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INDEMNITY AND GUARANTEE
(Ss. 124 to 147)
QUESTION BANK.
Q.1 What are the rights of the surety on payment or performance by him of guaranteed debt or duty?
Q.2. Discuss fully various modes of discharging surety from liability.
Q.3. “Between Co-sureties there is equality of burden and benefit” Comment.
Q.4 Distinguish between contract of Indemnity and contract of Guarantee. Illustrate your answer.
Q.5 What are the rights and liabilities of a surety against the (i) Principal Debtor (ii) Creditor (iii) the co-sureties?
Q6. What is a continuing guarantee? When and how it is revoked?
Q7. Discuss the concept of consideration in contract of Guarantee.
Q8. Explain the Liability of surety is Co-extensive.
Q.9. Explain the rights of the surety in detail
Q.10. What is contract of Indemnity and contract of guarantee? Distinguish between the two. Nov. 09.
Q.11. What is contract of indemnity? How does it differ from contract of guarantee?
Q.12 What is contract of indemnity? Illustrate your answer.
Q.12 Define indemnity. What are the rights of indemnity holder?
Q.13 “The surety is favoured debtor”. Explain.
Q.14 What is contract of guarantee? Discuss the different circumstances when surety is . discharged from liability.
SHORT NOTES.
- Surety’s liability. Apr.2000, 2008 , Nov.2006
- Right of Indemnity holder.Oct.2001,Apr.2001
- Continuing Guarantee.
SYNOPSIS
I. Part I: The Contract of Indemnity (Sections 124–125)
1. Statutory Definition and Scope-
2. Rights of an Indemnity Holder (Section 125)
3. Judicial Development and Landmark Case Law
II. Part II: The Contract of Guarantee (Sections 126–147)
1. Statutory Definition-
2. Statutory Essentials for a Valid Guarantee
a. Existence of a Enforceable Principal Debt:
b. The Requirement of Consideration (Section 127):
c. Absence of Misrepresentation or Concealment (Sections 142 & 143):
d. Form of Contract:
III. Part III: Important Structural Distinctions-
IV. Part IV: Nature and Quantum of a Surety's Liability
1. The Principle of Co-Extensive Liability (Section 128)
2. Joint and Several Enforcement
V. Part V: Classifications of Guarantees
1. Specific (Simple) Guarantee:
2. Continuing Guarantee (Section 129):
a. By Notice (Section 130):
b. By Death of the Surety (Section 131):
VI. Part VI: Surety's Rights=-
1. Rights Against the Creditor-
a. Right to Securities (Section 141):
b. Right to Set-Off:
2. Rights Against the Principal Debtor-
a. Right of Subrogation (Section 140):
b. Implied Right to Indemnity (Section 145):
3. Rights Against Co-Sureties
a. Right to Contribution (Section 146):
b. Effect of Releasing a Co-Surety (Section 138):
VII. Part VII: Discharge of a Surety from Liability
1. Invalidation of the Contract (Sections 142 & 143)
2. Material Variance in Contract Terms (Section 133)
3. Release or Discharge of the Principal Debtor (Section 134)
4. Composition, Extension of Time, or Covenant Not to Sue (Section 135)
5. Impairing the Surety's Remedial Recourse (Section 139)
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Comprehensive Legal Analysis: Indemnity and Guarantee (Sections 124–147)
The Indian Contract Act, 1872 governs specialized commercial transactions through the dedicated framework of Special Contracts under Chapter VIII. These arrangements provide legal mechanisms to allocate risk, secure credit, and facilitate corporate investments.
Part I: The Contract of Indemnity (Sections 124–125)
1. Statutory Definition and Scope-
Section 124 of the Indian Contract Act defines a Contract of Indemnity as:
"A contract whereby 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."
Illustration.
a) ‘A’ contracts to indemnify ‘B’ against any consequences of any proceeding which ‘C’ may take against ‘B’, regarding a certain sum of Rs. 200. This is a contract of indemnity.
b) ‘X’ is a friend of ‘Y’. Y is a shopkeeper who wants an honest boy as a servant. X sends ‘Z’ for service and assures ‘Y’ that if any loss or misappropriation is caused by ‘Z’, he will pay for that. It is the contract of Indemnity, wherein X promises to save Y from any loss caused to him by the conduct of Z.
a. Important Elements:
i. The Parties: There are strictly two parties in a contract of indemnity:
(1). The Indemnifier (Promisor): The party who promises to make good or compensate the loss.
(2). The Indemnified / Indemnity Holder (Promisee): The party who is protected from the loss.
ii. Contingent Nature: The liability of an indemnifier is contingent. It is triggered only upon the actual occurrence of the contemplated loss.
iii. Source of Loss: The statutory definition covers losses caused exclusively by human agency (either the promisor or any third party).
b. Conflict with English Common Law
Unlike Indian law, English Common Law recognizes a much broader definition of indemnity. It covers losses arising from accidents, natural disasters, or acts of God (such as fires or storms).
i. In England: All insurance contracts (excluding life insurance) are legally classified as contracts of indemnity.
ii. In India: Because standard insurance covers acts of nature, general insurance policies do not fit into Section 124. Instead, they are governed as Contingent Contracts under Section 31 of the Act.
c. Express vs. Implied Indemnity
An indemnity agreement can be explicitly executed (Express) or inferred from the conduct and circumstances of the parties (Implied):
i. Express Indemnity: A formal written bond or an explicit oral commitment.
ii. Implied Indemnity: Created by operation of law based on situational relationships. For instance, if an individual hires a horse for riding and through their negligence the horse is injured, they are legally obligated to indemnify the owner under an implied contract of indemnity.
Illustration
If ‘A’ hires a horse from ‘B’ for riding purposes, if, due to A’s negligence, an accident occurs and the horse gets injured, it is A’s responsibility to indemnify ‘B’ for injuries to the horse, even though there is no express contract of indemnity.
2. Rights of an Indemnity Holder (Section 125)
When sued in a matter covered by the indemnity, the indemnity holder has the statutory right to recover the following expenditures from the indemnifier, provided they acted prudently:
a. All Damages: Any damages they are legally compelled to pay in a lawsuit covered by the indemnity.
b. All Costs: All litigation expenses, attorneys' fees, and court costs incurred in defending or bringing a suit, provided they did not defy the indemnifier's explicit orders and acted as a reasonable uninsured individual.
c. All Sums Paid in Compromise: Any financial settlements paid under a compromise, provided the settlement was bona fide and not contrary to the explicit directions of the indemnifier.
Illustration
Due to an accident of a vehicle of A by B, the court ordered A to pay Rs. 10,000 damages and Rs. 1000 as a cost of the suit to the injured person. Here, A can recover Rs. 10000 damages and Rs. 1000 costs from him (B).
3. Judicial Development and Landmark Case Law
a. Adamson v Jarvis (1827) 4 Bing 66, 130 ER 693:
An auctioneer acted on the instructions of a client to sell certain cattle. It later emerged that the client did not own the livestock. The auctioneer was sued by the true owner and had to pay damages. The court held the defendant liable under an implied indemnity, establishing that a person executing an act in good faith under another's direction is entitled to be indemnified against any resulting legal injuries.
b. Gajanan Moreshwar Parelkar v. Moreshwar Madan Mantri (AIR 1942 Bom 302)
This case revolutionized the commencement of the indemnifier's liability. Historically, the English common law maxim was "you must be damnified before you can claim to be indemnified" (actual payment was required first). The Bombay High Court rejected this rigid approach, ruling that the indemnity holder can compel the indemnifier to pay as soon as their liability becomes absolute and clear, saving them from having to pay out of pocket.
Part II: The Contract of Guarantee (Sections 126–147)
1. Statutory Definition-
Section 126 defines a Contract of Guarantee as:
"A contract to perform the promise, or discharge the liability, of a third person in case of his default."
Illustration
If A requests B to pay Rs.1000 to C and guarantees that if C fails to pay, B will pay. This is the contract of guarantee, wherein A is surety, B is the creditor, and C is the ‘principal debtor’ or a ‘debtor’.
The Three Fundamental Parties:
a. The Principal Debtor: The individual primarily responsible for the underlying debt or performance.
b. The Creditor: The party to whom the security or guarantee is extended.
c. The Surety: The guarantor who steps in to assume secondary liability in case the principal debtor defaults.
2. Statutory Essentials for a Valid Guarantee
a. Existence of a Enforceable Principal Debt: A valid guarantee requires an underlying, legally enforceable debt or civil liability. If the foundational contract between the creditor and principal debtor is void (e.g., minor's agreement under Indian law), the guarantee generally cannot be enforced.
b. The Requirement of Consideration (Section 127): Section 127 specifies that any benefit conferred upon the principal debtor or any promise made by the creditor for the debtor's benefit serves as sufficient consideration to bind the surety.
Example (Valid): A requests B to sell goods on credit to C, and A promises to guarantee the payment. B's delivery of goods to C is the consideration supporting A's guarantee.
Example (Void): B has already delivered goods to C. A later promises to pay for them if C defaults, without any new promise or forbearance from B. This past transaction offers no fresh consideration, making the guarantee void.
c. Absence of Misrepresentation or Concealment (Sections 142 & 143): A guarantee is invalid if the creditor obtains it by misrepresenting material facts or remaining silent about vital circumstances.
Illustrations
(i) A engages B as a 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 a guarantee for B's duly accounting. A does not acquaint C with B's previous conduct. B afterwards makes default. The guarantee is invalid.
(ii) A guarantees to C the payment for iron to be supplied by him to B up to the amount of 2000 tons. 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 of an old debt. This agreement is concealed from A. A is not liable as a surety
London General Omnibus Co. v. Holloway (1912) 2 K.B. 72
A surety provided a fidelity guarantee for an employee. The employer failed to disclose that this employee had previously been caught committing dishonesty and embezzlement. When the employee stole money again, the court held the surety not liable because a material fact concerning the risk had been intentionally concealed.
d. Form of Contract: Section 126 explicitly allows a guarantee to be either oral or written. This differs fundamentally from English law under the Statute of Frauds, which mandates that a contract of guarantee must be entirely in writing to be legally actionable.
Part III: Important Structural Distinctions-
Basis of Distinction | Contract of Indemnity (Sec. 124) | Contract of Guarantee (Sec. 126) |
Number of Parties | Two: Indemnifier and Indemnified. | Three: Principal Debtor, Creditor, and Surety. |
Number of Contracts | One: A direct agreement between the indemnifier and the indemnified. | Three: Between creditor-debtor, creditor-surety, and an implied contract between debtor-surety. |
Nature of Liability | Primary and Independent: The indemnifier is the sole party responsible for the risk. | Secondary and Collateral: The surety becomes liable only if the principal debtor defaults. |
Underlying Object | To protect a party from unforeseen future losses or specific contingencies. | To provide security and credit confidence for an existing financial debt or duty. |
Right to Sue Third Parties | Cannot sue third parties in its own name; must sue through the name of the indemnified party. | The surety can sue the principal debtor directly after clearing the creditor's dues. |
Part IV: Nature and Quantum of a Surety's Liability
1. The Principle of Co-Extensive Liability (Section 128)
Section 128 mandates that the liability of the surety is co-extensive with that of the principal debtor, unless the contract explicitly provides otherwise. "Co-extensive" means that the surety's liability matches the exact scale, scope, and quantum of the principal debtor's liability.
a. If the principal debtor becomes liable for interest, legal costs, or penalty charges due to a breach, the surety is equally liable for those additions.
Illustration
A guarantee to B the payment of a bill of exchange by C, the acceptor. The bill is dishonoured by C. A is liable not only for the amount of the bill but also for any interest and charges that may have become due.
2. Joint and Several Enforcement
A creditor is not legally required to exhaust their remedies against the principal debtor before pursuing the surety. The surety is considered a "favoured debtor" under equity, yet their liability remains immediate upon default.
a. State Bank of India v. M/s Indexport Registered (1992) 3 SCC 159
The Supreme Court settled a long-standing debate by ruling that a creditor holds the absolute right to execute a decree directly against the surety without first liquidating the principal debtor's mortgaged properties or assets.
b. Vijay Singh Padode v. SICOM Ltd. 2000 SCC OnLine Bom 537
The Bombay High Court affirmed that upon default by the principal debtor, the creditor can bypass them entirely and directly exhaust their legal remedies against the surety. No prior notice of default is mandatory unless explicitly agreed upon in the contract.
Part V: Classifications of Guarantees
1. Specific (Simple) Guarantee: Given for a single, isolated debt or a specific transaction. It terminates automatically once that distinct debt is discharged.
Illustration
A guarantee of the debt of Rs. 5000 by the bank to B. In this case, the guarantee is specific for a loan of Rs. 5000.
2. Continuing Guarantee (Section 129): A guarantee that extends across a continuous series of transactions over a period of time.
Example: A guarantees payment to a merchant for any tea supplied to C up to a rolling balance of ₹5,000. This remains valid across multiple sequential deliveries and payments.
Illustration
(a) A, in consideration, that B will employ C in collecting the rent of B’s zamindari promises B to be responsible, to the amount of 5,000 rupees, for the due collection and payment by C of those rents. This is a continuing guarantee.
(b) A guarantees payment of 100 to B (a tea dealer) for any tea which he may time-to-time supply to C. Here, the liability of A is for 100, and not more than that, even though B has time-to-time supplied tea of 200 pounds.
(c) A guarantees payment to B of the price of five sacks of flour to be delivered by B to C and to be paid for in a month. B delivers five sacks to C. C pays for them. Afterwards, B delivers four sacks to C, which C does not pay for. The guarantee given by A was not a continuing guarantee, and accordingly, he is not liable for the price of the four sacks.
Revocation of a Continuing Guarantee
A continuing guarantee can be revoked at any time regarding future transactions via two methods:
a. By Notice (Section 130): The surety can halt future liability by serving an explicit notice of revocation to the creditor. They remain fully liable for any financial transactions completed prior to the notice.
Illustrations
(i) A, in consideration of B’s discounting, at A’s request, bills of exchange for C, guarantees to B, for twelve months, the due payment of all such bills to the extent of 5,000 rupees. B discounts bills for C to the extent of 2,000 rupees. Afterwards, at the end of three months, A revokes the guarantee. This revocation discharges A from all liability to B for any subsequent discount. But A is liable to B for the 2,000 rupees, on default of C.
(ii) A guarantees to B, to the extent of 10,000 rupees, that C shall pay all the bills that B shall draw upon him. B draws upon C. C accepts the bills. A gives notice of revocation. C dishonours the bill at maturity. A is liable upon his guarantee.
b. By Death of the Surety (Section 131): In the absence of a specific contract to the contrary, the sudden death of the surety automatically revokes the continuing guarantee regarding any future transactions. The deceased's estate remains liable only for obligations incurred before their passing.
Part VI: Surety's Rights-
1. Rights Against the Creditor-
a. Right to Securities (Section 141): A surety is entitled to the benefit of every security that the creditor holds against the principal debtor at the time the guarantee contract is signed. If the creditor loses, destroys, or parts with such security without the surety's consent, the surety is automatically discharged to the extent of that security's value.
Illustrations.
(i) C advances to B, his tenant, 2,000 rupees on the guarantee of A. C also has further security for 2,000 rupees through a mortgage on 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.
(ii) C, a creditor whose advance to B is secured by a decree, also receives a guarantee for that advance from A. C afterwards takes B’s goods in execution under the decree and then, without the knowledge of A, withdraws the execution. A is discharged.
b. Right to Set-Off: If sued by the creditor, the surety can claim any legal defenses or counter-claims/set-offs that the principal debtor possessed against the creditor.
2. Rights Against the Principal Debtor-
a. Right of Subrogation (Section 140): Upon paying off the creditor's claims, the surety is invested with all the rights that the creditor held against the principal debtor. The surety "steps into the shoes of the creditor" to recover the debt.
b. Implied Right to Indemnity (Section 145): Every guarantee contains an implied promise by the principal debtor to indemnify the surety. The surety can recover any sum they lawfully paid under the guarantee, but cannot claim costs incurred from filing groundless legal defenses.
Illustrations.
(i) B is indebted to C, and A is surety for the debt. C demands payment from A and, on his refusal, sues him for the amount. A defends the suit, having reasonable grounds for doing so, but is compelled to pay the amount of the debt with costs. He can recover from B the amount paid by him for costs, as well as the principal debt.
(ii) C lends B a sum of money, and A, at the request of B, accepts a bill of exchange drawn by B upon A to secure the amount. C, the holder of the bill, demands payment of it from A and, on A’s refusal to pay, sues him upon the bill. A, not having reasonable grounds for so doing, defends the suit and has to pay the amount of the bill and costs. He can recover from B the amount of the bill but not the sum paid for costs, as there was no real ground for defending the action.
3. Rights Against Co-Sureties
When multiple guarantors secure the same debt, they are termed Co-Sureties.
a. Right to Contribution (Section 146): In the absence of an express contract to the contrary, co-sureties are legally bound to contribute equally to discharge the defaulted debt.
Illustrations
(i) A, B and C are sureties to D for the sum of 3,000 rupees lent to E. E makes a default in payment. A, B and C are liable, as between themselves, to pay 1,000 rupees each.
(ii) A, B and C are sureties to D for the sum of 1,000 rupees lent to E, and there is a contract between A, B and C that A is to be responsible to the extent of one-quarter, B to the extent of one-quarter, and C to the extent of one-half. E makes a default in payment. As between the sureties, A is liable to pay 250 rupees, B 250 rupees, and C 500 rupees.
b. Effect of Releasing a Co-Surety (Section 138): If a creditor releases one co-surety from their obligations, it does not automatically discharge the remaining co-sureties. Furthermore, the released surety remains legally accountable to the other co-sureties for their equal share of contribution.
Part VII: Discharge of a Surety from Liability
A surety is legally released from their contractual liabilities under any of the following circumstances:
1. Invalidation of the Contract (Sections 142 & 143)
If the foundational guarantee was procured through misrepresentation, fraudulent concealment of material facts, or if a designated co-surety fails to join the contract as agreed, the contract is invalid, discharging the surety.
Illustrations
(a) A engages B as a clerk to collect money for him. B fails to account for some of his receipts, and A consequently 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.
(b) A guarantees to C payment for iron to be supplied by him to B in the amount of 2,000 tons. 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 of an old debt. This agreement is concealed from A. A is not liable as a surety.
2. Material Variance in Contract Terms (Section 133)
Any unilateral alteration or variance made to the terms of the underlying contract between the creditor and the principal debtor—without the explicit consent of the surety—instantly discharges the surety from all subsequent transactions.
Example: If an employee's salary structure or risk exposure is altered without the guarantor's permission, the fidelity guarantee is discharged.
Illustrations
(a) A becomes surety to C for B’s conduct as a manager in C’s bank. Afterwards, in the B and C contracts, B’s salary shall be raised without A's consent, and he shall become liable for one-fourth of the losses on overdrafts. B allows a customer 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.
3. Release or Discharge of the Principal Debtor (Section 134)
The surety is released if the creditor enters into a formal contract that legally releases the principal debtor, or commits an act or omission that legally dissolves the principal debtor's underlying liability.
4. Composition, Extension of Time, or Covenant Not to Sue (Section 135)
A surety is completely discharged if the creditor, without the surety's consent:
a. Enters into a composition agreement with the debtor.
b. Formally promises to grant the debtor extra time to pay.
c. Formally covenants or promises not to sue the principal debtor.
5. Impairing the Surety's Remedial Recourse (Section 139)
If a creditor commits any act that is inconsistent with the rights of the surety, or omits to perform a duty mandated by law, and thereby impairs the surety's eventual remedy against the principal debtor, the surety is discharged.
Example: A shipbuilder's performance is guaranteed by a surety, with payments scheduled in instalments based on construction stages. If the owner prematurely pays the final instalments without the surety's knowledge, the surety is discharged due to the impairment of financial leverage.
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