INDEMNITY AND GUARANTEE

INDEMNITY

Indemnity is compensation for damages or loss, and in the legal sense, it may also refer to an
exemption from liability for damages. The concept of indemnity is based on a contractual
agreement made between two parties, in which one party agrees to pay for potential losses or
damages caused by the other party. An example is an insurance contract, whereby one party
(the insurer or the indemnitor) agrees to compensate the other (the insured or the indemnitee)
for any damages or losses, in return for premiums paid by the insured to the insurer.

The English law definition of a contract of indemnity is – “it is a promise to save a person
harmless from the consequences of an act". Thus it includes within its ambit losses caused not
merely by human agency but also those caused by accident or fire or other natural calamities.

The word "indemnity" stems from the Latin root indemnis, meaning "unhurt, undamaged" or
"without loss."

Indemnity may be paid in the form of cash or by way of repairs or replacement, depending on
exactly what is spelled out in the indemnity agreement.

For example, in the case of home insurance, the homeowner pays insurance premiums to the
insurance company in exchange for the peace of mind of knowing that he or she will be
indemnified if the house sustains damage from fire, natural disasters or other perils specified in
the insurance agreement. In the unfortunate event that the home is damaged significantly, the
insurance company will be obligated to bring it back to its original state, either by means of
repairs by authorized contractors or by reimbursing the homeowner for expenditures incurred for
such repairs.

SECTION 124 OF INDIAN CONTRACT ACT, 1872

The term indemnity defined under ‘section 124’ of the Indian Contract Act, 1872- “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 conduct of any other person”. Thus, provision incorporates a contract
where one party promises to save the other from loss which may be caused, either

By the conduct of the promisor himself; By the conduct of any other person
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 200 rupees. This is a contract of indemnity.

NATURE

Indemnity can be treated as a sub-species of compensation and a Contract of Indemnity is a

species of contracts. The obligation to indemnify is a voluntary obligation taken by the
indemnifier. Indemnity contract includes two parties and one contract, it can be said that
indemnity contract is simple in nature.
ESSENTIALS –
There must be contract between the parties;
There must be two parties;

There must be a promise to save the other party from some loss: This is the most important
element of a contract of indemnity. One party must promise to save the other party from any
loss which he may suffer;

The loss may be due to the conduct of the promisor himself or any other person. The indemnity
may be for the loss which a party may sustain due to the conduct of the promisor himself or of
any other person. As stated earlier, this provision restricts the scope of contracts of indemnity as
it covers the loss caused by human agency only,that is, by the conduct of the promisor or of any
other person. However, the general definition of the contract of indemnity is much wider and it
also covers the losses caused by the acts other than human beings. In other words, the losses,
arising from accidents or events which do not losses arising from accidental fire, perils of the
seas, etc. Thus, the contracts of fire insurance and marine insurance also fall in the category of
contract of indemnity.

Types of Indemnity
The indemnities are of two types;

 Express Contract of Indemnity: When the contract of indemnity is written or orally

consented, then such indemnity contracts are said to be Express Contract of Indemnity.

Example: A and B are into the contract of Indemnity. A agrees to reimburse the loss incurred by
B from a contract with C of some so-called amount.

 Implied Contract of Indemnity: When the contract of indemnity is applied by a statute or by a

common law that is in existence, then such indemnity contracts are said to be Implied
Contract of Indemnity.

Example: A and B are agent and principal. A has to supply goods to B for his business. A
supplied goods but B did not want them and denied taking the same. A can sell the goods and if
he incurs any loss while selling them, then B has to make good the loss of A and the statue or
the common law will ensure the same.

In Indian Law, the express contract of indemnity is only covered and the implied contract of
indemnity is also covered by the decision of the court. The law in India says that the loss that
incur shall be due to the conduct of the person. The claim is actionable in India. The contract of
indemnity do not applies to the contract of Insurance.

In English law, both the express and the implied contracts of indemnities are covered. The loss
that was incurred can be in any way. The law also states that the indemnity can be assigned.
The insurance contract is an indemnity contract in English Law.

WHEN INDEMNITY IS ENFORCEABLE?

In England, under common law, it was essential for an indemnity holder to first pay for the
losses and then claim indemnity. With time, Court of Equity softened the law and in 1911 with
the RE: RICHARDSON, EX PARTE THE GOVERNORS OF ST THOMAS HOSPITAL case,
indemnity before payment by the indemnity holder was made the norm. Further in 1914, in the
case of RE LAW GUARANTEE & ACCIDENTAL case, it was stated that ‘to indemnify does not
mean merely to reimburse with respect to the money paid but to save from loss with respect to
liability for which indemnity has been given’. A Contract of indemnity would serve little purpose if
the indemnity holder was made liable in the first instance.

In India, there is no specific provision which states when a contract of indemnity is enforceable.
There have been confliction judicial decisions throughout. In Osmal Jamal & Sons Ltd vs. Gopal
Purushotam, was amongst the first Indian cases where right to be indemnified before paying
was recognised. But now, a consensus of sorts has been formed in favour of the opinion of
Equity Courts. In K Bhattacharjee vs. Nomo Kumar, Shiam Lal vs. Abdul Salal, and Gajanand
Moreshwar Case, it has been decided that the indemnified may compel the indemnifier to place
him in a position to meet liability that may be cast upon him without waiting until the promisee
(indemnified) has actually discharged it.

Indemnity requires that the party to be indemnified shall never be called upon to pay. Thus, the
liability of the indemnifier commences the moment the loss in form of liability to the indemnified
becomes absolute.

RIGHT OF INDEMNITY HOLDER (SECTION 125)

Rights of indemnity holder when sued

(1) All damages which he may be compelled to pay in any suit in respect of any matter to which
the promise to indemnify applies.
(2) all costs which he may be compelled to pay in any such suit if, in bringing or defending it, he
did not contravene the orders of the promisor, and acted as it would have been prudent for him
to act in the absence of any contract of indemnity, or if the promisor authorized him to bring or
defend the suit.
(3) all sums which 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, and was one which it would have
been prudent for the promisee to make in the absence of any contract of indemnity, or if the
promisor authorized him to compromise the suit.

Duties of indemnity-holder

The indemnifier will not liable for the loss in the following circumstances. They are called duties
of indemnity-holder too.

i. Duty to work prudently: The indemnifier will not liable for the loss caused by the negligence
work of the indemnity-holder. In other words, it is the duty of indemnity-holder to work prudently.
ii. Duty not to act to cause harm or loss: If the indemnity-holder acting with the intention of
causing any loss or damage, the indemnifier will not liable for such loss. In other words, it is the
duty of indemnity-holder not to act to cause harm or loss.
iii. Duty to comply with the intention of promisor: If the indemnity-holder acting against the
instruction of the other party or promisor, the indemnifier will not liable for the loss caused by
such against act to his instruction. In other words, it is the duty of indemnity-holder to comply
with the intention of promisor.

Rights of the Indemnifier

Although the rights of the indemnity-holder have been mentioned under the Act, the rights of the
indemnifier haven’t been mentioned expressly under the Act. In the judicial pronouncement of
Jaswant Singh v. Section of State, it was opined by the Court that the rights of the indemnifier
are similar to the rights of a surety. Rights of a surety have been stated under Section 141 of the
Act. The indemnifier, upon indemnification, will be entitled to all the protection which the
indemnified person was entitled to. The principle of subrogation comes into play here. The
principle of subrogation follows the principle of substitution. Once the promisor pays the amount
of compensation, he replaces the indemnified person.

INDEMNITY IN AGENCY

According to section 222 of Indian Contract Act, Agent to be indemnified against consequences
of lawful acts. The employer of an agent is bound to indemnify him against the consequences of
all lawful acts done by such agent in exercise of the authority Conferred upon him.

Illustration

B, at Singapore, under instructions from A of Calcutta, contracts with C to deliver certain goods
to him. A does not send the goods to B, and C sues B for breach of contract. B informs A of the
suit, and A authorizes him to defend the suit. B defends the suit, and is compelled to pay
damages and costs, and incurs expenses. A is liable to B for such damages, costs and
expenses.

GUARANTEE

A contract to perform the obligation or to discharge the liability of a third party in case of its
default is called contract of guarantee, (Section 126) Indian Contract Act, 1872. Contract of
Guarantee can be oral or written.

Guarantee contract includes three parties namely; Creditor, Principal Debtor and Surety. The
person who is granting the loan, the person who is utilizing the amount of loan is principal
debtor and the person who is giving guarantee is called surety or guarantor or favored debtor. In
case of guarantee contract there will be two types of liabilities namely; Primary liability and
secondary liability. Primary liability will be with principal debtor and Secondary liability goes to
surety.

Example: Y is in need of Rs. 10000/-. Upon guarantee by Z, Y has got the amount from X. Here
X, Y and Z are creditor, principal debtor and surety respectively.
The Essentials of a Contract of Guarantee are

 Tripartite Agreement: A contract of guarantee entails three parties, principal creditor,

creditor and surety. In a successful contract of guarantee, there must be three separate
contracts between the three parties and each and every contract must be consenting.

 Liability: Here the main liability lies with the principal debtor. Secondary liability lies with the
surety which can only be invoked once the principal debtor defaults on its payment.

 Essentials of a Valid Contract: Like any other general contract, it maintains free consent,
consideration, lawful object and competency of contracting parties as the essentials of a
valid contract.

 Medium of Contract: The Indian Contract Act, 1872, does not strictly mention the need for
any written form of contract of guarantee. Both oral and written form will suffice.

TYPES OF GUARANTEE

 Unilateral Contract of Commercial Credit

This is a type of contract of guarantee usually seen in trade transactions. It commonly arises
between the wholesale trader and a retail trader. Also, it arises between a retail trader and the
customer. In this type of guarantee contract, the goods are delivered against no payment but
with an agreement. The agreement between parties is either written or oral. The agreement may
or may not have any securities against discharge of the payment on a later date.

 Bank Guarantee

This type of guarantee contract is common in the contracts of the Government. Also, it is
common in tender for contracts. This type of guarantee contract is a commercial document. The
bank guarantee is autonomous and is independent of the contract that is underlying. It is a
guarantee from a bank against liabilities.

 Letter of Credit

A letter of credit is an instrument which is written by one person to the other about giving of
credit. The one who writes the letter, requests the other to give credit to the bearer of the letter
or in whose favor the letter is drawn. In the international trade this practice is commonly seen.
This can be general letter of credit which is drawn against merchants in general or special letter
of credit which is drawn against a specific person with all the information enclosed.

 Absolute Performance Bonds

Absolute means perfect and it also means complete. In this type of guarantee contract, the
surety pays the amount written in the contract upon the failure to discharge the contract by the
person against whom the guarantee is given.

 Retrospective Guarantee

When the guarantee is given for an existing obligation or debt, it is called retrospective
guarantee.

 Prospective Guarantee

When the guarantee is given for a future obligation or debt it is called prospective guarantee.

 Specific Guarantee

This type of guarantee is for a single transaction. It is extended only to a single debt. It is also
called as simple guarantee.

 Continuing Guarantee

This type of guarantee extends to more number of transactions. It continues until the guarantee
is revoked.

Surety’s Liability

Under section 128 of Indian Contract Act, the liability of surety is co-extensive that of the
principal debtor that means the surety is liable to the same extent as the principal debtor. For
example if the principal debtor is not liable for debt for some reason, then surety is also not
liable for the same.  Also, the principal debtor is discharged from his debt by the creditor for
some reason then surety will be discharged too. This section depends on the contract as well.
Therefore, the surety’s liability depends on the terms of the contract and is not liable to pay
more than the principal debtor has taken.

Illustration

A guarantees to B the payment of a bill of exchange by C, the acceptor. The bill is dishonoured
by C. A is liable, not only for the amount of the bill, but also for any interest and charges which
may have become due on it. A guarantees to B the payment of a bill of exchange by C, the
acceptor. The bill is dishonoured by C. A is liable, not only for the amount of the bill, but also for
any interest and charges which may have become due on it.

The liability of the surety is joint and connected with the principal debtor. It is the choice of the
creditor to recover the amount either from the principal debtor after his default or from surety.
He may file a suit against both the principal debtor and the surety or may file a suit against the
surety only or the principal debtor only.

In Bank of Bihar v Damodar Prasad it was held that the creditor do not have exhaust all the
remedies against principal debtor before suing the surety. It is the duty of the surety to pay the
debt if principal debtor does not pay. The purpose of contract of guarantee is defeated if the
creditor is asked to postpone his remedies against the surety. The liability of surety is
immediate.
Continuing Guarantee

Section 129 of Indian Contract Act defines continuing guarantee. A guarantee which extends to
a series of transactions is called continuing guarantee. It is not confined to a single transaction.
In this guarantee, surety is liable to pay the creditor for all the transactions. However, it is very
important to find out if the guarantee is a continuing one or not. 

Difference between continuing guarantee and simple guarantee

 A continuing guarantee can be revoked by the surety any time either by the notice to the
creditor or until the surety’s death. Whereas, simple guarantee can not be revoked in any
circumstances.
 In continuing guarantee, the transaction can go for long period of time therefore the surety
will be held liable for long time as well whereas in simple guarantee the surety liability is
over when the debt is paid or the performance is done.

Discharge of Surety

Section 133 -139 explains all the circumstances in which surety is discharged. All these section
can be called the rights of the surety as the surety will not be liable on the guarantee any more.

Contract of guarantee is a contract and can be discharged as a normal contract.

Section 133 of Indian Contract Act explains discharge of surety by variance.

“Discharge of surety by 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 transactions subsequent to the variance. 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 transactions subsequent to the variance.”

This section essentially the outcome of the general rule that is all the parties should be privy to
the contract. It stated that when a amendment takes place in the contract without taking surety,
the surety is discharged.  Surety cannot be bound to something for which he has not contracted.

For example: A becomes surety to C for B’s conduct as a manager in C’s bank. Afterwards B
and C contract without surety’s consent, that B’s salary sell be raised. In this Surety that is A is
discharged as A did not know about the contract between B and C.

Exception of this Section:

In this if the alteration is made in the agreement without the surety’s consent that is beneficial to
the surety, the surety is not discharged. The alteration should be unsubstantial/immaterial, then
surety is not discharged. In Anirudhan v The Thomco’s Bank Ltd it was held that the surety is
not discharged as the contract between the principal debtor and creditor is beneficial to the
surety.

Section 134 – Discharge of surety by release of Principal Debtor

In this section states that if the principal debtor is release because of any contract between
creditor and principal debtor or by any act or omission of the creditor, then the surety is
released. This section is connected with the section 128 of ICA which says that the liability of
the surety is co-extensive with that of principal debtor.  The reason for the discharge of surety is
with the principal debtor that this release of the principal debtor extinguishes the principal
obligation, to begin with.

In this section 2 types of release are mentioned.

1. Express release: This is a situation in where an express contract between the credit
and the principal debtor results in discharge/release
2. Implied release: In the section the words “by any act or commission of the creditor, the
legal consequence of which is the discharge of the principal debtor” refers to an
implied release/discharge.

Section 135– A contract between the creditor and the principal debtor without surety assent to

 to make a composition/compromise with

 promise to give time to
 not to sue the principal debtor
 discharges the surety

To make composition with”- This essentially mean if the creditor makes any sort of compromise
with the principal debtor with respect to the debt them surety will be discharged.

Promise to give time to”- where the creditor extends time for the payment of debt without the
consent of surety, then surety will be discharged.

Not to sue the principal debtor”- If the creditor agrees with the principal debtor to not to ever sue
against him, the surety will be discharged.

Section 136– Where a contract to give time to the principal debtor is made by the creditor with a
third person and not with the principal debtor, then the surety is not discharged.

For example- A agrees with B to supply 500 tons of steel in consideration of Rs 5 Lakhs. C
stands surety to A . A agrees with D (B’s father) to extends the delivery date. C is not
discharged as D is the third party and not the principal debtor.

Section 137– Mere Forbearance on the part of the creditor to sue the principal debtor or to
enforce any other remedy against him does not discharge the surety.

Mere forbearance means own its own. When creditor does not sue the principal debtor on its
own then the surety is not discharged.
Section 139– In this section consists of the following elements:

 The creditor either does something which is inconsistent with the rights of the surety or
omits to do his duty towards the surety
 And because of this the eventual remedy of the surety that he had against the principal
debtor is impaired(weakened) , the surety is discharged.

The object of this section is to ensure that no arrangement different from that contained in the
surety’s contract is forced upon him. Duty of care is owned by the creditor.

Section 140– The meaning of this section is that the surety steps into the shoes of the creditor
after he has paid the guaranteed debt or performed whatever he was liable for. This right of the
surety to step into the shoes of the creditor is known as the surety’s right of subrogation.

Automatic subrogation : Once the surety has paid the guarantee amount to the creditor. The
surety is invested with this right automatically without any pre-conditions attached to it.

Section 141– A surety is entitled to every security which the creditor has against the principal
debtor at the time when the suretyship is entered into. Or if the creditor loses or parts with such
security the surety is discharged to the extent of the value of the security. This section is applied
even when the surety’s consent is not there. The words “if the creditor loses security” refer to
deliberate action by the creditor and not a mistaken situation beyond the control of the creditor.

Extent of discharge: if the value of the security is less than the liability undertaken by the surety,
then the surety must be held to be discharged to the extend of the value of the security and that
he will still be required to discharged the liability which exceeds the value of security. However,
if the value of the security given is in far excess of the liability, the surety must be held to be
discharged wholly.

Section 142– Guarantee obtained by misrepresentation. Any guarantee obtained by

misrepresentation made by the creditor is invalid.

Section 143– Any guarantee which the creditor has obtained by means of keeping silence as to
a material circumstance is invalid.

Section 144– Guarantee on contract that creditor shall not act on it until co-surety joins. Where
a person gives a 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. 
Where a person gives a 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.

Section 145– In every contract of guarantee there is an implied contract of indemnity in between
the surety and principal debtor. Principal debtor has to indemnify the surety later with the
rightfully sum. The surety can sue the principal debtor for the guarantee amount as soon as his
liability becomes absolute. The surety may recover all damages, all costs and all sums in
accordance with section 125 of ICA.

Co-sureties
Section 138– When one co-surety is released does not discharge other co-surety. A release by
the creditor of one of them does not discharge the others neither does it free the surety so
released from his responsibility to the other sureties.

Section 146-This section defines co-sureties. Where 2 or more persons are co-sureties for the
same debt or duty are liable as between themselves to pay each an equal share of the whole
debt or of that part of it which remains unpaid by the principal debtor. contribution of all the co-
sureties should be equal, if not mentioned in the contract. It should be according to the contract
if the proportion is mentioned in the contract.

Section 147– Co-sureties are bond in different sums are liable to pay equally as far s the limits
of their respective obligations permit. For e.g.. – A, B and C are sureties for D enter into 3
several bonds. A in the penalty of Rs.10,000, B in that of Rs. 20,000 and C in Rs 40,000. D
makes a default to the extent of Rs. 40,000. So, the liability of A will be 10,000 , B’s liability will
be 15,000 and C’s liability will be 15,000 as well.

Difference between Indemnity Contract and Guarantee Contract

 Number of Parties: Indemnity contract includes two parties namely, indemnifier and

indemnity holder. But guarantee contract includes three parties namely creditor, Principal
debtor and surety.

 Number of Contracts: In case of indemnity contract, as there are only two parties, there is
possibility for existence of one contract only. But a contract of guarantee includes three sub-
contracts.

 Nature: As indemnity contract includes two parties and one contract, it can be said that
indemnity contract is simple in nature. But guarantee contract includes three parties and
three sub-contracts and hence be said that guarantee contract is complex in nature.

 Liability: In contract of guarantee there will be two types of liabilities namely; primary and
secondary liabilities which will be with principal debtor and surety respectively. But in
contract of indemnity there is no classification and sharing of liability where the absolute
liability rests with indemnifier.

 Recovery: In case of indemnity contract the indemnifier, after compensating indemnity

holder`s loss, cannot recover that amount from any person. But in contract of guarantee, if
surety makes payment to creditor, he (surety) can recover that amount from principal
debtor.

 Interest of parties: Indemnity contract gets formed upon indemnifier`s interest and

guarantee contract gets formed upon principal debtor`s interest.

Similarities between Indemnity Contract and Guarantee Contract

Guarantees and indemnities have numerous similar attributes. By and large likewise, similar
obligations and rights emerge between the parties. This will have impact particularly throughout
the time of looking to authorize the agreement. Contracts of indemnity and contracts of
guarantee impart certain central commonality. In every contract, one party consents to pay in
the interest of another. Also each of these categories of contracts is utilized as a safeguard
against misfortunes by people and organizations. One more point of similarity worth mentioning
is that they cannot be used to make unjust enrichments. In a comparative study
between Punjab National Bank Ltd. v. Bikram Cotton Mills and Anr and Gajan Moreshwar vs.
Moreshwar Madan, it can be seen, that both guarantee and indemnity are used to compensate
the creditor and indemnity holder respectively and the principal debtor and surety in the Punjab
National Bank case s well as the indemnifier had consented to pay to make good of the debt.