Contract of Indemnity & Guarantee: Notes | Corporate & Other Laws for CA Intermediate PDF Download

 Page 1


 
LEARNING OUTCOMES
 
THE INDIAN 
CONTRACT ACT, 1872 
 
UNIT–1: CONTRACT OF INDEMNITY AND 
GUARANTEE 
After studying this unit, you would be able to: 
? Identify special type of contracts i.e. Indemnity contracts 
and Guarantee contracts and also the nature of obligations 
and rights of each of the parties to the contracts. 
? Explain distinction between these contracts. 
 
 
CHAPTER 
1 
Page 2


 
LEARNING OUTCOMES
 
THE INDIAN 
CONTRACT ACT, 1872 
 
UNIT–1: CONTRACT OF INDEMNITY AND 
GUARANTEE 
After studying this unit, you would be able to: 
? Identify special type of contracts i.e. Indemnity contracts 
and Guarantee contracts and also the nature of obligations 
and rights of each of the parties to the contracts. 
? Explain distinction between these contracts. 
 
 
CHAPTER 
1 
 
 
1.2 CORPORATE AND OTHER LAWS 
 
 1. INTRODUCTION 
Contract of Indemnity and Guarantee are the specific types of contracts provided 
under sections 124 to 147 of the Indian Contract Act, 1872. In addition to the 
specific provisions (i.e. Section 124 to Section 147 of the Indian Contract Act, 
1872), the general principles of contracts are also applicable to such contracts. 
Even though both the contracts are modes of compensation based on similar 
principles, they differ considerably in several aspects. 
In this unit, the law relating to indemnity and guarantee are discussed in detail. 
 2. CONTRACT OF INDEMNITY 
The term “Indemnity” literally means “Security against loss” or “to make good the 
loss” or “to compensate the party who has suffered some loss”.  
The term “Contract of Indemnity” is defined under Section 124 of the Indian 
Contract Act, 1872. It is “a contract by which one party promises to save the other 
Contract of Indemnity and 
Guarantee [Section 124-
147]
Contract of Indemnity 
[Section 124-125]
Contract of Guarantee 
[Section 126-127]
Nature of Surety’s Liability 
[Section 128]
Continuing  Guarantee 
[Section 129-132]
Discharge of Surety 
[Section 133-139]
Rights of Surety [Section 
140-147]
 
Page 3


 
LEARNING OUTCOMES
 
THE INDIAN 
CONTRACT ACT, 1872 
 
UNIT–1: CONTRACT OF INDEMNITY AND 
GUARANTEE 
After studying this unit, you would be able to: 
? Identify special type of contracts i.e. Indemnity contracts 
and Guarantee contracts and also the nature of obligations 
and rights of each of the parties to the contracts. 
? Explain distinction between these contracts. 
 
 
CHAPTER 
1 
 
 
1.2 CORPORATE AND OTHER LAWS 
 
 1. INTRODUCTION 
Contract of Indemnity and Guarantee are the specific types of contracts provided 
under sections 124 to 147 of the Indian Contract Act, 1872. In addition to the 
specific provisions (i.e. Section 124 to Section 147 of the Indian Contract Act, 
1872), the general principles of contracts are also applicable to such contracts. 
Even though both the contracts are modes of compensation based on similar 
principles, they differ considerably in several aspects. 
In this unit, the law relating to indemnity and guarantee are discussed in detail. 
 2. CONTRACT OF INDEMNITY 
The term “Indemnity” literally means “Security against loss” or “to make good the 
loss” or “to compensate the party who has suffered some loss”.  
The term “Contract of Indemnity” is defined under Section 124 of the Indian 
Contract Act, 1872. It is “a contract by which one party promises to save the other 
Contract of Indemnity and 
Guarantee [Section 124-
147]
Contract of Indemnity 
[Section 124-125]
Contract of Guarantee 
[Section 126-127]
Nature of Surety’s Liability 
[Section 128]
Continuing  Guarantee 
[Section 129-132]
Discharge of Surety 
[Section 133-139]
Rights of Surety [Section 
140-147]
 
1.3 
CONTRACT OF INDEMNITY AND GUARANTEE 
 
from loss caused to him by the conduct of the promisor himself, or by the 
conduct of any other person.”  
Example 1: Mr. X contracts with the Government to return to India after 
completing his studies at University of Cambridge and serve the Government for 
a period of 5 years. If Mr. X fails to return to India, he will have to reimburse the 
Government. It is a contract of indemnity. 
There are two parties in this form of contract.  
a. The party who promises to indemnify/ save the other party from loss-  
‘indemnifier’,  
b. The party who is promised to be saved against the loss- “indemnified” 
or “indemnity holder”. 
Example 2: A may contract to indemnify B against the consequences of any 
proceedings which C may take against B in respect of a sum of ` 5000/- advanced by 
C to B.  In consequence, when B who is called upon to pay the sum of money to C 
fails to do so, C would be able to recover the amount from A as provided in Section 
124. 
Example 3: X, a shareholder of a company lost his share certificate. He applied for 
the duplicate. The company agreed to issue the same on the term that X will 
compensate the company against the loss where any holder produces the original 
certificate. Here, there is contract of indemnity between X and the company. 
Indemnifier
promises to 
indemnify/save the 
other party from 
loss
Indemnified
who is promised to 
be saved against 
the loss
Page 4


 
LEARNING OUTCOMES
 
THE INDIAN 
CONTRACT ACT, 1872 
 
UNIT–1: CONTRACT OF INDEMNITY AND 
GUARANTEE 
After studying this unit, you would be able to: 
? Identify special type of contracts i.e. Indemnity contracts 
and Guarantee contracts and also the nature of obligations 
and rights of each of the parties to the contracts. 
? Explain distinction between these contracts. 
 
 
CHAPTER 
1 
 
 
1.2 CORPORATE AND OTHER LAWS 
 
 1. INTRODUCTION 
Contract of Indemnity and Guarantee are the specific types of contracts provided 
under sections 124 to 147 of the Indian Contract Act, 1872. In addition to the 
specific provisions (i.e. Section 124 to Section 147 of the Indian Contract Act, 
1872), the general principles of contracts are also applicable to such contracts. 
Even though both the contracts are modes of compensation based on similar 
principles, they differ considerably in several aspects. 
In this unit, the law relating to indemnity and guarantee are discussed in detail. 
 2. CONTRACT OF INDEMNITY 
The term “Indemnity” literally means “Security against loss” or “to make good the 
loss” or “to compensate the party who has suffered some loss”.  
The term “Contract of Indemnity” is defined under Section 124 of the Indian 
Contract Act, 1872. It is “a contract by which one party promises to save the other 
Contract of Indemnity and 
Guarantee [Section 124-
147]
Contract of Indemnity 
[Section 124-125]
Contract of Guarantee 
[Section 126-127]
Nature of Surety’s Liability 
[Section 128]
Continuing  Guarantee 
[Section 129-132]
Discharge of Surety 
[Section 133-139]
Rights of Surety [Section 
140-147]
 
1.3 
CONTRACT OF INDEMNITY AND GUARANTEE 
 
from loss caused to him by the conduct of the promisor himself, or by the 
conduct of any other person.”  
Example 1: Mr. X contracts with the Government to return to India after 
completing his studies at University of Cambridge and serve the Government for 
a period of 5 years. If Mr. X fails to return to India, he will have to reimburse the 
Government. It is a contract of indemnity. 
There are two parties in this form of contract.  
a. The party who promises to indemnify/ save the other party from loss-  
‘indemnifier’,  
b. The party who is promised to be saved against the loss- “indemnified” 
or “indemnity holder”. 
Example 2: A may contract to indemnify B against the consequences of any 
proceedings which C may take against B in respect of a sum of ` 5000/- advanced by 
C to B.  In consequence, when B who is called upon to pay the sum of money to C 
fails to do so, C would be able to recover the amount from A as provided in Section 
124. 
Example 3: X, a shareholder of a company lost his share certificate. He applied for 
the duplicate. The company agreed to issue the same on the term that X will 
compensate the company against the loss where any holder produces the original 
certificate. Here, there is contract of indemnity between X and the company. 
Indemnifier
promises to 
indemnify/save the 
other party from 
loss
Indemnified
who is promised to 
be saved against 
the loss
 
 
1.4 
 
CORPORATE AND OTHER LAWS 
Example 4: X may agree to indemnify Y for any loss or damage that may occur if a 
tree on Y’s neighboring property blows over. If the tree then blows over and 
damages Y’s fence, X will be liable for the cost of fixing the fence. 
Analysis 
To indemnify means to compensate or make good the loss. Thus, under a 
contract of indemnity the “existence of loss” is essential. Unless the promisee has 
suffered a loss, he cannot hold the promisor liable on the contract of indemnity. 
However, the above definition of indemnity restricts the scope of contracts of 
indemnity in as much as it covers only the loss caused by: 
(i) the conduct of the promisor himself, or  
(ii) the conduct of any other person. 
Thus, loss occasioned by an accident not caused by any person, or an act of God/ 
natural event, is not covered.  
Mode of contract of indemnity: A contract of indemnity like any other contract 
may be express or implied. 
a. A contract of indemnity is said to be express when a person expressly 
promises to compensate the other from loss. 
b. A contract of indemnity is said to be implied when it is to be inferred from 
the conduct of the parties or from the circumstances of the case  
A contract of indemnity is like any other contract and must fulfil all the essentials 
of a valid contract which includes: 
a. Offer and acceptance 
b. Intention to create legal obligation 
c. Consideration 
d. Competency to contract 
e. Free consent 
f. Lawful object 
g. The agreement must not be expressly declared to be void- eg: an 
agreement in restraint of trade/ marriage etc. 
h. The terms of the agreement must not be vague or uncertain 
Page 5


 
LEARNING OUTCOMES
 
THE INDIAN 
CONTRACT ACT, 1872 
 
UNIT–1: CONTRACT OF INDEMNITY AND 
GUARANTEE 
After studying this unit, you would be able to: 
? Identify special type of contracts i.e. Indemnity contracts 
and Guarantee contracts and also the nature of obligations 
and rights of each of the parties to the contracts. 
? Explain distinction between these contracts. 
 
 
CHAPTER 
1 
 
 
1.2 CORPORATE AND OTHER LAWS 
 
 1. INTRODUCTION 
Contract of Indemnity and Guarantee are the specific types of contracts provided 
under sections 124 to 147 of the Indian Contract Act, 1872. In addition to the 
specific provisions (i.e. Section 124 to Section 147 of the Indian Contract Act, 
1872), the general principles of contracts are also applicable to such contracts. 
Even though both the contracts are modes of compensation based on similar 
principles, they differ considerably in several aspects. 
In this unit, the law relating to indemnity and guarantee are discussed in detail. 
 2. CONTRACT OF INDEMNITY 
The term “Indemnity” literally means “Security against loss” or “to make good the 
loss” or “to compensate the party who has suffered some loss”.  
The term “Contract of Indemnity” is defined under Section 124 of the Indian 
Contract Act, 1872. It is “a contract by which one party promises to save the other 
Contract of Indemnity and 
Guarantee [Section 124-
147]
Contract of Indemnity 
[Section 124-125]
Contract of Guarantee 
[Section 126-127]
Nature of Surety’s Liability 
[Section 128]
Continuing  Guarantee 
[Section 129-132]
Discharge of Surety 
[Section 133-139]
Rights of Surety [Section 
140-147]
 
1.3 
CONTRACT OF INDEMNITY AND GUARANTEE 
 
from loss caused to him by the conduct of the promisor himself, or by the 
conduct of any other person.”  
Example 1: Mr. X contracts with the Government to return to India after 
completing his studies at University of Cambridge and serve the Government for 
a period of 5 years. If Mr. X fails to return to India, he will have to reimburse the 
Government. It is a contract of indemnity. 
There are two parties in this form of contract.  
a. The party who promises to indemnify/ save the other party from loss-  
‘indemnifier’,  
b. The party who is promised to be saved against the loss- “indemnified” 
or “indemnity holder”. 
Example 2: A may contract to indemnify B against the consequences of any 
proceedings which C may take against B in respect of a sum of ` 5000/- advanced by 
C to B.  In consequence, when B who is called upon to pay the sum of money to C 
fails to do so, C would be able to recover the amount from A as provided in Section 
124. 
Example 3: X, a shareholder of a company lost his share certificate. He applied for 
the duplicate. The company agreed to issue the same on the term that X will 
compensate the company against the loss where any holder produces the original 
certificate. Here, there is contract of indemnity between X and the company. 
Indemnifier
promises to 
indemnify/save the 
other party from 
loss
Indemnified
who is promised to 
be saved against 
the loss
 
 
1.4 
 
CORPORATE AND OTHER LAWS 
Example 4: X may agree to indemnify Y for any loss or damage that may occur if a 
tree on Y’s neighboring property blows over. If the tree then blows over and 
damages Y’s fence, X will be liable for the cost of fixing the fence. 
Analysis 
To indemnify means to compensate or make good the loss. Thus, under a 
contract of indemnity the “existence of loss” is essential. Unless the promisee has 
suffered a loss, he cannot hold the promisor liable on the contract of indemnity. 
However, the above definition of indemnity restricts the scope of contracts of 
indemnity in as much as it covers only the loss caused by: 
(i) the conduct of the promisor himself, or  
(ii) the conduct of any other person. 
Thus, loss occasioned by an accident not caused by any person, or an act of God/ 
natural event, is not covered.  
Mode of contract of indemnity: A contract of indemnity like any other contract 
may be express or implied. 
a. A contract of indemnity is said to be express when a person expressly 
promises to compensate the other from loss. 
b. A contract of indemnity is said to be implied when it is to be inferred from 
the conduct of the parties or from the circumstances of the case  
A contract of indemnity is like any other contract and must fulfil all the essentials 
of a valid contract which includes: 
a. Offer and acceptance 
b. Intention to create legal obligation 
c. Consideration 
d. Competency to contract 
e. Free consent 
f. Lawful object 
g. The agreement must not be expressly declared to be void- eg: an 
agreement in restraint of trade/ marriage etc. 
h. The terms of the agreement must not be vague or uncertain 
 
 
1.5 
 
CONTRACT OF INDEMNITY AND GUARANTEE 
 
i. The agreement must be capable of performance- An agreement to do an 
impossible act is void. 
j. Legal formalities 
Example 5: A asks B to beat C promising to indemnify him against the 
consequences. The promise of A cannot be enforced. Suppose, B beats C and is 
fined 
`
1000, B cannot claim this amount from A because the object of the 
agreement is unlawful.  
A contract of Fire Insurance or Marine Insurance is always a contract of indemnity. 
But there is no contract of indemnity in case of contract of Life Insurance. 
Rights of Indemnity—holder when sued (Section 125): The promisee in a 
contract of indemnity, acting within the scope of his authority, is entitled to 
recover from the promisor/indemnifier— 
(1) all damages which he may be compelled to pay in any suit in respect of any 
matter to which the promise to indemnify applies;  
(2) all costs which he may be compelled to pay in any such suit if, in bringing or 
defending it, he did not contravene the orders of the promisor, and acted as 
it would have been prudent for him to act in the absence of any contract of 
indemnity, or if the promisor authorised him to bring or defend the suit;  
(3) all sums which he may have paid under the terms of any compromise of any 
such suit, if the compromise was not contrary to the orders of the promisor, 
and was one which it would have been prudent for the promisee to make in 
the absence of any contract of indemnity, or if the promisor authorised him 
to compromise the suit.  
Analysis: 
We can understand from the above provisions that, in a contract of indemnity, the 
promisee i.e., indemnity- holder acting within the scope of his authority is entitled 
to recover from the promisor i.e., indemnifier the following rights: 
(a) all damages which he may be compelled to pay in any suit 
(b) all costs which he may have been compelled to pay in bringing/ defending 
the suit and 
(c) all sums which he may have paid under the terms of any compromise of 
suit. 
It may be understood that the rights contemplated under section 125 are not 
exhaustive. The indemnity holder/ indemnified has other rights besides those