What are the Key Features of a Contract of Indemnity and a Contract of Guarantee?

Introduction

The Indian Contract Act, 1872, governs the formation and enforcement of contracts in India, including a range of special contracts designed to address specific legal relationships. Among these contracts of indemnity and guarantee are categorized as exceptional contracts. A contract of indemnity involves an agreement where one party promises to compensate the other for losses arising from the promisor's or a third party's actions. In contrast, a contract of guarantee is an agreement among three parties: the creditor, the principal debtor, and the surety. Here, the surety promises to fulfill the debtor’s obligations if the debtor defaults on their payment.

While both contracts aim to provide financial security, their purposes differ. A contract of indemnity focuses on protecting one party from losses, whereas a contract of guarantee ensures the creditor is compensated for the principal debtor's failure to perform their obligations.

The legal provisions for contracts of indemnity and guarantee are detailed in Chapter VIII of the Indian Contract Act, 1872, specifically in Sections 124 to 147. 

Contract of Indemnity

The phrase indemnity comes from the Latin word "indemnis" which means unharmed or suffering no injury or loss. It serves as a form of loss prevention or security. Indemnity refers to compensating an individual for losses arising from the actions of the promisor or a third party. According to Section 124 of the Indian Contract Act of 1872, an indemnity contract is one in which one party promises to protect the other from loss caused by the promisor's own or another person's action[1].

An indemnity contract has two parties i.e.

• The Indemnifier is the promisor who commits to compensate the other group for the damage they caused.
• The Indemnified or Indemnity Holder is the person who is compensated for any damages suffered. 

Essentials of Indemnity Contract

• An Indemnity contract must include all of the elements of a valid contract.
• The indemnity contract provides loss protection. The indemnifier is obligated to recover the losses.
• The indemnity contract involves two parties: the Indemnifier and the Indemnity Holder.
• There is only one contract between the Indemnity holder and the Indemnifier.
• The Contract of indemnity might be either oral or written. The parties may also infer it. 

Types of Indemnity

• Express Indemnity: It is often known as written indemnity. The contract precisely outlines all of the indemnity's terms and conditions. The agreement clearly sets forth both parties rights and duties. This form of arrangement comprises insurance indemnity contracts, construction contracts, agency contracts, etc.
• Implied Indemnity: A duty based on the facts and actions of the parties involved. This is not a written agreement. The master-servant relationship is a prime illustration of this form of indemnity. The master is obligated to indemnify his servant for any losses incurred while working under the course of business. 

Rights of the Indemnity Holder or Indemnified

The rights of the indemnity-holder are the obligations of the indemnifier. In the event that a third party sues an indemnitor and the indemnitor promises to indemnify the third party and acts as expected in the absence of an indemnity contract, Section 125 outlines the indemnifier's rights to recover damages, costs, and all amounts owed by him[2]. Against the indemnity holder, the indemnifier is obligated to:

1. Right to recover damages in a suit[3]

When a third party lodges a claim against the indemnity holder, it is usually accepted that the indemnifier bears the primary duty for paying the latter. Damages would definitely result from the indemnification bearer's full duty. The logical premise is that one who depends on another's assurance should be compensated. An indemnity-holder is entitled to recover from the indemnifier all damages that he may be obliged to pay in any litigation relating to any matter covered by the indemnity contract. The indemnitor is responsible for covering whatever damages he has agreed to cover in a lawsuit pertaining to any topic. In Nallappa Reddi v. Viridhachala Reddi And, Anr.[4], the court ruled that it is the indemnifier's responsibility to provide damages to the promisee. The responsibility arises as soon as the decree is issued against the promisee.

In Gokuldas v. Gulabrao[5], the court ruled that the indemnifier cannot claim immunity because he was not a party to the lawsuit and is still obligated to indemnify the promisee.

2. Right to recover cost in defending[6]

Under Section 125(2), the indemnity holder has the legal right to seek defense expenses and damages from the indemnifier during litigation related to the indemnity's purpose or action.

In the case of Pepin v. Chunder Seekur Mookerjee[7], the Court determined that expenses accrue while lowering, ascertaining, or defending the claim. As a result, such costs are recoverable. In Gopal Singh v. Bhawani Prasad[8], the Court ruled that only costs expended by a responsible man might be recovered. 

3. Right to recover sums paid under compromise[9]

This is similar to the preceding right, except it occurs in the event of a compromise. An indemnity-holder also has the right to recover all amounts paid under the terms of any compromise of any such suit from the indemnifier, if the compromise was not contrary to the promisor's orders and was one that the promisee would have made in the absence of any indemnity contract, or if the promisor authorized him to compromise the suit.

In Alla Venkataramanna v. Palacherla Manqamma[10], the court established the conditions under which the promisee's claim would be valid. If the indemnity holder sincerely wants the cash to be recovered, certain requirements with regard to the compromise so implemented are as follows:

• The compromise should have been carried out lawfully.
• It was settled without any collaboration.
• It has not been impeached for being an unethical transaction. 

Rights of Indemnifier

The rights of an indemnifier and a surety are equivalent, according to the ruling in Jaswant Singh v. The State[11], once all damages have been paid, the party paying the damages assumes the role of indemnity holder and is granted ownership of the property. He must reimburse the promisee for the losses specified in the contract's terms and conditions. After resolving all of his claims, he assumes the role of the creditor. 

1. Right to sue the third party

The third party has the right to be sued. The indemnity-holder is entitled to complete ownership of the property and the ability to sue the third party for it as soon as the indemnifier has paid the indemnity-holder for the property's damages and amount. He cannot sue the third party before compensating the indemnification holder. 

For instance, A guaranteed B that he would pay B's damages if C caused damage to his vehicle. After C causes damage to B and demands payment from A, A reimburses B and obtains ownership of the vehicle. A is now able to sue C and demand the losses.

2. Make up for losses that are covered by the deed

Only those losses covered by the indemnity contract may be paid for by the indemnitor. The Supreme Court in the case of Ramaswami v. Muthukrishna[12] directed the indemnifier to compensate the plaintiffs just for the Rs. 1236 that he actually lost. The Supreme Court rejected the additional appeal that was filed in an attempt to get more money from the defendant.

3. Right under the Subrogation Doctrine

After the previous creditor's claims are settled, the surety assumes the role of the creditor and, in some circumstances, is entitled to the whole amount owed by the debtor. This is known as the surety's subrogation rights. In a similar vein, the person who compensated may also be able to recover the funds or possession. 

Contract of Guarantee

To guarantee is to bear responsibility or to provide assurance. It is an agreement to answer for someone else's debt in the event that he defaults. According to Section 126 of the Indian Contract Act, 1872, a "contract of guarantee" is an agreement to fulfill a third party's commitment or release them from obligation in the event that they default. A guarantee can be given verbally or in writing. Under this agreement, the principal debtor may obtain employment, a loan, or items on credit, and in the event that the debtor defaults, the surety will guarantee repayment.

The contract of guarantee involves three parties i.e.

• Surety: The surety is the individual who provides the guarantee. The surety's liability is secondary, meaning that he will only be required to make payment if the principal debtor defaults on his end.
• Principal debtor: The principal debtor is the individual for whom the guarantee is provided in relation to their default.
• Creditor: The creditor is the individual to whom the guarantee is granted.

For instance, Mohan borrows Rs. 5 lakhs from the Lucknow University branch of UCO Bank. Sohan assures UCO Bank that Mohan will make the payment if he doesn't repay the loan on time. Mohan is the principal debtor under the contract of guarantee. Sohan is the surety, while UCO Bank is the creditor. 

Essentials of the Contract of Guarantee

The essentials are:

• The agreement may be made verbally or in writing[13].This is provided under Section 124 of the Act. However, under English law, the guarantee contract must be in writing.
• A principal debt ought to exist. Principal debt is the sum or item that the principal debtor borrows from the creditor, for which the surety has provided a guarantee in the event that the principal debtor defaults. Therefore, if there is no principal debt, there will also be no contract of guarantee. Let's use an example to better grasp this. Assume that A borrows Rs. 500 from landlord B, for which C has provided his assurance. In this instance, there won't be a contract of guarantee if A refuses to borrow money from B.
• Benefiting the principal debtor is sufficient consideration. Clear consideration between the creditor and the guarantee that the creditor has taken any suitable action for the principal debtor's benefit is not required. Let's say A requests particular things from B. And, if C is acting as a surety, the delivery of products to A will be considered as consideration for C, because A benefits from this supply of goods. This is mentioned in Section 127 of the Indian Contract Act, 1872. It states that everything done or promised for the benefit of the principal debtor may be adequate consideration for the guarantor to give the guarantee.
• It was improper to use deception or concealment to get the surety's consent. It is improper to use any unfair methods to get the surety's assent, such as lying or hiding any important information about the contract. Should any more information be discovered, the contract may be terminated and deemed void. Sections 142 and 143 of the Indian Contract Act of 1872 addresses this. According to Section 142, any assurance that was acquired by deceiving someone or hiding any important information about the transaction is void[14]. According to Section 143, any assurance that a creditor has received by remaining silent about material circumstances is void [15].Consent cannot be acquired by deceiving or hiding any information. 

Liability of Surety

Section 128 of the Indian Contracts Act, 1872 stipulates that the surety's liability is co-extensive with that of the principal debtor, unless otherwise specified in the contract. Surety's responsibility is equal to that of the principal debtor. A creditor may go straight against the surety. A creditor may sue the surety directly, rather than the principal debtor. Surety is obligated to pay immediately following the principal debtor's default on any payment.

The principal debtor, on the other hand, has primary responsibility for payment, with the surety taking on secondary duty. In reality, if the principal debtor cannot be held liable for any payment due to any paperwork error, the surety is not responsible for that payment. 

Surety's Rights

In relation to the principal debtor, creditor, and co-surety, a surety has specific rights.

1. Rights against Principal Debtor

• Rights of Subrogation: A surety acts on behalf of the principal debtor in the event that the principal debtor is unable to pay or fulfill their obligations to creditors. All of the creditor's rights against the principal debtor are then transferred to the surety. This is known as the "right of subrogation," which allows the surety to recoup the sum or performance that he has rendered on behalf of the principal debtor. Section 140 of the Indian Contract Act of 1872 makes reference to this.
• Indemnity right against the principal debtor: Section 145 of the Indian Contract Act of 1872 is covered in this section. In the event that the principal debtor defaults, the surety fulfills all of the creditor's requirements that the principal debtor is required to fulfill under the terms of the contract. Now, this contract contains an implied assurance that if the surety is acting on behalf of the principal debtor, the principal debtor will be responsible for repaying the surety for all money that the surety has legally paid to the creditor on his behalf. He has every right that a creditor may have against the principal debtor.

2. Rights against Creditor 

• Securities that the creditor acquired at the time of the guarantee of the contract: Section 141 of the Indian Contract Act, 1872, which states that sureties have the right to profit from creditors' securities, acquired at the time of giving guarantee. Regardless of whether the surety is aware of the existence of the security or not, they are entitled to the benefit of any security that the creditor has against the principal debtor at the time the suretyship contract is entered into. If the creditor loses the security or releases it without the surety's consent, the surety is released to the extent of the security's value.

3. Rights against Co-Sureties

• Contribution right against co-sureties in equal amounts: The Indian Contract Act of 1872's Section 146 addresses the clause pertaining to the division of debt obligations. According to Section 146, if two or more people are co-sureties for the same debt or obligation, either jointly or severally, under the same or different contracts, and with or without each other's knowledge, they are liable, as between themselves, to pay each other an equal share of the entire debt, or of the portion of the debt that the principal debtor has not paid. This section discusses the surety's equal contribution[16]. Whether the sureties signed the contract individually or collectively is immaterial. They must evenly divide the debt, whether or not they are aware of the other sureties. This section is the main focus.
• Right of Contribution against Co-sureties in Equitable quantities: Section 147 states that Co-sureties bound in varying quantities are obligated to provide equitable payments to the extent that their individual duties allow[17]. The co-sureties are free to enter into a contract with one another on the various proportions of culpability under several circumstances. There can be no interference between the principal debtor and the creditor. The upper limit will vary depending on the type of surety. If one of the other surety members is not prepared with the contract, the agreement will be void.
• Right of Contribution: One of the sureties is responsible for recovering the remaining funds from other sureties that he was not entitled to pay if, for any reason, he has paid off all of the debts owed to the creditor. The additional sureties' assent is not required in this case.

Difference between Contract of Guarantee and Indemnity Contract

• In a contract of indemnity, there are two parties: the indemnity holder, also known as the indemnified, and the indemnifier. Three parties are involved in a contract of guarantee: the principal debtor, the creditor, and the surety.
• An indemnification contract is a single agreement between the indemnity holder and the indemnifier that commits the indemnifier to paying the indemnity holder for any losses. In contrast, a contract of guarantee consists of three contracts: one between the principal debtor and the creditors, wherein they fulfill their duties against one another; the second is between the surety and the principal debtor, who performs the principal debtor's duties in the event of the principal debtor's default. The third is an implicit agreement between principal debtor and the guarantor that requires the principal debtor to reimburse the surety for his performance under the contract of guarantee.
• The goal of a contract of guarantee is to protect creditors; it indicates that the principal debtor has the primary responsibility for a given debt or obligation. The purpose of an indemnity contract is to shield the indemnity holder from any losses.
• Surety liability is referred to as secondary liability under the Contract of Guarantee, meaning that only the surety is responsible for paying the amount in the event that the principal debtor defaults. In contrast, the indemnity holder's principal obligation under the indemnity contract is to protect him from any losses.
• Once the surety has fulfilled the principal debtor's default, the contract of guarantee is complete. All of the creditor's rights against the principal debtor are vested in him. The same amount of money or the work that the surety completed on his behalf can then be given back to him. However, under an indemnity contract, the indemnity holder is exempt from repaying the indemnifier.
• In England, an indemnity contract may be verbal or in writing, whereas a guarantee contract must be in writing. However, in India, a contract of guarantee and a contract of indemnity can be either written or verbal. Such a restriction does not exist. 

Continuing Guarantee

The Continuing Guarantee is defined under Section 129 of the Indian Contract Act, 1872. A continuing guarantee is a type of assurance that is a series of transactions[18]. A continuing guarantee applies to all transactions that the debtor engages in until the surety revokes it.A continuing guarantee for future transactions may be withdrawn at any moment with notice to creditors. However, a surety's duty for transactions conducted prior to the withdrawal of the guarantee is not reduced.

Conclusion

In contrast, an indemnity allows for simultaneous duty with the principal, even though there is no compelling reason to look at the principal. In general, it is an agreement that the surety will indemnify the lender for any losses incurred as a result of the principal-debtor agreement. In general, a guarantee accommodates a responsibility that is far-reaching in relation with the principal. At the end of the day, the guarantor cannot be liable for much more than the client. The instrument will be interpreted as a guarantee if, throughout its actual development, the surety's commitments remain behind the principal and only come to the fore front once a commitment between the principal and the creditor is broken. The commitment is reflexive in nature. An indemnity arises when an incident occurs, whereas a guarantee arises when a third party fails to meet its obligations. As a result, we have described what indemnity and guarantee entails and why they differ, such as the number of parties involved and the nature of the risks involved, as well as the minor but significant distinctions between guarantee and indemnity in terms of working and principal. Thus, while there are some parallels between guarantee and indemnity, they are fundamentally different.

Both the indemnity and guarantee contracts give loss protection. However, as previously said, there is a significant differential between the two. In each scenario, determining whether a contract is an indemnity or a guarantee is a matter of construction.

[1] The Indian Contract Act, 1872, s.124.

[2] Id. at s. 125.

[3] Id. at s. 125(1).

[4] AIR 1915 MADRAS 36.

[5] AIR 1926 Nag 108. 

[6]The Indian Contract Act, 1872, s.125(2).

[7] 1880) ILR 5 Cal 811.

[8] (1888) ILR 10 All 531.

[9] The Indian Contract Act, 1872, s.125(3).

[10] AIR 1944 Mad 457.

[11] 1966 CRILJ 451.

[12] 1967 AIR 359.

[13] The Indian Contract Act, 1872, s.124.

[14] Id. at s. 142.

[15] Id. at s. 143.

[16] T Id. at s. 146.

[17] Id. at s. 147.

[18] Id. at s. 129.

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