By Ishita Sethi
Abstract
While the concepts of indemnity and guarantee differ in some ways, they are both systems of compensation with identical principles. The parallels and contrasts between the two are examined in this research. Indemnity, as defined under Section 124 of the Indian Contract Act, is a contract to keep a party indemnified against loss. A guarantee allows a person to obtain a loan on goods or employment, but it requires proper consideration. While a guarantee contract contains three parties with varied obligations, an indemnity contract only has two parties with primary liability. There are various such distinctions, with guarantee having a broad principle, as opposed to an indemnification, which appears on occasion.
I. Introduction
Contract of Indemnity and Contract of Guarantee differ on varied issues, while simultaneously being similar in certain ways. However, despite certain parallels, contracts of indemnity and guarantee differ in their basic meaning. In the present paper, the author seeks to draw such similarities and differences between the contract of indemnity and the contract of guarantee to grasp a better understanding of the same.
II. Contract of Indemnity
In layman’s terms, indemnity refers to the protection provided against any loss or damage. Legally, a contract of indemnity protects a party from the consequences of an act. Indemnity is defined in Section 124 of the Indian Contract Act, 1872, herein referred to as ICA, as the promise to save a party from loss caused by a third party or the promisor himself. In accordance with the illustration attached to Section 124, an indemnity contract is one in which a person promises to protect another from the consequences of a proceeding brought against him.
The essential elements of the definition are as follows:
- The indemnity-holder must face some financial loss or damage.
- The promisor or a third party must be responsible for the said loss/ damage.
- The indemnifier is liable to reimburse the loss or discharge the liability of the indemnity-holder.
A contract of indemnity encompasses all kinds of insurance except life insurance and personal accident insurance. When the indemnity holder incurs an absolute liability, they may ask the indemnifier to pay it off and release them from this obligation. The Indian Contract Act, 1872, provides that indemnity holders are entitled to recover the following amounts if they act within their authority:
- The promise of indemnity extends to all damages that he may be compelled to pay in any suit;
- If, in bringing or defending such suits, he does not violate the order of the promisor, and acted prudently in the absence of any indemnity contract, or if the promisor authorises him to bring or defend it, then he will be responsible for all costs;
- In the absence of any indemnity contract, or if the promisee was authorised by the promisor to compromise the suit, he would be liable for all sums he may have paid under the terms of any compromise of any such suit if the compromise was not contrary to the orders of the promisor.
The indemnity holder must keep certain conditions in mind while enjoying the above rights. His actions should be performed with care and caution, and he should act with normal intelligence. The indemnity-holder must act reasonably, just as if there were no contract of indemnity because the rights under the section are not absolute. All these conditions must be met for him to be eligible to claim these benefits.
In Gajanan Moreshwar Parelkar v. Moreshwar Madan Mantri, Chagla J. described the process of transformation and noted that even before indemnification, if the indemnity holder’s liability becomes absolute, the indemnifier may absolve him of his liability. The Calcutta High Court in its judgement in Osman Jamal & Sons Ltd. v. Gopal Purshottam reiterated this principle. Similarly, Adamson vs. Jarvis held that Adamson had to indemnify Jarvis since Jarvis was required to follow Adamson’s orders, and if anything went wrong, Jarvis would be compensated. Even before the actual loss occurs, the indemnity holder can contact the indemnifier to save him from loss.
III. Contract of Guarantee
A contract of guarantee as per section 126 of the Indian Contract Act 1872 is defined as— “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 provides the guarantee is termed the surety; the person 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.
The Kerala High Court ruled in P.J Rajappan v Associate Industries (P) Ltd that an oral guarantee is also valid, so a person whose signature did not appear on the guarantee papers is still liable.
The Essentials Of A Contract Of Guarantee are given as follows:
1. Tripartite Agreement: A contract of guarantee involves three parties, namely, principal creditor, creditor, and surety. Three separate contracts must exist in a contract of guarantee between three parties, each of which must be consenting.
2. Liability: Principal debtors are primarily liable in this case. In the event of default on payment by the principal debtor, the surety is liable for secondary damages.
3. Essentials of a Valid Contract: As with any general contract, it requires the consent, consideration, lawful object, and competency of the parties to be valid.
4. Medium of Contract: As aforementioned, the Indian Contract Act, of 1872, does not specify the necessity of a written guarantee contract. Both oral and written forms are acceptable.
Rights of a Surety:
As against the creditor:
In accordance with the Indian Contracts Act, of 1872,
1. Section 133: There should be no variation in the creditor-debtor agreement without the surety’s consent. In the event of a fluctuation, the surety will be released as to transactions resulting from the difference. If, however, the change is for the surety’s benefit or does not favour him, or if it is irrelevant, the surety may not be released.
2. Section 134: It is not appropriate for the creditor to discharge the principal debtor’s obligations under the agreement. By releasing the principal debtor, the surety is released as well. In law, any enactment or exclusion from the creditor that releases the principal debtor closes off the surety’s liability.
3. Section 135: As soon as a creditor and principal debtor reach an agreement to intensify the latter’s liability or guarantee him a greater period of time to fulfil the commitments, or swear to refrain from doing so beyond doubt, the surety is released unless he consents to the agreement.
4. Section 139: In the event that the creditor weakens the surety’s ability to pursue the principal debtor, the surety is released.
As against the principal debtor:
1. Right of subrogation – In the event that the surety makes good on the debt, he or she obtains a right of subrogation.
2. Section 140 of the ICA– The surety can’t assert his right of subrogation to the creditor’s securities if he has agreed as a security for a part of the contract and the creditor has secured the full amount due.
IV. Differences between Contract of Indemnity and Contract of Guarantee
In a contract of guarantee, there are always three parties; the creditor, the principal debtor, and the surety. In contrast, in a contract of indemnity, there are only two parties, the indemnifier and the indemnity holder. In a contract of indemnity, the indemnifier assumes the primary liability. In contrast, in a contract of guarantee, the debtor is primarily liable and the surety is secondary to the debtor in the event of a breach of contract.
When it comes to indemnity, the contingency present is the possibility or risk of suffering loss which the indemnifier agrees to compensate; however, in that case, it is a burden of payment or a duty whose performance is guaranteed by the surety; and in the case of guarantee, it is a debt or a duty whose performance is guaranteed by the surety.
The indemnifier’s interest is to earn a commission and a premium as a result of an indemnity contract, whereas, in a contract of guarantee, the only interest of the indemnifier is to obtain the guarantee. An indemnity contract prevents the indemnifier from suing a third party as a result of the indemnity. If the principal debtor has paid the debt, then surety has the right to sue the principal debtor in his name to collect the debt.
An indemnity contract aims to protect the party against loss by making a promise to pay the party in the event a loss occurs. In contrast, in a contract of guarantee the promise of payment or performance is split up into two separate promises, one being the original promise and the other being the promise of the guarantor to fulfil the promise if the original promise is not met.
It is evident from comparing Punjab National Bank Ltd. v. Bikram Cotton Mills and Anr and Gajan Moreshwar v. Moreshwar Madan that there is a clear difference between a guarantee and an indemnity. In the Punjab National Bank case, there are three parties involved, whereas in the case of Gajan Moreshwar, there are only two parties involved. The indemnifier in this case was Moreshwar Madan, and he was therefore the only one who was liable to make good on the money. However, in the Punjab National Bank case, the debtor, which is the first respondent company, is the primary liability holder, while the secondary liability lies with the surety, which is the respondent. In the case of Gajan Moreshwar, the Privy Council held that, even though the indemnity holder did not have the same rights that were stated in the sections mentioned above, he had other rights as well. If the indemnity holder incurs any liability, he can ask the indemnifier to discharge the liability, and Moreshwar Madan was instructed by the Privy Council to discharge Gajan Moreshwar’s liability. Although there was no risk involved in the case of Punjab National Bank, it is important to note that there is an existing obligation to pay off debts as outlined in the sections of the guarantee contract. Therefore, irrespective of the risk present in the contract, the principal debtor and surety have to do well to repay the debts to the creditor regardless of the presence of risk. Since it’s a contract of indemnity case, in the Gajan Moreshwar case, Gajan Moreshwar cannot sue K.D. Mohan. Only Moreshwar Madan can be sued. However, in the Punjab National Bank case, the surety can be sued along with the principal debtor.
V. Similarities between Contract of Indemnity and Contract of Guarantee
Indemnities and guarantees have a number of characteristics in common. It is generally accepted that the obligations and rights of both parties are largely similar over the course of the negotiation. This will have a great deal of bearing on the process of approving the contract, especially at the time of approving the contract. An important commonality between indemnity and guarantee contracts can be found in the way they are drafted. An important commonality between indemnity and guarantee contracts can be found in the way they are drafted. In every contract, one party consents to pay in the interest of another. These categories of contracts are also used by people and organisations to protect themselves against misfortunes. The other similarity that should be underlined is that they cannot be used to enrich themselves in an unjust manner.
It can be seen in a comparison of Punjab National Bank Ltd. v. Bikram Cotton Mills and Anr and Gajan Moreshwar vs. Moreshwar Madan that guarantee and indemnity are both used to compensate the creditor and indemnity holder respectively, and that both the principal debtor and surety in the Punjab National Bank case as well as the indemnifier had agreed to pay to make the debt good.
Furthermore, there is no requirement in either a contract of indemnity or a contract of guarantee that it be based on the Latin principle of uberrimae fidei. Generally, the term is used to describe the disclosure of all relevant facts and circumstances to the insurer, which is used most often in insurance law. It is perfectly fine, however, if parties do not disclose all of the events in the context of indemnity and guarantee, since there is no legal requirement to disclose all of these events. As an illustration of this fact, we can refer to the cases of British India General Insurance Co. Ltd., for contracts of indemnity and Hukumchand Insurance Co. Ltd. V. Bank of Baroda, for contracts of guarantee.
VI. Conclusion
Although there is no compelling reason to “look first” at the principal, an indemnity accommodates concurrent obligations with the principal. In general, it is an agreement that the surety will indemnify the lender for any disasters arising from the agreement between the principal and the lender. A guarantee, in general, accommodates a liability that is far-reaching with that of the principal. Finally, the guarantor cannot be held liable for much more than the client. The instrument will be interpreted as a guarantee if, in its real development, the surety’s commitments “stay behind” the principal and only come into play if a promise between the principal and the lender is broken. The commitment is auxiliary and reflexive in nature. An indemnity arises from the occurrence of an event, whereas a guarantee arises from the default of a third party. As a result, it has been discussed in the present paper what indemnity and guarantee imply and how they differ, such as the number of parties involved and the nature of the risks involved. Additionally, the little but crucial distinctions between guarantee and indemnity, both in practice and in principle, have also been described. As a result, while there are some parallels between guarantee and indemnity, they are fundamentally distinct.
Author’s Bio
Ishita Sethi is a third-year student at Jindal Global Law School, pursuing B.Com. LL.B. (Hons.)
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