Unit-II
SPECIFIC CONTRACTS
PREVIEW
a) Contract of Indemnity- Concept, Definition and Method
b) Commencement of liability of the indemnifier and Nature of
indemnity clauses
c) Right/Duties of Indemnifier, Indemnified and Surety
d) Contract of Guarantee- Concepts, Definition and Kinds of Guarantee
e) Discharge of Surety's liability and Distinction between indemnity
and Guarantee
a) Contract of Indemnity- Concept, Definition and Method
Introduction:
The term indemnity is derived from the Latin word “indemnis” which denotes uninjured or
suffering no damage or loss. It is a sort of security or protection against loss.
Literal Meaning: Indemnity means Insurance or Security or Protection. Contract of indemnity
is a special kind of contract. The term ‘indemnity’ literally means “security or protection
against a loss” or compensation.
In simple words, the meaning of indemnity is to indemnify one person by bearing his losses
incurred to him by the conduct of promissory or by any other party.
Principle: Indemnity is an obligation by a person (indemnitor/indemnifier) to provide
compensation for a particular loss suffered by another person (indemnitee/indemnity holder).
Parties to the Contract of Indemnity
A contract of indemnity has two parties.
1. The promisor or indemnifier
2. The promisee or the indemnified or indemnity-holder
The promisor or indemnifier: He is the person who promises to bear the loss.
The promisee or the indemnified or indemnity-holder: He is the person whose loss is
covered or who are compensated.
Indemnities form the basis of many insurance contracts; for example, a car owner may purchase
different kinds of insurance as an indemnity for various kinds of loss arising from operation of
the car, such as damage to the car itself, or medical expenses following an accident.
In the old English law, Indemnity was defined as “a promise to save a person harmless from the
consequences of an act. Such a promise can be express or implied from the circumstances of
the case”.
This view was illustrated in the case of Adamson vs. Jarvis 1872.
Indian contract Act 1872 makes the scope narrower by defining the contract of indemnity as
follows:
Section 124 - 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 a "contract of
Indemnity".
Illustration - 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.
This definition provides the following essential elements –
1. There must be a loss.
2. The loss must be caused either by the promisor or by any other person (in Indian context loss
is to be caused by only by a human agency).
3. Indemnifier is liable only for the loss.
Thus, it is clear that this contract is contingent in nature and is enforceable only when the loss
occurs.
Objective of Contract of Indemnity
The objective of entering into a contract of indemnity is to protect the promisee against
unanticipated losses.
b) Commencement of liability of the indemnifier and Nature of
indemnity clauses
Commencement of liability of the indemnifier:
Indian Contract Act, 1872 does not provide the time of the commencement of the
indemnifier’s liability under the contract of indemnity. But different High Courts in India have
held the following rules in this regard:
Indemnifier is not liable until the indemnified has suffered the loss.
Indemnified can compel the indemnifier to make good his loss although he has not
discharged his liability.
In the leading case of Gajanan Moreshwar vs. Moreshwar Madan(1942), Bombay high
court observed that the contract of indemnity held very little value if the indemnity holder
could not enforce his indemnity until he actually paid the loss.
The court further observed that “If the indemnified has incurred a liability and the liability
is absolute, he is entitled to call upon the indemnifier to save him from the liability and
pay it off”.
Indemnity Clause Defined
Indemnity clauses, also known as indemnification clauses, require one party to reimburse the
other for recoverable damages from third-party claims. The indemnifying party is demanding
payment. The indemnified party is required to pay.
Indemnity Clause Explained
There are mutual indemnification and one-side indemnification clauses. Mutual indemnity
requires both parties to compensate each other while the other only needs a single, indemnified
party to pay. Covered events can trigger indemnity clauses.
Purpose of Indemnity Clause
The purpose of indemnity clauses is to protect a party from third-party claims.
Types of Indemnity Clauses
Types of indemnity clauses include the following:
Bare Indemnity: Bare indemnity is when there’s no limitation on liability.
Reverse Indemnity: Reverse indemnity allows indemnifying parties to file claims against if
the third party doesn’t pay.
Limited Indemnities: Limited indemnities allow the indemnifying party to recover losses
except for negligence.
Third-Party Indemnities: Third-party indemnities assign liability to a separate party for
losses.
Financing Indemnities: Financing indemnities trigger when the indemnified party doesn’t
meet fiduciary obligations.
Party Indemnities: Party indemnities agree to indemnify each other if a negligence or breach
of contract claim arises.
Indemnity Clause Examples
To be indemnified for any losses or damages which resulted because of an unfortunate event
that occurred to the business, the owner of the business has been paying an insurance premium
to a well-known insurance company. As a part of the contract between the business owner and
the insurance company, if a mishap occurs, such as the building of the business underwent
structural damages or the like, in such a case the insurance company will be liable for
indemnity for those losses incurred by the owner through reimbursing the owner for repair
amount or by rebuilding the damaged parts by employing its own designated contractors.
Another example is Mr. Ram booking a package holiday via a travel agent that has provisions
for a hotel stay. As part of the holiday contract, there is an indemnity clause saying if Mr. Ram
damages any amenity of the hotel room, he will have to compensate the hotel for the same.
c) Right/Duties of Indemnifier, Indemnified and Surety
Rights of Indemnifier:
After compensating the indemnity holder, indemnifier is entitled to all the ways and means by
which the indemnifier might have protected himself from the loss.
Rights of the indemnity holder:
Section 125, defines the rights of an indemnity holder. These are as follows -
1. Right of recovering Damages
2. Right of recovering Costs
3. Right of recovering Sums
In United Commercial Bank v. Bank of India AIR 1981. In this case, Supreme Court held
that the courts should not grant injunctions restraining the performance of contractual
obligations arising out of a letter of credit or bank guarantee if the terms of the conditions have
been fulfilled. It held that such LoCs or bank guarantees impose on the banker an absolute
obligation to pay.
In the case of Mohit Kumar Saha vs New India Assurance Co AIR 1997, Calcutta HC held
that the indemnifier must pay the full amount of the value of the vehicle lost to theft as given
by the surveyor. Any settlement at lesser value is arbitrary and unfair and violates Art. 14 of
the constitution.
d) Contract of Guarantee- Concepts, Definition and Kinds of
Guarantee
What is Guarantee?
The term "guarantee" is defined by the Black Laws Dictionary as “the certainty that a legal
contract will be duly enforced”. Contract of Guarantee
The type of contractual arrangement in which one party promises or guarantees to stand for
another party to perform or discharge the liability of another in case of his default is called
the contract of guarantee. The main aim of a contract of guarantee is to protect the other
party from any loss.
A guarantee contract is regulated by Indian Contract Act, 1872, and comprises of 3 parties,
including one who serves as the guarantor if the defendant fails to meet his obligations.
Contract of Guarantee suggests that a contract is created to perform the guarantees or discharge
the liabilities of the person just in case he fails to discharge such liabilities. As per Section 126
of the Indian Contract Act, 1872, a contract of guarantee has 3 parties –
1. Surety: A surety could be a person giving a guarantee during a contract of guarantee.
Someone who takes responsibility to pay cash performs any duty for one more person just
in case that person fails to perform such work.
2. Principal Debtor: A principal debtor could be a person for whom the guarantee is given
during a contract of guarantee.
3. Creditor: The person to whom the guarantee is given is referred to as a creditor.
Example, if suppose A takes a loan of Rs. 1,00,000 from a Union bank of India. Here B,
promises to bank that if A some how fails to return the amount, then I will make payment on his
behalf.
Here, A is principal debtor, Union bank of India is creditor and lastly B will act as surety.
Tripartite Contract
Tripartite means involving three parties. In a contract of guarantee, due to the involvement of
three parties, there are three different contracts among the parties themselves. These contracts
are:
1. Between principal debtor and creditor (Which is the main contract that is expressed)
2. Between surety and creditor (Express contract of guarantee)
3. Between surety and principal debtor (It can be express or implied)
Essentials of Contract of Guarantee
The following are the essentials of the contract of guarantee:
1. There must be a valid contract between three parties, which are: principal debtor,
creditor, and surety.
2. Surety promises to perform the contract or discharge the liability of the principal debtor in
case of his default.
3. Such liability is voluntarily taken by the surety.
4. It may be either oral or written.
Consideration for Guarantee
Section 127 of the Indian Contract Act mentions the consideration for guarantee.
a) anything done, or
b) any promise made for the benefit of the principal debtor.
Kinds of guarantee
Contracts of guarantees may be classified into two types:
Specific Guarantee and Continuing Guarantee: When a guarantee is given in respect of a
single debt or specific transaction and is to come to an end when the guaranteed debt is paid or
the promise is duly performed, it is called a specific or simple guarantee.
However, a guarantee which extends to a series of transactions is called a continuing guarantee
(Section129).
The surety’s liability, in this case, would continue till all the transactions are completed or till
the guarantor revokes the guarantee as to the future transactions.
Illustrations
a) S is a bookseller who supplies a set of books to P, under the contract that if P does not pay
for the books, his friend K would make the payment. This is a contract of specific guarantee
and K’s liability would come to an end, the moment the price of the books is paid to S.
b) On M’s recommendation S, a wealthy landlord employs P as his estate manager. It was the
duty of P to collect rent every month from the tenants of S and remit the same to S before the
15th of each month. M, guarantee this arrangement and promises to make good any default
made by P. This is a contract of continuing guarantee.
The Concept of Continuing Guarantee
As per section 129 of the Indian Contract Act, a guarantee which extends to a series of
transactions is known as a continuing guarantee.
It means that once a guarantee is given, then it extends to the series of transactions.
For example: X, a milkman, contracts with Y to supply 1 litre of milk every day at Rs. 50 for
a month. But on a condition that Z shall pay the amount as a guarantor of Y. Here the amount
of Rs. 50 shall be paid by Z for a month. Every transaction of Rs. 50 for each day is a series of
transactions.
Revocation of Guarantee
Revocation of guarantee means to cancel or end the contract. The following modes can revoke
a normal contract of guarantee or a contract of continuing guarantee:
1. That if the surety produces a notice of revocation to the creditor in relation to future
transactions, which is provided under section 130 of the Indian Contract Act.
2. The death of the surety means automatic revocation of future transactions, which is provided
under section 131 of the Indian Contract Act.
Rights of Surety
In a contract of guarantee, the rights of surety extend against the principal debtor and the
creditor. Let us discuss them one by one.
Rights of Surety against a Principal Debtor
1. Right of subrogation under section 140 of the Indian Contract Act.
2. An implied right or promise to indemnify the surety after the surety has done his
responsibility under section 145 of the Indian Contract Act.
Rights of Surety against Creditor
1. Right to the benefit of creditors securities under section 141 of the Indian Contract Act.
2. Right to set off the debts which the debtor has against the creditor.
3. Right to recover financial loss which resulted due to any fraud or misrepresentation
practised by the creditor.
The Extent of Surety’s Liability
As per section 128 of the Indian Contract Act, the liability of the surety is co-extensive to that
of the principal debtor. Thus, the liability of the surety is of secondary nature while of the
principal debtor it is primary.
e) Discharge of Surety's liability and Distinction between indemnity
and Guarantee
Discharge of Surety’s Liability
The liability of the surety, that is, to repay the debt of his principal debtor in case he doesn’t
pay, is discharged by the following provisions of the Act.
1. If there are any changes made in terms of the contract without informing the surety about
the same, the surety is discharged. Provided under section 133 of the Indian Contract Act.
2. If the principal debtor is released or discharged by the creditor, the surety is discharged.
Provided under section 134 of the Indian Contract Act.
3. If the creditor himself compromises or extends the time to pay the debt or promises not to
sue the principal debtor, the surety is discharged. Provided under section 135 of the Indian
Contract Act.
4. If the creditor acts in such a manner or omits the conditions of the contract, the surety is
discharged. Provided under section 139 of the Indian Contract Act.
Note: A surety is also discharged under the provisions of sections 130 and 131 of the Indian
Contract Act.
Distinction Between contract of indemnity and Contract of guarantee
The following are the major differences between indemnity and guarantee:
In the contract of indemnity, one party makes a promise to the other that he will
compensate for any loss occurred to the other party because of the act of the promisor or
any other person. In the contract of guarantee, one party makes a promise to the other
party that he will perform the obligation or pay for the liability, in the case of default by a
third party
Definition
Indemnity is defined in Section 124 of Indian Contract Act, 1872, while in Section 126
Guarantee is defined.
Parties
In indemnity, there are two parties, indemnifier and indemnified but in the contract of
guarantee, there are three parties i.e. debtor, creditor, and surety.
Liability
The liability of the indemnifier in the contract of indemnity is primary whereas if we talk
about guarantee the liability of the surety is secondary because the primary liability is of
the debtor.
Purpose
The purpose of the contract of indemnity is to save the other party from suffering loss.
However, in the case of a contract of guarantee, the aim is to assure the creditor that either
the contract will be performed, or liability will be discharged.
In the contract of indemnity, the liability arises when the contingency occurs while in the
contract of guarantee, the liability already exists.
THE END
