Contracts of Indemnity & Guarantee
1. Contract of Indemnity (Section 124)
Under Section 124 of the Indian Contract Act 1872:
“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.”
Key Parties in Indemnity:
- Indemnifier: The person who gives the promise to protect from loss.
- Indemnity-Holder (Indemnified): The person who is protected against such loss.
Rights of Indemnity-Holder When Sued (Section 125):
The promisee (indemnity-holder), acting within the scope of his authority, is entitled to recover from the promisor:
- All damages he was compelled to pay in any suit in respect of any matter to which the promise to indemnify applies.
- All costs of litigation properly incurred in defending or bringing such suits.
- All sums paid under compromise, provided the compromise was prudent and not contrary to the indemnifier’s orders.
2. Contract of Guarantee (Section 126)
Section 126 defines a 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.”
Tripartite Contractual Structure of a Guarantee
1. Principal Debtor
The person in respect of whose default the guarantee is given (the primary borrower who owes performance or money).
2. Creditor
The person to whom the guarantee is given (the lender/seller to whom payment or performance is owed).
3. Surety (Guarantor)
The person who gives the guarantee, undertaking secondary liability in case the principal debtor defaults.
3. Key Differences: Indemnity vs. Guarantee
| Basis | Contract of Indemnity | Contract of Guarantee |
|---|---|---|
| Number of Parties | 2 parties: Indemnifier & Indemnity-Holder. | 3 parties: Creditor, Principal Debtor, and Surety. |
| Number of Contracts | Only 1 contract between indemnifier and indemnified. | 3 contracts (Creditor-Debtor, Creditor-Surety, Debtor-Surety). |
| Nature of Liability | Primary and independent liability. | Secondary (Surety is liable only upon Debtor’s default). |
| Existence of Debt | No existing debt; liability is contingent on future event. | There is an existing debt or duty whose performance is guaranteed. |
| Right to Sue Third Party | Cannot sue third party in own name; must sue in name of indemnified. | Surety, after discharging debt, steps into shoes of creditor (Subrogation). |
4. Nature and Extent of Surety’s Liability
- Co-extensive Liability (Section 128): The liability of the surety is co-extensive with that of the principal debtor, unless otherwise provided by the contract. Creditor can sue surety directly without first suing the principal debtor.
- Continuing Guarantee (Section 129): A guarantee extending to a series of transactions. Revocable for future transactions by notice to creditor (Sec 130) or by surety’s death (Sec 131).
Grounds for Discharge of Surety from Liability
Ground 1
By Notice of Revocation or Death (Sec 130-131):
Surety can revoke continuing guarantee as to future transactions by notice. Death of surety discharges him for future transactions.
Ground 2
Variance in Terms of Contract (Sec 133):
Any unauthorized change made between creditor and debtor without surety's consent discharges the surety as to all subsequent transactions.
Ground 3
Release or Discharge of Principal Debtor (Sec 134):
If creditor enters into a contract releasing the debtor, or does any act resulting in debtor's legal discharge, surety is automatically freed.
Ground 4
Loss of Security by Creditor (Sec 141):
If creditor loses or parts with any security held against debtor without surety's consent, surety is discharged to the extent of the security's value.