LAW OF CONTRACT - II

Faculty Shradha Baranwal sbaranwal@ddn.upes.ac.in

CONTRACT OF INDEMNITY AND GUARANTEE

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. Claim subsists against the action of promisor or any other person Indemnifier and indemnified

Promise to recompense i.e. compensate for any loss or liability Promise could be in three ways 1. Contract of indemnity [could be express or implied (e.g. encumbrances)] 2. Relation of the parties
(principal agent/ employer-employee etc)

3. By statute
(liability of railway in case of loss suffered by the consignor due to wrong specifications given by the railway, liability towards a person for loss suffered by him whose name has wrongly appeared in the prospectus)

NATURE OF CONTRACT OF INDEMNITY

Original and independent obligation i.e. primary responsibility Right to indemnity vs. right to damages

EXAMPLES OF INDEMNITY
A, a joint promisor pays off the whole debt and sues B for half the due amount. Liability of directors of the company to compensate for the loss suffered by a person whose name appears as director without his consent or the consent has been withdrawn.

Liability towards partner of a firm in respect of payments made by him on behalf of the firm in the ordinary course of business.

COMMENCEMENT AND EXTENT OF LIABILITY No clear provision under India Contract Act, 1872 Earlier position in English Law no indemnity till the actual losses have been suffered

Difficulty with the earlier position

Later development of Equitable Principle ...If payments is a condition precedent to recovery, the contract may be of little value to the person to be indemnified, who may be unable to meet the claim in the first instance.

Views of different High Courts with respect to the commencement of liability Calcutta High Court equitable principle Bombay High Court actual damage suffered
Law commission of India held indemnity as a claim and not mere reimbursement. (See thirteenth report)

LIMITATION ON CONTRACT OF INDEMNITY

Indemnifier cannot sue the debtor in his own name for want of Privity of contract Creditor also cannot sue the promisor of the contract of indemnity

Payment without actual loss absolute liability Payment only after loss where the liability is not absolute but a relative one.

RIGHT OF INDEMNITY HOLDER WHEN SUED Section 125 reads, The promisee in a contract of indemnity, acting within the scope of his authority is entitled to recover from the All damages All costs All sums Conditions are Orders of the promisor should not have been contravened Action of a prudent man in absence of contract of indemnity

Rights of the indemnifier

Based on the natural equity Where one person has agreed to indemnify another, 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.

Case laws
1. State Bank Of India & Anr vs Mula Sahakari Sakhar Karkhana Ltd on 6 July, 2006, Supreme Court Nature of contract of indemnity

2. Gajanan Parelkar v. Moreshwar Madan Mantri AIR 1942 BoMoreshwar m 302 3. Osman Jamal & Sons Ltd. v. Gopal Purshottam 1928 ILR 56 Cal 262 Commencement of liability

CONTRACT OF GUARANTEE
Sec. 126 defines contract of guarantee Includes Performance of a promise corresponds to a duty Discharge of a liability corresponds to a debt Either oral or written Operative only in case of default Surety principal debtor creditor

Essentials of contract of guarantee

Three necessary parties debtor, surety, creditor Failure to discharge of liability under legal obligation by the principal debtor Liability voluntarily taken by another person Contract of Guarantee by Company By writing under its common seal By any person on behalf of a company viz., Director

Guarantee and indemnity (similarity) Broadly both insures compensation to the creditor in case of loss Differences Guarantee and Indemnity 1. Parties and formation 2. Difference in liability 3. Formalities
Contract of Guarantee with the knowledge of the principle debtor (can avail 140, 141 and 145) Without the knowledge of principal debtor (can not avail 145)

Nature of contract of Guarantee Collateral or conditional contract Something auxiliary to an antecedent obligation. There are two classes of guarantee a promise which becomes effective if the debtor fails to perform his obligation and a promise that the debtor will perform his obligation. Guarantee in the latter case are effectively unconditional. A contract of Guarantee is not one uberrimae fidei, but a contract of strictissima juris.

 An arrangement under which the promisor undertakes an obligation which replaces and/or extinguishes the principal-debtors liability, whether by novation or otherwise, is not a guarantee. The principal-debtor may be a party to the contract by implication. Nature of liability under Contract of Guarantee Guild & Co. v Conrad (1894) 2 QB 885
There is a plain distinction between a promise to pay the creditor if the principal-debtor makes default in payment and promise to keep a person who has entered or about to enter, into a contract of liability indemnified against that liability independently of the question whether a third person makes default.

Liability should be legally enforceable Suretys liability equivalent to that of a principal. Liability subject to condition if provided For filing the suit for enforcing entitlement it is not necessary for the creditor to exhaust suit against principal debtor he can directly proceed against the surety and such suit is maintainable. (State Bank of India v Indexport (1992) 3 SCC 159) Criteria to determine whether contract of Guarantee or Indemnity Use and frequency of use of words Nature of liability

Effect of contract of Guarantee Suretys liability arises only in case of default Surety entitled to all the rights viz., discharge, indemnity from the principal debtor as per sec. 133 to 145 If a person becomes surety without the knowledge and consent of the principal debtor, the only rights which he acquires in that case are those given by section 140 and 141, and not those given by section 145.

Performance Bond, Bank Guarantee or letter of credit Could be conditional or unconditional Honored on first demand without any condition of proof Subsequent happenings in the establishment would not restrain Bank to honor the Guarantee.
EXCEPTIONS

Section 127 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. Section 128 Surety's liability The liability of the surety is co-extensive with that of the principal debtor, unless it is otherwise provided by the contract.

Nature of liability
Co extensive means to the that extent Surety cannot insist on exhausting the liability of principal debtor. The extent of liability would depend upon the terms of the contract. Any express or implied conditions precedent the suretys liability must be fulfilled before recourse can be had to him. Where the liability arises under the contract only on the happening of a contingency, the surety is not liable until the contingency has taken place.

 Liability for void or voidable contract (surety against minors debt) Discharge of principal debtor by operation of law does not discharge the surety Statutory reduction or extinguishment of liability Filing a suit and execution of a decree Effect of acknowledgement by a principal debtor does not bind the surety unless specifically empowered.

129. Continuing guarantee A guarantee which extends to a series of transaction, is called, a "continuing guarantee".
The nature of Guarantee is a question of the intention of the parties to the contract. Language, surrounding circumstances and relative position of the parties are the guiding factors in determining the status of guarantee.

130. 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.

 By giving notice guarantor can avoid future liability. Where a continuing relationship is constituted on the faith of guarantee, it cannot be revoked during the continuance of that relationship. However a material change in the guaranteed situation may justify revocation viz., proved misconduct of servant. Prescribed mode of revocation Continuing guarantee and change in the status of creditor would terminate the guarantee unless agreed otherwise.

131. Revocation of continuing guarantee by surety' death The death of the surety operates, in the absence of any contract to the contrary, as a revocation of the continuing guarantee, so far as regards future transactions.
In the absence of any contract in contrary Joint and several liability

Section 132 Liability of two persons primarily liable, not affected by arrangement between them that one shall be surety on others default.
Discharge of surety (Sec 133-139) General ways for discharge of contract Section 133 Discharge of surety by variance in terms of contract (variance without the consent of surety)

 Rule of strict interpretation Variance should be substantial Cases of ambiguity rule of contra preferentem

Section 134 Discharge of surety by release or discharge of principal A surety is discharged if the creditor without his consent, unconditionally release the principal debtor. Release of the principal debtor by a complete novation or otherwise terminates the guarantee Acceptance of second surety by the creditor Consent decree

Bishal Chand Jain v Chatlur Sen AIR 1967 All 506

Section 136. Surety not discharged when agreement made with third person to give time to principaldebtorSection 137. Creditors forbearance to sue does not discharge surety Section 138. Release of one co-surety does not discharge others Section 139. discharge of surety by creditors act of omission impairing suretys eventual remedy

Section 139 includes -does an act inconsistent with the rights of the surety; or - Omits to do any act which his duty to the surety requires him to do, and as a result the suretys eventual remedy against the principal debtor is thereby impaired.
Section 139 is residuary in nature which ensures that no contrary arrangement is made

Cases which can be covered under section 139 Where the creditor consented to the release of attachment over the properties; Where creditor failed to convey property in purchase, the price of which was guaranteed by the guarantor ; Sale of mortgaged property in favour of creditor without there being any occasion for the same; Loss of pledged goods; Failure of creditor to bring on record the LRs of the dead principal debtor resulting into abatement of proceedings against him. Security not returned in the same condition as given to the creditor THE ONUS LIES ON SURETY

Section 140. Rights of surety on payment or performance .Surety becomes invested with all the rights which the creditor had against the principal debtor.
Based on the principal of equity In counter guarantee for reimbursement the rights are transferred to the counter guarantor. Priority in cases of liquidation and winding up. Rights before demand of payment once the liability accrues Injunction even before the payment

Section 141. Suretys right to benefit of creditors securitySurety is entitled to all the securities creditor had at the time of entering into contract of surety irrespective of the knowledge of the same any impairment in the same would discharge the surety
Section 142. Guarantee misrepresentation, invalid obtained by

Section 143. Guarantee obtained by concealment, invalid

Circumstances in which necessary disclosure is made to the surety Where the surety has asked specific question to the creditor; Where the bank misleads the surety by volunteering only part of the truth; Where the surety makes a statement in the creditors presence that demonstrates that the he entirely misunderstood the principal debtors position; Where there is anything that might not naturally be expected to take place between the principal debtor and the creditor

Section 144. Guarantee on contract that creditor shall not act on it until co-surety joins Section 145. Implied promise to indemnify surety Based on equity Rightfully paid Includes property, assignment of rights Entitlement runs till full indemnification is done including payment towards interest. Recovery of cost Includes cases where surety has defended the debtor under his authority, for his benefit, or under circumstances which were unavoidable.

Section 146. Co-sureties liable to contribute equally Section 147. Liability of co-sureties bound in different sums

 Radha Kanta Pal v. United Bank of India AIR 1955 Cal 217
Gas Authority of India Ltd., New Delhi v Official Liquidator, Mumbai AIR 2004 Bom 220 Annandana Jadaya Gounder v Konammal AIR 1933 Mad 309 Bharat Nidhi v Bhagwandas Mehra CA SC 939 Syndicate Bank v Pamidi Somaiah (Died) AIR 2002 AP 12

Class exercise
1. A, introduced B to C for certain business leading to execution of a contract between B and C. Later C breached the contract Decide the liability of A Whether A is liable for indemnify or stands as Guarantee (Refer Chanana Steel Tubes Pvt. Ltd. v. Messrs Jaitu Steel Tubes Pvt. Ltd. AIR 2000 HP 48) 2. X invited Y for celebrating his marriage. Y promised to gift X a watch. Z a common friend to X and Y guaranteed the same in case Y defaults. Y defaulted in his promise. Decide the liability of Z.

3. X agreed to sell 500 pieces of shoes to Y for a consideration of 30,000 Rs. Y received the goods but failed in payment of the amount. Z a friend to Y entered into a contract with X for the payment of the due amount in consideration of discharging the liability of Y. Decide the status of Z whether he stands as surety to the contract between X and Y? 4. A agreed with B to pay off all the losses B would suffer due to payment against sale B concluded with C. The agreement between A and B was worded as follows:
This Agreement of Guarantee is been concluded between A and B whereby A guarantees to make payment in case of loss suffered by B on account of payment against sale concluded between B and C.

Decide the nature of contract between A and B

5. X borrowed Rs. 50,000 from Y. Z deposited his property papers to secure the payment without there being any express agreement. Decide the liability of Z in case of non payment by X. 6. In a writing by X to Y in the presence of Z: Please lend Rs. 1200 to Z; there will be no trouble in the payment of your money. Be assured, if there by any trouble, I undertake to indemnify you and would stand as equally liable. Decide whether contract of Guarantee or indemnity?