Theoretical overview
Contract of indemnity
According to the dictionary meaning indemnity is protection against loss, in the form of promise to pay or payment for loss of money ,good etc. It is compensation for loss.
According to section 124 of Indian contract act 1872 a contract of indemnity means “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.”
This provision incorporates a contract where one party promises to save the other from the loss which may be caused either
- By the conduct of the promisor himself or,
- By the conduct of any other person.
In the contract of indemnity the person who promises to indemnify is known as indemnifier and the person in whose favor such promises are made is known as indemnified or indemnity holder.
Example of contract of indemnity – car insurance.
Essentials of contract of indemnity
- Free consent
- Consideration
- The existence of loss is essential
- Lawful object
- Competency
For example: ‘X’ asks ‘Y’ to burn the house of ‘Z’ promising to compensate ‘Y’ against the consequences. ‘Y’ sets the house of ‘Z’ on fire and is fines Rs 10,000 ‘Y’ can not recover the amount from ‘X’ as the object of contract is not lawful.
Right of indemnity holder- Section 125 states the right of an indemnity holder in a contract of indemnity
Section 125(1) – all the damages which he may be compelled to pay under the contract in any suit.
Section125(2)- all the costs he may be compelled to pay in any suit.
Section125(3)- all the sums which he may have paid under the terms of any compromise of any such suit.
Contract of Guarantee
Section 126 of Indian contract act 1872 defines a guarantee as under :
‘A contract of guarantee is a contract to perform the promise or discharge the liability of third person in case of his default.’
Such contract involves three parties The Creditor, The Surety, The Principal Debtor
- Creditor- The person to whom guarantee is given.
- Surety – The person who gives the guarantee .
- Principal Debtor – The person in respect of whose default the guarantee is given.
For example:- Mr. john takes a loan from the bank which Mr. Harry has taken the guarantee that he will discharge the liability if john default in paying the said amount. Here Harry plays the role of Surety, John plays the role of principal debtor and bank is creditor.
There will be 3 contracts which are as follows:-
- Between the main debtor and creditor
- Between the main debtor and surety
- Between the creditor and surety
Main features of contract of Guarantee:
- The contract may be either written or oral:- according to Section 126, a guarantee may be either oral or written. On this point , position in India is different from that in England. According to English law for a valid contract of guarantee, it is necessary that it should be in written n signed by the party to be charged therewith.
- namely the creditor, the principal debtor and surety all the three parties are necessary and three separate contracts are made among them a) the principal debtor and creditor b) between surety n debtor c)between surety n creditor
- No misrepresentation of facts a/c to contract:- the creditor should not obtain any guarantee either by any misrepresentation or concerning a material fact concerning the material transaction if the guarantee has been obtained that way the guarantee is invalid. The position is explained by section 142 and 143 which is as under:
Section 142 guarantee obtained by misrepresentation invalid- ‘any guarantee which has been obtained by means of misrepresentation made by creditor or with his knowledge and assent concerning a material part part of transaction is invalid.’
Section 143 guarantee obtained by concealment invalid– ‘any guarantee which the creditor has obtained by means of keeping silence as to material circumstances is invalid.
- No direct consideration b/w the surety and creditor : as in any contract the consideration is also needed for a contract of guarantee but for surety promise it is not compulsory that there should be a direct consideration between the creditor n surety.
Important difference
| Contract of indemnity | Contract of guarantee |
| A contract in which one party promises to save the other from the loss caused to him by the conduct of promisor or by the conduct of any other parties. | A contract in which to perform promise or discharge the liability of the third party in case of his default. |
| Section 124 of Indian contract act defines the contract of indemnity. | Section 125 of Indian contract act defines the contract of guarantee. |
| 2 parties i.e indemnifier & indemnity holder. | 3 parties i.e creditor, debtor & principal debtor. |
| Only one contract. | Three contract |
| The main purpose to compensate loss. | To give assurance to the promise. |
RELEVENT SECTIONS
Section 124 of Indian contract act 1872
A contract of indemnity:- “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.”
Section 125 of Indian contract act 1872
States the right of an indemnity holder in a contract of indemnity
Section 125(1) – all the damages which he may be compelled to pay under the contract in any suit.
Section125(2)- all the costs he may be compelled to pay in any suit.
Section125(3)- all the sums which he may have paid under the terms of any compromise of any such suit.
Section 126 of Indian contract act 1872
Contract of guarantee:- ‘A contract of guarantee is a contract to perform the promise or discharge the liability of third person in case of his default.’
Section 142 guarantee obtained by misrepresentation invalid-
‘Any guarantee which has been obtained by means of misrepresentation made by creditor or with his knowledge and assent concerning a material part part of transaction is invalid.’
Section 143 guarantee obtained by concealment invalid–
‘Any guarantee which the creditor has obtained by means of keeping silence as to material circumstances is invalid.
Important case laws
In state bank of India v. mula sahakari sakhar karkhana ltd., the respondent a co-operate society having a sugar factory, entered into a contract with one M/s. Pentagon Engineering Pvt. Ltd. for the installation of paper plant as per the agreement Pentagon furnished a bank guarantee/indemnity for the release. The retention money of 10% from the proforma invoice of the material reached at the site. The operative portion of the bank guarantee read as to “indemnify and keep indemnified Mula Sahakari Sakhar Karkhana ltd against all loss claim damages action n cost in respect of such sums which supplier shall become liable to pay as the term of said order.”
Disputes and differences arose between the parties and as a result the respondent terminates the control and invoked the Bank Guarantee against Pentagon holding the document indemnifying the respondent was a contract of indemnity and not guarantee the apex court said that the claim made by the assured on termination of contract need not to be honoured by the bank without the proof of loss.
Narayan Singh v. Chattarsingh , it has been held that if the principal debtor’s liability is scaled down in an amended decree or otherwise extinguished in whole or in part by a statue the liability of the surety would also pro tanto be reduse or extinguished . in this case liability of an agriculturist who was the principal debtor was scaled down under the Rajasthan relief of agriculture indebtedness ACT 1957. It was held that effect of scaling down the principal debtor liability was that the suety liability had also been reduce accordingly. The suety liability was considered to be reduce for another reason also and that was that if the surety is made liable for the full amount he in his turn will become intitle to recover the same from the principal debtor.
Points to remember
- section 124 of Indian contract act 1872 defines the contract of indemnity “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.”
- It is compensation for loss.
- In the contract of indemnity the person who promises to indemnify is known as indemnifier
- Section 125 of Indian contract act 1872 defines the contract of guarantee ‘A contract of guarantee is a contract to perform the promise or discharge the liability of third person in case of his default.’
- Such contract involves three parties The Creditor, The Surety, The Principal Debtor.
