Contract of Indemnity and Law of Guarantee

The term Indemnity literally means “Security against loss”. In a contract of indemnity one party – i.e. the indemnifier promise to compensate the other party i.e. the indemnified against the loss suffered by the other.

The English law definition of a contract of indemnity is – “it is a promise to save a person harmless from the consequences of an act”. Thus it includes within its ambit losses caused not merely by human agency but also those caused by accident or fire or other natural calamities.

The definition of a contract of indemnity as laid down in Section 124 – “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, is called a contract of indemnity.

The definition provided by the Indian Contract Act confines itself to the losses occasioned due to the act of the promisor or due to the act of any other person.

Under a contract of indemnity, liability of the promisor arises from loss caused to the promisee by the conduct of the promisor himself or by the conduct of other person. [Punjab National Bank v Vikram Cotton Mills].

Every contract of insurance, other than life insurance, is a contract of indemnity. The definition is restricted to cases where loss has been caused by some human agency. [Gajanan Moreshwar v Moreshwar Madan]

Section 124 deals with one particular kind of indemnity which arises from a promise made by an indemnifier to save the indemnified from the loss caused to him by the conduct of the indemnifier himself or by the conduct of any other person, but does not deal with those classes of cases where the indemnity arises from loss caused by events or accidents which do not depend upon the conduct of indemnifier or any other person. [Moreshwar v Moreshwar]

“Contract of indemnity” defined.-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, is called a “contract of indemnity”.

Illustration

A contracts to indemnify B against the consequences of any proceedings which C may take against B in respect of a certain sum of 200 rupees. This is a contract of indemnity.

Nature of Contract of Indemnity –

A contract of indemnity may be express or implied depending upon the circumstances of the case, though Section 124 of the Indian Contract Act does not seem to cover the case of implied indemnity.

A broker in possession of a government promissory note endorsed it to a bank with forged endorsement. The bank acting in good faith applied for and got a renewed promissory note from the Public Debt Office. Meanwhile the true owner sued the Secretary of State for conversion who in turn sued the bank on an implied indemnity. It was held that – it is general principle of law when an act is done by one person at the request of another which act is not in itself manifestly tortious to the knowledge of the person doing it, and such act turns to be injurious to the rights of a third person, the person doing it is entitled to an indemnity from him who requested that it should be done. [Secretary of State v Bank of India].

The Indian Contract Act also deals with special cases of implied indemnity –

1.            U/s 69 if a person who is interested in payment of money which another is bound by law to pay and therefore pays it, he is entitled to be indemnified. For instance – if a tenant pays certain electricity bill to be paid by the owner, he is entitled to be indemnified by the owner.

2.            Section 145 provides for right of a surety to claim indemnity from the principal debtor for all sums which he has rightfully paid towards the guarantee.

3.            Section 222 provides for liability of the principal to indemnify the agent in respect of all amounts paid by him during the lawful exercise of his authority.

The plaintiff, an auctioneer, acting on the instruction of the defendant sold certain cattle which subsequently turned out to belong to someone else other than the defendant. When the true owner sued the auctioneer for conversion, the auctioneer in turn sued the defendant for indemnity. The Court held that the plaintiff having acted on the request of the defendant was entitled to assume that, if it would turned out to be wrongful, he would be indemnified by the defendant. [Adamson v Jarvis].

Validity of Indemnity Agreement

A contract of indemnity is one of the species of contracts. The principles applicable to contracts in general are also applicable to such contracts so much so that the rules such as free consent, legality of object, etc., are equally applicable.

Where the consent to an agreement is caused by coercion, fraud, misrepresentation, the agreement is voidable at the option of the party whose consent was so caused. As per the requirement of the Contract Act, the object of the agreement must be lawful. An agreement, the object of which is opposed to the law or against the public policy, is either unlawful or void depending upon the provision of the law to which it is subject.

Contract of indemnity when enforceable –

The question whether the liability of indemnifier commences only when the indemnified has actually suffered loss or when there is an apprehension that the indemnified by all chances is likely to suffer it.

The former view was held in cases like – Shankar Nimbaji v Laxman Sapdu / Chand Bibi v Santosh Kumar Pal.

The plaintiff filed a suit to recover Rs. 5,000/- and interest from defendant by the sale of a mortgaged property and, in case of deficit, for a decree against the estate of defendant 2 which was in the hands of his sons, the defendant 2 died during the pendency of the suit. It was held that plaintiff cannot sue the defendant in anticipation that the proceeds realized by the sale of the mortgaged property would be insufficient and there would be some deficit. [Shankar Nimbaji v Laxman Sapdu]

The defendant’s father while purchasing certain property covenanted to pay off mortgage debt incurred by the plaintiff and also promised to indemnify him if they were made liable for the mortgage debt. The defendant’s father failed to pay off the mortgage debt and plaintiff filed an action to enforce the covenant. It was held as the plaintiff had not yet suffered any damage, the suit was premature so far as the cause of action on indemnity was concerned. [Chand Bibi v Santosh Kumar Pal]

A different point of view was held by the Courts in the following cases –

Plaintiff company agreed to act as commission agent for the defendant firm for purchase and sale of “Hessian” and “Gunnies” and charge commission on all such purchases and the defendant firm agreed  to indemnify the plaintiff against all losses in respect of such transactions. The plaintiff company purchased certain Hessian from one Maliram Ramjidas. The defendant firm failed to pay for or take delivery of the Hessian. Then Maliram Ramjidas resoled it at lesser price and claimed the difference as damages from the plaintiff company. The plaintiff company went into liquidation and the liquidator filed a suit to recover the amount claimed by Maliram from the defendant firm under the indemnity. The defendant argued that in as much as the plaintiff had not yet paid any amount to Maliram in respect of their liability they were not entitled to maintain the suit under indemnity. It was held negative and decided in plaintiff’s favour with a direction that the amount when recovered from the defendant firm should be paid to Maliram Ramjidas. [Osmal Jamal & Sons Ltd. v Gopal Purushotham]

After the landmark deicision in the case of Gajanan Moreshwar v Moreshwar Madan Mantri it has been well established that the liability of the indemnifier commences as soon as the loss of the indemnified becomes absolute, certain or imminent. It is not necessary that the promisee should pay for the loss.

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

It is important to note here that the right to indemnity cannot be claimed of dishonesty, lack of good faith and contravention of the promisor’s request. However, the right cannot be negatived in case of oversight. [Yeung v HSBC]

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. [Simpson v Thomson]

Principle of Subrogation is applicable because it is an essential part of law of indemnity and is based on equity and the Contract Act contains no provision in contravention with [Maharaja Shri Jarvat Singhji v Secretary of State for India]

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 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.

Illustrations

(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.

(b) A sells and delivers goods to B. C afterwards requests A to forbear to sue B for the debt for a year, and promises that, if he does so, C will pay for them in default of payment by B. A agrees to forbear as requested. This is a sufficient consideration for Cs promise.

(c) A sells and delivers goods to B. C afterwards, without consideration, agrees to pay for them in default of B. The agreement is void.

Suretys liability:-

The liability of the surety is coextensive with that of the principal debtor, unless it is otherwise provided by the contract.

Illustration

A guarantees to B the payment of a bill of exchange by C, the acceptor. The bill is dishonoured by C. A is liable not only for the amount of the bill but also for any interest and charges which may have become due on it.

Continuing guarantee.-A guarantee which extends to a series series of transactions is called a “continuing guarantee”.

Illustrations

(a) A, in consideration that B will employ C in collecting the rent of Bs zamindari, promises B to be responsible, to the amount of

5,000 rupees, for the due collection and payment by C of those rents.

This is a continuing guarantee.

(b) A guarantees payment to B of the price of five sacks of flour to be delivered by B to C and to be paid for in a month. B

delivers five sacks to C. C pays for them. Afterwards B delivers four sacks to C, which C does riot pay for. The guarantee given by A was not a continuing guarantee, and accordingly he is not liable for the price of the four sacks.

Revocation of continuing guarantee.-A continuing guarantee may at any time be revoked by the surety,as to future transactions, by notice to the creditor.

Illustrations

(a) A, in consideration of Bs discounting, at As request, bills of exchange for C, guarantees to B, for twelve months, the due payment of all such bills to the extent of 5,000 rupees. B

discounts bills for C to the extent of 2,000 rupees. Afterwards, at the end of three months, A revokes the guarantee. This revocation discharges A from all liability to B for any subsequent discount. But

A is liable to B for the 2,000 rupees, on default of C.

Revocation of continuing guarantee by suretys death.-The death of the surety operates, in the absence of any contract to the contrary, as a revocation of a continuing guarantee, so far as regards future transactions.

Discharge of surety by variance in terms of contract.

Any variance, made without the suretys consent, in the terms of the contract between the principal 1[debtor] and the creditor, discharges the surety as to transactions subsequent to the variance.

Illustrations

(a) A becomes surety to C for Bs conduct as a manager in Cs bank. Afterwards B and C contract, without As consent, that Bs salary shall be raised, and that he shall become liable for one-fourth of the losses on overdrafts. B allows a customer to overdraw, and the bank loses a sum of money. A is discharged from his suretyship by the variance made without his consent, and is not liable to make good this loss.

(b) A guarantees C against the misconduct of B in an office to which B is appointed by C, and of which the duties are defined by an

Act of the Legislature. By a subsequent Act, the nature of the office is materially altered. Afterwards, B misconducts himself. A is discharged by the change from future liability under his guarantee, though the misconduct of B is in respect, of a duty not affected by the later Act.

(c) C contracts to lend B 5,000 rupees on the 1st March. A guarantees repayment. C pays the 5,000 rupees to B on the 1st January. A is discharged from his liability, as the contract has been varied, inasmuch as C might sue B for the money before the 1st of March.

Discharge of surety by release or discharge of principal debtor:-

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 omission of the creditor, the legal consequence of which is the discharge of the principal debtor.

Illustrations

(a) A contracts with B to grow a crop of indigo an As land and to deliver it to B at a fixed rate, and C guarantees As performance of this contract. B diverts a stream of water which is necessary for irrigation of As land and thereby prevents him from raising the indigo. C is no longer liable on his guarantee.

Discharge of surety when creditor compounds with, gives time to, or agrees not to sue, principal debtor.-

A contract between the creditor and the 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.

Surety not discharged when agreement made with third person to give time to principal debtor. 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.

Illustration

(a) C, the holder of an overdue bill of exchange drawn by A as surety for B, and accepted by B, contracts with M to give time to B. A is not discharged.

Release of one co-surety does not discharge others.-

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. Discharge of surety by creditors act or omission impairing suretys eventual remedy.

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.

Guarantee on contract that creditor shall not act on it until co-surety joins

Where a person gives a guarantee upon a contract that the creditor shall not act upon it until another person has joined in it as co-surety, the guarantee is not valid if that other person does not join.

Co-sureties liable to contribute equally.

Where 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 debtor1*.

Illustrations

(a)A, B and C are sureties to D for the sum of 3,000 rupees lent to E. E makes default in payment. A, la and C are liable, as between them selves, to pay 1,000 rupees each.

(b)A, B and C are sureties to D for the sum of 1,000 rupees lent to E, and there is a contract between A, B and C that A is to be responsible to the extent of one-quarter, B to the extent of one-quarter, and C to the extent of one-half. E makes default in payment. As between the sureties, A is liable to pay 250 rupees, B 250 rupees, and C 500 rupees.

Liability of co-sureties bound in different sums.-

Co-sureties who are bound in different sums are liable to pay equally as far as the limits of their respective obligations permit.

Illustrations

(a)A, B and C, as sureties for D, enter into three several bonds, each in a different penalty, namely, A in the penalty of 10,000

rupees, B in that of 20,000 rupees, C in that of 40,000 rupees, conditioned for Ds duly accounting to E. D makes default to the extent of 30,000 rupees. A, B and C are liable to pay 10,000 rupees.

(b)A, B and C, as sureties for D, enter into three several bonds, each in a different penalty, namely, A in the penalty of 10,000 rupees, B in that of 20,000 rupees, C in that of 40,000 rupees, conditioned for Ds duly accounting to E. D makes default to the extent of 70,000 rupees. A, B and C have to pay each the full penalty of his bond.

Difference between Indemnity and Guarantee:-

In a contract of indemnity there are two parties i.e. indemnifier and indemnified. A contract of guarantee involves three parties i.e. creditor, principal debtor and surety.

An indemnity is for reimbursement of a loss, while a guarantee is for security of the creditor.

In a contract of indemnity the liability of the indemnifier is primary and arises when the contingent event occurs. In case of contract of guarantee the liability of surety is secondary and arises when the principal debtor defaults.

The indemnifier after performing his part of the promise has no rights against the third party and he can sue the third party only if there is an assignment in his favour. Whereas in a contract of guarantee, the surety steps into the shoes of the creditor on discharge of his liability, and may sue the principal debtor.