Critical Analysis Of Difference Between Contract Of Indemnity And Contract Of Guarantee Under The Indian Contract Law

Introduction

Indemnity and Guarantee are both a means of compensation and they both are formulated on similar principles such as matters of good faith, unjust enrichment, etc.[i] In spite of the formulation on a similar set of principles, there are several issues and technicalities on which the concept indemnity and guarantee differ. Through this article, the researcher will try to vividly explain the concept of guarantee and indemnity and the differences and similarities between these two concepts.

Contract of Indemnity

According to Longman’s dictionary of contemporary English, indemnity is protection against loss, especially in the form of a promise to pay, or payment for loss of money, goods, etc.[ii] An agreement of indemnity is a legal agreement between two parties in which one party agrees to reimburse/compensate the other party for the harm contingent on certain requirements and conditions unless other circumstances are specified.[iii] Under the Indian Contract Act, 1872, a contract of indemnity is defined as “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.”[iv] For instance, A contracts to indemnify B against the consequences of any proceedings which may be taken by X against B in respect of any consideration such as a sum of Rs 500 or any other commodity, etc.[v] This is a contract of indemnity as her one party (A) promises to save the other party (B) from the loss which may be caused by the conduct of any other person (C). 

In a contract of indemnity, there are two parties involved: The indemnifier and the indemnified. The indemnifier is the promisor who agrees to compensate/reimburse the other party for the loss caused. The indemnified is the person who is assured of reimbursement for damage occurred by the conduct of the promisor/indemnifier himself or by the conduct of any other person.[vi] The indemnified is also called the indemnity holder.

It is under Section 125 that states the rights of indemnity holder in case he/she is sued. Under this article, the indemnity holder is empowered to recover from the promisor all the damages he might have been compelled to pay in any suit in respect of any matter covered by the contract, all the costs related to the institution and defending of the suit and all sums which he may have paid under terms of any compromise.[vii] However, it has also been stated that the compromise must not be against the directions of the indemnifier.[viii]

Contract of Guarantee

The contract of Guarantee is instituted with the concurrence of the principal debtor, the creditor, and the surety. Under the Indian Contract Act, 1872 it is section 126 that defines the contract of guarantee. Section 126 states that “contract of guarantee” is a contract to perform the promise, or discharge the liability, of a third person in case of his default.[ix] Section 126 further elaborates that 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”.[x] The last line of section 126, that is, “A guarantee may be either oral or written” indicates that there is no need for evidence to show the existence of a guarantee and an implied guarantee is sufficient to satisfy this requirement.[xi] But in the case of English law, a guarantee must be written and signed by the party to be charged therewith to constitute a valid contract of guarantee.[xii]

Consideration is essential to constitute a valid contract of guarantee. In case of absence of consideration, a contract of guarantee ceases to stay valid and is rendered void.[xiii] In the case of a surety, there is no need for a direct consideration between the creditor and the surety. Even if the creditor has only done something for the principal debtor, this also constitutes sufficient consideration. Section 127 upholds this view by stating that —”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”[xiv] indicating that benefit to the principal debtor is sufficient consideration.

Another important element of a valid contract of guarantee is the free consent of surety. It has been stated in section 142 and section 143 that the guarantee obtained by misrepresentation and concealment is invalid.[xv] Keeping silence as regards material facts/circumstances, which could impact and influence the surety’s consent, would also render the contract of guarantee void. For instance, if through concealment of fact that an employee is indebted to an extent more than that of the guarantee, a surety is made to guarantee an employee’s conduct and future liabilities, then the surety will not be liable[xvi] and contract of guarantee would be invalid.[xvii]

Difference Between Contract of Indemnity and Contract of Guarantee

The first difference between a contract of indemnity and a contract of guarantee is the number of parties involved. In the case of a contract of indemnity, there are two parties involved, that is, the indemnifier and the indemnified. In the case of a contract of guarantee, there are three parties involved, that is, the creditor, the principal debtor, and the surety.

Secondly, the object of the contract of indemnity is reimbursement of a loss and protection of the promisee against some likely loss.[xviii] On the other hand, the main objective of a contract of guarantee is the security of the creditor in the case of a default by principal debtor.

Thirdly, the liability of the indemnifier in case of a contract of indemnity is primary in nature and is contingent on the occurrence of an event or a condition.[xix] In the case of the contract of guarantee, the liability of a surety is secondary in nature and arises only when the principal debtor defaults.

Fourthly, in the case of a contract of indemnity, the rights of the indemnifier are comparatively limited, and the indemnifier can only sue the third party only if there is an assignment in his favor.[xx] In the case of contract of guarantee, the surety has comparatively more rights and he is empowered to step into the shoes of the creditor and he may sue the principal debtor after the discharge of surety’s liabilities.

Lastly, in the case of English Law, the contract of guarantee should be in writing to constitute a valid contract of guarantee. But in the case of a contract of indemnity, indemnity may be either oral or in writing.[xxi] But in the case of Indian Law, there is no such distinction and both contracts  of indemnity and contract of bailment can be either oral or written.

Conclusion

From the above discussion, both contract of indemnity and contract of guarantee are mediums through which the other party is provided compensation/security in case of default by the promisor in case of contract of guarantee and promisor or any other party. Both are centered around the principles of prevention of unjust enrichment and good faith.

There are some differences between the contract of indemnity and contract of guarantee. In case of contract of indemnity, two parties are involved and in case of contract of guarantee, three parties are involved. Secondly, in case of contract of indemnity the responsibility and obligation of the indemnifier is primary and in case of contract of guarantee, the responsibility and obligation of surety is secondary in nature. There are some other differences such as number of contracts involved, the object and purpose behind them, etc. But both contract of guarantee and contract of indemnity are formulated with the aim to provide a sense of security to the promisee and both are quite detrimental in ensuring benefit to both the parties of contract in terms of reimbursements, monetary gains, etc.


References:

[i] Sagnik Saha, Indemnity and guarantee LAWOCTOPUS (Feb. 14, 2015), https://www.lawctopus.com/academike/indemnity-and-guarantee/.

[ii] Longman’s Dictionary Of Contemporary English.

[iii] Deeksha Tiwari, Contract of Indemnity and Guarantee Legal Service India, http://www.legalserviceindia.com/legal/article-4039-contract-of-indemnity-and-guarantee.html.

[iv] The Indian Contract Act, 1872, No. 124 (India).

[v] The Indian Contract Act, 1872, No. 124 Illustration (India).

[vi] Deeksha, supra note 3.

[vii] Lawteacher.net, Contract of Indemnity and Law of Guarantee, https://www.lawteacher.net/free-law-essays/contract-law/contract-of-indemnity-and-law-of-guarantee-contract-law-essay.php (last visited Mar. 3, 2021).

[viii] The Indian Contract Act, 1872, No. 125 (India).

[ix] The Indian Contract Act, 1872, No. 126 (India).

[x] Id.

[xi] Sagnik, supra note 1.

[xii] Dr. R.K. Bangia, Contract-II, 7-9 (7th Edition, 2017), Allahabad Law Agency, Haryana.

[xiii] Janki Paul v Dhokar Mall Kidarbux, (1935) 156 IC 200.

[xiv] The Indian Contract Act, 1872, No. 127 (India).

[xv] Bangia, supra note 12, at 9.

[xvi] Id., at p. 10.

[xvii] Lee v Jones, (1863) 17 C.N.B.S. 482.

[xviii] Bangia, supra note 12, at 10.

[xix] supra note 7.  

[xx] Id.

[xxi] Bangia, supra note 12, at 11.

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