MODULE I: CONTRACT OF

INDEMNITY AND GUARANTEE

Points to be covered
• General Meaning
• ICA meaning
• Diff between English Law and Indian Law
• Validity
• Nature
• Liability when commences?
• Rights of an Indemnity holder
Meaning
• General Meaning: to make good the loss

• English Law: “promise to save a person HARMLESS from the loss caused as a
consequences of an Act”

• Adamson v Jarvis: auctioneer sold cattle based on instruction of wrong

defendant, held was entitled to indemnity (Also case of implied indemnity)

• English law: Ambit Wider: not restricted to losses caused by merely human
agency
• ICA : Sec 124

• Indemnifier = Promisor

• Indemnity Holder = Promisee

• Indemnify against losses

1. Caused by promisor himself

2. Any other person

• Gajanan Moreshwar v Moreshwar Madan: Restricted meaning: limited to

human agency ,Excludes loss from accidents or fire or natural calamities
• All Insurance Contracts are contracts of Indemnity except Life Insurance

• Contract of Indemnity can be express or Implied

• ICA also has special cases of implied indemnity

1. Sec 69: Person interested in payment of money

2. Sec 145: Surety and principal Debtor indemnity

3. Sec 222: Principle and Agent Indemnity

Validity of Indemnity Contract

• Special Contract
• All general principles also applicable
Rights of Indemnity Holder
• Sec 125
• The promisee in a contract of indemnity, acting within the scope of
his authority, is entitled to recover from the promisor
• all damages
• all costs
• all sums
Commencement of Liability
• Whether when actually loss suffered or when there is an
apprehension?
• Original English Rule: “ You must prove to be damnified before
claiming for indemnity”
• Upheld in many judgements
• Liverpool Mortgage Insurance Co's. case [1913] 2
“in the view of a Court of Equity to indemnify does not merely mean to
reimburse in respect of moneys paid, but (in accordance with its
derivation) to save from loss in respect of the liability against which the
indemnity has been given”

“if it be held that payment is a condition precedent to recovery, the

contract may be of little value to the person to be indemnified, who
may be unable to meet the claim in the first instance”
• Shankar Nimbaji v. Laxman Supdu: under a contract of indemnity the cause
of action arises when the damage which the indemnity is intended to cover is
suffered, and a suit brought before actual loss accrues is premature

• Chand Bibi v. Santoshkumar Pal (1933) I.L.R. 60 Cal. 761: as the plaintiffs had
not yet had to pay anything in respect of the mortgage although they were
called upon to do so, and as the mortgagee had not yet taken any
proceedings on the mortgage, the plaintiffs had not yet suffered any damage,
and, therefore, the suit was premature so far as the cause of action on the
indemnity was concerned
• Gajanan Moreshwar Parelkar vs Moreshwar Madan Mantri (1942)
44 BOMLR 703
• Sections 124 and 125 of the Indian Contract Act are not exhaustive
of the law of indemnity
• Section 125 is by no means exhaustive of the rights of the
indemnity-holder
• Courts here would apply the same equitable principles that the
Courts in England do
• if the indemnified has incurred a liability and that liability is
absolute, he is entitled to call upon the indemnifier to save him from
that liability and to pay it off
13th Law Commission Report
• Definition of “indemnity” u/s 124 be expanded to include cases of
loss caused by events which may or may not depend upon the
conduct of any person and provide clearly That promises maybe
implied
• u/s 125 The Rights of Indemnity Holder to be fully defined and
remedies of indemnity holder shall be stated even in cases he hasn’t
been sued.
CONTRACT OF GUARANTEE
Points to be Covered
• Basic Essentials of a Valid Contract of Guarantee: Definition and Parties to a
contract of Guarantee
• Features of a Contract of Guarantee
• Liability of Surety: Nature and extent
• Rights of Surety
• Co-surety
• Continuing Guarantee
• Discharge of Surety
• Difference between contract of Indemnity and contract of Guarantee
• Bank Guarantee
 What is Contract of Guarantee?

•Sec. 126 - A “Contract of Guarantee” is a contract to perform the

promise, or discharge the liability, of a third person in case of his
default.
•The person who gives the guarantee is called the " surety";
•The person in respect of whose default the guarantee is given is called
the " principal debtor” and
•The person to whom the guarantee is given is called the " creditor ".
•Economic Functions: enable a person to get loan or goods on credit or
employment
• Guarantee is a Tripartite Contract: 3 parties, i.e. the Creditor, Principal
Debtor and the Surety.
• a collateral undertaking to be liable for the default of another is a
“Contract of Guarantee”
• There must be a conditional promise to be liable on the default of the
principal debtor. A liability which is incurred independently of a
default is not within the definition of “guarantee”: Punjab National
Bank vs. Sri Vikram Cotton Mills AIR 1970 SC 1973
• Primary liability is of principal debtor and the surety has a secondary
liability. Which means that the payment is to be made by the surety
only if the debtor does not pay

• In England, a guarantee to be enforceable at law must be in writing.

• P.J. Rajappan v Associated Industries (P) Ltd: Court cannot adopt a

hypertechnical attitude that the guarantor has not signed the
agreement and so he cannot be saddled with the liability. Due regard
has to be given to the relative position of the contracting parties and
to the entire circumstances which led to the contract.
Difference between Contract of Indemnity and Contract of Guarantee.
Grounds INDEMNITY GUARANTEE

No of Parties 2: Indemnifier Indemnity Holder 3: Creditor Principal Debtor and

Surety
Extent of the liability of the indemnifier is primary the liability of the surety is
Liability and independent secondary as the primary liability is
that of the principal debtor
Arising of The liability of the indemnifier arises only liability is already in existence but
Liability on the happening of a contingency specifically crystalizes when
principal debtor fails
Time to Act The indemnifier need not necessarily act surety must act by extending
at the request of indemnified guarantee at the request of debtor

Right to Sue indemnifier cannot sue a third party for surety can proceed against principal
Third Party loss in his own name debtor in his own right because he
gets all the rights of a creditor after
discharging the debts
ESSENTIALS FEATURES OF GUARANTEE
1. Principal Debt: Recoverable debt necessary
• Purpose of guarantee: to secure payment of a pre-existing debt
• If no principal debtor present then no valid guarantee
Swan v Bank of Scotland
Facts: The payment of the overdraft of a banker’s customer was guaranteed by
the defendant. The overdrafts were contrary to a statute, which not only
imposed penalty upon the parties to such drafts but also made them void. The
customer having defaulted, the surety was sued for the loss
Held: He was held not liable. The court said that “If there is nothing due, no
balance, the obligation to make that nothing good amounts itself to nothing. If
no debt is due, if the banker is forbidden from having any claim against his
customer, there is no liability incurred by the co-obligers.
What happens when a Minor’s debt has been guaranteed?
• To be legally effective a guarantee must be given for debt which is
enforceable. If the debt is not enforceable, the guarantee will not be
enforceable. Thus a minor not being answerable for a debt he incurs, a
guarantee for such debt is likewise void: Coutts & Co v Brown Lecky and
others [1946] 2 All E.R. 207
• In India where a minor’s debt has been knowingly guaranteed, the
surety should be held liable as principal debtor himself
• If the debt is void the contract of so called surety is not collateral, but a
principal contract.
2. Consideration for Guarantee
• A contract of guarantee like other contracts must fulfill essentials of a
valid contract
• It is not necessary that there must be direct consideration between
the surety and the creditor.
• Anything done, or any promise made, for the benefit of the principal
debtor, may be a sufficient consideration to the surety for giving the
guarantee
• ILLUSTRATIONS
• When consideration fails then no question of recovering anything
from surety or principal debtor
• Ujjal Transport agency v Coal India Ltd: Tender invited for cutting and
removing timber from forest. Payment for the same guaranteed by the
Bank and some amount deposited as earnest money. The Forest
Authorities later notified that cutting of timber on that land not
permissible. So Consideration failed. Held: Neither Bank Guarantee
could be invoked nor the Contractor’s earnest money be forfeited.
• Guarantee for Past Debts:
• Do the words anything done u/s 127 include past debts: even before
the guarantee was given?
• Contended: Language of section implies executed consideration rather
than executory
• Courts held otherwise. Judicial conflict on the same
• UOI v A P Bhonsle: Bombay HC: It is well settled that just as
Illustrations should not be read as extending the meaning of a section,
they should also not be read as restricting its operation, especially so,
when the effect would be to curtail a right which the plain words of
the section would confer
• It is therefore clear that if the language of the text of Sec 127 of
Contract Act is clear and unambiguous, the sweep of the text cannot
be curtailed by using Illustration (c) to impose a limitation on the
expression "anything done or any promise made for the benefit of the
principal debtor" that it should be done at the time of giving the
guarantee.
• The language is wide enough to include anything that was done or a
promise made before giving the guarantee and would not restrict the
application of the section
• CONCEALMENT: A guarantee which the creditor obtains by means of
keeping silence to material circumstances is invalid. The expression
keeping silence means intentional concealment of the facts. The
creditor should disclose to surety the facts which are likely to affect the
surety’s liability (Section 143)
• MISREPRESENTATION: A guarantee obtained by means of
misrepresentation made by the creditor or with his knowledge and
assent, concerning a material part of the transaction is invalid. If the
consent of surety will be obtained by misrepresentation, the surety is
discharged from his liability (section 142).
• A Contract of Guarantee not a contract of uberrimae Fides
• Not a duty to disclose everything but a duty to place the surety in
possession of all the facts likely to affect the degree of his
responsibility; and if neglects to do so, it is at his peril.
SURETY’S LIABILITY
• Sec 128: The liability of the surety is co-extensive with that of the principal
debtor, unless it is otherwise provided by the contract.
Co-extensive:
• Maximum extent of the surety’s liability
• Liable for the whole amount for which the principal debtor is liable and not
anything more
• Where the parties do not specifically agree as to the extent of the liability or
the surety does not put up any limit on his ability at the time of entering into
the contract,
• the liability of the surety will be co-extensive with that of the principal
debtor.
• In other words, whatever amount of money a creditor can legally realise
from the principal debtor including interest, cost of litigation, damages etc.,
the same amount he can recover from the surety.
Conditions precedent( Conditional guarantee)
• When there is a condition precedent to the surety’s liability, he will not
be liable unless that condition is first fulfilled.
• Sec 144
• National Provincial Bank of England v Brackenburry: Defendant
signed a guarantee which was intended to be a joint and several
guarantee of three persons with him. One of them dint sign. Held
defendant not liable since condition precedent not fulfilled
• James Graham & Co ltd v. Southgate Sands: Signature of co surety
forged, again held not responsible.
Can the Creditor proceed against the Surety
without exhausting remedies against the debtor?
• Bank of Bihar v Damodar Prasad (1969):
• Defendant guaranteed a bank’s loan. At default of the debtor defendant
was sued. Trial court decreed that bank shall enforce the guarantee only
after all remedies against the principal debtor is exhausted. Appealed in
Patna HC rejected. SC overruled.
• “The very object of the guarantee is defeated if the creditor is asked
to postpone his remedies against the surety. In the present case the
creditor is banking company. A guarantee is a collateral security
usually taken by a banker. The security will become useless if his rights
against the surety can be so easily cut down.”
• The creditor can proceed against the Principal Debtor alone. His suit
cannot be rejected on the ground that he has not joined the surety as a
defendant to the suit.

• A suit can also be brought against the surety alone without joining the
principal debtor

• SICOM Ltd v Harjindersingh (2004): Guarantors can not argue that

where no suit was brought against the principal debtor, a suit against
the guarantor alone will not be permissible
• Death of the Principal Debtor:
• Syndicate Bank v A.P Manjunath : A suit filed against PD and surety. PD
died before the institution of the suit. The surety held not to be
discharged. Suit can proceed against him even in the absence of PD
since creditor has an option of suing either the PD or the surety.
Surety’s Right to limit his liability or make it
conditional
• Open to the surety to place a limit upon his liability
• Can set a limit on his liability or attach any condition on it.

• Liability of a surety does not depend upon possibility of the surety

being able to realise the amount from the principal debtor
• Sec 132: Liability of 2 persons primarily liable not affected by internal
arrangement
Rights of Surety
A surety has rights against:
• Principal debtor
• Creditor
• Co-sureties
Rights against Principal Debtor
• Doctrine of Subrogation
• Doctrine of Indemnity
Doctrine of Subrogation
• Sec 140
• If the liability of surety is co-extensive with that of Principal Debtor his
right is not less coextensive with that of the creditor after he satisfies
the creditor’s debt.
• Surety will be entitled to every remedy that the creditor has against
the Principal debtor; to enforce every security and all means of
payment; to stand in place of creditor; to have all securities
transferred to him, though there was no stipulation
• May or may not be advantageous to surety
Rights before Payment?
• Does a surety have any right against the PD even before the payment?
• Surety has an equitable right to compel PD to pay the debt and so
relieve the surety from the necessity of paying it
Right to Indemnity
• Sec 145
• Implied promise to indemnify surety
• Illustrations
Right against Creditor
• Right to Securities : Sec 141
• Right to share reduction
• Right to set off
• Right to Securities : Sec 141
• Illustrations
• Craythorne v Swinburne: Surety is entitled to every remedy including
enforcement of security
• Immaterial whether surety knows about it or not
• Duty of Creditor to keep the securities intact

• Right to share reduction

• Right to set offs