Contracts of Guarantee and Indemnity

Q. Define contract of Indemnity and explain its essentials fully. Distinguish between a contract of Indemnity and contract of guarantee. [20 marks - 2015]
Q. Define continuing guarantee [ 4 marks - 2015]
Q. Discuss liabilities and rights of a surety in contract of Guarantee. Would the liability be differ if there are more than one sureties? [20 marks - 2016]
Q. Define Continuing Guarantee [4 marks - 2017]
Q. What are the essential elements of guarantee? What is the difference between indemnity and guarantee? [20 marks - 2022]


Contracts of Guarantee and Indemnity

The contract of indemnity and the contract guarantee are the special contracts under the Indian Contract Act, 1872. Both the contracts are for providing compensation to the creditor for the failure of a third party to perform their obligation.

Contract of Indemnity
Section 124 of the Indian Contract Act, 1872 defines a contract of indemnity as a contract wherein 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.

Essentials in the Contract of Indemnity
(1) Valid contract: The contract must be valid as per the Indian Contract Act, 1872.
(ii) Protection of loss: The contract should be for protection of loss.
(iii) Two parties: There should be two parties in the indemnity contract. The indemnifier and the holder.
(iv) Express or implied: The indemnity contract can express or implied.

Express Indemnity:
This is a type of written indemnity, where all the terms and conditions of the indemnity are mentioned specifically in the contract.

Implied Indemnity:
The indemnity where the obligation arises from the facts and the conduct of the parties involved. For example, master servant relationship. There is no written contract in this type of indemnity.

Rights of an Indemnity Holder
A per section 125 of Indian contract Act, 1872 the promisee in a contract of indemnity is entitled to recover from the promisor:
(i) All damages which he may be compelled to pay in any suit related to this contract.
(ii) All costs which he may be compelled to pay in any such suit.
(iii) All sums which he may have paid under the terms of any compromise of any such suit.

Rights of the Indemnifier
After the indemnity holder is paid for the damage incurred, the compensator shall have all the rights to all the methods and services which can save the compensator from the damage.

Case References for Contract of Indemnity
Gajanan Moreshwar vs. Moreshwar Madan, (1942)
Lala Shanti Swarup vs Munshi Singh & Others, (1967)


Contract of Guarantee
Section 126 of the Indian Contract Act, 1872 states that a "contract of guarantee" is a contract to perform the promise, or discharge the liability, of a third person in case of his default.

Essentials of a Contract of Guarantee
(i) Surety: The person providing guarantee is called the surety.
(ii) Principal debtor: The person for whose default the guarantee is given is the principal debtor.
(iii) Creditor: The person to whom the guarantee is given called the creditor.
(iv) Guarantee: A written or verbal guarantee.

Example of a Contract of Guarantee
Mr. X takes a loan of Rs. 5 lakhs from the ABC Bank. Mr. Y promises to pay the loan amount to UCO Bank if Mr. X fails to repay. This is a contract of guarantee and Mr X is Principal debtor, ABC Bank is creditor and Mr. Y is surety.

Liability of Surety
(i) Section 128 of the Indian Contracts Act, 1872 states the liability of the surety is same as the principal debtor, unless it is otherwise mentioned in the contract.
(ii) The surety can be sued directly by the creditor in case of default by the principal debtor.

Rights of Surety
(1) Rights against the principal debtor
(i) Right to give notice.
(ii) Rights of sub-rogation.
(iii) Right of indemnity.
(iv) Right to get securities.
(v) Right to ask for relief.

(2) Rights against the creditor
(i) Right to get securities.
(ii) Right to ask for set-off.
(iii) Rights of sub-rogation.
(iv) Right to advice to sue principal debtor.
(v) Right to insist on termination of services.

C. Rights against co-sureties
(i) Right to ask for contribution from the co-sureties.
(ii) Right to claim share in securities.

Continuing Guarantee
A form of guarantee that extends to a series of transactions is a continuing guarantee. A continuing guarantee extends to all transactions that the principal debtor enters into before the surety revokes it.
A continuing guarantee for future transactions may be withdrawn at any time by notice to the creditors. However, the responsibility of a surety for transactions completed prior to such revocation of guarantee is not diminished.


Difference between Contract of Indemnity and Contract of Guarantee


Contract of Indemnity Contract of Guarantee
There are two parties: the indemnifier and the indemnity holder. There are three parties: the principal debtor, the creditor, and the surety.
There is only one contract between the indemnifier and the indemnity holder.  There are three contracts between:
(i) the principal debtor and the creditor.
(ii) the creditor and surety
(iii) the principal debtor and surety
The liability of the indemnifier is primary. The liability of the surety is a secondary. His obligation to pay arises only when the principal debtor defaults. 
The liability of an indemnifier is not conditional.  Liability of surety is conditional on the default of the principal debtor. 
Once the indemnifier indemnifies the indemnity holder, he cannot recover that amount from anybody else. After the surety has made the payment, he becomes the creditor and can recover the sums paid by him from the principal debtor.

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