Difference between contract of indemnity

and contract of guarantee

Introduction

Contract of guarantee and contract of indemnity perform similar commercial

functions in providing compensation to the creditor for failure of a third party
to perform their obligation. However, there are some major differences
between the two. In this article, the author will talk about the differences
between the contract of indemnity and contract of guarantee along with
relevant legal provisions of the Indian Contract Act, 1872.

Meaning

Indemnity

The dictionary meaning of the term ‘indemnity’ is protection against future

loss. Indemnity is the protection against loss in the form of a promise to pay
for loss of money, goods, etc. It is security against or compensation for loss
incurred.

According to Halsbury, indemnity refers to an express or implied contract

that protects a person who has entered or is going to enter into a contract or
incur any other duty from loss, irrespective of the default incurred by a third
person.

As per the Oxford Dictionary of Law, indemnity is an agreement by one

person to pay to another, a sum that is owed or which may be owed, to him
by a third person. It is not conditional on the third person defaulting on the
payment.
Guarantee

Guarantee enables a person to get a loan, to get goods on credit, etc.

Guarantee means to give surety or assume responsibility. It is an agreement
to answer for the debt of another in case he makes default.

The Oxford Dictionary of Law defines guarantee as a secondary agreement in

which a person (guarantor) is liable for a debt or default of another (principal
debtor) who is the party primarily liable for the debt. A guarantor who has
paid out on his guarantee has a right to be indemnified by the principal
debtor.

Contract of Indemnity

Chapter VIII of the Indian Contract Act, 1872 contains the legal provisions
governing a contract of indemnity and a contract of guarantee in India.

Section 124 : Contract of indemnity

Section 124 of the Act defines a contract of indemnity as a contract wherein

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.

A contract of indemnity can provide protection against loss caused—

1. By the conduct of promisor, or

2. By the conduct of any other person.

Under Indian law, a contract of indemnity can only provide for losses caused
by human agency whereas in England, it includes a promise to save the
other person from loss caused whether by acts of promisor or of any other
person or any other event like fire, accident, etc.
Indemnifier

The person who makes a promise to indemnify against the loss or to make
good the loss (promisor) is called an indemnifier.

Indemnity-holder

The person in whose favour such a promise to indemnify is made (promisee)

is called indemnity-holder.

For example, Anil enters into a contract with Swapnil to indemnify him
against the consequences of any proceedings which Mrinal may initiate
against Swapnil in respect of a certain sum of Rs. 2000/-. In this contract,
Anil is the indemnifier and Swapnil is the indemnity-holder.

Main features

1. It involves two parties i.e. promisor being the indemnifier and promisee
being the indemnity holder.

2. Object of the contract of indemnity is to protect from a loss.

3. As per the Indian Contract Act, the contract of indemnity must be to

indemnify against a loss caused by any act or conduct of the promisor
himself or by the conduct of any other person.

4. It is not contingent on the default of some third person.

What are the rights of an indemnity holder

Section 125 of the Act covers ‘Rights of indemnity-holder when sued’. This
Section provides for the right of the indemnity holder to recover the
damages and costs that he may have been compelled to pay in a suit filed
against him, in a case where the indemnity-holder has promised such
indemnity, i.e., where a contract of indemnity to that effect exists. The rights
of the indemnity holder are-

1. Right to recover from the promisor, the damages that he may be

compelled to pay in any suit in respect of any matter to which the
promise to indemnify applies.

2. Right to recover from the promisor all the costs that he may be
compelled to pay in any suit, provided—

1. that he did not contravene any of the orders of the promisor in filing or
defending such suit, and

2. that he acted in a manner as would have been prudent for him to act in
the absence of any such contract of indemnity, or

3. that the promisor had authorised him to file or defend such a suit.

4. Right to recover from the promisor all such sums that he paid under
the terms of any compromise of any such suit, provided-

1. the compromise was not contrary to orders of the promisor, and

2. such compromise is one as the promisee would have made while acting
in a prudent manner even if such contract of indemnity did not exist, or

3. that the promisor had authorised the promisee to compromise the suit.

When liability commences

A pertinent question that arises with regard to a contract of indemnity is,

‘when does the liability to indemnify commence/arise’. Originally, under
English law, the rule was that the indemnity holder cannot recover the
amount unless he had suffered actual loss i.e. ‘you must be damnified before
you can claim to be indemnified’. However, this position of the law changed.
In Richardson Re, Ex parte the Governors of St. Thomas’s Hospital (1911), it
was held that indemnity is not necessarily given by repayment after
payment, but it requires that the party to be indemnified shall never have to
pay. This principle was followed by the Calcutta High Court in Osman Jamal &
Sons Ltd. v. Gopal Purshottam (1928).

As far as Indian position is concerned, the Bombay High Court in Gajanan

Moreshwar v. Moreshwar Madan (1942), held that the equitable principle
applicable in England shall be applicable in India too and therefore, where
the indemnity holder has incurred a liability and that liability is absolute, he
is entitled to call upon the indemnifier to save him from that liability and pay
it off.

Contract of guarantee

Section 126 of the Indian Contract Act defines the term contract of
guarantee, surety, principal debtor and creditor. The purpose behind a
contract of guarantee is to give additional security to the creditor that his
money will be paid back by the surety if the debtor makes a default.

Contract of guarantee : 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 contract of guarantee has three parties involved, namely, the principal
debtor, the creditor, and the surety.

Surety

The person who gives the guarantee is called the Surety. The liability of the
surety is secondary, i.e., he has to pay only if the principal debtor fails to
discharge his obligation to pay.
Principal debtor

The person in respect of whose default the guarantee is given is the Principal
debtor. The principal debtor has the primary liability to pay.

Creditor

The person to whom the guarantee is given is called the creditor.

For example, Anil orders certain goods of the value of Rs. 2000/- from
Swapnil on credit. Mrinal guarantees that, if Anil will not pay for the goods,
she will. This is a contract of guarantee. Here, Rs. 2000 is the principal debt,
Anil is the principal debtor, Mrinal is surety and Swapnil is the creditor.

Main features

1. A contract of guarantee may be oral or written: According to Section

126, a contract of guarantee may be oral or in writing. However, under
English law, for a contract of guarantee to be valid, it has to be in
writing and signed.

2. There must be a principal debt: The existence of a principal debt is

necessary for a contract of guarantee. If there is no principal debt, then
there is no existing obligation to pay. As a result of the absence of such
obligation to pay, there cannot be any promise/guarantee. If there is a
promise to pay for compensating some loss without there being any
principal debt, such a contract will become a contract of indemnity.

3. Contract of guarantee is tripartite in nature: There being three parties

involved in a contract of guarantee, three contracts take place in a
contract of guarantee-

 The principal debtor promises to make payment to the creditor.

  Surety undertakes to pay the creditor in event of default of payment by
the principal debtor.

 An implied promise by the principal debtor in favour of surety to

indemnify him in case he discharges the liability of the principal debtor.

4. There is a promise to pay upon default of payment by the debtor: In a

contract of guarantee, the surety’s promise to pay is dependent on the
default of the debtor i.e. surety pays only when the debtor defaults.

5. The consideration is the benefit to the debtor: As per Section 127,

anything done or promise made for the benefit of the principal debtor
may be a sufficient consideration to the surety for giving the
guarantee. For example, Anil sells and delivers certain goods worth Rs.
5000 to Swapnil. Mrinal afterward requests Anil to refrain from suing
Swapnil for a year and promises that if he does so, she will pay for the
goods in default of payment by Swapnil. Anil agrees. The forbearance
by Anil to sue is of benefit to Swapnil (the debtor) and that constitutes
sufficient consideration for Mrinal (surety) for giving the guarantee.

6. The consent of the surety should not have been obtained by

misrepresentation or concealment of material facts: Section 142 of the
ICA, 1872 provides that a guarantee obtained using misrepresentation
made by the creditor or with his knowledge or assent, concerning a
material part of the transaction is invalid.
Section 143 provides that a guarantee obtained by the creditor by keeping
silent as to some material circumstance is also invalid.

Difference between contract of indemnity and

contract of guarantee
BASIS OF
CONTRACT OF INDEMNITY CONTRACT OF GUARANTEE
DISTINCTION

There are two parties in a contract of There are three parties in a contract of
Parties indemnity, namely the indemnifier and the guarantee, namely the principal
indemnity holder. debtor, the creditor, and the surety.

It consists of three contracts-A

contract between principal debtor and
creditor wherein the debtor promises
to perform his obligation/make
payment. The contract between surety
It consists of only one contract between and creditor wherein the surety
the indemnifier and the indemnity holder. promises to perform the aforesaid
No. of contracts The indemnifier promises to indemnify the obligation/make the payment if the
indemnified/indemnity holder in event of a principal debtor makes a default. An
certain loss. implied contract between the surety
and the principal debtor. The
principal debtor bounds himself to
indemnify the surety for the sum that
he has paid under the guarantee
undertaken by him.

3. Nature of The liability of the indemnifier is The liability of the surety is a

liability primary. The liability in a contract of secondary one, i.e., his obligation to
indemnity is contingent in the sense that it pay arises only when the principal
may or may not arise. debtor defaults. Liability in a contract
of guarantee is continuing in the sense
that once the guarantee has been acted
upon, the liability of the surety
automatically arises. However, the
 said liability remains in suspended
animation until the debtor makes
default.

The liability of an indemnifier is not Liability of surety is conditional on

conditional on the default of somebody the default of the principal debtor. For
else. For example, Mrinal promises the example, Anil buys goods from a
Default of third shopkeeper to pay, by telling him that, seller and Mrinal tells the seller that if
person “Let Anil have the goods, I will be your Anil doesn’t pay you, I will. This is a
paymaster”. This is a contract of contract of guarantee. Thus, the
indemnity as the promise to pay by Mrinal liability of Mrinal is conditional on
is not conditional on default by Anil. non-payment by Anil.

Principal debt is necessary. (refer to

Principal debt No requirement of the principal debt.
the previous example)

After the surety has made the

Whether Once the indemnifier indemnifies the
payment, he steps into the shoes of
subsequent indemnity holder, he cannot recover that
the creditor and can recover the sums
recovery is possible amount from anybody else.
paid by him from the principal debtor.

Whether a contract
has to be in writing In India, contracts of indemnity may be In India, a contract of guarantee may
or can be oral as either oral or written. be either oral or written.
well

Conclusion

Both the contract of indemnity and contract of guarantee are similar in the
sense that they provide protection against loss. However, as mentioned
above, there is an important distinction between the two. Whether a contract
is a contract of indemnity or a contract of guarantee is a question of
construction in each case. One of the ways to identify such a contract might
be the description of the agreement as to whether it is named as a contract
of guarantee or indemnity and if those terms are mentioned in the contract a
few times or more. However, that cannot be considered conclusive enough.
Another way might be to see if under the contract, the liability of a person
exists irrespective of the default of the principal debtor or where such
liability is for a greater amount than the amount payable by principal debtor.
In that case, the contract may be construed as a contract of indemnity. Thus,
it will depend on a case to case basis and while analysing the
facts/agreement, one must keep in mind the relevant points of distinction
between the two concepts.