Indemnity and Guarantee(Project in the subject of Specific Contracts)

SUBMITTED BY:SUBMITTED TO:

Madhurima Gadre,Semester III- BBA. LLB,Roll No. 1063 (Section A)

Ms. Gargi Chakrabarti,Faculty of Law,NLU Jodhpur.

National Law University, Jodhpur (Session of July-November 2014)

Acknowledgement

I take this opportunity to express my profound gratitude and deep regards to my guide Ms. Gargi Chakrabarti for her exemplary guidance, monitoring and constant encouragement throughout the course of this project. The blessing, help and guidance given by her from time to time shall carry me a long way in the journey of knowledge on which I am about to embark.I also take this opportunity to express a deep sense of gratitude to the staff of the library for their cordial support, valuable information and guidance, which helped me in completing this task through various stages.I am obliged to staff members of NLU, Jodhpur for the valuable information provided by them in their respective fields. I am grateful for their cooperation during my venture.

Through the medium of this project in the subject of Specific Contracts, I have tried my best in giving the reader a full analysis of a Contract of Indemnity and a Contract of Guarantee, their various aspects & relevant cases. I sincerely hope that after going through my work on this topic, one will be enlightened on the subject.Lastly, I thank everyone for their constant encouragement without which this Herculean task would not be possible.

-Madhurima Gadre2

19

Table of Contents

Table of Contents3 Introduction.4Objectives..5Research Methodology..5Chapter 1: Contract of Indemnity And Guarantee..6Chapter 2: Distinction between Indemnity & Guarantee10Chapter 3: Case Laws..13Conclusion...17Bibliography...18

Introduction

Indemnity and Guarantee are both closely related and often confused concepts. Parties rarely stop to consider whether they should be seeking a guarantee from the third party or both guarantee and indemnity, or even realize that there is a distinction between the respective obligations.

In fact, there are some significant differences between them and in particular differences in principle i.e. how they are created, the effect of variations of the obligations during the term and the discharge of the obligations.

In general an indemnity creates a primary obligation and a guarantee creates a secondary obligation.The contract of indemnity is for compensating the loss suffered by one person, either by the person causing the loss or a third party. Whereas, guarantee is a contract to perform the promise or discharge the liability of a third person, in case of his/her default. Unlike guarantee under indemnity, there is no direct right of action on the original contract to the person whose conduct has caused loss. The indemnity holder can only sue in the name of the promisee.

In the course of this project, the researcher has analyzed the rights & obligations of parties under Contract of Indemnity and Contract of Guarantee respectively, how a Contract of Indemnity differs from a Contract of Guarantee & the relevant cases pertaining to both topics. After such an analysis, the researcher concludes with a brief summary of the topics covered under this project.

Objectives:

1. To understand the concepts of Indemnity and Guarantee.2. To study the distinction between these two very similar types of Contracts.3. To analyze case laws highlighting the various aspects of Indemnity and Guarantee.

Research Methodology:

Primary sources for data required for the study of this topic include books, journals, reports etc. Secondary sources will include articles, commentaries, & other information available on the internet. Firstly, the concepts of Indemnity and Guarantee are thoroughly discussed. Then the essential elements, differences & case laws are analyzed. The project is concluded by summarizing the conceptual, India specific and comparative analysis of both Indemnity and Guarantee.

Chapter 1:Contract of Indemnity and Guarantee

I. Contract of Indemnity

Section 124 in the Indian Contract Act, 1872 encapsulates the concept of Indemnity: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.Illustration: A contracts to indemnify B against the consequences of any proceedings which C may take against B in respect of a certain sum of 200 rupees. This is a contract of Indemnity.

A contract of indemnity may arise either by- (i) an express promise, or (ii) operation of law. Indemnity normally denotes a contract by which the promisor undertakes an original and independent obligation to indemnify, as distinct from a collateral contract in the nature of a guarantee by which the promisor undertakes to answer for the default of another person who is to be primarily liable to the promise.[footnoteRef:2] Thus, we see that a Contract of Indemnity is a type of contingent contract. The Indemnifiers liability arises only if the losses have been suffered by the Indemnified party. For a claim of Indemnity to succeed, it is necessary to prove that the losses are actually suffered by the Indemnified party & also the suffered losses are in the ambit of the Contract of Indemnity. [footnoteRef:3] Rights and liabilities of parties in the indemnity contract are discussed below in detail. [2: Halsburys Laws of England, 4th Ed., Vol 20, para 305.] [3: S.S. Gulshan, Business Law, 4th Ed., Excel Books (2010).]

A. Rights of the Indemnified:

applies The indemnity holder is entitled to recover from the promisor all damages that he/she may be compelled to pay in any suit with respect to matters that the promise to indemnify. Indemnity holder can recover all costs of suit that he/she may have to pay to the third party, provided the person either acted under the authority of the indemnifier or if he/she has acted in such a way as a prudent person would act in his/her own case. Indemnified party can recover all sums that may have been paid under the terms of any compromise of any such suit if the compromise was not contrary to the orders of the indemnifier and was one which it would have been prudent for the promisee to make. Basically, the Indemnified party is entitled to recover all damages, costs & sums from the Indemnifying party arising out of the contingencies in the Indemnity Contract.

B. Rights of the Indemnifier:

The Indian Contract Act, 1872 makes no mention of the rights of the indemnifier. However, the indemnifiers rights are similar to the rights of a surety under Section 141. Section 141 reads that the person is entitled to the benefits of all the securities that the creditor has against the principal debtor, whether he/she was aware of them or not.

C. Commencement of Indemnifiers Liability:

The Indian Contracts Act, 1872 makes no mention of the commencement of the indemnifiers liability. Due to this reason, the English law is followed, according to which the indemnifiers liability commences only when the indemnified party incurs a loss in accordance to the Indemnity Contract. Indemnity requires that the party to be indemnified shall never be called upon to pay. The Indemnified party may compel the Indemnifier to place him in a position to meet liability that may be cast upon him without waiting until the Indemnified party has actually discharged it.[footnoteRef:4] [4: Kucchal M.C., Business Law, Vikas Publishing House Pvt. Ltd., New Delhi (2002).]

In some cases, High Courts have held that the indemnifiers liability shall commence as soon as the indemnity holders liability becomes absolute.II. Contract of Guarantee:

Section 126 in the Indian Contract Act, 1872 encapsulates the concepts of guarantee, surety, Principal-debtor, and creditor as follows:A contract of guarantee is a contract to perform the promise or to discharge the liability of a third person in case of his default. The person who gives the guarantee is called the surety; the person in respect of whose default the guarantee is called the principle-debtor, and the person to whom the guarantee is given is called the creditor. A guarantee may be oral or written.

The guarantee is a promise to answer for the payment of some debt, or the performance of some duty, in case of the failure of another party, who is in the first instance, liable to such payment or performance.[footnoteRef:5] Important concepts to be highlighted while studying guarantee are as follows: [5: Re Conley Trustee v. Barclays Bank Limited, (1939) 2 All ER 127.]

A. Concept of Continuing Guarantee:

A Guarantee which extends to a series of transactions is called a continuing guarantee. A continuing guarantee may at any time be revoked by the surety, as to future transactions, by notice to the creditor. 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.

B. Rights of a Surety as against the Creditor:

According to theIndian Contract Act, 1872, Section 133 - The creditor shall not vary terms of the contract between the creditor and the principal debtor without the surety's consent. Any such variance discharges the surety as to transactions subsequent to the variance. However if the variance is for the benefit of the surety or does not prejudice him or is of an insignificant character, it may not have the effect of discharging the surety. Section 134 - The creditor should not release the principal debtor from his liability under the contract. The effect of the discharge of the principal debtor is to discharge the surety as well. Any act or omission on the part of the creditor which in law has the effect of discharging the principal debtor puts an end to the liability of the surety. Section 135 - If an agreement is made between the Creditor and Principal debtor for compounding the latters liability or promising him extension of time for carrying out the obligations or promising not to sure, discharges the surety unless he assents to such a contract. Section 139 - The surety is discharged if the creditor impairs the surety's eventual remedy against the principal debtor.

C. Rights of Surety as against the Principal Debtor

Right of subrogation - The surety on payment of the debt acquires a right of subrogation. Section 140 - The surety cannot claim the right of subrogation to the creditor's securities if he has signed up as a security for a part of the agreement and security has been held by the creditor for the whole debt.

Chapter 2:Distinction between Indemnity and Guarantee

The term indemnity is used to denote a contract by which the promisor undertakes an original and independent obligation to indemnify, as distinct from a collateral contract in the nature of a guarantee by which the promisor undertakes to answer for the default of another person who is to be primarily liable to the promise.[footnoteRef:6] [6: Halsburys Laws of England, Fourth Edition, Vol. 20, para 305.]

While a guarantee is a tripartite contract between three persons: the principal-debtor, creditor and surety, a contract of indemnity is bilateral. Where the only contracts are between the principal debtor and the creditor, and the creditor and the surety, but no contract between the principle debtor and the surety, the case is one of indemnity.[footnoteRef:7] In a contract of indemnity, there is no privity of contract between the surety and the debtor,[footnoteRef:8] and the surety (here, indemnifier), cannot compel the principal debtor (here, the person in respect of whose conduct the indemnity is given) to pay.[footnoteRef:9] Unlike guarantee under indemnity, there is no direct right of action on the original contract to the person whose conduct has caused loss. The indemnity holder can only sue in the name of the promise.[footnoteRef:10] [7: Ramchandra B. Loyolka v. Shapurjee N. Bhownagree, AIR 1940 Bom 315; Brahmayya & Co. Official Liquidators v. K Srinivasan Thangirayyar, AIR 1959 Mad 122; Janwatraj v. Jethmal, AIR 1958 Raj 343.] [8: Jaganolb Boksh Singh v. Chandra Bhukan Singh, AIR 1937 Oudh 19.] [9: Ramchandra B. Loyolka v. Shapurjee N. Bhownagree, AIR 1940 Bom 315.] [10: K. V. Periyamianna Marakkayar & Sons v. Banians & Co., AIR 1926 Mad 544.]

L.C. Mather in his book Securities Acceptable to the Lending Banker[footnoteRef:11] has brought out the distinction between indemnity and guarantee with the following illustration. [11: L.C. Mather, Securities Acceptable to the Lending Banker, 4th Ed., Waterlow Publishers (1979)]

Illustration: A contract in which A says to B, If you lend Rs. 1 Lac to C, I will see that your money comes back is an indemnity. Onthe other hand undertaking in these words, If you lend 1 Lac to C and he does not pay you, I will pay is a guarantee.

Thus, in a contract of indemnity, there are only two parties, indemnifier and indemnified. In case of a guarantee, on the other hand, there are three parties, the principal debtor, the creditor and the surety.

A guarantee is a promise to someone that a third party will meet its obligations to them. If they do not pay you, I will pay you. An indemnity is a promise to be responsible for another persons loss and to agree to compensate them for anyloss or damageon mutually agreed terms. For example, one agrees to pay the difference of repairs if they exceed a certain limit.

Other points of difference between a Contract of Indemnity & Contract of Guarantee are explained as follows:

Contract of IndemnityContract of Guarantee

Comprises of only two parties- the indemnifier and the indemnity holder.There are three parties namely the surety, principal debtor and the creditor.

Liability of the indemnifier is primary in a Contract of Indemnity

The liability of the surety is secondary. The surety is liable only if the principal debtor makes a default. The primary liability being that of the principal debtor.

The indemnifier need not necessarily act at the request of the indemnified.The surety give guarantee only at the request of the principal debtor

The possibility of any loss happening is the only contingency against which the indemnifier undertakes to indemnify.There is an existing debt or duty, the performance of which is guarantee by the surety.

The indemnifier cannot proceed against third parties inhis own name, unless there is an assignment in his favor.After discharging the debt, the surety is entitled to proceed against the principal debtor in his own name.

In short, the contract of indemnity is for compensating the loss suffered by one person, either by the person causing the loss or a third party. Whereas, Guarantee is a contract to perform the promise or discharge the liability of a third person, in case of his/her default. [footnoteRef:12] [12: Tulsian P.C., Business Law, TataMcGraw-HillPvt. Ltd., New Delhi (2002).]

Chapter 3: Case Laws

I. Gajanan Moreshwar Parelkar v. Moreshwar Madan Mantri.[footnoteRef:13] [13: Gajanan Moreshwar Parelkar v. Moreshwar Madan Mantri, (1942) 44 BOMLR 703.]

A. Facts: The Plaintiff got a plot of land on lease from Municipal Corporation of Mumbai. The Plaintiff allowed the Defendant to erect building on that land. The Defendant, in this course, incurred debt of Rs.5000 from building material supplier, twice. On both the occasions, the Plaintiff mortgaged part of the land to the supplier. The Plaintiff, on the Defendants request transferred the land to the Defendant, on the consideration that he would discharge of all the liabilities arising out of that land. The Defendant failed to adhere to his consideration. The Plaintiff filed a suit for discharge of liabilities on him, alleging the Defendant to be the indemnifier.

B. Issues: Whether Sections 124 and 125 of the Indian Contract Act, 1872 are exhaustive? Whether no action could be maintained by the indemnity holder until the actual loss has occurred?

C. Held: Under both the mortgage and the further charge there is a personal covenant by the plaintiff to pay the amount due, and it would be open to the mortgagee to sue the plaintiff on the personal covenant reserving his rights under the security. Therefore, the liability of the plaintiff under the personal covenant is absolute and unconditional.

D. Importance: Section124 deals only with one particular kind of indemnityin which the loss is causedby the conduct of the indemnifier himself or of other person, but does not cover the cases outside this or cases when liability arises because of something done by the indemnified at the request of the indemnifier. Section 124 talks about subsequent conduct but here the liabilities were past, i.e. prior to the date when the contract was actually entered into force. Earlier to this contract, all the acts were done merely on request and without any consideration and hence, were not binding. Therefore Section 124 is inapplicable here.

II. Janwatraj v. Jethmal[footnoteRef:14] [14: Janwatraj v. Jethmal, AIR 1958 Raj 343.]

A. Facts: There was a partnership firm consisting of the plaintiff Janwatraj, the defendant Jethmal and certain other persons, which carried on business in the name and style of Oswal Brothers. The firm did business in the manufacture of pen-holders and required some machinery for that purpose. The plaintiff's case was that a sum of Rs. 3000/- was given by him to one Umar Bhai for purchasing the machinery and thereby a loss of Rs. 3000/- had been incurred. This loss was divided between the partners of the firm, and the defendant executed a khata for a sum of Rs. 561/8/- on 20th August 1947 by which it was agreed that the defendant would pay the aforesaid amount to the plaintiff if the said Umar Bhai refused to pay it. Umar Bhai did not pay anything to the plaintiff, and, consequently the latter tiled the present suit for the sum of Rs. 561/8/- as principal plus Rs. 118/13/- as interest, total Rs. 680/5/- on the 2nd of March, 1951.

B. Issues: Whether the position of the defendant in the case was that of surety or indemnifier?

C. Judgment: The suit concerned a contract of indemnity. Appeal was allowed and relief of damages plus due interest granted by the Court.

D. Importance: For suretyship to exist there have to be three parties creditor, principal debtor and surety and there has to be privity of contract between them. The surety can guarantee payment to the creditor only when asked to by the debtor. A contract to compensate the creditor for loss caused to him, without privity between them, makes it a contract of indemnity.

III. Bank of Bihar v. Damodar Prasad[footnoteRef:15] [15: Bank of Bihar v. Damodar Prasad, AIR 1969 SC 297.]

A. Facts: On the date of the suit Damodar Prasad (principal debtor) was indebted to the plaintiff for Rs. 11,723.56 on account of principal and Rs. 2,769.37 on account of interest. In spite of demands neither he nor Mr. Paras Nath Sinha, the guarantor, paid the dues. The guarantor agreed to pay and satisfy the liabilities of the principal debtor upto Rs. 12,000/- and interest thereon two days after demand. The bond provided that the plaintiff would be at liberty to enforce the guarantee. The demand for payment of the liability of the principal debtor was the only condition for the enforcement of the bond. That condition was fulfilled. Yet, neither the principal debtor nor the surety discharged the admitted liability of the principal debtor in spite of demands. Hence, the present suit for the recovery of sum.

B. Issues: Whether the plaintiff can only enforce his dues against the guarantor after exhausting all remedies against the principal debtor?

C. Judgment: The appeal was allowed and the respondent Dr. Paras Nath Sinha was directed to pay to the appellant costs.

D. Importance: The direction postponing payment of the amount decreed must be clear and specific. The injunction upon the creditor not to proceed against the guarantor until the creditor has exhausted his remedies against the principal is of the vaguest character. It is not stated how and when the creditor would exhaust his remedies against the debtor. The solvency of the principal is not a sufficient ground for restraining execution of the decree against the guarantor since, it is the duty of the guarantor to pay the amount.

Conclusion

In simple words, indemnity denotes a contract by which the promisor undertakes an original and independent obligation to indemnify, as distinct from a collateral contract in the nature of a guarantee by which the promisor undertakes to answer for the default of another person who is to be primarily liable to the promise.

For example, a contract in which A says to B, If you lend Rs. 1 Lac to C, I will see that your money comes back is an indemnity. Onthe other hand undertaking in these words, If you lend 1 Lac to C and he does not pay you, I will pay is a guarantee.

In other words, a guarantee is a promise to someone that a third party will meet its obligations to them. If they do not pay you, I will pay you. An indemnity is a promise to be responsible for another persons loss and to agree to compensate them for anyloss or damageon mutually agreed terms. For example, one agrees to pay the difference of repairs if they exceed a certain limit.

The contract of indemnity is for compensating the loss suffered by one person, either by the person causing the loss or a third party. Whereas, Guarantee is a contract to perform the promise or discharge the liability of a third person, in case of his/her default. Unlike guarantee, under indemnity there is no direct right of action on the original contract to the person whose conduct has caused loss.

Thus, in the course of this project the researcher has analyzed the rights & obligations of parties under Contract of Indemnity and Contract of Guarantee respectively, the distinction between the two & the relevant cases pertaining to both topics.

Bibliography

I. Treatises:

R.G. Padia (Ed.), Pollock & Mulla, Indian Contract and Specific Relief Act, Vol II, New Delhi Butterworth, 2011. A.C. Moitra, Principles and Digest of Indian Contract Act, Universal Book Agency, 1998. Chitty on Contracts, Specififc Contracts, Vol II, Sweet & Maxwell, London, 2008. Halsburys Laws of England, Guarantee & Indemnity, 4th Ed., Vol 20. S.S. Gulshan, Business Law, 4th Ed., Excel Books (2010). Kucchal M.C., Business Law, Vikas Publishing House Pvt. Ltd., New Delhi (2002).

II. Acts:

The Indian Contract Act, 1872.

III. Cases:

Gajanan Moreshwar Parelkar v. Moreshwar Madan Mantri, (1942) 44 BOMLR 703. Ramchandra B. Loyolka v. Shapurjee N. Bhownagree, AIR 1940 Bom 315. Brahmayya & Co. Official Liquidators v. K Srinivasan Thangirayyar, AIR 1959 Mad 122. Janwatraj v. Jethmal, AIR 1958 Raj 343. Jaganolb Boksh Singh v. Chandra Bhukan Singh, AIR 1937 Oudh 19. K. V. Periyamianna Marakkayar & Sons v. Banians & Co., AIR 1926 Mad 544. Re Conley Trustee v. Barclays Bank Limited, (1939) 2 All ER 127. Bank of Bihar v. Damodar Prasad, AIR 1969 SC 297.

IV. Websites:

http://www.indialawinfo.com/bareacts/soga.html books.google.co.in www.manupatrafast.in www.indiankanoon.org scholar.google.co.in www.lawnotes.in www.jstor.org indiancaselaws.wordpress.com www.preservearticles.com