DISTINCTION BETWEEN INDEMNITY AND GUARANTEE, RIGHTS AND DUTIES OF INDEMNIFIER AND INDEMNIFIED

This article is written by Bhumi Reddy Vanaja of BA LLB of 4^th Semester of Sri Padmavati Mahila Viswa Vidyalayam, Tirupati, an intern under Legal Vidhiya

ABSTRACT

In contract law, the concepts of indemnity and guarantee are critical in establishing the parties’ rights, obligations, and liabilities. Though these terms are frequently used interchangeably, they refer to distinct legal structures with important significance.

This extensive article explores the complex legal distinction between guarantee and indemnity. It examines each concept’s definitions, key components, and related rights and obligations as they are stated in the Indian Contract Act of 1872 and pertinent case law. In-depth analysis is done on the main distinctions between indemnity and guarantee, including the nature of liability, the number of contracts formed, the parties involved, the need for written agreements, the capacity to recover paid amounts, and the contingency on a third party’s default. Legal practitioners may make sure that contracts for indemnity and guarantee are accurately identified, drafted, interpreted, and enforced by having a complete awareness of these subtleties. This information is necessary to prevent misclassification and the incorrect legal principles from being applied as a result, which could have serious consequences for everybody involved.

In order to properly manage the rights and obligations of all stakeholders, it is crucial to understand the distinction between indemnity and guarantee, which is a basic idea in contract law. This article’s conclusion emphasizes the need of making this distinction.

KEYWORDS

Guarantee, Indemnity, Indemnifier, Indemnified, principal debtor, creditor, co-sureties, Contractual capacity, Minor, liability, Rights, and Duties.

INTRODUCTION

Under the Indian Contract Act,1872, the contracts of indemnity and guarantee are considered exceptional contracts. The indemnity and the guarantee are two closely related but very different legal notions in the complicated subject of contract law. Since these terms are commonly used interchangeably, confusion and misunderstandings between legal professionals and law students might arise. However, for the purpose of contract drafting, interpretation, and effective construction, everyone must understand the distinction between an indemnity and a guarantee. Although the concepts of a guarantee and an indemnity contract are very similar, there are important differences in terms of the parties’ rights, obligations, and third-party liability in the event of a contract default, as well as the remedies available to them under the Indian Contract Act of 1872. In that they both “provide compensation to the creditor for the failure of a third party to perform their contractual obligations,” the Contract of Indemnity and the Guarantee serve comparable purposes.

The term “contract of Indemnity” refers to a formal agreement in which one party guarantees to compensate the other for any losses or damages. A Contract of Guarantee is an agreement whereby one party agrees to bear responsibility for the debt or default of another. In the Indian legal system, the laws related to the contract of indemnity and guarantee are outlined in Chapter VIII, Sections 124–147^[1] of the Indian Contract Act, 1872. Section 124 of the Indian Contract Act provides a definition for a contract of indemnity, which is described as “a contract by which a party promises to save another party against the loss caused by the promisee’s or any other person’s conduct” in 1872.  A Contract of Guarantee is a pledge to execute or discharge a third party’s liability in event of default by Section 126^[2] of the Indian Contract Act, 1872.

The legal differences between indemnity and guarantee are thoroughly examined in this article, which covers their definitions, significant components, parties’ rights and duties, and the main distinctions between the two types of contracts. By the time this essay is finished, the reader will have a thorough understanding of these basic legal ideas and how they differ, giving them the ability to more accurately and confidently negotiate the complexity of contract law

CONCEPT OF INDEMNITY

Meaning of Indemnity: The word “ Indemnity” originated from the Latin word “ indemis”, which means “injured” or “ no damage or any loss occurred”. When used in a legal context, indemnity refers to a contract in which one party (the indemnifier) promises to pay another party (the indemnified) back for any losses, damages, or liabilities that are incurred.

Definition of Indemnity

Section 124^[3] of the Indian Contract Act, 1872 defines a contract as one in which one party promises to protect the other from loss caused by the promisor’s or another person’s actions.

This definition lists the following three components as necessary for the indemnity contract:

1. A loss must occur.
2. The promise made by the indemnifier is to protect the person being indemnified from the loss (the indemnifier bears sole liability for the loss).
3. The indemnifier (the promisor) or any other person must have caused the loss.

Parties involved in the contract of Indemnity

Under the contract of Indemnity, there are two parties involved.

1. Indemnifier: The individual who guarantees to compensate for the damage is referred to as the “indemnifier,” sometimes called the “promisor.”
2. Indemnified: An indemnity holder, or indemnified, is the individual for whom the promise is made.

Illustration

A and B have a contract wherein B agrees to provide A with items in exchange for Rs. 10,000 per month. B is guaranteed payment by C for any damage incurred by him as a result of A. In this case, C is the indemnity holder and B is the indemnifier under an indemnity contract.

ESSENTIAL FEATURES

The following requirements must be fulfilled for the indemnity contract to be enforceable and legal under the Indian Contract Act of 1872:

1. Valid Contract: In order for an indemnity contract to be deemed valid under the Indian Contract Act of 1872, it must contain all of the following basic components: offer and acceptance; legal relationship; competency to contract; legitimate object; and legal formalities.
2. The parties: As was previously stated, there must be two parties to an indemnity contract: the indemnifier and the indemnified.
3. Protection against loss: The principal goal of an indemnity contract is to shield the promisee from financial loss. The promisee’s loss must be made up by the promisor.
4. One Contract: The indemnifier and the party being indemnified have only one contract in an indemnity agreement. Whether multiple contracts are included in a guarantee agreement.
5. An indemnity contract could be implied or express:

Contract for express indemnity: When one party specifically commits to reimburse the other for the loss, the agreement to indemnify is referred to as express.

Implied indemnity contract: When an indemnity agreement can be inferred from the parties’ actions or the facts of the case, it is referred to as an implied contract.

TYPES OF CONTRACTS FOR INDEMNITY

They are divided into three distinct categories under the terms of the indemnity contract:

Insurance Indemnity: All insurances, with the exception of life and personal accident, are contracts of indemnification. Insurance contracts are not the same as contracts because they deal with the taking of insurance by the promisee or promisor. Here, consideration is absent from indemnity contracts because they have paid some money and taken other amount as consideration.

Express Indemnity: Sometimes referred to as written indemnity, this kind of protection has all of the terms and circumstances spelled out in a contract and is specifically addressed in the agreement.The agreement makes clear the indemnifier’s and the indemnified’s rights and obligations.Contracts for building, insurance, and agencies are a few instances of express indemnity.

Implied Indemnity: In the absence of a written contract, implied indemnity results from the actions and statements of the parties. The connection between a master and servant is a classic example of implied indemnification, as the master is responsible for compensating the servant for any damages sustained while carrying out the master’s instructions.

THE RIGHTS AND DUTIES OF INDEMNIFIER AND INDEMNIFIED

RIGHTS OF THE INDEMNIFIER

Regarding the indemnifier rights, the Contract Act is silent. On July 15, 1965, a ruling was made in Jaswant Singh v. The State,^[4] holding that the rights of the indemnifier and the rights of the surety’s rights under Section 141^[5] of the Indian Contract Act, 1872 are equivalent. Following the settlement of all damages, the indemnifier assumes ownership of the property and becomes the indemnity holder. He must reimburse Promisee for losses up to the amount specified in the contract’s terms and conditions. Following the settlement of all of his claims, he assumes the role of creditor.

• Right to sue the third party

The indemnity holder is entitled to complete ownership of the property and the ability to sue a third party for the property as soon as the indemnifier has compensated him for the property’s losses and value. He is not permitted to sue the third party before compensating the indemnity holder for losses.

For instance, A has assured B that he will reimburse him if C causes damage to B’s vehicle. After that, A indemnifies B and obtains ownership of the car when B requests money from A after suffering harm as a result of C. A can now file a lawsuit against C and demand damages.

• Compensate losses which are covered in the deed

Only losses covered by the indemnity contract may be paid for by the indemnifier. The plaintiffs in Rama swami v. Muthukrishna^[6] High Court directed the indemnifier  to reimburse them solely for the amount of Rs. 1236/-that represented his genuine loss. The Supreme Court dismissed the subsequent appeal that was filed in an attempt to get more money from the defendant.

• Right under Doctrine of Subrogation

Subrogation rights allow the guarantor to assume the role of the creditor following the settlement of the prior creditor’s claims. In some situations, this entitles the surety to receive the whole amount from the debtor. Comparably, the indemnifier may also be entitled to the return of funds or property in certain circumstances.

DUTIES OF THE INDEMNIFIER

The rights of the indemnity holder are the obligations of the indemnifier. In any lawsuit involving any matter in which the indemnifier promised to indemnify the other party and acted as he would have in the absence of a contract of indemnity, Section 125[7] specifies the indemnifier rights to recover damages, costs, and all amounts due by him. Against the indemnity holder, the indemnifier  is obligated to:

• Indemnify promisee for all damages

The indemnifier bears the responsibility of covering all damages he has agreed to pay in any lawsuit pertaining to any of the issues. As per Duffield v. Scott,^[8] the promisee must demonstrate that he was legally obligated to provide damages. It is not necessary to provide evidence to support the claim that the loss was direct or indirect.

Vridhachala Reddi vs. Nallappa Reddi And additionally,^[9] the court mandated that the indemnifier pay the promisee’s losses. As soon as the decree is issued against the promisee, the obligation begins.

According to the court ruling in Gokuldas v. Gulabrao,^[10] the promisee is obligated to be indemnified by the indemnifier and cannot claim not to be a party to the suit.

In the case of Toplis v. Grane,^[11] the court noted that the indemnifier is required to compensate the plaintiff for any harm caused by the conduct when it is carried out by the promisee with a valid purpose and infringes upon the rights of any other person.

• Indemnify promisee against all the costs

When an indemnity holder is required to pay costs in a lawsuit but did not violate the promisor’s requirements, it is the indemnifier’s responsibility to cover all of those costs. The indemnity-holder is entitled to reimbursement for reasonable expenses incurred during the course of evaluating, determining, or fending off claims. All of the costs that the promisee has incurred throughout the court processes are entitled to be reimbursed.

Jarvis sold his cattle to Adamson for an auction in the case of Adamson v. Jarvis.^[12] Adamson was unaware that Jarvis was not the actual cattle owner. The true owner claimed his animals as soon as he learned about the auction, and Adamson was required to reimburse him for the money. After Adamson sustained harm, Jarvis was sued. Because Adamson believed Jarvis had implied power and was ignorant that Jarvis was not the true owner of the cattle, the court ordered the latter to reimburse Adamson for both the cost and the amount of damage he sustained.

• Indemnify for the sum paid by the promisee in the event of compromise

The promisee is entitled to the money from the indemnifier if he complied with the terms of the suit’s compromise and did not act against the promisor’s instructions.

In Venkatarangayya Appa Rao v. Varaprasada Rao Naidu,^[13] the court ruled that, provided certain requirements are met namely, that the compromise be carried out in a bona fide manner, that there be no collusion during the settlement process, and that it not be characterized as an immoral bargain the indemnity holder is entitled to receive the full amount in the case of compromise.

RIGHTS OF INDEMNIFIED PARTY OR INDEMNITY HOLDER

The Indian Contract Act’s Section 125^[14] addresses the rights of the indemnity holder. When acting within the bounds of his authority, the indemnity holder in a contract of indemnity has the following rights against the indemnifier (promisor):

• Right to recover all the damages: All damages that the party seeking indemnity may be required to pay in a lawsuit pertaining to any subject matter covered by the indemnity promise. To put it plainly, to get all of the subject matter’s harms back.
• Right to recover all costs : All expenses that the person being indemnified might be required to pay for filing or defending these lawsuits. However, the indemnified ought to have behaved with the indemnifier’s permission or as any wise man would have in his own situation given the same circumstances.
• Right to recover sums paid under compromise: if the compromise falls within the parameters of the indemnification contract, to recoup all money paid by the party being indemnified for the compromise of any such lawsuit.

Case law: Gajanan Moreswar v. Moreswar Madan(1942)^[15], Gajanan Moreswar, the plaintiff in this case, had a long-term lease on a piece of property owned by the Bombay Municipality. He gave the defendant, Moreswar Madan, the lease, and the Bombay Municipality gave its approval. However, the defendant did not benefit from the execution. Thus, the plaintiff was still named on the lease. The defendant took out a loan of Rs. 5,000 from “A.” “A” received the leasehold interest as security. At the defendant’s request, the plaintiff signed the mortgage. Although the defendant had promised to pay the interest and release the mortgage, the mortgage document was never released. The defendant was then sued by the plaintiff for indemnity.  As a result, the Bombay High Court determined that the plaintiff, or indemnity bearer, had absolute liability. For the indemnifier (the defendant) to reimburse.

DUTIES OF THE INDEMNITY HOLDER

1. The indemnification holder’s primary responsibility is to follow the guidelines outlined in the indemnity contract. The indemnity provider will not be obligated to provide indemnification if the indemnity holder violates any of the terms and conditions of the agreement.
2. Prudence is the primary obligation of the indemnity bearer.
3. The indemnity holder has an obligation to behave with good faith. If his actions were motivated by malice, that would be a violation. Instead, he must behave in good faith. The indemnifier will not be held responsible for any losses incurred by the indemnity holder should the indemnifier attempt to force the indemnifier to reimburse himself for his own losses.
4. The indemnification holder’s primary responsibility is to avoid inflicting any harm or loss.
5. The indemnity holder’s responsibility is to adhere scrupulously to the indemnifier instructions.

CONCEPT OF GUARANTEE

Definition

A “guarantee” is someone who gives surety or takes on responsibility for another person’s debt or duty. A contract of guarantee is an agreement that, in the legal context, binds one party (the guarantor or surety) to carry out the promise or release the principal debtor from obligation in the event of default.

 “A contract that guarantees the promise, or discharge the responsibility, of a third person in case of his default” is the definition of a “contract of guarantee” in Section 126^[16] of the Indian Contract Act, 1872.

A contract of guarantee serves as further protection for the creditor, guaranteeing that their funds would be reimbursed in the event that the principal debtor fails to fulfill their end of the bargain.

Parties Involved in a Contract of Guarantee

A guarantee contract involves three parties:

1. The Surety: The surety, sometimes referred to as the guarantor, is the one who provides the assurance.
2. The Principal Debtor: The person for whose default the guarantee is provided is known as the principal debtor.
3. The Creditor: The party to whom the guarantee is given is known as the creditor.

The surety’s liability is secondary, meaning they only have to pay if the major debtor fails to fulfill their responsibility to the creditor.

ESSENTIAL ELEMENTS OF A  CONTRACT OF GUARANTEE

1. It may either be oral or written: Section 126 of the Indian Contract Act permits an oral or written contract of guarantee. It could be implied or expressed. It is possible to infer an implied guarantee contract from the parties’ actions. In England, a guarantee contract must be in written and signed by the parties involved to be legally binding.
2. Existence of a Principal Debt:  A contract of guarantee must first be in place before there can be a principal debt or liability. The agreement may be categorized as an indemnification contract rather than a guarantee if there is no principal debt.
3. Tripartite Nature: Three parties enter into a contract of guarantee: the surety, the creditor, and the major debtor. This leads to the creation of three separate contracts:

• A pledge made by the major debtor to the creditor that they will pay their debt.
• In the event that the major debtor defaults, the surety guarantees payment to the creditor.
• An unwritten agreement whereby the principal debtor agrees to reimburse the surety for any payments made in accordance with the guarantee.

4. Surety’s Promise to Pay upon Default: The primary debtor’s failure to make payments is a requirement for the surety’s payment commitment. Liability of the surety only occurs in the event that the principal debtor defaults on their obligations to the creditor.

5. Consideration: Anything done or promised for the principal debtor’s advantage may be deemed adequate consideration for the surety to grant the guarantee, as per Section 127 of the Indian Contract Act.

6. Consent without Misrepresentation or Concealment: Section 142 of the Indian Contract Act states that any assurance obtained via deception or concealment of material facts is null and invalid.

EXTENT OF SURETY’S LIABILITY

The Indian Contract Act’s Section 128^[17] addresses the type and scope of a surety’s liability.  Section 128 states, “Unless otherwise provided by the contract, the surety’s liability is co-extensive with that of the principal debtor.”

This means that the creditor can sue the guarantor without first suing the primary debtor, and the surety’s liability is equal to that of the latter. When the debtor defaults, the surety is responsible for making the payment.

The debtor bears main responsibility for payment, whereas the surety is only liable for secondary obligations. If a fault in the contract prevents the debtor from being held accountable, the surety may also be released.

RIGHTS OF THE SURETY

Rights of the surety are classified as:

1. Rights against the principal debtor
2. Rights against the creditor
3. Rights against co-sureties.

Rights against the Principal Debtor

• Right to be relieved of liability: The main debtor may be terminated by the surety in order to release him from liability prior to the payment being made. However, the debt needs to be determined before he may proceed. Once the debtor’s liability has reached a predetermined amount, the surety may request that he be released from that obligation.
• Right to Indemnity: There is an implied promise by the debtor to indemnify the surety in every contract of guarantee, and the surety has the right to pursue recovery against the debtor. Regardless of the amount he has legitimately paid under the guarantee, he is not entitled to the money he paid improperly.

Rights against the Creditor

• Right to securities: When a contract of surety-ship is signed, a surety is entitled to the benefit of all security that the principal creditor possesses against the principal debtor. Regardless of whether the surety was aware of the security or not, in the event that the creditor suffered a loss or did not consent to the security, the surety would be released to the extent of the security’s value.
• Right to claim set off: The surety may rely on any set-off or counterclaim in the event that the creditor files a lawsuit. Which the creditor is facing from the debtor.

Rights against Co-Sureties

Meaning: Co-sureties are those who guarantee the same debt or obligation jointly with one another.

• Right to claim contribution: When the principal debtor defaults, the sureties may demand payment from one another if they have committed to equal amounts.
• Right to claim a share in securities: The other co-surety or co-sureties have the right to share any security that a co-surety gets from the principal debtor.

DISTINCTION BETWEEN THE GUARANTEE AND INDEMNITY

PARAMETER	INDEMNITY	GUARANTEE
Definition	One party to a contract promises to compensate the other party for any future loss or injury.	A guarantee is a formal commitment by a third party to pay another party’s debt or obligation in the event that the other party defaults on their end.
Nature of Obligation	One main duty that exists independently of all other duties indemnity.	A guarantee is an additional duty that applies in the event that the principal duty (the debt) is not satisfied.
Number of parties involved	Indemnity normally involves two parties: the indemnifier and the indemnified party.	Guarantee typically involves three parties: the creditor, the principal debtor, and the guarantor.
Risk	The indemnifier is responsible  for the loss incurred by the indemnified party.	The guarantor is responsible for the principal debtor’s default, which is often deemed riskier.
Purpose	The goal of indemnity is too compensate for a loss.	A guarantee’s purpose is to secure the performance of an obligation.
Example	Example for indemnity is an insurance contract.	Bank guarantees are serves as an example of guarantee.

CONCLUSION

In legal terminology, the terms “guarantee” and “indemnity” refer to different contractual agreements that carry substantial consequences for the parties concerned. Both aim to compensate a creditor for a third party’s failure to fulfill their obligations, but there are significant differences between the underlying legal systems, parties involved, and the type of liability assumed. Under a contract of indemnity, the indemnifier bears the main burden of paying the party being indemnified for any loss or liability, regardless of the party being indemnified’s fault. Liability of the indemnifier is not reliant on a third-party defaulting. But in a guarantee agreement, the surety’s liability is secondary and only arises in the event that the primary debtor defaults. This transaction involves three parties.

For legal practitioners, correctly classifying a contract as a guarantee or an indemnity is essential since it establishes the relevant legal framework, the parties’ rights and obligations, and any potential liabilities. Depending on the details and conditions of the contract, it is up to the construction industry to determine whether a certain agreement falls under the category of a contract of guarantee or indemnity.  Legal professionals may make sure that the suitable legal framework is used, the planned risk allocation is accurately reflected, and the rights and responsibilities of all parties are precisely defined and safeguarded by having a complete awareness of the subtle differences between indemnity and guarantee. To guarantee the efficient writing, comprehension, and implementation of these vital legal agreements, the difference between indemnity and guarantee is ultimately a basic issue in contract law that necessitates meticulous thought and analysis.

REFERENCES

1. Drishti Judiciary, https://www.drishtijudiciary.com/to-the-point/ttp-indian-contract-act/contracts-of-indemnity-and-guarantee, (last visited Apr.22 , 2024)
2. 12 Avtar Singh, Contract & Specific Relief 591-669 (EBC Publishing 2020)
3. Law foyer, https://lawfoyer.in/rights-and-duties-of-indemnifier/ ( last visited April 22, 2024)
4. Blog ipleaders, https://blog.ipleaders.in/contract-indemnity-insurance/ ( last visited April 22, 2024)
5. Jaswant Singh vs The State on 15 July, 1965 (Equivalent citations: 1966CRILJ451).
6. Rama Swami v. Muthukrishna , SC 1967 AIR 359 .
7. Duffield v. Scotty, 235 wis 142.
8. Vridhachala Reddi vs. Nallappa Reddi and additionally, AIR 1915 MADRAS 36
9. Gokuldas v. Gulab Rao, AIR 1926 Nag 108 .
10. Toplis v Grane ENR (1839) 5 Bing NC 636 .
11. Adamson v Jarvis (1827) 4 Bing 66.
12. Raja Venkatarangayya Appa Rao And Two vs Raja Varaprasada Rao Naidu And Anr. On 12 July, 1920.
13. Gajanan Moreshwar v. Moreshwar Madan, AIR 1942 Bom 302.
14. Indian Contract Act, 1872, No.9, Acts of Parliament. ( India)

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[1] Indian Contract Act 1872, § 124, No. 9, Acts of Parliament, 1872 (India).

[2] Indian Contract Act 1872, § 126, No. 9, Acts of Parliament, 1872 (India).

[3] Indian Contract Act 1872, § 124, No. 9, Acts of Parliament, 1872 (India).

[4]  Jaswant Singh vs The State on 15 July 1965  (Equivalent citations: 1966CRILJ451).

[5] Indian Contract Act 1872,  § 141, No. 9, Acts of Parliament, 1872 (India).

[6]  Rama Swami v. Muthukrishna, SC 1967 AIR  359.

[7] Indian Contract Act 1872, § 125, No. 9, Acts of Parliament, 1872 (India).

[8]  Duffield v. Scotty, 235 Wis 142.

[9] Vridhachala Reddi vs. Nallappa Reddi and additionally, AIR 1915 MADRAS 36

[10] Gokuldas v. Gulab Rao, AIR 1926 Nag 108 .

[11] Toplis v Grane ENR (1839) 5 Bing NC 636 .

[12] Adamson v Jarvis (1827) 4 Bing 66.

[13] Raja Venkatarangayya Appa Rao And Two  vs Raja Varaprasada Rao Naidu And Anr. On 12 July, 1920.

[14] Indian Contract Act 1872, § 125, No. 9, Acts of Parliament, 1872 (India).

[15] Gajanan Moreshwar v. Moreshwar Madan, AIR 1942 Bom 302.

[16] Indian Contract Act 1872, § 126, No. 9, Acts of Parliament, 1872 (India).

[17] Indian Contract Act 1872, § 128, No. 9, Acts of Parliament, 1872 (India).

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