eventual remedy of the surety himself against the principal debtor is thereby impaired, the surety is discharged. Loss of Security [Section 141] If the creditor loses, or without the consent of the surety, parts with security given to him, the surety is discharged from liability to the extent of the value of security. By Creditor's Act or Omission Impairing Surety's Eventual Remedy [Section139] (i) Where a contract to give time to the principal debtor is made by the creditor with a third person, and not with the principal debtor, the surety is not discharged. (ii) Mere forbearance on the part of the creditor to sue the principal debtor or to enforce any other remedy against him, does not, in the absence of any provision in the guarantee to the contrary, discharge the surety. (iii) Where there are co-sureties, the release by the creditor of one of them does not discharge the other nor does it free the surety so released from his responsibility to the other sureties. [Section 138] CASES WHERE SURETY IS DISCHARGED SAMIUDDIN __CONTRACT II
INVALIDATION OF CONTRACT Guarantee Obtained by Misrepresentation [Section 142] Any guarantee which has been obtained by means of misrepresentation made by a creditor or with his knowledge and assent, concerning a material part of the transaction, is invalid. Guarantee Obtained by Concealment [Section 143] Any guarantee which a creditor has obtained by means of keeping silence to material circumstances is invalid Failure of Co-surety to Join a Surety [Section 144] Where a person gives a guarantee upon a contract that a creditor shall not act upon it until another person has joined in it as co-surety SAMIUDDIN __CONTRACT II
Rights of a surety Rights against the creditor, Rights against the principal debtor, Rights against co-sureties SAMIUDDIN __CONTRACT II
DIFFERENCE BETWEEN INDEMNITY & GUARANTEE INDEMNITY GUARANTEE In indemnity there are two, one who is indemnified and the other indemnifier. There are three parties, Principal debtor, surety and the Creditor. There are three contracts between surety, principal debtor and creditor. It consists of only one contract under which indemnifier promises to pay in the event of certain loss. The object of contract of guarantee is the security of the creditor. The contract of indemnity is made to protect the promise against some likely loss. In guarantee the liability of surety is only a secondary, when principal debtor default. The liability of the indemnifier in a contract of indemnity is a primary one. The liability arises only on the nonperformance of an existing promise or non-payment of an existing debt. The liability arises only on the happening of a contingency. A surety, on discharging the debt of principal debtor, can sue 'the principal debtor in his own The indemnifier cannot sue a third party in his own name because of absence of privity of contract between him and a third party. He can sue the third party in his own name if there in an assignment in his favour. SAMIUDDIN __CONTRACT II
Rights against the principal debtor Right to Subrogation [Section 140] On payment of the guaranteed debt or performance of the guaranteed duty; the surety acquires all the rights which the creditor had against the principal debtor. Thus, the surety steps into the shoes of creditor. Right to Indemnity [Section 145] In every contract of guarantee there is an implied promise by the principal debtor to indemnify the surety; and the surety is entitled to recover from the principal debtor whatever sum he has rightfully paid under the guarantee, but not those sums which he had paid wrongfully. SAMIUDDIN __CONTRACT II
RIGHTS OF AGAINST CREDITOR Right to Securities [Section 141] A surety is entitled to the benefit of every security which the creditor has against the principal debtor at the time when the contract of suretyship is entered into, whether the surety knows of the existence of such security or not; and if the creditor loses, or, without the consent of the surety, parts, with such security, the surety is discharged to the extent of the value of the security. Right to Claim Set Off The surety has the right to claim set off or counterclaim, if any, which the principal debtor had against the creditors in case the creditors sues him for payment of liability of principal debtor. SAMIUDDIN __CONTRACT II
Rights against co-suriteis Meaning of Co-sureties:- When the same debt or duty is guaranteed by two or more persons, such persons are called as 'co-sureties Co-sureties liable to contribute equally (Section 146) : Equality of burden is the basis of Co-suretyship. This is contained in section 146 which states that when two or more persons are co-sureties for the same debt, or duty, either jointly, or severally and 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 share of the whole debt, or of that part of it which remains unpaid by the principal debtor . Liability of co-sureties bound in different sums (Section 147) : The principal of equal contribution is, however, subject to the maximum limit fixed by a surety to his liability. Co-sureties who are bound in different sums are liable to pay equally as far as the limits of their respective obligations permit. SAMIUDDIN __CONTRACT II
Right to Claim Contribution:- If a co-surety pays more than his proportionate share of liability, he has a right to claim contribution from the other co-surety or co-sureties. Right to Share the Security:- If a co-surety obtains any security of principal debtor, the other co-surety (or co-sureties) has (or have) a right to share such security. Effect of Release of One Co-surety [Section 138] Where there are co-sureties, a release by the creditor of one of them does not discharge the others; neither does it free the surety so released from his responsibility to the other sureties. However, under English law the release of one co-surety shall release all the other co-sureties since the liability of cosureties under English law is only joint and not joint and several. SAMIUDDIN __CONTRACT II
