INDEMNITY AND GUARANTEE

Abstract

Though the concept of indemnity and guarantee is somewhat different on various issues, they are still modes of compensation with overlapped principles. This article analyzes the similarities and the differences between the two. Indemnity, as explained by S. 124 of the Indian Contract Act, is the contract that keeps a party indemnified against loss. Guarantee makes possible for a person to get a loan on goods, or an employment, and requires a valid consideration. While a contract of guarantee involves 3 parties with different liabilities, a contract of indemnity involves two parties with primary liability. There are several such differences, and a guarantee has far-reaching principles whereas an indemnity comes into existence sometimes.

Keywords

Indemnity, Guarantee, Indian Contract Act, 1872, Section 124, Section 126, Surety, Principal Debtor, Creditor, Contract Law, Tripartite Agreement, Liability, Rights of Indemnity Holder, Rights of Surety, Subrogation, Unjust Enrichment, Legal Compensation, Legal Obligations, Contractual Relationships

Introduction

‘Indemnity and Guarantee are two sides of the same coin’- It means that indemnity and guarantee differ on a lot of issues while being similar on the issue that they both guarantees and indemnities serve as forms of compensation and share similarities in principles such as unjust enrichment and the requirement of good faith. Despite these fundamental commonalities, contracts of indemnity are inherently distinct from contracts of guarantee. We will first explain what indemnity and guarantee mean. Then we shall discuss what the differences are between guarantee and indemnity and what are the similarities between guarantee and indemnity.

Indemnity[1]

Section 124 of the Indian Contract Act, 1872 defines the term indemnity. As described by Halsbury, indemnity refers to a contract—whether express or implied—designed to protect a person who has entered, or is about to enter, into a contract or incur any liability, by compensating them for any loss, regardless of whether a third-party default[2]. Chitty says that the term, indemnity is used in the law in several different times and cases. Generally, indemnity is the compensation for any loss or liability suffered by a person, though the duty to indemnify may follow from an agreement or not. Thus, for instance, whenever breach of contract comes into the picture, then the associated claim for damages may well include a claim to be indemnified against certain losses or liabilities. Section 126 of the Indian Contract Act 1872, refers to the rights given to the indemnity holder and the necessary conditions under which he may exercise these rights. It was held in Adamson vs. Jarvis, that Adamson has to indemnify Jarvis as Jarvis was to follow the orders of Adamson, and if anything went amiss Jarvis would be indemnified. The indemnity holder has the right to demand protection from the indemnifier against potential loss, even before the loss has actually occurred.

Rights of Indemnified or Indemnity Holder

All losses for which he may be forced to pay in any action liable to any proceeding to which the promise to indemnify extends;
All charges to which he may be liable as a cost in any such action, if, in bringing or defending it, he did not repel the demands made on him by the promisor, and proceeded as it would have been prudent for him to have proceeded without such undertaking to repay or indemnify, or if the promisor permitted him to bring or defend an action
Every sum which he may have paid under the terms of any bargain of any such suit, if the bargain was not in despite of the requests of the promisor, and was something that it would have been reasonable for the promisee to undertake without any indemnity agreement, or if the promisor permitted them to negotiate the lawsuit.

Rights of Indemnifier

After compensating the indemnity holder, the indemnifier retains the right to utilize all available methods and avenues that could have helped them protect themselves from the loss.

Guarantee[3]

Guarantee is made with the concurrence of the principle debtor, the creditor, and the surety. And that does not mean that there must be evidence showing that the principle-debtor undertook his obligation at the express request of the principle debtor as implied request will be quiet sufficient to satisfy this requirement. The purpose of a contract of guarantee is to allow an individual to obtain a loan for goods on credit or to secure employment. Additionally, a contract of guarantee becomes void if it lacks valid consideration[4].

A contract of guarantee involves the following essential components:

Tripartite Agreement: It is a contract of guarantee which involves the three parties namely the principal creditor, the creditor, and the surety. In the perfected contract of guarantee, there should be distinct contracts between three parties under which every single contract must be consenting.
Liability: In this case, the main liability of the principal debtor. The liability of a surety is secondary and can be invoked only when the primary debtor defaults in its payment.
Essentials of a Valid Contract: As in the case of any other general contract, it retains 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 classify the requirement of any written form of contract of guarantee. It may be both oral and written form.

Rights of a surety

As against the Creditor:

According to the Indian Contract Act, 1872,

Section 133: The creditor must not alter the terms of the agreement with the principal debtor without obtaining the surety’s consent. Any such modification releases the surety from liability for subsequent transactions. However, if the change benefits the surety, is neutral, or is insignificant, it may not necessarily release the surety from their obligations.
Section 134: The creditor must not discharge the principal debtor from their obligations under the contract. If the principal debtor is released from their obligations, the surety is also discharged from their responsibilities. Any act or omission by the creditor that legally releases the principal debtor from liability will also end the surety’s liability.
Section 135: If the creditor and principal debtor enter into an agreement that either increases the principal debtor’s liability, extends the time for fulfilling obligations, or includes a promise not to sue, the surety is released unless they have agreed to such terms.
Section 139: The surety is released from their obligation if the creditor takes actions that impair the surety’s potential recourse against the principal debtor.

As Against the Principal Debtor

Right of Subrogation: When the surety satisfies the debt, they acquire the right of subrogation, meaning they step into the creditor’s shoes to recover the amount from the principal debtor.

Section 140: The surety cannot claim the right of subrogation over the creditor’s securities if the surety has provided a guarantee for only a portion of the debt, and the creditor has obtained security for the entire debt.

Differences between guarantee and indemnity[5]

A contract of guarantee includes all the three, namely, the creditor, principal debtor and the surety, while the contract of indemnity includes only the indemnifier and holder of indemnity. In an indemnity contract, the primary liability lies with the indemnifier, not like a guarantee wherein the primary liability is held by the principal debtor and the liability of the surety is secondary. Therefore, contingency is comprised in a contract of indemnity in the form of possibility or risk of loss that he may suffer, which he obliges the indemnifier to protect him against. Against this, a contract of guarantee offers an existing debt or obligation, and a surety guarantees fulfillment of it.

The indemnifier’s interest under an indemnity contract is usually tied up with the earning of a commission or premium, whereas in guarantee, the interest lies only in providing the guarantee. Thirdly, a contract of indemnity is that contract in which the indemnifier is not allowed to sue a third party. In a contract of guarantee, on the other hand, when he pays the debt, he is permitted to sue the principal debtor in his own name. A contract of indemnity imposes but a single promise: the promise to pay in case of a loss. A guarantee, on the other hand, consists of several promises: those of the debtor himself to pay and that of a guarantor to fulfill debt or obligation in case of default.

In the two cases which follow, it has been observed that indemnity and guarantee differ as follows: Punjab National Bank Ltd. v. Bikram Cotton Mills and Anr[6] and Gajan Moreshwar vs. Moreshwar Madan. Here in the Punjab National Bank case, three parties are involved, whereas in the case of Gajan Moreshwar, two parties alone were present. In the case of Gajan Moreshwar, Moreshwar Madan as an indemnifier is liable for the entire loss but in the case of Punjab National Bank, the liability was majorly accompanied by the principal debtor that is, the first respondent company and here the liability of the surety is secondary. In Gajan Moreshwar case, the Privy Council held that rights of indemnity holder are other than that which is explicitly claimed by the law. Here, the indemnity holder may ask the indemnifier to cover his liability so the resultant ruling that Moreshwar Madan must discharge Gajan Moreshwar’s liability.

In the case of Punjab National Bank, there was no risk but only a debt which was already incurred and had become due and payable within the meaning of sections of the enactments regarding guarantees. Both the principal debtor and the surety bound themselves to settle the debt of the creditor in the present case. Gajan Moreshwar could not sue K.D. It was a contract of indemnity, and he could sue only Moreshwar Madan. In Punjab National Bank, both the principal debtor and the surety can be sued.

Similarities[7]

Guarantees and indemnities share several similar characteristics. Generally, comparable rights and obligations arise between the parties involved, particularly when it comes to enforcing the agreement. Both contracts of indemnity and contracts of guarantee possess fundamental similarities. In each, one party agrees to pay on behalf of another. Moreover, these types of contracts are commonly employed by individuals and businesses as a safeguard against losses. Another notable point of similarity is that they cannot be used to result in unjust enrichment.

In a comparative analysis of Punjab National Bank Ltd. v. Bikram Cotton Mills and Anr and Gajan Moreshwar vs. Moreshwar Madan, it becomes evident that both guarantees and indemnities serve to compensate the creditor and indemnity holder, respectively. In the Punjab National Bank case, the principal debtor and surety, along with the indemnifier in the Gajan Moreshwar case, had all agreed to pay and fulfill their respective financial obligations to cover the debt.

Conclusion[8]

An indemnity, by contrast, accommodates simultaneous obligation with the principal although and there is no compelling reason to “look first” at the principal. Typically, it is an agreement where the surety agrees to protect the lender from any losses arising from the contract between the principal debtor and the lender. In general, a guarantee covers an obligation that is as extensive as that of the principal debtor. At the end of the day, the guarantor can’t be at risk for much more than the client. The document will be understood as a guarantee if, on its actual development, the commitments of the surety are to “remained behind” the principal and just go to the fore once this commitment between the principal and the lender is breached, the surety obligation becomes secondary and reactive. The indemnity arises with the occurrence of some event, whereas a guarantee gets triggered with the default of some third party. We have, hereabove, explained the difference between indemnity and guarantee and indicated differences between them for instance involving the number of parties, nature of risk, etc. We address here very fine yet critical differences through which both the concepts work and in their underlying principles. So, guarantees and indemnities are essentially different concepts despite some similarities.

References

Indemnity and Guarantee (lawctopus.com)

[1] Contract of Indemnity available at http://www.lawnotes.in/Contracts_of_Indemnity#ixzz2sqefMeVf

[2] Adamson v. Jarvis, (1827) Bing 66: 5 LJ OS 68

[3] Contract of Guarantee available at http://www.lawnotes.in/Contract_of_Guarantee#ixzz2uGPMTPeF

[4] Janaki Paul v. Dhokar Mall Kidarbux, (1935) 156 IC 200

[5] Difference between Indemnity and Guarantee available at http://www.ehow.com/info_8094382_differences-contract-indemnity-contract-guarantee.html#ixzz2swbr3ui2

[6] The Differences between Contract of Indemnity & Contract of Guarantee available at http://www.ehow.com/info_8094382_differences-contract-indemnity-contract-guarantee.html#ixzz2swdShgGT

[7] GUARANTEE AND INDEMNITY AS SUBJECTS OF SECURITY, Ale-Daniel Olaoluwa, Jonathan Julius Iyieke, Udeogu Chijioke

[8] Difference between Indemnity and Guarantee available at http://judicially-yours.blogspot.in/2010/02/difference-between-indemnity-and.html

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