Contracts of Indemnity & Guarantee | UGC NET Commerce Preparation Course PDF Download

Contract of Indemnity and Guarantee

The contract of indemnity and the contract of the guarantee are two distinct agreements within the Indian Contract Act, 1872. Under a contract of indemnity, one party agrees to compensate for losses suffered by another. On the other hand, a contract of guarantee involves three parties, where a third party pledges to settle a debt in case the debtor defaults on payment.

Contract of Indemnity

A contract of indemnity involves one party providing assistance and compensating the other party for any losses incurred. The individual offering the indemnity is known as the indemnifier, while the recipient of the indemnity, who is compensated for losses, is the indemnity-holder or indemnified.

Rights of Indemnity-holder

The indemnity-holder possesses certain entitlements under the indemnifier's contract:

• The right to have all damages from any legal action covered, regardless of circumstances
• The right to receive financial support for all legal defense costs
• The right to receive funds for settling any legal disputes

Commencement of Liability

Indemnity is not solely about reimbursement after a payment has been made. It stipulates that the indemnified party should not have to make any payments. According to prominent legal precedents, once the obligation to pay is definitively established for the indemnity-holder, they can demand that the indemnifier be prepared to meet any repayment claims.

Indemnity Bond

An indemnity bond allows an employee to terminate their employment before the agreed-upon period. However, this withdrawal is permissible only upon payment of a forfeiture fee, which is considered valid if both the fee and the duration of the bond are reasonable. The bond amount retained is intended to compensate the employer for any losses incurred due to the early termination.

Contract of Guarantee

A contract of guarantee involves a third party taking on the responsibility of a debtor towards a creditor. The individual offering the guarantee is known as the surety, the one receiving the guarantee for repayment is the principal debtor, and the recipient of the guarantee is the creditor. Guarantees can be oral or in writing. This agreement allows the principal debtor to access employment, loans, or goods on credit, with the surety ensuring repayment in case the debtor defaults.

Salient Features of Guarantee

The guarantee or surety is solely for securing the debt and requires the existence of a recoverable debt. - The contract of guarantee must include all essential components of a valid contract. - A guarantee remains valid even if the principal debtor is legally incompetent, but if the surety is incompetent, the contract becomes void. - Valid consideration is essential for a contract. The consideration from the principal debtor must be adequate for the surety to provide a guarantee. - Any contract obtained through misrepresentation is considered invalid. Misrepresentation by the creditor or if the creditor is silent on crucial details renders the guarantee invalid.

Surety's Liability

The surety's liability typically matches that of the principal debtor unless stated otherwise in the contract, representing the maximum liability of the surety. - The contract may limit the surety's liability to a specific amount, beyond which they are not accountable.
Responsibility of Surety

• General Rule: The surety is responsible for paying all the debts of the principal creditor. The principal debtor can claim costs, damages, and interests from the surety.
• Exception: An exception may apply if the contract specifies otherwise.
• Default and Surety's Responsibility: Upon default by the principal debtor, the surety becomes responsible immediately. The creditor is not required to first sue or notify the principal debtor. The surety is liable only up to a certain limit.

Continuing Guarantee

A continuing guarantee extends to a series of transactions.

Joint-Debtor and Surety-ship

In a two-party contract with a third party, if the two parties agree that one will be liable for the other's default, the third party is not involved in this agreement. The liability of the two parties with the third party remains unaffected despite the existence of the second contract.

Discharge of Surety from Liability

Revocation:

• The surety can revoke a continuing guarantee by notifying the creditor. This applies to future transactions.

Death of Surety:

• The death of the surety ends the continuing guarantee for future transactions.

Death of Surety's

Variance in the Contract:

• Point 1: When changes are made in the contract between the creditor and the principal debtor, the surety is released from liability.

Discharge or Release of Principal Debtor:

• Point 2: If the principal debtor is discharged from the contract, the surety is also freed from liabilities. The discharge usually happens due to an action or inaction by the creditor.

Composition, Promise not to Sue or Extension of Time:

• Point 3: If the creditor alters the contract without informing the surety, the surety is no longer liable. These alterations will change the original terms of the contract.
• Point 4: Simply forbearing to sue the principal debtor does not release the surety from obligations.

A Promise Made with the Third Person:

• Point 5: An agreement with a third party to give the principal debtor more time does not affect the surety's responsibility. This agreement is solely between the creditor and the third party.

Impairing Surety's Remedy:

• Point 6: If the creditor acts in a way that harms the surety's ability to seek remedy against the principal debtor, the surety is discharged. The creditor must respect the surety's rights for this to hold.

Rights of Surety

Rights of Subrogation:

• One of the surety's main rights is to step into the shoes of the creditor after paying off the debt of the principal debtor.

Right to Indemnity:

• In a guarantee agreement, the principal debtor promises to compensate the surety for any payments made on their behalf.
• The principal debtor is obligated to reimburse all rightfully paid sums, excluding any amounts paid erroneously.

Right to Creditor's Securities:

• The surety is entitled to benefit from any security held by the creditor against the principal debtor at the time of entering the contract.
• Even if the surety is unaware of the security's existence during the agreement, they still have rights over it.
• If the creditor loses or relinquishes the security, the surety's liability is reduced by the value of the security.

Right to Set-off:

• If the creditor takes legal action against the surety, the surety can utilize the right of set-off.

Release of Co-surety:

• When multiple co-sureties are involved, releasing one co-surety does not absolve the others of their obligations.
• This action also does not free the surety from responsibilities towards the remaining co-sureties.

Rights against Co-sureties

• Release of Co-surety: Co-sureties have the right to seek contribution from each other if they share liability for the same debt. They are obligated to pay an equal share of the full or outstanding debt owed by the principal debtor, regardless of whether the liability stems from the same or different contracts, and irrespective of whether the co-sureties were aware of the liability or not.
• Right to Contribution: Co-sureties are responsible for sharing the debt among themselves if they have jointly guaranteed the same debt. They must each cover an equal portion of the total or remaining debt that the principal debtor has not paid. This obligation remains unchanged whether the liability arises from the same or a different contract, and it applies regardless of whether the co-sureties are aware of each other's liabilities.