Contracts of Indemnity and Guarantee

Abstract

The Article deals with the concept of Contract of Indemnity and Contract of Guarantee separately as well as jointly. The concept of Indemnity has been dealt with respect to English as well as Indian Law and a line of difference has been drawn between the two. The concept of Guarantee has been rather dealt with briefly because of the vastness of the topic. However, the Article touches upon its important aspects, its elements, liability of the Surety and, the relationship between the Parties. Lastly, a distinction has been drawn between the two Contracts which shows that how the two are different from each other yet connected on the basis of protecting the Parties from the losses.

Keywords: Indemnity, Indemnifier, Indemnity-Holder, Insurance, Guarantee, Creditor, Principal-Debtor, Surety, liability, difference.

What is Indemnity?

Indemnity or Contract of Indemnity is defined under Section 124 of the Indian Contract Act and comprises under its ambit Section 124 and Section 125. It is very narrow in terms of definition and is restricted to only those situations where there is a promise to indemnify against losses. Indemnity basically means to make good to the losses occurred due to the promisor or by a third person.

The concept of Indemnity is different under English Law and Indian Law. The Article will be dealing with both the laws separately.

Indemnity under English Law:

Contract of Indemnity is wide under the English Law. It arises in situations where there is an implied condition that the person shall be indemnified even though there was no express Contract to the effect. The above statement shall be supported by the following case laws. In the case of Adamson v. Jarvis[1], there was an auctioneer (Plaintiff) who was told by the Defendant to sell cattle. However, the Plaintiff later came to know that the Cattle did not belong to the Defendant, he did not have any authority to instruct him with regard to it. The person to whom the Cattle actually belonged sued the Plaintiff. The Plaintiff in turn sued the Defendant for the loss he had to incur because of his wrong deed. The Court in this case held that the Plaintiff was entitled to assume that, what he did on the basis of the instruction given by the Defendant, if, turned out to be wrongful then he could be indemnified. This shows that indemnity under English Law ensures that a person is saved from the wrongful act and its consequences.

In another case of Dugdale v. Lovering[2], the Plaintiff had the possession of certain trucks which were claimed by the Defendant as well as one K.P. Co. When the Defendant demanded the delivery of the Trucks, the Plaintiff said that they needed an indemnity bond for their protection, however, they got no reply from the other side. K.P Co. sued the Plaintiff for conversion of their property. The Court said that the Plaintiffs were entitled to be indemnified by the Plaintiffs as is implied from their action of demanding indemnity on delivery of trucks. This case shows that under English Law, the person is entitled to indemnification even under situations of implied promise or in situations where it appears from the actions of the promisee that they shall have acted only if they would be getting indemnification.

The English Law uses maxim: “You must be damnified before you can claim to be indemnified”[3], this means that in order to claim to indemnification, the person must face some kind of loss, i.e., there should be a loss which has to be made good. Further, under English Law the Contract of Indemnity also applies in situation where loss may occur due to some form of accident such as fire.[4]

Indemnity under Indian Law:

Indemnity under Indian Law is mentioned and developed under Section 124 and Section 125 of Indian Contract Act, 1872.

Section 124 defines Indemnity. This definition is very plain and narrow as it simply states that the other party will be entitled to indemnity if they have been given the promise to be indemnified for a loss which occurs/may occur due to the action of the indemnifier or any other person.

The person who gives the promise to provide indemnification is known as the Indemnifier, while the person to whom the indemnification will be given due to any event which might cause loss to them is known as the indemnity-holder.

In respect of Section 124, Gajanan Moreshwar Parlekar v. Moreshwar Madan Mantri[5]is one of the most important landmark case. In this case, BMC gave a land to the Plaintiff on lease for 999 years. The Plaintiff allowed Defendant to carry out construction on the land. During the construction, he incurred a debt of Rupees 5,000 to the material supplier (twice). So, he asked the Plaintiff to mortgage the part of the land to the material supplier with the promise that he will be indemnified by the Defendant in case of any loss. The Defendant failed to pay the money to the material supplier, so the Plaintiff sued the Defendant. The Court held that in order to get indemnification the indemnity-holder does not have to be damnified like the English Law. If the Indemnity-Holder has not faced any loss but may suffer in the future, then he may sue to get indemnity. But since in this case the liabilities were past, which means prior to the date when the Contract was entered into, so Section 124 was not applicable.

The next Section to be dealt with is Section 125. It deals with the Right of the Indemnity-Holder and lays down three conditions under which they can recover their amount which they spent during the civil suit. These three conditions are that of: Damages, Costs and Sums, and the important thing to be noted is that all the sums and costs should be incurred as a prudent man would incur in the absence of a Contract.

A person who encashes an indemnity bond can keep only that part of the money which forms the damages, or the loss incurred by them as a result of the conduct of the indemnifier. Any amount kept in addition to this amount would be beneficial for one and a fine for the other party.[6]

Contracts of Insurance:

All Insurances are Contracts of Indemnity other than that of life and accident[7], because there is no value of a person’s life and it cannot be attributed to money. This statement marks a difference between English and Indian Law, as, in English Law accidents are considered to be a part of Contract of Indemnity. The case of New India Assurance Company Ltd. v. Kusumanchi Kameshwra Rao & Ors.[8], laid the difference between the Contracts of Insurance and Contract of Indemnity. It stated that the Contract of Indemnity deals with those cases where the loss occurs due to the events which is caused by the actions of the Indemnifier, unlike Contracts of Insurance. A similarity between both the Contracts is that both of them are Contingent Contracts, as both of them depend on the future happenings.

What is a Contract of Guarantee?

Contract of Guarantee has several definitions in various sources. However, to simply put it, it is a promise for assurance of payment of debt or performance of some duty to another party.

The person who gives such promise/guarantee is known as the ‘Surety’, the person on whose default such promise if given is known as the ‘Principal-Debtor’, and the person to whom the promise is given is known as the ‘Creditor’.[9]

The Elements of it are as follows:

· Three Parties:

It consists of three parties i.e., The Creditor, The Principal-Debtor, and the Surety.

· Existing Liability:

In Contracts of Guarantee, the Liability is an existing liability and is not time-barred.

· Payable on Demand:

The amount for which Guarantee is given is payable only on demand, i.e., the limitation period will start only when the demand for the money is made.

· Consideration:

In Contracts of Guarantee, the amount advanced by the Creditor to the Principal-Debtor is enough consideration for the Surety to accept the agreement. [10]

Relationship between the Principal-Debtor and Surety:

The case of V. Velayudhan v. State Bank of India[11]establishes that the relationship between the Principal-Debtor and Surety is based on trust i.e., there exists a fiduciary relationship between the Principal-Debtor and the Surety. In this case, the Bank had to recover a loan, but since the Principal-Debtor had died so the amount had to be recovered from the Surety. However, the Surety refused to pay the amount on the contention that he did not have enough money with respect to the payment of loan. The Court held that: The Surety has to act in a fiduciary capacity as he had put himself in this position by promising to act for the benefit of the Principal-Debtor. The Creditor had given the money on the basis of promise which the Surety had given at the time of the formation of Contract, he had reposed his trust into the Surety. Thus, the role/position of a Surety is near to that of a trustee.

Extent of Surety’s Liability:

The liability of a Surety is co-extensive with that of the Principal-Debtor[12], this means that he will be liable for the amount which the Principal-Debtor owes to the Creditor and will not be liable for more.

Ø Joint and Several Liability:

In cases where there is more than one guarantor, all the guarantors have equal position and responsibility. This shall be proved through the case law mentioned below.

In the case of National Provincial Bank of England v. Brackenbury[13], the defendant signed a guarantee, and since there were more than 1 guarantors who had to sing an agreement, so the Contract was prima facie that of joint and several. However, one of them did not sign. The Court held that there was no agreement between the Bank and the co-guarantors as the signature of all the guarantors were not present.

Ø Does the Creditor have to exhaust all his remedies before claiming the amount from the Surety?

The answer to this question lies in the case of Bank of Bihar v. Damodar Prasad[14]. In this case, the Defendant had guaranteed to pay a Bank Loan if the Principal-Debtor defaulted. When the Principal-Debtor defaulted to pay, the Defendant was sued. The Trial Court held that the Creditor first has to exhaust all his remedies against the Principal-Debtor then only can he approach the Surety. This decision was upheld by the Patna High Court. However, the Supreme Court overruled the decisions and held that this would defeat the very purpose for which the Contract of Guarantee was formed. If the Creditor first has to exhaust all his remedies against the Principal-Debtor, then what would be the purpose of a Surety. It is the duty of the Surety to pay the amount when the Principal-Debtor has defaulted and cannot dictate the terms to the Creditor by asking him to first exhaust all his remedies against the Principal-Debtor.

Difference between Contract of Indemnity and Contract of Guarantee:

Conclusion:

After perusing the above points, it can be concluded that Contract of Indemnity and Contract of Guarantee differ from each other yet are similar in some respects. They are connected to each other in terms of the compensation they give to the Parties. Both the Contracts are crucial to the very existence of Contracts as they protect the parties from the loss which they may incur or which they might have incurred, and while a Contract of Indemnity may not be in a Contract (either expressly or impliedly), but if there is a Contract of Guarantee, the Contract of Indemnity will be there.

[1] (1827) 4 Bing 66. [2] (1875) LR 10 CP 196. [3] Contract of Indemnity and Guarantee, Contract of Indemnity & Guarantee, Academia, available at http://www.academia.edu/9012692/Contract_of_Indemnity_and_Guarantee, last visited on (14/01/2021). [4] Contract of Indemnity in India and UK, available at http://lawtimesjournal.in/contract-of-indeminity/#_ftn5 , (last visited on 14/01/2021). [5] AIR 1942 Bom 302. [6] Cargill International SA v. Bangladesh Sugar & Food Industries Corpn, (1996) 4 AII ER 563 (CA). [7] Avtar Singh, Contract & Specific Relief Act 594 (Eastern Book Company, 34, Lalbagh, Lucknow- 226 001, 12th edn., 2019). [8] (1997) 9 SCC 179. [9] The Indian Contract Act, 1872 (Act 9 of 1872), s.126. [10] The Indian Contract Act, 1872 (Act 9 of 1872), s. 127. [11] AIR 1989 Ker 38. [12] The Indian Contract Act, 1872 (Act 9 of 1872), s. 128. [13] [(1906) 22 TLR 797]. [14] [(1969) 1 SCR 620]. [15] Yeoman Credit Ltd v. Latter, [1961] 2 All ER 294. [16] Subramanium Chettiar v. M P Narayanswami Gounder, AIR 1958 Mad 48. Also see Ayupanni Mani v. Devassy Kochouseph, AIR 1966 Kerala 203, this case upheld the decision of the aforementioned case.