Class Notes on Contract II – Unit I (2nd Sem / 3 year LL.B)

Contract of Indemnity

Indemnity Meaning –

To make good the loss incurred by another person
To compensate the party who has suffered some loss
To protect a party from incurring a loss

‘Contract of Indemnity’ Definition

A contract is called as a ‘contract of indemnity’ if –

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.

Modes of contract of indemnity

Expressed: When a person expressly promises to compensate the other from loss.
Implied: When the contract is to be inferred from the conduct of the parties or from the circumstances of the case.

Essential elements of a contract of indemnity

Contract: All the essentials of a valid contract must also be present in the contract of indemnity

Example:- X asks Y to beat Z and promises to indemnify Y against the consequences. Y beats Z and is fined Rs.1,000. Y cannot claim this amount from X because the object of the agreement was unlawful.

Loss to one party: A person can indemnify another person only if such other person incurs some loss or it has become certain that he will incur some loss.

Indemnity by the Promisor: The purpose of contract of indemnity is to protect the indemnity holder from any loss that may be caused to the indemnity holder.

Reason for loss: The contract of indemnity must specify that indemnity holder shall be protected from the loss caused due to –

Action of the promisor himself; or
Action of any other person; or
Any act, event or accident which is not in the control of the parties.

Rights of indemnity holder

Right to recover damages

The indemnity holder has the right to recover all the damages which he is compelled to pay in any suit in respect of any matter covered by the contract of indemnity.

Right to recover costs

The indemnity holder has the right to recover all the costs which he is compelled to pay in bringing or defending such suit.

Condition: The indemnifier authorised him to bring or defend the suit; or

The indemnity holder did not contravene the orders of the indemnifier; and The indemnity holder acted as it would have been prudent for him to act in the absence of any contract of indemnity.

Right to recover sums paid

The indemnity holder has the right to recover all the sums which he has paid under the terms of a compromise of such suit.
The indemnifier authorised him to compromise the suit; or
The indemnifier holder did not contravene the orders of the indemnifier; and the indemnity holder acted as it would have been prudent for him to act in the absence of any contract of indemnity.

Commencement of the indemnifier’s liability

Contract of Guarantee

Meaning of ‘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.

Meaning of ‘surety’: The person who gives the guarantee is called as ‘surety’

Meaning of ‘principal debtor’: The person in respect of whose default the guarantee is given is called as ‘principal debtor’.

Meaning of ‘creditor’: The person to whom the guarantee is given is called as ‘creditor’.

guarantee-chart

Difference between contract of indemnity and Guarantee

Essentials of a valid Contract Of Guarantee

Must have all the essentials of a valid contract: All the essentials of a valid contract must be present in the contract of guarantee.

Exceptions:

Consideration received by the principal debtor is a sufficient consideration to the surety for giving the guarantee.
Even if principal debtor is incompetent to contract, the guarantee is valid. But, if surety is incompetent to contract, the guarantee is void.

Primary liability of some person

The principal debtor must be primarily liable. However, even if the principal debtor is incompetent to contract the guarantee is valid.
The debt must be legally enforceable.
The debt must not be a time barred debt.

The contract must be conditional

The liability of surety is secondary and conditional.
The liability of surety arises only if the principal debtor makes a default.

No misrepresentation

The creditor should disclose all the facts which are likely to affect the surety’s liability.
There must not be any concealment of facts.

Form of contract

A contract of guarantee may be either oral or written.

Joining of other co-sureties

The guarantee by a surety is not valid if –

A condition is imposed by a surety that some other person must also join as a co-surety; but
Such other person does not join as a co-surety.

Nature and Extent of Surety’s Liability

Surety’s liability is coextensive with liability of principal debtor

General rule –

Surety is liable for all the debts payable by the principal debtor to the creditor.Accordingly, interest, damages, costs etc. may also be recovered from the surety.

Exception:-

The contract of guarantee may provide otherwise.

Commencement of surety’s liability

The liability of surety arises immediately on default by the principal debtor.

The creditor is not required to –

(a) first sue the principal debtor; or
(b) first give a notice to the principal debtor.

Surety’s liability may be limited

The surety may fix a limit on his liability up to which the guarantee shall remain effective.

Surety’s liability may be continuous

The surety may agree to become liable for a series of transactions of continuous

nature. However, the surety may fix –

– a limit on his liability upto which the guarantee shall remain effective;
– a time period during which the guarantee shall remain effective.

Surety’s liability may be conditional

The surety may impose certain conditions in the contract of guarantee. Until those conditions are met, the surety shall not be liable.

Continuing Guarantee

Meaning: A guarantee which extends to a series of transactions is called as continuing guarantee.

Revocation (Sec.130):
Continuing guarantee may be revoked, at anytime, by the surety by giving a notice to the creditor. However, revocations shall be effective only in respect of future transactions (i.e. the liability of the surety with regard to previous transactions remains unaffected)

Death of surety (sec. 131): Death of the surety operates as a revocation of a continuing guarantee as to future transaction.

Rights of Surety (Sec.140, 141, 145, 146 and 147)

I. Rights against principal debtor

Right of indemnity

There is an implied promise by the principal debtor to indemnity the surety.
The surety is entitled to claim from the principal debtor all the sums which he has rightfully paid.
The surety cannot recover such sums, which the he has paid wrongfully.

Right of subrogation

On payment of a debt, the surety shall be entitled to all the rights which the creditor could claim against the principal debtor.

II. Rights against the creditor

Right of subrogation

The surety can claim all the securities which the creditor had at the time of giving of guarantee
It is immaterial as to whether the surety had knowledge of such securities or not.
If the securities are returned by the creditor to the principal debtor the surety is discharged to the extent of value of the securities so returned.

Right of set off

Any amount recoverable by the principal debtor may be claimed as deduction.
Any amount recoverable by the surety may be claimed as deduction.

Rights to share reduction

If the principal debtor becomes insolvent, the surety may claim proportionate reduction in his liability.

III. Rights against co-sureties

Rights to contribution

General Rule: All the co-sureties shall contribute equally

Exceptions

Under the contract of guarantee, the co-sureties may fix limits on their respective liabilities.
Even in such a case, the co-sureties shall contribute equally, subject to maximum limit fixed by the co-sureties.
The contract of guarantee may provide that the co-sureties shall contribute in some other proportion.

Right to share benefit of securities

If one co-surety receives any security, all the other co-sureties are entitled to share the benefit of such security.

Distinction between Indemnity and Guarantee

Basis	Contract of indemnity	Contract of guarantee
Meaning	A contract by which one partypromises to save the other from loss caused to him is called as a contract of indemnity.	A contract of guarantee is acontract to perform the promise, or discharge the liability of a third person in case of his default.
Parties	There are only two parties, viz, the indemnifier and the indemnity holder.	There are three parties, viz., the principal debtor, creditor and the surety.
Nature of liability	The liability of the indemnifier is primary and independent.	The liability of the surety is secondary and conditional.
Number of contract	In a contract of indemnity there is only one contract.	In the contract of guarantee, there are three contracts; first between principal debtors and creditor, second between creditor and surety, and third between surety and principal debtor.
Nature of contract	The contract of indemnity is for the reimbursement of the loss.	The contract of guarantee is for the security of the creditor.

Discharge of Surety from Liability (Sec.130 to 144)

	DISCHARGE OF SURETY
Revocation of contract of guarantee	Invalidation of contract of guarantee	Conduct of Creditor

Notice of revocation by surety

Specific guarantee

A specific guarantee can be revoked only if liability of principal debtor has not
arisen.

Continuing guarantee

A continuing guarantee can be revoked only in respect of future transactions.

Death of surety

In case of death of surety, a continuing guarantee is automatically revoked in respect of future transactions.

Variance in terms If –

Any variation is made subsequent to formation of contact of guarantee; and
Such variation is made without the consent of surety;

Then –

The surety shall be released for such transactions as take place after such variation.

Release or discharge of principal debtor

If –

The creditor makes a fresh contract with the principal debtor whereby the principaldebtor is relieved from his liability; or –
The creditor does any act or omission resulting in discharge of the principal debtor;