INDEMNITY AND GUARANTEE

(Project in the subject of Specific Contracts)

SUBMITTED BY: SUBMITTED TO:
Madhurima Gadre,
Semester III- BBA. LLB,
Roll No. 1063 (Section A)


Ms. Gargi Chakrabarti,
Faculty of Law,
NLU Jodhpur.




National Law University, Jodhpur
(Session of July-November 2014)
2

ACKNOWLEDGEMENT


I take this opportunity to express my profound gratitude and deep regards to my guide Ms. Gargi
Chakrabarti for her exemplary guidance, monitoring and constant encouragement throughout the
course of this project. The blessing, help and guidance given by her from time to time shall carry
me a long way in the journey of knowledge on which I am about to embark.

I also take this opportunity to express a deep sense of gratitude to the staff of the library for their
cordial support, valuable information and guidance, which helped me in completing this task
through various stages.

I am obliged to staff members of NLU, Jodhpur for the valuable information provided by them in
their respective fields. I am grateful for their cooperation during my venture.

Through the medium of this project in the subject of Specific Contracts, I have tried my best in
giving the reader a full analysis of a Contract of Indemnity and a Contract of Guarantee, their
various aspects & relevant cases. I sincerely hope that after going through my work on this topic,
one will be enlightened on the subject.

Lastly, I thank everyone for their constant encouragement without which this Herculean task
would not be possible.


-Madhurima Gadre
3

TABLE OF CONTENTS



TABLE OF CONTENTS3
INTRODUCTION.4
OBJECTIVES..5
RESEARCH METHODOLOGY..5
CHAPTER 1: CONTRACT OF INDEMNITY AND GUARANTEE..6
CHAPTER 2: DISTINCTION BETWEEN INDEMNITY & GUARANTEE10
CHAPTER 3: CASE LAWS..13
CONCLUSION...17
BIBLIOGRAPHY...18


4

INTRODUCTION


Indemnity and Guarantee are both closely related and often confused concepts. Parties rarely
stop to consider whether they should be seeking a guarantee from the third party or both
guarantee and indemnity, or even realize that there is a distinction between the respective
obligations.

In fact, there are some significant differences between them and in particular differences in
principle i.e. how they are created, the effect of variations of the obligations during the term and
the discharge of the obligations.

In general an indemnity creates a primary obligation and a guarantee creates a secondary
obligation. The contract of indemnity is for compensating the loss suffered by one person, either
by the person causing the loss or a third party. Whereas, guarantee is a contract to perform the
promise or discharge the liability of a third person, in case of his/her default. Unlike guarantee
under indemnity, there is no direct right of action on the original contract to the person whose
conduct has caused loss. The indemnity holder can only sue in the name of the promisee.

In the course of this project, the researcher has analyzed the rights & obligations of parties under
Contract of Indemnity and Contract of Guarantee respectively, how a Contract of Indemnity
differs from a Contract of Guarantee & the relevant cases pertaining to both topics. After such an
analysis, the researcher concludes with a brief summary of the topics covered under this project.
5

OBJECTIVES:

1. To understand the concepts of Indemnity and Guarantee.
2. To study the distinction between these two very similar types of Contracts.
3. To analyze case laws highlighting the various aspects of Indemnity and Guarantee.

RESEARCH METHODOLOGY:

Primary sources for data required for the study of this topic include books, journals, reports etc.
Secondary sources will include articles, commentaries, & other information available on the
internet. Firstly, the concepts of Indemnity and Guarantee are thoroughly discussed. Then the
essential elements, differences & case laws are analyzed. The project is concluded by
summarizing the conceptual, India specific and comparative analysis of both Indemnity and
Guarantee.





6

CHAPTER 1:
CONTRACT OF I NDEMNI TY AND GUARANTEE


I. CONTRACT OF INDEMNITY

Section 124 in the Indian Contract Act, 1872 encapsulates the concept of Indemnity:
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.

A contract of indemnity may arise either by- (i) an express promise, or (ii) operation of law.
Indemnity normally denotes a contract by which the promisor undertakes an original and
independent obligation to indemnify, as distinct from a collateral contract in the nature of a
guarantee by which the promisor undertakes to answer for the default of another person who is to
be primarily liable to the promise.
1
Thus, we see that a Contract of Indemnity is a type of
contingent contract. The Indemnifiers liability arises only if the losses have been suffered by the
Indemnified party. For a claim of Indemnity to succeed, it is necessary to prove that the losses
are actually suffered by the Indemnified party & also the suffered losses are in the ambit of the
Contract of Indemnity.
2
Rights and liabilities of parties in the indemnity contract are discussed
below in detail.

A. RIGHTS OF THE INDEMNIFIED:

applies The indemnity holder is entitled to recover from the promisor all damages that he/she
may be compelled to pay in any suit with respect to matters that the promise to indemnify.

1
Halsburys Laws of England, 4
th
Ed., Vol 20, para 305.
2
S.S. Gulshan, Business Law, 4
th
Ed., Excel Books (2010).
7

Indemnity holder can recover all costs of suit that he/she may have to pay to the third party,
provided the person either acted under the authority of the indemnifier or if he/she has acted
in such a way as a prudent person would act in his/her own case.
Indemnified party can recover all sums that may have been paid under the terms of any
compromise of any such suit if the compromise was not contrary to the orders of the
indemnifier and was one which it would have been prudent for the promisee to make.
Basically, the Indemnified party is entitled to recover all damages, costs & sums from the
Indemnifying party arising out of the contingencies in the Indemnity Contract.

B. RIGHTS OF THE INDEMNIFIER:

The Indian Contract Act, 1872 makes no mention of the rights of the indemnifier.
However, the indemnifiers rights are similar to the rights of a surety under Section 141.
Section 141 reads that the person is entitled to the benefits of all the securities that the
creditor has against the principal debtor, whether he/she was aware of them or not.

C. COMMENCEMENT OF INDEMNIFIERS LIABILITY:

The Indian Contracts Act, 1872 makes no mention of the commencement of the
indemnifiers liability.
Due to this reason, the English law is followed, according to which the indemnifiers liability
commences only when the indemnified party incurs a loss in accordance to the Indemnity
Contract.
Indemnity requires that the party to be indemnified shall never be called upon to pay.
The Indemnified party may compel the Indemnifier to place him in a position to meet
liability that may be cast upon him without waiting until the Indemnified party has actually
discharged it.
3

In some cases, High Courts have held that the indemnifiers liability shall commence as soon
as the indemnity holders liability becomes absolute.

3
Kucchal M.C., Business Law, Vikas Publishing House Pvt. Ltd., New Delhi (2002).
8

II. CONTRACT OF GUARANTEE:

Section 126 in the Indian Contract Act, 1872 encapsulates the concepts of guarantee, surety,
Principal-debtor, and creditor as follows:
A contract of guarantee is a contract to perform the promise or to 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 called the principle-debtor, and the person
to whom the guarantee is given is called the creditor. A guarantee may be oral or written.

The guarantee is a promise to answer for the payment of some debt, or the performance of some
duty, in case of the failure of another party, who is in the first instance, liable to such payment or
performance.
4
Important concepts to be highlighted while studying guarantee are as follows:

A. CONCEPT OF CONTINUING GUARANTEE:

A Guarantee which extends to a series of transactions is called a continuing guarantee.
A continuing guarantee may at any time be revoked by the surety, as to future transactions,
by notice to the creditor.
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.

B. RIGHTS OF A SURETY AS AGAINST THE CREDITOR:

According to the Indian Contract Act, 1872,
Section 133 - The creditor shall not vary terms of the contract between the creditor and the
principal debtor without the surety's consent. Any such variance discharges the surety as to
transactions subsequent to the variance. However if the variance is for the benefit of the
surety or does not prejudice him or is of an insignificant character, it may not have the effect
of discharging the surety.

4
Re Conley Trustee v. Barclays Bank Limited, (1939) 2 All ER 127.
9

Section 134 - The creditor should not release the principal debtor from his liability under the
contract. The effect of the discharge of the principal debtor is to discharge the surety as well.
Any act or omission on the part of the creditor which in law has the effect of discharging the
principal debtor puts an end to the liability of the surety.
Section 135 - If an agreement is made between the Creditor and Principal debtor for
compounding the latters liability or promising him extension of time for carrying out the
obligations or promising not to sure, discharges the surety unless he assents to such a
contract.
Section 139 - The surety is discharged if the creditor impairs the surety's eventual remedy
against the principal debtor.

C. RIGHTS OF SURETY AS AGAINST THE PRINCIPAL DEBTOR

Right of subrogation - The surety on payment of the debt acquires a right of subrogation.
Section 140 - The surety cannot claim the right of subrogation to the creditor's securities if he
has signed up as a security for a part of the agreement and security has been held by the
creditor for the whole debt.









10

CHAPTER 2:
DI STI NCTI ON BETWEEN I NDEMNI TY AND GUARANTEE


The term indemnity is used to denote a contract by which the promisor undertakes an original
and independent obligation to indemnify, as distinct from a collateral contract in the nature of a
guarantee by which the promisor undertakes to answer for the default of another person who is to
be primarily liable to the promise.
5


While a guarantee is a tripartite contract between three persons: the principal-debtor, creditor and
surety, a contract of indemnity is bilateral. Where the only contracts are between the principal
debtor and the creditor, and the creditor and the surety, but no contract between the principle
debtor and the surety, the case is one of indemnity.
6
In a contract of indemnity, there is no privity
of contract between the surety and the debtor,
7
and the surety (here, indemnifier), cannot compel
the principal debtor (here, the person in respect of whose conduct the indemnity is given) to pay.
8

Unlike guarantee under indemnity, there is no direct right of action on the original contract to the
person whose conduct has caused loss. The indemnity holder can only sue in the name of the
promise.
9


L.C. Mather in his book Securities Acceptable to the Lending Banker
10
has brought out the
distinction between indemnity and guarantee with the following illustration.
Illustration: A contract in which A says to B, If you lend Rs. 1 Lac to C, I will see that your
money comes back is an indemnity. On the other hand undertaking in these words, If you lend
1 Lac to C and he does not pay you, I will pay is a guarantee.


5
Halsburys Laws of England, Fourth Edition, Vol. 20, para 305.
6
Ramchandra B. Loyolka v. Shapurjee N. Bhownagree, AIR 1940 Bom 315; Brahmayya & Co. Official Liquidators
v. K Srinivasan Thangirayyar, AIR 1959 Mad 122; Janwatraj v. Jethmal, AIR 1958 Raj 343.
7
Jaganolb Boksh Singh v. Chandra Bhukan Singh, AIR 1937 Oudh 19.
8
Ramchandra B. Loyolka v. Shapurjee N. Bhownagree, AIR 1940 Bom 315.
9
K. V. Periyamianna Marakkayar & Sons v. Banians & Co., AIR 1926 Mad 544.
10
L.C. Mather, Securities Acceptable to the Lending Banker, 4
th
Ed., Waterlow Publishers (1979)
11

Thus, in a contract of indemnity, there are only two parties, indemnifier and indemnified. In case
of a guarantee, on the other hand, there are three parties, the principal debtor, the creditor and
the surety.

A guarantee is a promise to someone that a third party will meet its obligations to them. If they
do not pay you, I will pay you. An indemnity is a promise to be responsible for another persons
loss and to agree to compensate them for any loss or damage on mutually agreed terms. For
example, one agrees to pay the difference of repairs if they exceed a certain limit.

Other points of difference between a Contract of Indemnity & Contract of Guarantee are
explained as follows:

Contract of Indemnity Contract of Guarantee
Comprises of only two parties- the
indemnifier and the indemnity holder.
There are three parties namely the surety,
principal debtor and the creditor.
Liability of the indemnifier is primary in a
Contract of Indemnity


The liability of the surety is secondary.
The surety is liable only if the principal debtor
makes a default.
The primary liability being that of the principal
debtor.
The indemnifier need not necessarily act at
the request of the indemnified.
The surety give guarantee only at the request
of the principal debtor
The possibility of any loss happening is the
only contingency against which the
indemnifier undertakes to indemnify.
There is an existing debt or duty, the
performance of which is guarantee by the
surety.
The indemnifier cannot proceed against third
parties in his own name, unless there is an
assignment in his favor.
After discharging the debt, the surety is
entitled to proceed against the principal debtor
in his own name.


12

In short, the contract of indemnity is for compensating the loss suffered by one person, either by
the person causing the loss or a third party. Whereas, Guarantee is a contract to perform the
promise or discharge the liability of a third person, in case of his/her default.
11



11
Tulsian P.C., Business Law, Tata McGraw-Hill Pvt. Ltd., New Delhi (2002).
13

CHAPTER 3: CASE LAWS


I. Gajanan Moreshwar Parelkar v. Moreshwar Madan Mantri.
12


A. FACTS:
The Plaintiff got a plot of land on lease from Municipal Corporation of Mumbai.
The Plaintiff allowed the Defendant to erect building on that land. The Defendant, in this
course, incurred debt of Rs.5000 from building material supplier, twice.
On both the occasions, the Plaintiff mortgaged part of the land to the supplier.
The Plaintiff, on the Defendants request transferred the land to the Defendant, on the
consideration that he would discharge of all the liabilities arising out of that land.
The Defendant failed to adhere to his consideration.
The Plaintiff filed a suit for discharge of liabilities on him, alleging the Defendant to be the
indemnifier.

B. ISSUES:
Whether Sections 124 and 125 of the Indian Contract Act, 1872 are exhaustive?
Whether no action could be maintained by the indemnity holder until the actual loss has
occurred?

C. HELD:
Under both the mortgage and the further charge there is a personal covenant by the plaintiff
to pay the amount due, and it would be open to the mortgagee to sue the plaintiff on the
personal covenant reserving his rights under the security.
Therefore, the liability of the plaintiff under the personal covenant is absolute and
unconditional.

D. IMPORTANCE:

12
Gajanan Moreshwar Parelkar v. Moreshwar Madan Mantri, (1942) 44 BOMLR 703.
14

Section 124 deals only with one particular kind of indemnity in which the loss is caused by
the conduct of the indemnifier himself or of other person, but does not cover the cases
outside this or cases when liability arises because of something done by the indemnified at
the request of the indemnifier.
Section 124 talks about subsequent conduct but here the liabilities were past, i.e. prior to the
date when the contract was actually entered into force.
Earlier to this contract, all the acts were done merely on request and without any
consideration and hence, were not binding. Therefore Section 124 is inapplicable here.


II. J anwatraj v. J ethmal
13


A. FACTS:
There was a partnership firm consisting of the plaintiff Janwatraj, the defendant Jethmal and
certain other persons, which carried on business in the name and style of Oswal Brothers.
The firm did business in the manufacture of pen-holders and required some machinery for
that purpose.
The plaintiff's case was that a sum of Rs. 3000/- was given by him to one Umar Bhai for
purchasing the machinery and thereby a loss of Rs. 3000/- had been incurred.
This loss was divided between the partners of the firm, and the defendant executed a khata
for a sum of Rs. 561/8/- on 20th August 1947 by which it was agreed that the defendant
would pay the aforesaid amount to the plaintiff if the said Umar Bhai refused to pay it.
Umar Bhai did not pay anything to the plaintiff, and, consequently the latter tiled the present
suit for the sum of Rs. 561/8/- as principal plus Rs. 118/13/- as interest, total Rs. 680/5/- on
the 2nd of March, 1951.

B. ISSUES:
Whether the position of the defendant in the case was that of surety or indemnifier?


13
Janwatraj v. Jethmal, AIR 1958 Raj 343.

15

C. JUDGMENT:
The suit concerned a contract of indemnity. Appeal was allowed and relief of damages plus
due interest granted by the Court.

D. IMPORTANCE:
For suretyship to exist there have to be three parties creditor, principal debtor and surety
and there has to be privity of contract between them.
The surety can guarantee payment to the creditor only when asked to by the debtor. A
contract to compensate the creditor for loss caused to him, without privity between them,
makes it a contract of indemnity.

III. Bank of Bihar v. Damodar Prasad
14


A. FACTS:
On the date of the suit Damodar Prasad (principal debtor) was indebted to the plaintiff for Rs.
11,723.56 on account of principal and Rs. 2,769.37 on account of interest. In spite of
demands neither he nor Mr. Paras Nath Sinha, the guarantor, paid the dues.
The guarantor agreed to pay and satisfy the liabilities of the principal debtor upto Rs.
12,000/- and interest thereon two days after demand. The bond provided that the plaintiff
would be at liberty to enforce the guarantee.
The demand for payment of the liability of the principal debtor was the only condition for the
enforcement of the bond. That condition was fulfilled.
Yet, neither the principal debtor nor the surety discharged the admitted liability of the
principal debtor in spite of demands.
Hence, the present suit for the recovery of sum.

B. ISSUES:
Whether the plaintiff can only enforce his dues against the guarantor after exhausting all
remedies against the principal debtor?

14
Bank of Bihar v. Damodar Prasad, AIR 1969 SC 297.

16


C. JUDGMENT:
The appeal was allowed and the respondent Dr. Paras Nath Sinha was directed to pay to the
appellant costs.

D. IMPORTANCE:
The direction postponing payment of the amount decreed must be clear and specific. The
injunction upon the creditor not to proceed against the guarantor until the creditor has
exhausted his remedies against the principal is of the vaguest character. It is not stated how
and when the creditor would exhaust his remedies against the debtor.
The solvency of the principal is not a sufficient ground for restraining execution of the decree
against the guarantor since, it is the duty of the guarantor to pay the amount.

17

CONCLUSION


In simple words, indemnity denotes a contract by which the promisor undertakes an original
and independent obligation to indemnify, as distinct from a collateral contract in the nature of a
guarantee by which the promisor undertakes to answer for the default of another person who is to
be primarily liable to the promise.

For example, a contract in which A says to B, If you lend Rs. 1 Lac to C, I will see that your
money comes back is an indemnity. On the other hand undertaking in these words, If you lend
1 Lac to C and he does not pay you, I will pay is a guarantee.

In other words, a guarantee is a promise to someone that a third party will meet its obligations to
them. If they do not pay you, I will pay you. An indemnity is a promise to be responsible for
another persons loss and to agree to compensate them for any loss or damage on mutually
agreed terms. For example, one agrees to pay the difference of repairs if they exceed a certain
limit.

The contract of indemnity is for compensating the loss suffered by one person, either by the
person causing the loss or a third party. Whereas, Guarantee is a contract to perform the promise
or discharge the liability of a third person, in case of his/her default. Unlike guarantee, under
indemnity there is no direct right of action on the original contract to the person whose conduct
has caused loss.

Thus, in the course of this project the researcher has analyzed the rights & obligations of parties
under Contract of Indemnity and Contract of Guarantee respectively, the distinction between the
two & the relevant cases pertaining to both topics.

18

BIBLIOGRAPHY


I. TREATISES:

R.G. Padia (Ed.), Pollock & Mulla, Indian Contract and Specific Relief Act, Vol II, New
Delhi Butterworth, 2011.
A.C. Moitra, Principles and Digest of Indian Contract Act, Universal Book Agency, 1998.
Chitty on Contracts, Specififc Contracts, Vol II, Sweet & Maxwell, London, 2008.
Halsburys Laws of England, Guarantee & Indemnity, 4
th
Ed., Vol 20.
S.S. Gulshan, Business Law, 4
th
Ed., Excel Books (2010).
Kucchal M.C., Business Law, Vikas Publishing House Pvt. Ltd., New Delhi (2002).

II. ACTS:

The Indian Contract Act, 1872.

III. CASES:

Gajanan Moreshwar Parelkar v. Moreshwar Madan Mantri, (1942) 44 BOMLR 703.
Ramchandra B. Loyolka v. Shapurjee N. Bhownagree, AIR 1940 Bom 315.
Brahmayya & Co. Official Liquidators v. K Srinivasan Thangirayyar, AIR 1959 Mad 122.
Janwatraj v. Jethmal, AIR 1958 Raj 343.
Jaganolb Boksh Singh v. Chandra Bhukan Singh, AIR 1937 Oudh 19.
K. V. Periyamianna Marakkayar & Sons v. Banians & Co., AIR 1926 Mad 544.
Re Conley Trustee v. Barclays Bank Limited, (1939) 2 All ER 127.
Bank of Bihar v. Damodar Prasad, AIR 1969 SC 297.




19

IV. WEBSITES:

http://www.indialawinfo.com/bareacts/soga.html
books.google.co.in
www.manupatrafast.in
www.indiankanoon.org
scholar.google.co.in
www.lawnotes.in
www.jstor.org
indiancaselaws.wordpress.com
www.preservearticles.com