Published On:Saturday, 17 December 2011
Posted by Muhammad Atif Saeed
INDEMNITY and GURANTEE
Introduction
To “ indemnify ” means “ to make good the loss of another in certain events”. Suppose a friend of yours sends you a parcel of books from Mumbai through railway. He sends you the receipt by post which entitles you to claim the parcel from the railway. If the receipt is lost , you can claim the parcel from the railway by filling in an indemnity bond by which you undertake to make good the loss of the railway in case any other claimant comes forward to claim the parcel.
“Guarantee“ means an agreement by which a person undertakes to answer for the payment of a debt or the performance of a duty of another in case he makes a default. Suppose you want to buy a car on hire- purchase by making monthly payments over a period of time. The car company would agree to deliver the car to you when someone on your behalf assures the company to make the monthly payments in case you make a default. This undertaking by that person would result in a contract of surety ship or guarantee.
Contracts of indemnity and guarantee are a species of a general principles of law of contract are applicable to them.
CONTRACT OF INDEMNITY
A contract by of indemnity is defined by Sec. 124 as under :
A contract by which one party promises to save the other from loss caused to him by the conduct of any other person, is called a contract of indemnity.
Example. A contracts to indemnify B against the consequences of any proceedings which C may take against B in respect of a certain sum of Rs.200. This is a contract of indemnity.
The person who promise to make good the loss is called the indemnifier ( promisor ) and the person whose loss is to be made good is called the indemnified ( promisee).
The definition of a contract of indemnity as given in the Indian Contract Act , 1872 is not exhaustive. It does not include:
(a) implied promises to indemnify , and
(b) cases where loss arises from accidents and events not depending on the conduct of the promisor or any other person.
CONTRACT OF GURANTEE:
Sec. 126 defines a contract of guarantee as follows :
A contract of guarantee is a contract to perform the promise or discharge the liability, of a third person in case of his default. The person who gives the guarantee is called Surety, the person in respect of the default the guarantee is given is called the principal debtor and the person to whom the guarantee is given is called the creditor. A guarantee may be either in written or oral.
Example: A request B to lend Rs.500 to C and guarantees that if C fails to pay the amount than he will pay it. This is a contract of guarantee. A , in this case, is the surety; B in this case is the principal debtor.
A contract of indemnity and of guarantee must have all the essentials elements of a valid contract. The following two points should be noted in the connection with the contract of guarantee:
1. Though all the parties must be capable of entering into a contract , the principal debtor may be a party incompetent to contract, e.g. a minor
2. Consideration received by the principal debtor is sufficient 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.“
Example: B requests A to sell and deliver to him goods on credit. A agrees to do so provided C will guarantee the payment of the price of goods. C promise to guarantee the payment in consideration of A’s promise to deliver the goods . This is sufficient consideration for C’s promise.
Distinction between a contract of indemnity and a contract of guarantee
| Contract of indemnity
| Contract of guarantee
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Nature of contract of insurance. A contract of insurance except life insurance is a contract of indemnity.
Rights of indemnity holder :
According to sec. 125 an indemnity holder ( i.e. indemnified ) is entitled to recover from the promisor ( i.e. indemnifier )
- All damages which he may be compelled to pay in any suit in respect of a matter to which the promise to indemnify applies;
- all costs which he may be compelled to pay in such suits , provided he acted as any prudent man would act under the similar circumstances in his own case or with the authority of the promisor ( indemnifier); and
- all sums which he may have paid under the terms of any such suit provided the compromise was prudent or was authorised by the promisor(indemnifier).
Nature of surety’s liability
The liability of the surety is co-extensive with that of principal debtor , unless it is otherwise provided by the contract
Example: A guarantees to B the payment of Bill of Exchange by C, the acceptor. The bill is dishonoured by C. A is liable not only for the amount of bill but also for any interest charges which may have due on it.
KINDS OF GUARANTEE
A guarantee may be given for the payment of debt , for the payment of the price of goods sold on credit, the good conduct or honesty of a person employed in a particular office. In last case, the guarantee is called a fidelity guarantee.
A guarantee may be given for existing or future , debt or obligation. In the former case it is called retrospective guarantee and in latter case it is termed as prospective guarantee.
A guarantee may be in respect of a single transaction or a number of transactions.
Specific guarantee. When a guarantee extends to a single transaction or debt it is called as a specific or simple guarantee. It comes to an end when the guaranteed debt is duly discharged or the promise is duly performed.
Continuing guarantee. When a guarantee extends to a series of transactions, it is called as continuing guarantee( Sec. 129 ). The liability of the surety in case of a continuing guarantee extends to all the transactions contemplated until the evocation of guarantee.
Examples :
S guarantees payment of C, a tea dealer, to the amount of Rs.10,000 for any tea he may from time to time supply to P. C supplies P with tea to the value above Rs.10,000 and P pays for it to C. Afterwards C supplies P with tea to the value of Rs.20,000P fails to pay it. The guarantee given by S is a continuing guarantee and he is accordingly liable to C to extent of Rs.10,000.
There can be continuing guarantee for a fixed period. A continuing guarantee only speaks of continuing transactions and not the period of such transactions
Revocation or termination of a continuing guarantee. A continuing guarantee may be revoked:
- By notice. A continuing guarantee may at any time be revoked by the surety as to the future transactions, by the notice to the creditor. ( Sec. 130)
- By the death of surety. The death of the surety generally operates as a revocation of a continuing guarantee, so far as regards future transactions ( Sec. 131 )
- By variance in terms of the contract. Any variance, made without surety’s consent, in the terms of the contract , between the principal debtor and the creditor, discharges the surety as to the transactions subsequent to the variance. (Sec. 133 )
Example. A becomes surety to B for the amounts he lends to C up to Rs.10,000 at 20 percent per annum. Afterwards, when B had already lent Rs.6,000 to C they mutually agree that the rate of interest for the subsequent loans should be reduced to 10 percent only. A is discharged from the liability for the subsequent loans.
- By novation. A continuing guarantee can be also determined by the novation which means substitution of the new contract for the old one.
- Release or discharge of principal debtor. If the principal debtor is released or discharged by any contract between the creditor and the principal debtor or by any act or the omission of the creditor, the continuing guarantee is terminated.( Sec. 134 )
- Arrangement with the principal debtor. If without the consent of surety there is a contract between the creditor and the principal debtor, by which the creditor makes the composition of debt with the principal debtor or gives him time for the repayment of the debt or promises not to sue him, the continuing guarantee terminates .( Sec. 135 )
- Act or omission imparting 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 continuing guarantee.
- Loss of security. If the creditor loses, or without the consent of the surety parts with the security given to him by the principal debtor at the time of the contract , the continuing guarantee terminates. ( Sec. 141 )
DISCHARGE OF SURETY
A surety is discharged from liability in one of the following ways:
1. Revocation
(a) Revocation by the surety giving a notice( Sec. 130 ). A guarantee may be a specific guarantee or a continuing guarantee. A specific guarantee which is given for a single specific debt , cannot be revoked by the surety , as to the future transactions , by notice to the creditor.
(b) Revocation by death. ( Sec. 131 ). The death of the surety normally operates as a revocation of a continuing guarantee so far as regards future transactions.
The deceased surety’s estate will not be liable for any transaction entered into between the creditor and the principal debtor after the death of the surety, even if the creditor has no notice of death.
(c) Revocation by novation.(Sec. 62). Novation means substitution of a new contract for an old one either between the same parties or between the different parties, the consideration for the new contract being mutual discharge of the old contract.
2. Conduct of the creditor
(a) Variance in terms of contract(Sec. 133). A surety is liable for what he has undertaken in the contract in the contract. Any alteration in the terms of the contract without the surety’s consent will discharge him as to the transactions subsequent to the variance.
Where the guarantee is a continuing one, any such alteration will discharge the surety from the liability for the transactions entered into subsequent to the variance.
Example. C contracts to lend B Rs.5,000 on 1st March. A guarantees repayment , C pays Rs.5,000 to B on the 1st January. A is discharged from his liability , as the contract has been varied in as much as C might sue B for the money before March 1st.
(b) Release or discharge of principal debtor( Sec. 134). The surety is discharged by any contract between the creditor and the principal debtor by which the principal debtor is released , or by act or omission of the creditor , the legal consequence of which is the discharge of the principal debtor.
Example. A contracts with B for a fixed price to build a house for B within the stipulated time , B supplying the necessary timber. C guarantees A’s performance of the contract. B omits to supply the timber . C is discharged from his guarantee.
However, the omission of the creditor to sue within the period of limitation. Does not discharge the surety.
(c)compounding by creditor with the principal debtor. ( Sec. 135 ) . 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 a contract.
It should be noted that where a contract 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 )
(d) Creditor’s act or omission imparting surety’s eventual remedy( Sec. 139 ). 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.
Example. B contracts to build up a ship for C for a given sum to be paid by instalments as the work reaches certain stages. A becomes surety to C for B’s due performance of the contract. C , without the knowledge of A prepays to B the last two instalments. A is discharged by this prepayment.
(e) Loss of security( Sec. 141). If the creditor loses or , without the consent of the surety , parts with any security given to him at the time of the contract of guarantee , the surety discharged from the liability to the extent of the security.
Example. C advances B , his tenant Rs.2,000 on the guarantee of A . C has also a further security for the sum by a pledge of B’s furniture. C cancels the pledge. B becomes insolvent and C sues A on his guarantee. A is discharged from the liability to the amount of the value of furniture.
Invalid contract of guarantee
A contract of guarantee is held to be invalid in the following cases:
1. When guarantee is obtained by misrepresentation(Sec. 142 ): Any guarantee which has been obtained by the means of misrepresentation by the creditor or with his knowledge and assent , concerning the material part of the transaction, is invalid.
2. When the guarantee is obtained by concealment( Sec. 143 ): Any guarantee which the creditor has obtained by means of keeping silence as to material circumstances is invalid.
3. When the creditor acts, the condition of co-surety joining not being fulfilled ( Sec. 144 ). When a person gives a guarantee upon a contract that the creditor shall not act upon it until another person has joined in it as a co-surety , the guarantee is not valid if that other person does not join.
4. When the contract of guarantee lacks one or more of the essential elements of the contract: A contract of guarantee , like any other contract , must have all the essential elements of a valid contract . if therefore , one or more of the essential elements is/are lacking , the contract shall become invalid.
RIGHTS OF SURETY:
A surety has rights against:
· The creditor
· The principal debtor and
· The co-sureties
1. Rights against the creditor:
(a) Before payment of the guaranteed debt: A surety may, after the guaranteed debt has become due and before he is called upon to pay, require the creditor to sue the principal debtor. However, the surety will have to indemnify the creditor for any expenses or loss resulting therefrom. In case of fidelity guarantee the surety can ask the employer to dismiss the employee in the event of his proven dishonesty.
(b) Right of set off: On being sued by the creditor the surety can rely on any set off or counter claim which the debtor has against the creditor (Bachevaise v. Lewis, (1872)]
(c) On payment of guaranteed debt: the surety is subrogated to all the rights of the creditor and gets the right to demand from the creditor at the payment of all the securities whether they had been received before, at or after, the creation of the guarantee(Sec.141)
Example: C advances to P, his tenant, Rs. 2,000 on the guarantee of S. C has also further security for Rs.2000 by a pledge of P’s furniture. C cancels the pledge. P becomes insolvent and C sues S on his guarantee. S is discharged from the liability to the amount of the furniture.
(d) Right to equities: On payment of the guaranted debt the surety is entitled to all the equities which the creditor could have enforced not only the principal debtor himself but also against the person claiming through him.
(e) Right of subrogation: Where a guaranteed debt has become due and the surety has paid all that he is liable for he is invested with all the rights which the creditor had against the principal debtor (Sec. 140). This means on payment of the guaranteed debt, the surety steps into the shoes of the creditor.
Right against the principal debtor
A surety has the following rights against the principal debtor:
(a) Rights to be relieved of liability: Before the payment has been made, the surety can compel the principal debtor to relieve him from the liability by paying off the debt. But before he can do so, the debt must be ascertained.
(b) Right to indemnify: In every contract of guarantee there is an implied promise by the principal debtor to indemnify the surety; and the surety is entitled to recover from the principal debtor, all the payments made properly (Sec. 145).
Examples: P is indebted to C and S is the surety for the debt. C demands the payment from S and on his refusal, sues him for the amount. S defends the suit, having reasonable grounds for doing so, but is compelled to pay the amount of debt with costs. He can recover from P the amount paid by him for costs, as well as the principal debt.
Rights against the Co-sureties:
(a) Right of Contribution. This rule is contained in Sec. 146 and 147. When a debt is guaranteed by two or more sureties, they are called co-sureties. The co-sureties are liable to contribute as agreed towards the payment of the debt to the creditor. If one of the co-sureties makes payment on the behalf of others then he has right to sue other co-sureties for their contribution.
(b) Co-Sureties liable to contribute equally (Sec. 146): If there is no contract between the co-sureties regarding their contribution towards the payment of the debt, then they are liable contribute equally.
(c) Release of Co- Surety: Where there are co-sureties, a release by the creditor of one of them does not discharge others, neither does it free the surety so released from his responsibility to the other sureties (Sec. 138)
(d) Liability of Co-sureties bound in different sums: (Sec. 147) Where the co-sureties have agreed to guarantee different sums, they have to contribute equally subject to the maximum amount guaranteed by each one. The fact that the sureties are jointly or severally liable under the contract, or without the knowledge of each other, is immaterial.
As between the co-sureties, the right of contribution arises only when the co-surety has paid more than he is liable to pay. And if co-surety obtains from the creditor any security of the principal debtor, the other co-sureties have a right to share in the proceeds of the security.
