INDEMNITY AND GUARANTEE


INDEMNITY AND GUARANTEE

CONTRACTS OF INDEMNITY

Definition

Section 124 of the Contract Act defines a contract of indemnity as a contract by which one party promises to save the other party from loss caused to him by the conduct of the promisor himself, or by the conduct of any other person. P. contracts to indemnify Q against the consequences of any proceeding which R may. take against Q in respect of a certain sum of Rs. 200. This is a Contract of Indemnity: P is called the indemnifier and Q the Indemnity-holder.

Characteristics

Characteristics (or the requisites) of a Contract of indemnity are as follows :

l. A contract of guarantee must satisfy all the essential elements of a contract. For example, the object must be lawful, there must be free consent etc.

2. The Contract may be express or implied. An express contract is by word or by writing. An implied contract of indemnity comes from the circumstances of the` case or the relationship between the parties.

3. Section 69 implies a promise to indemnify

Definition not exhaustive

Section 124 of the Indian Contract Act does not  give an exhaustive definition of contracts of indemnity. This section Includes

(i) only express promises to indemnify and

(ii) only those cases where the loss arises from the conduct of the promisor or of any other person.

It does not include

(i) implied promises to indemnify and

(ii) cases where loss arises from accidents and events not depending on the conduct of any person.

it has been held in a number of cases in India that a duty to indemnify may arise by operation of law even in the absence of express agreements. A promise to indemnify may be either express or implied from the circumstances of the case. – The illustration given above is an example of an express promise to indemnify. The following is an example of an implied promise to indemnify.

A broker forged the signature of the holder of a Government promissory note and endorsed it to the Bank of India. The bank got the note renewed from the Government. The holder sued the Government and recovered damages. The Government sued the bank for indemnity. The Privy Council decreed the suit, quoting with approval the following observations of Lord Halsbury :

“It is a general principle of law that when an action is done by one person at the request of another which act is not in itself manifestly tortious to the knowledge of the person doing it, and such act turns out to be injurious to the rights of a third party, the person doing it is entitled to indemnity from him who requested that it should be done.” Secretary of State etc. v. Bank of India

Under English law, contracts of indemnity cover a much wider field than that included in section 124 of the Indian Contract Act. In England contracts of indemnity include prom­ises, express and implied, to indemnify a person from loss caused by events or accidents which may not depend upon the conduct of any person. In a Bombay case it was held that, “Sections 124 and 125 of the Contract Act are not exhaustive of the law of indemnity and the courts here would apply the same equitable principles that the courts in England do.” Gajanan v. Moreslrar.

Rights of the Indemnity-holder

Section 125 of the Contract Act lays down that the indem­nity-holder is entitled to get from the indemnifier :

1. all damages which he may be compelled to pay in any suit in respect of any matter to which the promise to indemnify applies ;

2. all costs which he may be compelled to pay in such suits (provided he acted prudently or with the authority of the indemnifier) ;

3. all sums which he may have paid upon compromise of such suit (provided the compromise was prudent or was authorized by the indemnifier).

Comments :

It has been held that the rights of the Indemnity holder, under Section 125, are not exhaustive. The indemnity holder may be entitled to other equitable reliefs also.

Bombay and Nagpur High Courts have held the indemnifier will be liable only after the actual loss was incurred. But according to the High Courts of Calcutta, Madras and Allahabad, the indemnity-holder can compel payment from the indemnifier even before he (the indemnity-holder) has met his liability. Osman Jamal & Sons v. Gopal.

CONTRACTS OF GUARANTEE

Definition

A contract of guarantee is a contract to perform the promise or discharge the liability, of a third person in case of his default.-Sec. 126.

P lends Rs. 5,000 to Q and R promises to P that if Q does not pay the money R will do so. This is contract of guarantee. Q is called the Principal Debtor, P the Creditor, and R the Guarantor or the Surety.

Classification

Contracts of guarantee may be of three types :

(1) for payment to the Creditor to the Principal Debtor by the Guarantor ;

(2) payment of price for goods sold, and

(3) fidelity guarantee

i.e. to discharge the liability of a person for good conduct of a service-holder.

A contract of guarantee may be for

(1) a future debt or obligation or for

(2) an existing debt.

A guarantee can also be

(1) a Simple Guarantee or

(2) a Continuing Guarantee

Essentials of a Valid Guarantee

1. A contract of guarantee must satisfy all the essential elements of a contract. (For example, the object must be lawful ; there must be free consent etc.) But the following points are to be noted.

2. A contract of guarantee may be either oral or written. ­Sec 126.

3. In a contract of guarantee there are three parties i.e., the creditor, the principal. debtor and the surety. All the parties must join the contract.

4. In a contract of guarantee, the primary liability is that of principal debtor. The liability of surety arises only when there is a default of the principal debtor. Therefore, the liability of the surety is secondary.

5. in a contract of guarantee the principal debtor may be a minor. In this case the surety is liable to pay even though the minor may not be. The contract will be enforced as between the surety and the creditor.

6. Consideration : In a contract of guarantee, the consi­deration received by the principal debtor is taken to be sufficient consideration for the surety. “Anything done, or any promise made, for the benefit of the principal debtor may be sufficient consideration to the surety for giving guarantee.”-Sec.127. Examples :

(i) B requests P to sell and deliver to him goods on credit. P agrees to do so, provided C will guarantee the payment of the price of goods. C promises to guarantee the payment in consideration of P’s promise to deliver the goods. This is a sufficient consideration for C’s promise.

(ii) P sells and delivers goods to B. C afterwards requests P to forbear to sue B for the debt for a year and promises that if he does so, C will pay for them in default of payment by B, P agrees to forbear as requested. This is a sufficient consideration for C’s promise.

(iii) P sells and delivers goods to B. C afterwards, without consideration agrees to pay for them in default of B. The agreement is void.

Contracts of Guarantee which are invalid

A contract of guarantee is invalid in the following cases :

1.misrepresentation : Any guarantee which has been obtained by means of misrepresentation mode by the creditor, or with his knowledge and assent, concerning a material part of the transaction, is invalid.-Sec. 142.

2. Concealment : Any guarantee which ,the creditor has obtained by means of keeping silence as to material circums­tances is invalid. Sec. 143. Examples :

(a) D engages B as clerk to collect money for him. B fails to account for some of his receipts, and D in consequence calls upon him to furnish security for his duly accounting. C gives his guarantee for B’s duly accounting. D does not acquaint C with B’s previous conduct. B afterwards makes default. The guarantee is invalid.

(b) G guarantees to C payment for iron to be supplied by him to B to the amount of 2000 tons. B and C have privately agreed that B should pay five rupees per ton beyond the market price, such excess to be applied in liquidation of an old debt. This agreement is concealed from G. G is not liable as a surety.

3.when Co-surely does not join : Where a person gives a guarantee upon a contract that the creditor shall not act upon it until another person has joined in it as co-surety, the guarantee is not valid if that other person does not join.-Sec. 144.

4. Lack of essential elements : A contract of guarantee is invalid if it lacks one or more of the essential elements of a contract (e.g., if there is want of free consent or if the object is illegal).

DIFFERENCES BETWEEN INDEMNITY AND GUARANTEE

1. In a contract of indemnity, there are ‘two parties : the indemnifier and the indemnity-holder. In a contract of guarantee there are three parties : the creditor, the principal debtor, and t surety.

2. In a contract of indemnity it is necessary to have only one contract, i.e., between the indemnity-holder and the indem­nifier ; in a contract of guarantee it is necessary to have three contracts, between the parties, i.e., between the creditors, the principal debtors and the surety.

3.in a contract of indemnity, the liability of the indemnifier is primary ; in a contract of guarantee, the liability of the surety is secondary i.e., the surety is liable only if the principal debtor fails to perform his obligations.

4. in a contract of guarantee there is an existing debt or duty, the performance of which is guaranteed by the surety. In a contract f indemnity, the liability of the indemnifier arises only on the happening of a contingency.

5. In a contract of indemnity the indemnifier can sue only the indemnity older for his loss, because there is no contract between the indemnified and other parties unless there is an assignment on his favour ; in a contract of guarantee the surety can proceed against principal debtor.

6. in a contract of guarantee the surety, after he discharges the debt owing to the creditor, can proceed against the principal debtor; in a contract of indemnity the loss falls on the indemnifier except in certain special cases.

CONTINUING GUARANTEE

Definition

A guarantee which extends to a series of transactions is called a Continuing Guarantee. (Sec. 129). A guarantee covering a single transaction may be called a Simple -Guarantee or Specific Guarantee.

Examples :

(i) D. in consideration that Q will employ C in collecting the rents/ of B’s zamindari, promises B to be responsible, to the amount of 5,000 rupees, for the due collection and payment by C of those rents. This is a continuing guarantee.

(ii) P guarantees payment to B a tea dealer, to the amount of Rs. 100 for any tea he may from time to time supply to C. B supplies C with tea to the value of Rs. 1000 and C pays B for it. After-ward B supplies C with tea to the value of Rs. 2000. C fails to pa The guarantee given by P was a continuing guarantee, and is accordingly liable to B to the extent of Rs. 1000.

(iii) P guarantees payment to B of the price of five sacks of flour o be delivered by B to C to be paid for in a month. B delivers re sacks to C. C pays for them. Afterwards B delivers four sack to C. which C does not pay for. The guarantee given by P was, of a continuing guarantee, and accordingly he is not liable for the rice of the four sacks.

How a Continuing Guarantee is Revoked

A continuing guarantee is revoked under the f owing circumstances.

I. By notice of revocation by the surety : The notice operates to revoke the surety’s liabilities as regards transaction is entered into after the notice. He continues to be liable for transactions entered into prior to the notice.-Sec. 130.

2. By the death of the surety : “The death of the surety operates, in the absence of a contract to the contrary, as a revocation of a continuing guarantee, so far a regards future transactions.”-Sec. 131

The estate of the surety is liable for all transactions entered into prior to the death of the surety unless there was a contract to the contrary. It is not necessary that the creditor must have notice of the death.

A continuing guarantee is terminated under the same cir­cumstances under which a surety’s liability is discharged.

THE EXTENT OF THE LIABILITY OF THE SURETY

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.­ Sec. 128.

Example :

G guarantees to B the payment of a bill of exchange by C, the acceptor. The bill is dishonored by C. G is liable not only for the amount of the bill but also for any interest and charges which may have become due on it.

A creditor is not bound first to proceed against the principal debtor. He can sue the surety without suing the principal debtor 3r without making the principal debtor a co-defendant. When the ?principal debtor is a minor, the surety alone is liable to the creditor.

Liability of two persons, primarily liable, not affected by arrangement between them that one shall be surety on other’s default

Where two persons contract with a third person to undertake e certain liability, and also contract with each other that one of them shall be liable only on the default of the other, the third person not being a party to such contract, the liability of each of such two persons to the third person under the first contract is not affected by the existence of the second contract, although much third person may have been aware of its existence.-Sec. 132.

Example

A and B made a joint and several promissory note to C A makes it, in fact, as surety for B and C. knows this as the time when the note is made. The fact that .4, to the knowledge of C made the note as surety for B, is no answer to a suit by C against .A upon the note.

WHEN IS A SURETY DISCHARGED FROM LIABILITY ?

The liability of a surety under a contract of guarantee comes to an end under any one of the following circumstances :

1. Notice of revocation

In the case of a continuing guarantee, a notice by the surety to the creditor stating that he will not be responsible, will revoke his liability as regards all future transactions. He will remain liable for all transactions entered into prior to the date of the notice.-Sec. 130.

2. Death of surety

In the case of a continuing, guarantee the death of a surety discharges him from all liabilities as regards transactions after his death unless there is a contract to the contrary .sec 131

3.variation  of contract

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.Sec. 133.

examples :

(a).a becomes surety to C for B’s conduct as a manager in C’s bank. Afterwards B and C contract, without A’s consent, the B’s salary shall be raised and that he shall become liable for one-fourth of the losses on overdraft. B allows a customer to overdraw, and the bank loses a sum of money. :I is discharged from his surety ship by the variance made without his consent, and is not liable to make good this loss.

(b) C agrees to appoint B as his clerk to sell goods at a yearly salary, upon ,4′s becoming surety to C for B’s accounting for moneys received by him as such clerk. Afterwards. without A’s knowledge or consent, C and B agree that B should be paid by a commission on the goods sold by him and not by a fixed salary a is not liable for subsequent misconduct of B.

(c)A gives to C a continuing guarantee to the extent of 3,000 rupees for any oil supplied by C to B on credit. Afterwards B becomes embarrassed, and without the knowledge of A. B and C contract that C.’ shall continue to supply B with oil for ready money and that the payments shall be applied to the then existing debts between B and C. .4 is not liable on his guarantee for any goods supplied after this new arrangement.

(d)C contracts to lend B 5,000 rupees on the 1st March. A guarantees repayment. C pays the 5,000 rupees to B on the 1st January. A is discharged from his liability, as the contract has been varied inasmuch as C might sue B for the money before the 1st March.

4. Release or discharge of principal debtor

The surety is discharged by any contract between the creditor and the principal debtor, by which the principal debtor is released, or by any act or omission of the creditor, the legal consequence of which is the discharge of the principal debtor.-Sec. 134.

Effect of Debt Relief Acts :

The Madras High Court held that if the liability of the principal debtor is reduced under the provisions of an Act for debt relief, the surety is liable only for the reduced amount. Subramania Chettiar v. M. P. Naravarrswami Gounder.

The Nagpur and the Kerala High Courts have held similar decisions.

Examples :

(a) G gives a guarantee to C for goods to be supplied by C to B. C supplies goods to 8 and afterwards B becomes embarrassed and contracts with his creditors (including C) to assign to them his property in consideration of their releasing him from their demands. Here B is released from his debt by the contract with C and G is discharged from his suretyship.

(b) A contracts with B to grow a crop of sugarcane on .4′s land and to deliver it to B at fixed rate, and C guarantees A’s performance of this contract. B diverts a stream of water which is necessary for irrigation of A’s land and thereby prevent him from raisin; the crops. C is no longer liable on his guarantee.

(c) D contracts with B for a fixed price to build a house for B within a stipulated time. B supplying the necessary timber. C guarantees D’s performance of the contract. B omits to supply the timber. C is discharged from hit suretyship.

5. Arrangement with principal debtor

A contract between the creditor and the principal debtor, by which the creditor makes a composition with, or promises to give time to, or not to sue, the principal debtor, discharges the surety, unless the surety assents to such contract.-Sec. 135.

With a third person

But where a contract to give time to the principal debtor is made by the creditor with a third person, and not with the principal debtor, the surety is not discharged.-Sec. 136.

Example :

C, the holder of an overdue bill of exchange drawn by D as surety for B, and accepted by B, contracts with M to give time to B. D is not discharged.

6. Creditor’s forbearance to sue does not discharge surety

Mere forbearance on the part of the creditor to sue the principal debtor or to enforce any other remedy against him does not, in the absence of any provision in the guarantee to the contrary, discharge the surety.–Sec. 137.

Examples :

(i) B owes to C a debt guaranteed by G. The debt becomes payable. C does not sue B for a year after the debt has become payable. G is not discharged from his suretyship.

(ii) Failure to sue the principal debtor until recovery is barred by Statute of Limitation does not operate as a discharge of the surety. mohant Singh v. Ba yi

7. Release of one co-surety

Where there are co-sureties, a release by the creditor of one of them does not discharge the others ; neither does it free the surety so released from his responsibility to the other sureties. ­Sec. 138.

8. Act or omission impairing surety’s eventual remedy

If the creditor does any act which is inconsistent with the rights of the surety, or omits to do any act which his duty to the surety requires him to do and the eventual remedy of the surety himself against the principal debtor is thereby impaired, the surety is discharged.-Sec. 139.

Examples :

(a) B contracts to build a ship for C for a given sum, to be paid by installments as the work reaches certain stages. S becomes surety to C for B’s due performance of the contract. C, without the knowledge of S prepays to B the last two installments. S is discharged by the prepayment.

(b) C lends money to 8 on the security of a joint and several promissory note made in C’s favour by B and by S as surety for B, together with a bill of sale of B’s furniture, which gives power to C to sell the furniture, and apply the proceeds in discharge of the note. Subsequently, C sells the furniture, but, owing to his misconduct and willful negligence, only a small price is realized. S is discharged from liability on the note.

(c) S puts M as apprentice to B, and gives a guarantee to B, for M’s fidelity. B promises on his part that he will, at least once a month. see M make up the cash. 8 omits to see this done as promised, and M embezzles. S is not liable to B on his guarantee.

9. Loss of security

If the creditor loses or parts with any security given to him by the principal debtor at the time the contract to guarantee was entered into, the surety is discharged to the extent of the value of the security, unless the surety consented to the release of such security.-Sec. 141.

10. Miscellaneous

A contract of guarantee is invalid if it is obtained by means of misrepresentation (Sec. 142), silence as to material circum­stances (Sec. 143), or if a co-surety fail; to join according to the terms of the contract (Sec. 144). See-pp. 150-151.

THE RIGHTS OF THE SURETY

A surety has the following rights :

Against the Principal Debtor

1. Right of Subrogation : Upon payment of performance of all that he is liable for, he is invested with all the rights which the creditor had against the principal debtor.-Sec. 140.

2. Right to Indemnity : in every contract of guarantee there is implied promise by the principal debtor to indemnify the surety; and the surety is entitled to recover from the principal debtor whatever sum he has rightfully paid under the guarantee, but no sums which he has paid wrongfully.-Sec. 145.

Examples :

(a) B is indebted to C and A is surety for the debt. C demands payment from A, and on his refusal sues him for the amount. A defends .       the suit,, having reasonable grounds for doing so, but is compelled to pay the amount of the debt with costs. He can recover from B the amount paid by him for costs, as well as the principal debt.

(b) C lends 8 a sum of money and A. at the request of B accepts at bill of exchange drawn by B upon A to secure the amount. C, the holder of the bill, demands payment of it from .a. and on .4′s refusal him upon the bill. .a not having reasonable grounds to pay, sues defends the suit, and has to pay the amount of the for so doing, costs. He can recover from B the amount of the bill, but bill and sum paid for costs, as there was no real ground for defending the action.

(c)A surety settled with the creditor by paying a sum smaller than the amount guaranteed. Held, he can recover only what he paid. Reed v. Norris.

Againstthe Creditor

A surety is entitled to the benefit If every Right of Security: which the creditor has against the principal debtor at security

when the contract of suretyship is entered into. Whether the time knows of the existence of security or not is imma­terial -Sec. 141.

“The expression `security’ in Section 141 is not used in any sense ; it includes all rights which the creditor had technical of the principal debtor at the date of against the property contract.” State of M P. v. Kalurum

examples :

(a) advances to B his tenant, 2000 rupees on the guarantee of A.C has also a further security for the 2000 rupees by a mortgage of  B’s furniture. B cancels the mortgage. 8 becomes insolvent, and of B to the (‘ sues .4 on his guarantee. A is discharged from liability to the amount of the value of the furniture.

(b)C a creditor whose advance to B is secured by a decree, receives also a guarantee for that advance from A.C  takes B’s goods  in execution under the decree, and then without the knowledge of A, withdraws the execution. A is discharged

(c)A is Sure for B, makes a bond jointly with B to C. to secure a from C to B. Afterwards, C obtains from B a further security loan the same debt. Subsequently, C gives up the further security. A it is not discharged­

Against the Co-surety-See Below.

CONTRIBUTION  BETWEEN CO-SURETIES

Definition

Where several persons guarantee a debt  or duty, they are called co-sureties.

Co-suretiesliable to contribute equally

Where two or more persons are co-sureties for the same debt or duty, either jointly or severally, and whether under the same or different contracts, and whether with or without the knowledge of each other, the co-sureties in the absence of any contract to the contrary, are liable as between themselves, to pay each an equal share of the whole debt, or of that part of it which remains unpaid by the principal debtor.-Sec. 146.

examples :

(a) A. B and C are sureties to D for the sum of 3,000 rupees lent to E. E makes default in payment. A. B and C are liable as between themselves, to pay 1000 rupees each.

(b) .4, B and C are sureties to D for sum of 1000 rupees lent to F_ and there is a contract between .4. B and (‘ that .q is to be responsible to the extent of one-quarter, B to the extent of one-quarter, and C to the extent of one-half. E makes default in payment. As between the sureties .4 is liable to pay 250 rupees, B 250 rupees and C 500 rupees.      .

Liability of Co-sureties bound in different sums

Co-sureties who are bound in different sums are liable to pay equally as far as the limits of their respective obligations permit.-Sec. 147.

examples :

(a) .A, B and C as sureties for D, enter into three several bonds, each in a different penalty, namely .9 in the penalty of 10,000 rupees, B in that of 20,000 rupees, C in that of 40,000 rupees, conditioned for D’s duly accounting to E. D makes default to the extent of 30,000 rupees. .4. B and C are each liable to pay 10,000 rupees.

(b)A, B and C as sureties for D, enter into three several bonds each in a different penalty, namely A in the penalty of 10,000 rupees, B in the that of 20,000 rupees, C in that of 40,000 rupees, conditioned for D’s duly accounting to E. D makes default to the extent of 40,000 rupees. A  is liable to pay 10,000 rupees, and B and C 15,000 rupees.

release of one co-surety – See para 7, p. 156.