Contracts of Indemnity and Guarantee
- Indemnity : Indemnity means making good (to indemnify / compensate) the loss incurred by another person. A wider meaning of ‘indemnity’ is to protect (i.e., save) a party from incurring loss.
- Guarantee : Guarantee means promise to perform or discharge of liability of a third person, in case of his default.
Contracts of indemnity and guarantee are a kind general contract and the general principles & law of contract are also applicable to them.
Contract of Indemnity
- In a contract of indemnity, one party (the promisor, called the indemnifier) promises to save the other (the promisee, called the indemnified ) from loss caused to him. So, a contract of indemnity may be viewed as a special class of contingent contracts. (s.124)
- A contract of indemnity may be express or implied.
- Express contract of Indemnity : The indemnifier expressly undertakes to indemnify the loss.
- Implied contract of indemnity : The undertaking of indemnification may be inferred from the circumstances of the case or from relationship of the parties. [Adamson v. Jarvis]
Essential elements of a contract of indemnity
- Valid Contract: All the essentials of a valid contract must also be present in the contract of indemnity.
- Loss to one party: A person indemnities another person only when such other person incurs some loss (or is about to incur some loss).
- Indemnity from the future loss: The purpose of contract of indemnity is to protect the indemnity holder from any loss that may be caused to the indemnity holder in future.
- Not control on loss: Indemnity holder shall be protected from the loss caused due to action of the promisor or event which is not in the control of parties.
Nature of Contract of indemnity
A contract of indemnity contains a promise to save the other person, if loss is caused to him. It is entered into with the object of protecting the promisee against any anticipated loss. The contingency upon which the whole contract of indemnity depends is the happening of the loss.
So, contract of indemnity, is conditional contract like contingent contract. Their performance depends upon happening or non-happening of certain specified but uncertain event. So, a contract of indemnity is also a type of contingent contracts.
Rights of indemnity holder
- An indemnity-holder (i.e., indemnified), when sued, is entitled to recover from the promisor (i.e., indemnifier) in following cases:
- all damages which he may be compelled to pay in any suit in respect of any matter to which the indemnity applies [s.125(1)]
- all costs which he may be compelled to pay in bringing or defending such suits.
- all sums which he may have paid under the terms of any compromise of any such suit.
- When Indemnified has incurred a liability and that liability is absolute, he is entitled to call upon the indemnifier to pay off to discharge his liability.
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, between the following parties (s.126)
- Surety: The person who gives the guarantee.
- Principal Debtor: The person in respect of whose default, the guarantee is given.
- Creditor: The person to whom the guarantee is given.
- It is a tripartite agreement contemplating the Principal Debtor, the Creditor, and the Surety, creating a triangular relationship, giving rise to three collateral contracts :
- Between Creditor and Principal Debtor : A contract out of which the guaranteed debt arises.
- Between Surety and Creditor : A contract by which Surety guarantees to pay to Creditor, the debts of Principal Debtor in case of his (Principal Debtor’s)default.
- Between Surety and Principal Debtor : A contract that Principal Debtor shall indemnify Surety in case Surety pays in the event of a default by Principal Debtor. This contract, if not expressed between the parties, is always implied.
- A Guarantee may be expressed or implied and may even be inferred from the course of conduct of the parties concerned.
Essential features of a contract of Guarantee
- Concurrence: A contract of guarantee requires the concurrence of all the three parties to it, viz., the principal debtor, the creditor, and the surety.
- Liability: There must be a liability enforceable by law. The primary liability is of the principal debtor. The liability of the surety is secondary. It arises only when the principal debtor defaults.
- Valid Contract: A contract of guarantee must have all the essential elements of a valid contract.
- Capacity to Contract : All the parties must be capable of entering into a valid contract. However, the principal debtor may be incapable to contract (e.g. a minor) and in such case, the surety is regarded as the principal debtor and is liable to pay personally even though the principal debtor is not liable to pay.
- Consideration (s.127): It is sufficient that principal debtor has received some consideration. It is not necessary that surety himself must get some benefit.
Kinds of Guarantee
- Guarantee on Money : It can be further divided as :
- On basis of nature of payment guarantee :
- Specific Guarantee: This type of guarantee is for single transaction. It ends with the performance of promise or when the debt is discharged.
- Continuing Guarantee (s.129): This is for series of transaction. The liability of such guarantee extends till the revocation of guarantee. [Kay v. Groves],
- On basis of effective time of payment :
- Retrospective guarantee: This type of guarantee is for an existing debt or obligation.
- Prospective guarantee: It is for future debt or obligation.
- Guarantee on Person: This type of guarantee is based on a person’s quality (i.e, good conduct or honesty) employed in an organisation.
Contract of Guarantee is not a contract of uberrimae fidei
A contract of guarantee is not a contract of uberrimae fidei, the principal debtor need not disclose all material facts to the surety before the contract is entered into. Fraud on part of the principal debtor is not enough to set aside the contract, unless the surety proves that the creditor or his agent knew of the fraud and is a party to it,
- In case of guarantee given to a banker, the banker need not disclose all facts to the surety.
- In case of guarantee in the nature of an insurance, all material facts must be disclosed otherwise the surety can avoid the contract.
- A Guarantee which extends to a series of transactions is called as ‘continuing guarantee’. It is not confined to a single transaction.
- Continuing guarantee covers a number of transactions over a period of time. Instead of a specific single transaction, it applies to a series of transactions, making the surety liable until the guarantee is revoked. [Wingfield vs de St Croix]
- The surety may limit his liability by making an express provision in the contract that the surety shall not be liable:
- beyond a fixed amount (i.e., a ceiling may be fixed on the liability of surety); or
- beyond a fixed period (i.e., a time period may be specified during which the guarantee shall remain effective).
- A guarantees payment to B, to the extent of Rs.10,000 for any supplies made by him to C. B supplies C worth Rs.12,000, and C pays B for it. Afterwards, B supplies C worth Rs.15,000, but C fails to pay. The guarantee given by A was a continuing guarantee, and he is accordingly liable to B to the extent of Rs.10,000.
- A guarantees payment to B 100 Bags of cement to be delivered by B to C and to be paid for in a month. B delivers 100 Bags of cement to C. C pays for them. Afterwards B delivers another 50 Bags cement to C, C does not pay for. The guarantee given by A was not a continuing guarantee, and accordingly. A is not liable for the price of 50 Bags.
In following circumstances, continuing guarantee can be revoked:-
- By notice: Continuing guarantee may be revoked at any time by the surety as to future transactions by due notice to the creditor. (s. 130)
- By death: Death of the surety operates as revocation of the continuing guarantee with reference to the future transactions unless the contract otherwise provide. (s.131)
- By variation in contract: If any variation is done in the terms of contract of guarantee between the creditor and the principal debtor, without the knowledge of the surety, the contract of guarantee is revoked.
- By Novation: The contract of guarantee will be revoked when the parties agree to substitute a new contract for the old contract or rescind or alter the old contract. (s. 62)
- By creditors act of omission: Any omission by the creditor which impairs the eventual remedy of the surety against the debtor amounts to revocation of the contract of guarantee.
A stands as surety to C for any money lent by C to B during the next 3 months subject to a maximum liability of Rs.50,000. Afterwards, A revokes the guarantee. As on the date of revocation of guarantee, C has already lent Rs.5,000 to B.
- A is discharged from all liabilities to C for any subsequent loan.
- If B makes a default in payment of Rs. 5,000 to C already lent, A cannot deny his liability in respect of Rs. 5,000, lent by C to B before revocation of continuing guarantee. In that case, C can sue B or A or both, since liability of surety is co-extensive with liability of principal debtor.
Distinction between contract of Indemnity & Guarantee
|Contract of indemnity||Contract of guarantee|
|Parties||There are two parties to the contract,the indemnifier (promisor) and the indemnified (promisee).||There are three parties to the contract,the creditor, the principal debtor and the surety.|
|Liability||The liability of the indemnifier to the indemnified is primary and independent.||The liability of the surety to the creditor is collateral or secondary, the primary liability being that of the principal debtor.|
|Contracts||There is only one contract in the case of a contract of indemnity, i.e., between the indemnifier and the indemnified.||In a contract of guarantee, there are three collateral contracts between a) principal debtor and the creditor, b) creditor and the surety c) surety and the principal debtor.|
|Action||It is not necessary for the indemnifier to act at the request of the indemnified.||Surety should give the guarantee only at the request of the debtor.|
|Liability||The liability of the indemnifier arises only on the happening of a contingency.||There is usually an existing debt or duty, the performance of which is guaranteed by the surety.|
|Rights||An indemnifier cannot himself sue a third party unless there is an assignment in his favour.||A surety, on discharging the debt due by the principal debtor, steps into the shoes of the creditor. He can proceed against the principal debtor in his own right.|
Liability of Surety in Contract of Guarantee
- The liability of Surety arises only when the principal debtor does not pay. His liability is thus secondary, so Surety is treated with favour both in law and equity, and the following rules apply:
- The liability of the surety is co-extensive with that of the principal debtor, unless it is otherwise provided by the contract.
- The surety is liable for what the principal debtor is liable. The surety must not be made liable beyond the terms of his engagement. A creditor can sue the surety without suing the principal debtor.
- Although liability of the surety is co-extensive with that of the principal debtor, he may limit his liability.
- In case of continuing guarantee, the liability of surety extends to all transactions contemplated until revocation of guarantee (s.129).
- The surety is liable for all the debts payable by the principal debtor to the creditor. Accordingly, interest, damages, costs etc. which may be recovered from the principal debtor, may also be recovered from the surety.
- The liability must be proved against the surety in the same way as against the principal debtor. The surety is liable to the same extent as the principal debtor. So, the principal debtor and surety are jointly and severally liable. If the principal debtor is not liable on the principal debt (principal debt is illegal or is unenforceable), the principal debtor is discharged by creditor’s breach and the surety shall also be discharged.
- If the principal debtor cannot be held liable due to any defect in the document executed by him, the surety also ceases to be liable on the contract.
- Thus, ordinarily, the liability of the surety shall be same and co extensive with that of the principal debtor.
Liability of surety in a void or voidable contract
The contract between the surety and the creditor is an independent contract.
- If the contract between the principal debtor and the creditor is found to be void or voidable, the creditor can enforce the liability of the surety,
- Where the creditor does not sue the principal debtor within the period of limitation, the surety is not discharged.
- Discharge of the principal debtor by operation of law does not discharge the surety. The death of the principal debtor also does not release the surety from his obligations incurred during his lifetime.
- In case of a minor’s agreement, the surety is liable as a principal debtor.
Rights of Surety in Contract of Guarantee
A surety has rights against i) the creditor, ii) the principal debtor, iii) the co-sureties.
Rights of Surety against Creditor in Contract of Guarantee
- Sue the Principal before payment. A surety may, after theguaranteed debt has become due but before he is called upon to pay, ask the creditor to sue the principal debtor. The surety will indemnify the creditor for any expenses or loss resulting therefrom. In case of fidelity guarantee, the surety can ask the employer to dismiss the employee in the event of his proven dishonesty.
- Right of set-off .On being sued by the creditor, the surety can enforce any claim (set-off or counter claim) which the debtor has against the creditor.
- Rights of Creditor subrogated. On payment of guaranteed debt, the surety is subrogated to all the rights of the creditor and can demand from the creditor all the securities (received before or after the creation of the guarantee), whether known to the surety or not (s.141).
- Right to equities. On payment of the guaranteed debt, the surety is entitled to all equities which the creditor could have enforced against the principal debtor himself and also against persons claiming through him.
- Right of subrogation. Where a guaranteed debt has become due and the surety has paid all that he is liable for, the surety steps into the shoes of the creditor and acquires all the rights the creditor had against the principal debtor (s.140).
- Right to revoke the guarantee. Surety may revoke at any time, a continuing guarantee as to future transactions, by giving a notice to the Creditor (s.130)
Rights of Surety against principal debtor in Contract of Guarantee
- Right of liability ascertained. Before the payment has been made, the debt must be ascertained. Once the principal debtor’s liability accrues as a fixed sum, the surety can make payment and ask him to exonerate him from liability.
- Right to indemnity : The principal debtor is liable to indemnify the surety and the surety is entitled to recover from the principal debtor all payments properly made. The surety can recover the amount paid under the guarantee and interest thereon from the principal debtor, along with damage for any loss sustained. (s.145).
Rights of Surety against co-sureties in Contract of Guarantee
When a debt is guaranteed by two or more sureties (called the co-sureties), all of them are liable to contribute towards the payment of the guaranteed debt. When one of the co-sureties makes payment to the creditor, he has a right to claim contribution from the other co-sureties, under following rules :
- When the principal debtor makes a default of a debt, all the extent of the default (s.146).
- If the co-sureties guarantee different sums, they have to contribute equally subject to the
maximum amount guaranteed by each one. (s. 147)
A release by the creditor of one of the co-sureties does not discharge the other co-sureties, the surety so released is not discharged from his responsibility to the other sureties (s. 138).
Rights & Duties of co-sureties in Contract of Guarantee
- Burden or Responsibilities:
- As a general rule, all co-sureties shall contribute equally, subject to the maximum limit fixed by the co-sureties. If a co-surety pays to the creditor more than his share of debt, he becomes entitled to claim the amount from the other co-sureties.
- So, burden of all the co-sureties are equal. However, if a creditor releases one of the co-sureties, the other co-sureties are not discharged from its liabilities.
- Benefits or Rights:
- If one co-surety has received security from the principal debtor, all the other co-surety shall be entitled to share the benefit of such security. Therefore co-sureties share the same benefit among themselves.
- If there is any understanding between two sureties that one of them only will be liable as a surety, the rights of the creditor will not be effected even if the creditor knew the arrangement between the debtor (s.132). The contract will be applicable only when the liability is taken up jointly by two parties in relation of the same debt. This provision will not be applicable if the debts are different.
Example: L and M make a joint and several promissory note to N. L makes it, in fact, as surety for M and N knows this at the time when the note is made. The fact that L, to the knowledge of N, made the note as surety for M, is of no effect to a suit by N against L upon the note.
Discharge of Surety in Contract of Guarantee
A surety is said to be discharged when his liability comes to an end, in following ways:
- By Revocation : Notice (s.130), Death (s.131), Novation (s.62).
- By Creditor : Variance in terms of contract (s.133), Release or discharge of principal debtor (s.134), Compounding by creditor with principal debtor (s.135), Impairing rights of surety (s.139), Severance of security (s.141).
- By Invalidation of Contract : Misrepresentation. (s. 142), Concealment (s. 143), Joining of co-surety. (s. 144), Consideration.
Discharge of Surety by Revocation in Contract of Guarantee
- Notice: A specific guarantee cannot be revoked by the surety if the liability has already accrued. The surety may revoke a continuing guarantee by notice to the creditor as to future transactions (but remains liable for past transactions). (s.130) [Wingfield v. de St. Croix]
- Death: On death of the surety, his estate will not be liable for any transactions entered into after his death, but his estate will be liable for contracts entered into prior to his death. (s.131)
- Novation: When a contract of guarantee is substituted by a new one (called Novation), the original contract of guarantee comes to an end (s. 62).
Discharge of Surety by Creditor in Contract of Guarantee
- Variance in terms of contract
- When the terms of the contract between the principal debtor and the creditor are varied without the surety’s consent, the surety is discharged in respect of transactions subsequent to the variance. (s. 133)
- Where the guarantee is for the performance of several distinct, duties or obligations or for the payment of distinct debts, a variance in the nature of one of them will not discharge the surety as to the rest.
- Where the guarantee is a continuing one, any such variance will discharge the surety as to the transactions subsequent to variance. [Bacon v. chesney]
- Discharge of principal debtor (s.134)
- If the Creditor discharges the principal debtor, the surety is discharged.
- If the principal debtor is discharged by any act or omission of the creditor, the surety is also discharged.
- Creditor compounding with Debtor: (s.135) The surety is discharged when the creditor and the principal debtor, without consent of the surety, makes a composition or promises to give time to or not to sue the principal debtor. [Midland Motor Showrooms, Ltd. V. Newman], [Kurian vs. The Alleppey C.C.M.S Society]
- Impairing rights of surety : The surety is discharged when the creditor does any act which impairs the remedial rights of the surety (s.139). [Hewison vs Ricket]
- Severance of security.: If the creditor, without the consent of the surety, parts with any security given to him at the time of the contract of guarantee, the surety is discharged from liability to the extent of the value of security. If there are two or more debts each secured by separate security, the surety for one of the debts is not discharged if the creditor parts with the security relating to other debts (s.141). [Hewison vs Ricket], [State of M.P vs Kaluram]
Discharge of Surety by Invalidation of contract in Contract of Guarantee
The Surety is discharged in respect of guarantee given in the following cases:
- Misrepresentation (s.142). Any guarantee which has been obtained by means of misrepresentation made by the creditor.
- Concealment (s.143). Any guarantee which the creditor has obtained by means of keeping silence as to material circumstances, is invalid. [London General Omnibus Co.vs Holloway]
- Joining of co-surety (s.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, the guarantee is not valid if the co-surety does not join. [National Provincial Bank of England v. Brackenbury],
- Consideration. The surety is discharged in case of lack of consideration between creditor and the principal debtor.
The Surety is not discharged in the following circumstances:
- Grant of Time (s. 136): The Surety is not discharged where the creditor makes an agreement with the third person to grant time to Principal Debtor.
- Creditors forbearance to sue (s. 137): In absence of any provision to the contrary in the guarantee, mere forbearance on the part of Creditor to sue Principal Debtor or to enforce any remedy against him does not discharge the Surety.
- Operation of law : Surety is not discharged by operation of law (e.g omission of the creditor to sue within the period of limitation).
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