CONTRACT OF INDEMNITY VS CONTRACT OF GUARANTEE

Introduction

This article is an effort and aims to explore the different provisions in India between the contract of Indemnity and Guarantee.

Guarantees and indemnities are common ways in which creditors/lenders protect themselves from the risk of debt defaulters. Creditors will often seek a guarantee or an indemnity if they have doubts about a borrower's ability to fulfil its commitments or obligations under a loan agreement. Guarantors and indemnifiers take on a serious financial risk while entering into such transactions, and it is important that they are aware of all the implications and laws protecting them.

CONTRACT OF INDEMNITY

Meaning & Nature

“Indemnity” is a widespread expression used not only in a contractual context. It can be defined as “a duty to make good any loss, damage or liability incurred by another,” or alternatively “the right of an injured party to claim reimbursement for its loss, damage or liability from a person who has such duty.”[1]

If we have to explain a layman, Indemnity means “Security from the loss”. This term is generally used for insurance contracts, but it may be noted here that Life insurance is not a contract of indemnity and does not fall under the purview of indemnity.

Provisions in India

The scope of“Indemnity” as a concept, developed under the common law, and is much wider inits scope and application as compared to the scope of “Indemnity” as defined under Section 124 of the Indian Contract Act, 1872. Indemnity, as developed in common law, includes the losses caused by events or accidents which may not depend on the conduct of any person and includes losses due to accident or events which may not have been caused by the indemnifier or any other individual.  Section 124 of the Indian Contract Act, in contrast, limits itself to losses caused by the indemnifier or any other person. The Act does not, within its scope, include indemnity tolosses arising out of any natural event or act of god or any accident not caused by any person.

In the case of Gajanan Moreshwar vs Moreshwar Madan Mantri,[2]

Section 124 of the Contract Act, deals only with one particular kind of indemnity which arises from a promise made by the indemnifier to compensate the indemnified from the loss caused to him by the conduct of the indemnifier himself or by the conduct of any other individual, but does not deal with those cases where the indemnity arises from loss caused by events or accidents which do not or may not depend upon the conduct of the indemnifier or any other person, or by reason of liability incurred by something done by the indemnified at the request of the indemnifier himself. Section 125 of the Indian Contract Act, deals only with the rights of the indemnity-holder in the event of his being sued by the indemnifier.

CONTRACT OF GUARANTEE

Meaning

A "contract of guarantee” is a contract to perform a promise, or 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 given is called the " principal debtor ", and the person to whom the guarantee is given is called the " creditor ". A guarantee may be either oral or written.

One of the most important cases related to guarantee is,

State of M P V Kaluram (1967)

State sold a lot of felled timber to a person. Price was payable in 4 installments. Payment was guaranteed by defendant-if there was default in payment of an installment, State would prevent further removal of timber & sell remaining timber for realisation of price.Buyer defaulted but even so State allowed him to remove the Timber. Surety was then sued for the price. Held- not liable. By allowing goods to be removed by the buyer the security was lost.If the securities are burdened with further advances it will not affect the rights of the surety.

Following are the main points of difference between a contract of indemnity and a contract of guarantee:

I)                  In a contract of indemnity there are only two parties i.e., indemnifier and the indemnified,while in a contract of guarantee there are three parties-  principal debtor, creditor and the surety.

II)                In a contract of indemnity there is only one contract, whereas in a contract of guarantee, there are three contracts.

III)            In a contract of indemnity, the indemnifier undertakes to save the indemnified from any loss caused to him by the conduct of indemnifier himself or the conduct of any other person. While in a contract of guarantee, the surety undertakes for the payment of debts of principal debtor, if the principal debtor fails to pay the required amount.

IV)             In a contract of indemnity, the liability of indemnifier is primary and independent, while in a contract of guarantee the liability of surety is secondary i.e., it arises on the default of principal debtor. The primary liability falls on the principal debtor.

V)               In a contract of indemnity, the indemnifier's liability arises only on the happening of a contingency or a situation, while in a contract of guarantee there is an existing duty or debt,the performance or payment which is guaranteed by the surety.

VI)            In a contract of indemnity, indemnifier acts independently without any request of the debtor or any third party, while in a contract of guarantee the surety guarantees at the request of principal debtor.

VII)         In a contract of guarantee, if the principal debtor fails to pay the amount and the surety discharge his debt, the surety can proceed against the principal debtor in his own right, while in a contract of indemnity, the indemnifier cannot sue the third party in his own name unless there is an assignment in the indemnifier's favour. If there is no such assignment, from The other side, then the indemnifier must bring the suit in the name of indemnified.

[1] Black’s Law Dictionary

[2](1942) 44 BOMLR 703

‍