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Indemnity and Guarantee
business law 1st sem bcom hons
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Indemnity and Guarantee
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INDEMNITY AND GUARANTEE ‘The Contract of Indemnity and Guarantee are special types of Contract. The Jaw relating to indemnity and guarantee is contained in Chapter VIII under Secs. 124 to 147 of the Indian Contract Act, 1872. In addition to these specific provisions, the general principles of contracts are also applicable to such specific contracts. CONTRACT OF INDEMNITY Meaning of Contract of Indemnity (Sec. 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 called a “contract of indemnity’. Meaning of Indemnifier and Indemnity-Holder The person who promises to make good the loss is called the ‘indemnifier. The person whose loss is to be made good is called ‘indemnity-holder. Examples: 1) Where Mr. A says that railway receipt (RUR) related to goods is lost by him and he claims those goods. Railway company shall ask him for executing an ‘indemnity bond’ so that railway company can claim indemnity for the loss from Mr. A in case of genuine counter claim to goods made by fel owner, ifany. Here Mr. A will bean ‘indemnifier’ and railway company will be ‘indemnity-holder. 2) A contracts to indemnify B against the consequences of any proceedings which C may take against B in respect of a certain sum of € 20,000. This is a contract of indemnity. y In the above example, A is the indemnifier and B is the indemnity-holder. | | @ scanned with OKEN Scannern2 Business oy, Whether Contract of Insurance is @ Contract of Indemnity or not? mnity covers the cases of loss caused by the event he conduct of the Promisor or Bg depend upon t : words whether the contract of indemnity shal, not? Whether Contract of Inden or accidents which do not other Person or not. In other tract of insurance OF nity under the English Law English law as “a promise to save It of a transaction entered intg cover the con Definition of Indem mnity is defined in the A contract of inden as a resul another harmless from loss caused at the instance of the promisor” When the English and Indian found that the Indian definitio: definitions of indemnity are compared, it is .n of indemnity is narrower in scope (it covers the loss caused by human agency only) as compared to the English definition, It needs to be noted that the Indian Courts follow the English law definition in respect of indemnity. With adoption of this practice a contract of insurance (marine and fire insurance) comes very well within the ambit of contract of Indemnity. Essential Elements of Contract of Indemnity = of indemnity may be express or implied promise to indemnify. In ion to this all the essentials of a valid contract must also be present. an present. X asks Y to beat Z ses to indemni and promises to indemnify Y against the consequence. Y beats Z and is fined & 1,000. Y cannot clai 000. t ; oe ee claim this amount from X because the object of the Rights of Indemnity. holder bales ee ‘older when sued: According to Sec. 125 the indemnity sul and Gi) Casoropce indents i) all damages, (i) all oss of he vith aud oe cepa ee eer of comm Se doer nots anatment of the Indemnifer’s Liability: The Contact At 8 about it. But it has been held in various judgments @ scanned with OKEN Scannerindemnity holder can ¢, : ut ema ry cent the indemnifier to is cnt eed nea TRACT OF GUARANTEE + i of a Contract of Guarantee Hontract of Buarantee’ is a conty wbilty ofa third person in ca: specontractof guarantee ao uy goods on credit (Sec, 126) Act LO perform th ; Se of his defautt, ‘entered into to enable OF seek employment, he promise or di harge 4 person to borrow money pom {and his friend Y enter a shop and X says to 7% yy and if he does not pay you, 1 will” It is : ce qourse has been requested by Y to give guarant ‘Supply the goods required ‘ontract of guarantee (X of tee). parties to a Contract of Guarantee ‘There are three parties to a Contract of Guarantee, Principal Debtor, Creditor and Surety. Principal Debtor (Sec. 126). The person in respect of whose default the gurantee is given is called the ‘Principal debtor. Y is the principal debtor. Creditor (Sec. 126). The person to whom the guarantee is given, is called the ‘aeditor. Z is the creditor. ‘ Surety (Sec. 126). The person who gives the guarantee is called the ‘Surety’. X isthe surety in the above example. Essential Features of a Contract of Guarantee The essential features of a contract of guarantee are: 1. Essentials of valid contract. The contract of guarantee is a special contract. It must have all the essential elements ofa valid contract. Example: Cssells and delivers the good: mance, § refuses to give guarante The contract of guarantee is not val 1s to P provided S gives assurance for P's perfor- . C obtains his guarantee at the gun point Tid because the consent of surety i not fee, ; oe 4 No direct consideration is require - Consideration for Guarantee. ; bet 7 rety and the creditor. Sec. 127 of the Act states that b ne the su iui promise made, for the benefit of the principal det i a 7 Sr ficent consideration for the surety for giving the tor, may be a Ea guarantee” Surety need not be benefitte @ scanned with OKEN Scanner14 PUsiness 1, Man, to sell and deliver to him goods on credit. A agrees to dy 0 Ato “Wee the payment of the price of the goog, ¢° ent in consideration of AS promise , ise t ee the payme ‘ sufficient consideration for C’ promise, 1s goods to B, C afterwards requests A to forbear to sy, and promises that, if he does 80, C will pay, y forbear as requested, ‘his B for the debt for a year :lt of payment by B. A agrees (0 C's promise. wards, without consideration, agree, cement is void as the guarantee fo, them in det it a sufficient consideration for 43) Aselisand delivers goods to B. Calter to pay for them in default of B. The agr the past debt would be invalid. Capacity of the parties. In the contract of guarantee the Parties must be competent to contract. But the competency of the parties is required only for the creditor and the surety. The principal debtor may not be competent to contract. His incompetency to contract will not invalidate the contract of guarantee. In such a case, the surety is regarded as the principal debtor. Existence of a recoverable debt. There cannot be a contract of guarantee without the existence of recoverable debt or liability. Case Law: Swan v. Bank of Scotland (1836) ‘A took some overdraft from the bank. The payment of the overdraft was guaranteed by C. The overdrafts were against provisions of the law which not only imposed penalties upon the parties to such drafts but also made them void and unenforceable. A committed default and the bank sued C for the loss. Held, he was not liable. The court said, “If nothing is due from the party then the promise given by the surety to make nothing good amounts to nothing, ifthe banker is forbidden from claiming any amount from its customer, there is no liability incurred by the co-obligers”. Hence surety was under no obligation to pay any amount to the bank. No misrepresentation or concealment of facts. A contract of guarantee : wi a contract of utmost good faith, it is not necessary that principal el itor di inte ine creditor disclose all the material facts to the surety: i . '¢ provisions of Sec. 142 and 143 give protection to the suretY: ; eat to Sec. 142 and 143 of the Act: 4) Guarantee not to be Obtained Misrey i 142). Any guarantee which has been oby by Misepresentation (See 142) tained by i tation made by the creditor, y means of misrepresen! —. or with his knowledge and assent, concerni?& ial part of the transaction, is invalid, @ scanned with OKEN ScannerTheo uarantee not te . 0 poaratee cian ae by Concealment (Sec. 143). Any itor hag obtai I f ; § oblaine, silence a8 to material circumstances is in i u_— of keeping samples lid, Ea eB i een aa {0 collect money for him, B fails to account for some his duly accounting c ate calls upon him to furnish security for Pe aeeusint C vit oe Buarantee for B's duly accounting. A does ‘The guarantee is invalid. ‘ous conduct. B afterwards makes a default. 7 a earoriowien for ron to be supplied by him to B to the , and C have privately agreed tha agreed that B should paj 500 per ton beyond the market pri ch excess to be applied liquidation of an old debt. This agreement is A. Aisi . tis is ligt 7 greement is concealed from A. A is not 6. Conditional or secondary liability of surety. Under the contract of guarantee the liability of the surety is conditional or dependent. It arises only when default is committed by the principal debtor. 7. Guarantee only at the request. It is necessary that the surety should give the guarantee only at the request of the principal debtor. Example: P buys some goods on credit basis from C. $ without being requested by P undertakes the responsibility to indemnify C against any damage that may arise from a breach of P’s obligation. $ does not become a surety because a person can become a surety with the consent of the principal debtor. 8. Express or Implied. A contract of guarantee may be either oral or written. It may be express or implied (Karnataka State Industrial Investment and Development Corporation Ltd. v. State Bank of India, 2005). DISTINCTION BETWEEN CONTRACT OF INDEMNITY AND GUARANTEE ‘Table 11.1: Distinction Between Contract of Indemnity and Guarantee Contract of Indemnity Contract of Guarantee Tis a contract to protect the other | It is a contract to perform the person fromlosscaused tohimeither | promise or discharge the liability of bythe conduct ofthepartiesorfrom | a third person incase ofis default an event or accident (English (Sec. 126). definition). 2 Number of | There aretwo parties nacontractof | ‘Therearethree parties ina contract Patties indemnity, va, the indemnifie and | of guarantee, viz. the surety, the the indemnified. principal debtor and the creditor @ scanned with OKEN ScannerBusiness Lay, ue the contract | The object of contrac, ide guaranteeis to provide secur to-ensure discharge ofa bigs” ‘The main object ol : oF of indemnity is to provi one protection tothe indemnified from losses. [ine emity there isonly There are three contracts in care — . case fit 4 Namibseof [Trea ntact that is between | of guarantee, ontracts one €or Benes = i fier and indemnified, @ Principal deb, indemnifier and in cee or (i) Between the surety and the creditor. (ii) Between the principal debtor and the surety. fe eee Eee Zo naureot | Theliability of the indemnifi In the contract of guarantee the | iain isprimary. liability of the surety to the ee creditoris secondary. Itarises only when the defaultis commited by the principal debtor. % Baistence of | The liability ofthe indemnifier | The recoverable liability or debt risk or debt arises only on the happening ofa is in existence at the time of ~ orliability contingency which may or may | contract. nothappen. Thustheriskis non- cexistentat the time of contract. 7, Righttosue | Theindemnifiercannotfileasuit | When the surety discharges the ‘against a third party in his own | liability of debtor, he steps into name because thereisno privity | the shoes of creditor. Therefore, ‘of contract. He is allowed todo. | _hecan proceed against the debtor $0 ifthe claim is assigned in his | "in his own right. favour. Kinds of Guarantee A guarantee may be classified under the following heads: 1. Retrospective or prospective guarantee. cee guarantee is one which is given for the past debt. Retrospective ae forapast debt are not enforceable at law because these guarantees ay os (refer to example 3, page 11.4). Retrospective Soe the orn Ut tothe creditor whereby the creditor promises not sulficiem paren seins his default is, however, valid as there is io rene example2, page 11g)” Teditor against surety’s promise (refer 10 Prospective guarantee i a ichiso Staranteeis one which i given for the future debt or obligation. @ scanned with OKEN Scannerontyond Guarantee w specific or continuing uarantee 17 3b i 'd to a singl ‘fi saction. It comes to an end when py, a single or specific jeovigaion isduly performed, "*™ed debt is duly discharged or le: paamp a tuys LV. fr & 30,000 from a dealer on credit, § 7 gives the pun \ sats the payment onthe due date. Sis discharged en his iy, oe continuing guarantee. A guarantee whic i" 7 h extends to a series of transactions, is called a continuing Suarantee’ guamples. (Adapted from illustrations appended to sec, 129 in Bare Act) @) A. in consideration that B will emy promises B to be responsible, payment by C of those rents, ploy C in Collecting the rents of B’s zamindari, to the amount of 5 lakhs, for the due collection and This is a continuing guarantee, (}) Aguarantees payment to B, a tea-dealer, to the amount of & 1 lakh, for any tea he may from time to time supply to C. B supplies C with tea of above the value of lakh, and C pays B for it. Afterwards, B supplies C with tea of the value of & 2 lakh. C fails to pay. The guarantee given by A was a continuing guarantee, and he isaccordingly liable to B to the extent of @ 1 lakh. 3, Fidelity Guarantee Guarantee which is given for the good conduct or honesty of a person employed in a particular organisation. Such guarantee is known as fidelity Suarantee. Revocation of Continuing Guarantee Acontinuing guarantee can be revoked at any time as to future transactions in the following circumstances: 1. By notice (Sec. 130). “A continuing guarantee may be revoked at any time by the surety, as to future transactions, by notice to the creditor”. However, he remains liable for the transactions prior to such notice. 2. By death of surety (Sec. 131). “The death of a surety operates, in the ‘bens of 7 contract to the contrary, as @ revocation of a continuing Suarantee with regard to future transactions”. lo not .d to be gi -ditor. The estate of is i be given to the cre No notice of death is required t ‘ ‘ the surety is liable for the transactions undertaken prior to his death, @ scanned with OKEN Scannerus NATURE 1. Surety’s ial - _ Surety’s liability is se |. Surety’s liability arises AND EXTENT OF SURETY’S LIABILITY bility is co-extensive. Sec. 128 of the Act explains the ratize of surety's liability. As P e surety is co-extensive with that of the Principal therwise provided by the contract”. Therefore, the ty's liability will be equal to that of the Principal t of money the principal debtor owe, the surety is also liable to pay the jt er this section: and exten “The liability of th debtor unless it is 0 nt of the suret ver amoun| t and charges, amout debtor. Whate inclusive of interest same amount. Limit on Surety’s liability by contract. As per Sec. 128, the liability of surety equals the liability of the principal debtor and parties may agree otherwise by providing so in contract. So if the surety is given only for a part of the debt, the liability of surety shall be for that part only. condary. The primary liability is that of the jiability of the surety being secondary arises principal debtor. The li al debtor. For this reason surety’s only in case of default by the princip: liability is termed as contingent or dependent. immediately on the default of the principal t required to give a notice of default of ety. The creditor need not exhaust his remedy against the principal debtor before proceeding against the the surety directly even if the surety and may bring a suit against tl principal debtor has not been sued (Ram Krishan v. State of UP SC 2012). Case Law: K.Paramasivam v, The Karur Vysya and Anr. (SC, 2022) ‘The principle that the liability of guarantor is co-extensive with that of the principal borrower and arises immediately on default got reinforced in this case. It held that Corporate Insolvency Resolution Process (CIRP) can be initiated directly against corporate guarantor without proceeding against principal borrower. nuing debtor. The creditor is no’ principal debtor to the sui . Surety’s liability in continuing guarantee. In case of conti ea the liability of the surety is not confined toa single transaction ut extends to a series of transactions over a period of time. is ee urety’s liability where the original contract between the principal debt itor is vol a ae creditor is void or voidable. The contract between the and surety is an independent contract and not collateral. The G@ scanned with OKEN Scanneryand Guarantee 3 CO Versa. For gga Ml the principal debtor minor, pes who stands surety for see 'N case of a loan given to _ surety isa favoured debinn loan shall be lable, & ‘voured debtor because of the ton as always been considered a a) Surety is liable only when princi een debtor does Ss Not pay ty can in ng 7 principal debtor. It may, howeve, that effect. ° case be more than that of the © restricted by a special term to c) The surety will not be liabl panera iat where the creditor has obtained Tepresenting a material fact, RIGHTS OF SURETY - discharging the liability of the Principal debtor, the surety gets various rights: Rights of Surety Right against Right against Right against the principal debtor the creditors the co-sureties 4 A (@) Right to | | (6)Rightto | | Right to claim securities | | claimset off | | contribution @Rightto |[ (b) Right to Subrogation || claim indemnity Figure 11.1 : Rights of Surety 1. Rights against the Principal Debtor (@) Right to Subrogation (Sec. 140). On payment of the guaranteed debt or performance of the guaranteed duty, the surety acquires all the rights which the creditor had against the principal debtor. This is known as the right of subrogation. Subrogation simply means substitution. Thus, the surety steps into the shoes of creditor. ‘ tract of guarantee Right demnity (Sec. 145). “In every contract ; ania a fed promise by the principal debtor to indemnity the suet : snd the surety is entitled to recover from the principal debtor irety; ans @ scanned with OKEN ScannerBusiness Lay, rightfully paid under the guarantee, BUt not thoge had paid wrongful)” 11.10 whatever sum he has sums whieh I for the debt. C demands payment fro mount, A defends the suit, havine compelled to pay the amount qf ‘om B the amount paid by him ie nd A issurety n for the js for doing so, but li He can recover fr principal debt. to the extent of € 5,000, payment for wheat to be ies to B wheat of fess amount than & 5,000 byt 1% 5,000 in respect of the wheat ¢ than the price of the wheat reas the debt with & as well as the A guarantees t0 Cs supplied by Cro B.C sup sprains from A payment of the sunt Ol supplied. A cannot recover from B mor actually supplied. Rights against the Creditor (Sec. 141). “A surety is entitled to the benefit of ich the creditor has against the principal debtor at retyship is entered into, whether the surety knows of the existence of such security or not; and if the creditor loses, or, without the consent of the surety, parts with such security, the surety is-discharged to the extent of the value of the security”, i) I. (a) Right to Securit every security whi the time when the contract of su Example: advances to B his tenant, & 5,000 on the guarantee of A. C has also a security for & 3,000 by a mortgage of B's furniture, C cancels the mortgage. B becomes insolvent, and C sues A on his guarantee. A is discharged from liability to the amount of the value of the furniture. Right to Claim Set off, ifany. The surety has the right to claim set off or counter claim, ifany, which the principal debtor had against the creditor incase the creditor sues him for payment of liability of principal debtor. ® IIL. Right of Contribution against Co-sureties ‘Meaning of Co-sureties. When the same debt or duty is guaranteed by two or more persons, such persons are called as ‘co-sureties’ Ri A roe ne - an Contribution. Ifa co-surety pays more than his proportionate of liability, he has a right to claim contribution from the other co- surety or co-sureties, Right to Share it ae rthe ii {faco-surety obtains any security of principal debtors ty (or co-sureties) has (or have) a right to share such security. Liability of Co-sureti sureties, iabili 112, reties. The liability of co-sureties is summarized in table 4 @ scanned with OKEN Scanner‘Table 11.2; Wey “at he co-sureties have agreed |The Wel antee different sums ‘ability, Of Co-sureties The co-sureties are liable to contribute equally subject to the maximum amount |__Buaranteed by each one (Sec. 147) pSCHARGE OF SURETY asarety is said to be discharged when his liability as surety comes to an end. she various modes of discharge of a surety are shown below in Figure. By = [By Conduct ofthe Creditor | of Contract Bnew ][ ByDean | [ By Novation | secson 130) |] of Surey || [Section 63} {Section 131] Teese | [RSs] [Arann Tasof seein |) charge of || bermeea seciiy the pint || pineal (Seton coowne ||acbos |] ever and ut) [Section [Section ‘ereditors 134) | [serion 138 tsesuon 139) one yma. Taarsice | [Ginasiee |) [Faire ofa dbaiety | | candy | | cose riweprerenatin | | concaimet | | insur {Section 42] | [{Section 143} | | [Section 148) Figure 11.2: Modes of Discharge of Surety L__ By Revocation of Contract of Guarantee (@) By Notice (Sec. 130). “A continuing guarantee may at any time be revoked by the surety as to future transactions by notice to the creditor”. Homes ie surety remains liable for the past transactions which have already taken place. (b) By Death of Surety (Sec. 131). “The death of surety operates, in the ce of any contract to the contrary, a8 @ revocation of a continuing guarantee as to future transactions. However, the deceased surety’s @ scanned with OKEN Scanner1 (o M. (a) (b) © (d) Musiness ng past transactions and will not be Via s liable for the ns liable for death of surety even jg he tions taking place after the ice of surety’s death estate rem: for the transac! creditor has no nol aid 10 be discharge 2). A contract of guarantee ginal contract of guarantee Comes £0 aM end jy under original contract is discharged, By Novation (Sec. he orf by novation. novation and the surety By Conduct of Creditor . By Variance in terms of Contract (Sec, 133). “Any variance, macy without the surety’s consent, in the terms of the contract between the principal debtor and the creditor, discharges the surety as 4 transactions subsequent to the variance’. Example: becomes surety to C for B's conduct as a manager in C’s bank. Afterwards, 4 and C contract, without As consent, that B's salary shall be raised, and that he shall become liable for one-fourth of the losses on overdrafts. B allows a cus. tomer to overdraw, and the bank loses a sum of money. A is discharged from his suretyship by the variance made without his consent, and is not liable to make good this loss. But variation which is trivial or which is beneficial to the surety will not discharge him of his liability. By Release or Discharge of Principal Debtor (Sec. 134). “The surety is discharged by any contract between the creditor and the principal debtor, by which the principal debtor is released, or by any act or ‘omission of the creditor, the legal consequence of which is the discharge of the principal debtor”. Example: A contracts with B for a fixed price to build a house for A within a stipulated time, B supplying the necessary timber. C guarantees A’s performance of the contract. B omits to supply the timber. C is discharged from his suretyship. By Arrangement or Composition (Sec.135). “A contract between the creditor and principal debtor, by which the creditor makes a composition with, or promises to give time to, or not to sue the Principal debtor, discharges the surety, unless the surety assents to such contract”. ec ror ‘ ec Act or Omission Impairing Surety’s Eventual Remedy ne a fa creditor does any act which is inconsistent with the € surety, or omits to do any act which his duty to the surety @ scanned with OKEN Scannerspiel () Ill. () ® © yyand Guarantee requires him to do, and the eve 1A3, work reaches certain stage: A eraaiten Sum, to be paid by instalments as the the contract. C, without the knowledya et? © £0 BS due performance of " instalments. Ais discharged by isp os Pre-pays to B the last two Loss of Security (Sec. 141). “Ifthe cre of the surety, ‘ditor loses, or without the consent Parts with security gi i: sahil given to him, the is dis from liability to the extent of the value of. scour. i Example: A gave a loan to B on the guarantee of C as : H well as on the mortgage of B's furniture Afterwards, A cancels the mortgage. B becomes insolvent and A sues Con this guarantee. C is discharged from liability to the value of furniture. By Invalidation of Contract Guarantee Obtained by Misrepresentation of Material Fact (Sec. 142). “Any guarantee which has been obtained by means of misrepresentation made by a creditor or with his knowledge and assent, concerning a material part of the transaction, is invalid”. Guarantee Obtained by Concealment of Material Fact (Sec.143). “Any guarantee which a creditor has obtained by means of keeping silence as to material circumstance, is invalid’. Examples: 2) A engages B as clerk to collect money for him. B fails to account for some of his receipts, and A in consequence calls upon him to furnish security for his duly accounting. C gives his guarantee for B’s duly accounting. A does not acquaint C with B's previous conduct. B, afterwards makes default. The guarantee is invalid. cipittiog it toc: ent for iron to be supplied by him to: ‘the amount tatoo tone B and c have privately agreed that B should pay five rupees per ton beyond the market price, such excess to be applied in liquidation ofan old debt. This agreement is ‘concealed from A. A is not liable as a surety. Fail £ Co-surety to Join a Surety [Sec. 144]. “Where a person ween na contract that a creditor shall not act upon it i jee upo! ‘ Bives a guarantee YP as joined in it as co-surety, the guarantee is not until another person has joine? ! valid if that person fails to jo @ scanned with OKEN ScannerBusiness “a nat indemnity. What are the essential element. of ract of indemnity: cont - 2. Define contract of guarantee, When can it be revoked? Jain the nature and extent of surety’s liability in contract of guarantee oe [B.Com (Hons) 2023 Modifieg) wus circumstances in which surety is discharged from Explain the var s his liability in a contract of guarantee. 5, Distinguish between: (a) Contract of indemnity and contract of guarantee. [B. Com (Hons) 2018, 2023) (b) Specific guarantee and continuing guarantee. 6. Discuss the rights of surety against principal debtor, creditor and co- sureties. [B. Com (Hons) 2017, [B. Com, 21-22, 23-24] 7. Write a note on ‘Surety is a favoured debtor. [B. Com (Hons) 2019] 1. X gives a guarantee for Y to Z for the amount which he may lend to Y within three months. The maximum limit of the guaranteed amount is 50,000. After one month X revokes his guarantee. Before revocation Zhad lend to Y € 10,000, (@ Is X discharged from his liability to Z for any subsequent loan? (i) IsX liable if Y commits default to Pay & 10,000 to Z? rane According to Sec. 130, continuing guarantee can be withdrawn Y the surety at any time as to future transactions. But he is liable for the tre i 7 7 nie fansactions undertaken Prior to revocation of guarantee. In this yee aoe i) a discharged from liability to Z for any subsequent loan because ¢ has withdrawn his guarantee, (i) FY commits def, toZ) S default to pay & 10,000, X will have to pay this amount @ scanned with OKEN Scannertee atyand Guarar ie ests B a journali - C inthe ncinbager| a 7 Publish defamatory statement against Promi i ‘i ‘ consequences of the publicati Ses to indemnify B against the : ‘on. C sues B and B has to pay d: pay damages and also incur some expenses obligation to indemnify B? indemnify B because this contract of ject is unlawful being opposed to public ISA under (Hint: No, A is not liable to j indemnity isnot valid, The obj policy). p Find out more @ scanned with OKEN Scanner
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