Contract of Indemnity and Guarantee
‘Indemnity and Guarantee are two sides of the same coin’- It means that indemnity and guarantee differ on a lot of issues while being similar on the issue that they are both modes of compensation and that they are similar on certain principles like unjust enrichment and matters of good faith. In spite of their basic similarities, contracts of indemnity are inherently different from contracts of guarantee.
Indemnity is defined under Section 124 of the Contract Act 1872. Indemnity means to make the loss good to the other person. The one who gives indemnity is known as Indemnifier. And the one who holds/has indemnity is known as Indemnified or Indemnity Holder. According to Halsbury, indemnity is a contract, express or implied to keep a person, who has entered into or who is about to enter into, a contract or incur any other liability, indemnified against loss, independently of the question whether a third person makes a default.
Section 126 of the Indian Contract Act 1872, talks about the rights conferred on the indemnity holder and the essential conditions for him to claim these rights. It was held in Adamson vs. Jarvis, that Adamson has to indemnify Jarvis as Jarvis was asked to follow the orders of Adamson, and if anything went amiss Jarvis would be indemnified. The indemnity holder can call upon the indemnifier to save him from loss even before the actual loss is incurred.
Section 126 of the Indian Contract Defines the contract of Guarantee as, “A “contract of guarantee” is a contract to perform the promise, or discharge the liability, of a third person in case of his default. A contract of guarantee is rendered void without valid consideration.
The person who gives the guarantee is called the “surety”. The surety is also known as Guarantor.
The person in respect of whose default the guarantee is given is called the “principal debtor”,
The person to whom the guarantee is given is called the “creditor”. The function of a contract of guarantee is to enable a person to get a loan or goods on credit. or employment. Some person comes forward and tells the lender, on the supplies, on the employee that he may be trusted, and in case of any default, I undertake to be responsible. A guarantee may be either oral or written.
‘A’ wanted to insure his car. He went to an insurance company GIC (General Insurance Company) The GIC agreed to give him a loan but also asked for a surety. ‘A’ asked ‘M’ to become his surety and ‘M’ agreed to be A’s surety.
Here, in the above example, A is the Principal debtor, M is the surety, whose liability is secondary. and the GIC is the creditor.
Rule of subrogation:
It means when a principal debtor makes default and surety have to pay the amount. In this situation the surety steps into the shoes of the creditor.
Rights of a Surety
- Right to be indemnified
- Right to claim security
- Right to subrogation
- Right against co-surety
Features of Contract of Indemnity and Guarantee
Essentials or features of a contract of indemnity
A valid contract of indemnity should fulfill the following conditions:
- Anticipated loss: A contract of indemnity is a security for an anticipated loss.
- Requirements of a valid contract: A contract of indemnity being a species of contract must have all essentials of a valid contract like free consent, the competence of the parties, consideration, etc.
- To save other parties: There must be a promise to save the other party from some loss.
- Covers only the actual loss: It covers only the actual loss that may be due to the promisor himself or any other person and it covers only the loss caused by an event mentioned in the contract. The event mentioned in the contract must happen.
- May be express or implied: The contract of indemnity may be express or implied. An express promise is one where a person promises to compensate the other party in an express term. Implied promise is one where the conduct of the promisor shows his intention to indemnify the other party from a loss.
- Depend on good faith: This contract depends on good faith.
Main features of a Contract of Guarantee
- The contract may be either oral or written: According to Section 126, a guarantee may be either oral or written. In this regard, the position in India is different from that in England. According to English Law, for a valid contract of guarantee, it is necessary that it should be in written form and signed by the parties.
- There should be a principal debt: A contract of guarantee presumes a principal debt or an obligation to be discharged by the principal debtor. The surety undertakes to be liable only if the principal debtor fails to discharge his obligation. If no such liability exists, there can be no contract of guarantee. Thus, where the debt, which is sought to be guaranteed, is already time-barred or void, the surety is not liable.
- The benefit to the principal debtor is sufficient consideration: A contract guarantee like other contracts must be supported by some consideration. It is not necessary that there must be a direct consideration between the surety and the creditor. The consideration by the principal debtor is sufficient for the surety.
Section 127 provides,
“Anything did, or any promise made, for the benefit of the principal debtor may be sufficient consideration to the surety for giving the guarantee.” Thus, any benefit received by the debtor is adequate consideration to bind the surety.
- Consent of the surety should not have been obtained by misrepresentation or concealment: A guarantee obtained by means of misrepresentation or concealment of material facts concerning the transaction is void. The position is explained by Section 142 and Section 143.
Section 142 provides, “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.”
Section 143 provides, “Any guarantee which the creditor has obtained by means of keeping silence as to a material circumstance is invalid.
Differences between indemnity and guarantee
A contract of guarantee always has three parties; they are, the creditor, the principal debtor, and the surety; whereas a contract of indemnity has two parties, the indemnified, and the indemnity holder. In a contract of indemnity, the indemnifier assumes primary liability, whereas in a contract of guarantee, the debtor is primarily liable and the surety assumes secondary liability. In indemnity, the contingency present is that of the possibility or risk of suffering a loss to which the indemnifier agrees to indemnify; while in guarantee, there is an existing debt or duty whose performance is guaranteed by the surety.
In the case of an indemnity contract, the indemnifier’s interest lies in earning a commission and a premium whereas, in a contract of guarantee, the only interest is the guarantee itself. In a contract of indemnity, the indemnifier cannot sue a third party. The surety is entitled to file a suit against the principal debtor in his own name if only he has paid the debt. In a contract of indemnity, there is a single promise or contract; a promise to pay if there is a loss. In a contract of guarantee, by contrast, there are multiple promises, including the original promise to pay or perform and the guarantor’s promise to pay or perform in the event of default.
In a case study between, Punjab National Bank Ltd. v. Bikram Cotton Mills and Anr and Gajan Moreshwar vs. Moreshwar Madan,
the difference between indemnity and guarantee is clearly visible. There are three parties here, in the Punjab National Bank case whereas only two parties in Gajan Moreshwar. Here Moreshwar Madan was the indemnifier and hence he was the only one liable to make good of the money, whereas in the Punjab National Bank case, the debtor, which is the first respondent company, is the primary liability holder and the secondary liability belongs to the surety which is the respondent.
The Privy Council in the Gajan Moreshwar case held that the indemnity holder has rights other than those mentioned in the sections mentioned. If the indemnity holder has incurred any liability, he can ask the indemnifier to do well of the liability and Moreshwar Madan was directed by the Privy Council to do well of the indemnity holder, Gajan Moreshwar’s, liability. In the Punjab National Bank case, there was no risk involved, but there is an existing duty to pay off debts as mentioned in the sections governing guarantee.
Hence irrespective of the presence of risk, the principal debtor and surety have to do well on the debts of the creditor. In the Gajan Moreshwar case, Gajan Moreshwar can’t sue K.D. Mohan, as it is a contract of indemnity. He can only sue Moreshwar Madan. But in the Punjab National Bank case, along with the principal debtor, the surety can also be sued.
Guarantees and indemnities have numerous similar attributes. By and large likewise, similar obligations and rights emerge between the parties. This will have an impact particularly throughout the time of looking to authorize the agreement. Contracts of indemnity and guarantee impart certain central commonality. In every contract, one party consents to pay in the interest of another. Also, each of these categories of contracts is utilized as a safeguard against misfortunes by people and organizations.
One more point of similarity worth mentioning is that they cannot be used to make unjust enrichments. In a comparative study between Punjab National Bank Ltd. v. Bikram Cotton Mills and Anr and Gajan Moreshwar vs. Moreshwar Madan, it can be seen, that both guarantee and indemnity are used to compensate the creditor and indemnity holder respectively and the principal debtor and surety in the Punjab National Bank case s well as the indemnifier had consented to pay to make good of the debt.
 Section 124, the Indian Contract Act,1872
 Adamson v. Jarvis, (1827) bing 66: 5 LJ OS 68
 Janaki Paul v. Dhokar Mall Kidarbux, (1935) 156 IC 200
 Section 127, The Indian Contract Act
 Section 142, The Indian Contract Act
 Section 143, The Indian Contract Act
 Punjab National Bank Ltd. v. Bikram Cotton Mills and Anr,1970 AIR 1973
 Gajan Moreshwar vs. Moreshwar Madan, (1942) 44 BOMLR 703
 GUARANTEE AND INDEMNITY AS SUBJECTS OF SECURITY, Ale-Daniel Olaoluwa, Jonathan Julius Iyieke, Udeogu Chijioke
 Supra At. 6
 Supra At. 7