Contract Idemnity - types of guarantee

Explain the meaning and nature of contract of indemnity.

State the rights of indemnity holder and indemnifier.

Contract 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. The person who promises to compensate the loss is called the indemnifier and the person who is so promised is called the indemnity holder. According to the definition of indemnity, the loss to be made good must be caused either by the conduct of the promisor himself or by the conduct of any other person, and, so if the loss is caused by accident or by the conduct of the promisee (indemnity holder), there would be no indemnity. However, the Indian Courts have taken the view that this interpretation is not correct and that indemnity cannot exclude insurance.

A contract of indemnity being basically a contract, it has to possess all the essential elements of a valid contract such as free consent, lawful consideration and competence of parties to enter into contract etc. Further, a contract of indemnity can be either express or implied. An implied contract of indemnity can be inferred from the conduct of the parties or the circumstances of the case.

Since the Contract Act has not stated the time of the commencement of the indemnifiers liability to indemnify and the word ‘loss’ has been used in Section 124, doubt arises as to the commencement of the promisors liability. However, it is the settled position of law that the indemnified (promisee) does not have to wait till the time he has to actually sustain the loss. He can compel the indemnifier to place him in a position to meet the liability that may be cast upon him without waiting until the promisee has actually discharged it.

Rights of indemnity holder : As we have already seen, contract of indemnity is a contract where the indemnifier promises the indemnity holder to save the latter from any loss that may be caused to him under the contract. From this, the rights of the indemnity holder can be stated as follows:
1. If the indemnity holder has to pay any compensation to any party in any suit in respect of any matter pertaining to which the indemnity applies, he can recover the same from the indemnifier;
2. He can recover from the indemnifier all costs of suit which he has to pay to such third party (provided he has acted in good faith, under the authority of the indemnifier and as per his instructions);
3. If any amount has been paid by the indemnity holder to any third party in any such suit by way of compromise, he can recover the same from the indemnifier, provided such compromise was not contrary to the orders of the indemnifier. Rights of indemnifier: The Act is silent as to the rights of the indemnifier. However, his rights are similar to the rights of Surety under contract of guarantee. For example, he becomes entitled to all securities which the creditor has against the principal debtor. (Students are advised to refer to “rights of Surety” under the contract of guarantee.)

State the nature and features of contract of guarantee. Explain various types of guarantee.

(b) Explain the rights and liabilities of Surety and co-Surety. When is Surety discharged from his liability? (a) Contract of guarantee and its types

According to section 126, ‘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 the ‘Surety’ and 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 can be oral or written.

In a contract of guarantee it is essential that there are three parties, viz. the Surety, the principal debtor and the creditor. It is also necessary that there is a liability, existing or future, enforceable by law. The moment there is a default on the part of the principal debtor, the Surety immediately becomes liable as if he were the principal debtor. He has no right to ask the creditor to first proceed against the principal debtor nor can he demand a notice from the creditor that the principal debtor has defaulted, because it is the Surety’s duty to ensure that the principal debtor pays or performs his obligation. 

A contract of guarantee is like any other contract and therefore all the essential elements of valid contract, such as free consent, competence of parties etc. have to be present in the contract of guarantee also. However, so far as consideration is concerned, it is not separately needed for the Surety in the Contract of guarantee: Section 127 expressly provides that –‘anything done or any promise made, for the benefit of the principal debtor, may be sufficient consideration to the Surety for giving the guarantee.’

Types of Guarantee:

A guarantee may be either ‘specific guarantee’ or ‘continuing guarantee.’

Specific Guarantee: It is given for single debt or obligation and comes to an end when the debt guaranteed has been paid or obligation guaranteed has been discharged. Thus, where A gives a loan to B for which C stands guarantee, it is a case of a specific guarantee. In this case, there is a specific debt and the guarantee shall come to an end the moment the loan is repaid.

A specific guarantee cannot be revoked. Once the guarantee is given it cannot be withdrawn or revoked and even after the death of the Surety (guarantor), it continues to operate making his legal representatives liable for the same.Continuing Guarantee: On the other hand, a continuing guarantee is one where the guarantee given is not for a single or specific debt or obligation, but for a series of debts.

(b) Rights and liabilities of Surety and co-Surety and discharge of Surety:

 The rights of Surety can be discussed under three heads:

 1. Rights against the creditor;

2. Rights against Principal debtor; and

3. Rights against co-Surety

 Surety’s rights against creditor

 1. Right to benefit of creditor’s securities: At the time of entering into the contract of guarantee, the creditor may have certain securities in his possession given by the Principal debtor against the performance. The Surety is entitled to demand from the creditor, at the time of payment (or discharge of liability) all the securities, which the creditor has against the principal debtor at the time when the contract of Suretyship is entered into or subsequently acquired. It is not necessary that the Surety should have knowledge of the existence of such securities. If the creditor loses or parts with the securities, which are acquired at the time of contract, the Surety is discharged to the extent of value of such securities lost. But if the securities are lost due to act of God or unavoidable accident, the Surety would not be discharged. Similarly, if the creditor parts with the securities, which he has acquired subsequent to the contract of Surety, the Surety’s liability is not reduced. It should be noted that the right of Surety to benefit of the securities arises only after the payment in full of the debt of the principal debtor to the creditor. He cannot claim the benefit of the part of the securities merely because he has paid a part of the debt.2. Right to claim set-off, if any: The Surety is also entitled to the benefit of any set-off or counter claim, which the principal debtor might possess against the creditor in respect of the same transaction. In other words, the principal debtor may have certain claims against the creditor arising out of the same transaction. Upon default by the principal debtor in discharging his liability, the Surety may make use of the said counter claim in reducing his liability.

Surety’s rights against the Principal debtor: The Surety enjoys the following two rights against the Principal debtor.

 1. Right of subrogation: When the Surety pays off the debt on default of the principal debtor, he is invested with all the rights, which the creditor had against the principal debtor. In other words, the Surety steps into the shoes of the creditor and will be able to exercise all those rights and remedies, which could be exercised by the creditor against the principal debtor. The Surety is subrogated to all rights, which the creditor had against the principal debtor. He is entitled to the securities held by the creditor and also can sue the principal debtor for recovery of the debt paid by the Surety. 2. Right to claim indemnity: 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 whatever sum he has rightfully paid under the guarantee. However, he cannot claim the amounts which he has paid wrongfully. Thus, a Surety is entitled to be indemnified by the Principal debtor for whatever amount he has rightfully paid to the creditor under the contract of guarantee.It should be noted that the Surety is entitled to recover from the Principal debtor only that amount which he has actually paid to the creditor and no more. Thus, where there is a compromise between the creditor and the Surety under which the Surety pays a lesser amount, he can get from the Principal debtor only the amount actually paid.

Surety’s right against the Co-sureties: Where a debt is guaranteed by two or more Sureties, they are called co-sureties. In such a case, all the co-sureties are liable to contribute towards the payment of the guaranteed debt as per the agreement between them. But in the absence of any agreement, if one co-surety is compelled to pay the entire debt, he is entitled to contribution from the other co-surety or co-sureties.

Discharge of Surety from liability: A Surety is freed from his obligation under the contract of guarantee under any of the following circumstances. 1. Notice of revocation: A guarantee given for a specific transaction or for a specific debt cannot be revoked. But a continuing guarantee may be revoked at anytime by the Surety as regards the future transactions. Thus, the liability of Surety comes to an end in respect of future transactions which may take place between the creditor and principal debtor. 2. Death of Surety: In case of continuing guarantee, the death of Surety discharges him from liability as regards the transactions after his death and the estate of the Surety shall not be liable. Death of the Surety acts as revocation and it is not necessary that the creditor should have knowledge of the death of the Surety. If the creditor enters into any fresh transactions after the Surety’s death without the knowledge of the death of the Surety, the estate of the deceased Surety shall not be liable for such transactions. 3. Variance in terms of contract: 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 the transactions subsequent to the variance. In other words, if there is any alteration in the terms of the contract, under which the Surety has undertaken the liability, without his consent, such alteration will discharge him from his liability. It is immaterial whether the variance is very small or even when it is to the benefit of the principal debtor. Strictly speaking, this rule is applicable to continuing guarantee, but the principle involved here is also applicable to specific guarantee. When there is any alteration in the terms of the contract of guarantee, even though it is for a specific debt, the Surety has a right to disown his obligation on the ground that the contract is no longer the same, which he had entered into. 4. Release or discharge of Principal debtor: The Contract Act provides for the following two ways in which the Surety will be discharged:a. A Surety will be discharged if the creditor makes a contract with the Principal debtor by which the Principal debtor is released. Any release of the Principal debtor is the release of the Surety also.b. The Surety is also discharged by any act or omission on the part of the creditor, the legal consequence of which is the discharge of the Principal debtor. 5. Arrangement by creditor with Principal debtor without the consent of Surety: Where the creditor, without the consent of the Surety, makes an arrangement with the Principal debtor for composition or promises to give time or not to sue him, the Surety will be discharged. However, mere forbearance on the part of the creditor to sue the Principal debtor does not discharge the Surety. For example, B owes to C a debt guaranteed by A. The debt becomes payable, but C does not sue B for a year. A is not discharged from the liability of suretyship. 6. Creditor’s act or omission impairing 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 Surety is discharged. In other words, it is the duty of the creditor to do every act necessary for protection of the rights of Surety and if he fails in this duty, the Surety is discharged. Thus, where the integrity of a cashier is guaranteed, it is the duty of employer to give information to the Surety about any dishonest act done by the employee. If the employer continues to employ him after an act of dishonesty, the Surety is discharged, if he is not informed within a reasonable time. In this case, the eventual remedy of the Surety to take appropriate action against the employee is lost. 7.  Loss of security: 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 is discharged from liability to the extent of the value of the security.  This loss of the security however, should be due to the negligence of the creditor. If it is due to the act of God or unavoidable accident, the Surety is not discharged. If a loan, guaranteed by Surety is also secured with the mortgage of the property of the borrower and the creditor subsequently cancels the mortgage, thus parting with the security, the Surety is discharged. 8. Invalidation of contract of guarantee: A Surety is discharged from liability when contract of guarantee (in between creditor and Surety) is invalid. A contract of guarantee is invalid for the following reasons: a. Where the guarantee has been obtained by means of misrepresentation or fraud or by keeping silence as to the material facts of the transaction, by the creditor or with the knowledge of the creditor. However, it should be noted that if the misrepresentation or concealment is done by the debtor without the knowledge of the creditor, the Surety is not discharged. b.  Where a person gives guarantee upon a contract that the creditor shall not act upon it until another person has joined in it as co-surety, the guarantee is not valid if that other person does not join. c.Where the contract of guarantee does not possess any of the essential elements of a valid contract; for example, competence to contract or the legality of object etc.