Indemnity and Guarantee UNIT-1

8/2/2019 Indemnity and Guarantee UNIT-1

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LAW OF CONTRACT - II

Faculty Shradha Baranwal

[email protected]
mailto:[email protected]:[email protected]


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CONTRACT OF INDEMNITY AND

GUARANTEE

Section 124 A contract by which one partypromises to save the other from loss causedto him by the conduct of the promisor

himself, or by the conduct of any otherperson, is called a contract ofindemnity.

Claim subsists against the action of promisoror any other person

Indemnifier andindemnified


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Promise to recompense i.e. compensate for any loss orliability

Promise could be in three ways

1. Contract of indemnity[could be express orimplied (e.g.encumbrances)]

2. Relation of the parties

(principalagent/

employer-employee etc)

3. By statute

(liability of railway in case of loss suffered by the consignor due towrong specifications given by the railway, liability towards aperson for loss suffered by him whose name has wrongly appearedin the prospectus)


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NATURE OF CONTRACT OF INDEMNITY

Original and independent obligation i.e. primary

responsibility

Right to indemnity vs. right to damages


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EXAMPLES OF INDEMNITY

A, a joint promisor pays off the whole debt and sues Bfor half the due amount.

Liability of directors of the company to compensate forthe loss suffered by a person whose name appearsas director without his consent or the consent hasbeen withdrawn.

Liability towards partner of a firm in respect ofpayments made by him on behalf of the firm in theordinary course of business.


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COMMENCEMENT AND EXTENT OF LIABILITY

No clear provision under India Contract Act, 1872

Earlier position in English Law

no indemnity till the actual losseshave been suffered

Difficulty with the earlier position

Later development of Equitable Principle

...If payments is a condition precedent to recovery,the contract may be of little value to the person tobe indemnified, who may be unable to meet theclaim in the first instance.


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Views of different High Courts with respect to the

commencement of liability

Calcutta High Court equitable principle

Bombay High Court actual damage suffered

Law commission of India held indemnity as a claim

and not mere reimbursement. (See thirteenth report)


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LIMITATION ON CONTRACT OF INDEMNITY

Indemnifier cannot sue the debtor in his own

name for want of Privity of contract

Creditor also cannot sue the promisor of the

contract of indemnity

Payment without actual loss absolute liability

Payment only after loss where the liability is

not absolute but a relative one.


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RIGHT OF INDEMNITY HOLDER WHEN SUED

Section 125 reads,

The promisee in a contract of indemnity, acting within thescope of his authority is entitled to recover from the

All damages

All costs

All sums

Conditions are

Orders of the promisor should not have been contravened

Action of a prudent man in absence of contract ofindemnity


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Rights of the indemnifier

Based on the natural equity

Where one person has agreed to indemnify

another, he will, on making good the

indemnity, be entitled to succeed to all the

ways and means by which the person

indemnified might have protected himselfagainst, or reimbursed himself for the loss.


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Case laws

1. State Bank Of India & Anr vs Mula Sahakari

Sakhar Karkhana Ltd on 6 July, 2006, SupremeCourt

Nature of contract of indemnity

2. Gajanan Parelkar v. Moreshwar Madan MantriAIR 1942 BoMoreshwar m 302

3. Osman Jamal & Sons Ltd. v. Gopal Purshottam1928 ILR 56 Cal 262

Commencement of liability


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CONTRACT OF GUARANTEE

Sec. 126 defines contract of guarantee

Includes Performance of a promise corresponds to a duty

Discharge of a liabilitycorresponds to a debt

Either oral or written

Operative only in case of default

Surety

principal debtor creditor


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Essentials of contract of guarantee

Three necessary parties debtor, surety, creditor

Failure to discharge of liability under legal

obligation by the principal debtor

Liability voluntarily taken by another person

Contract of Guarantee by Company

By writing under its common seal

By any person on behalf of a company viz., Director


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Guarantee and indemnity (similarity)

Broadly both insures compensation to the

creditor in case of loss

Differences Guarantee and Indemnity

1. Parties and formation

2. Difference in liability

3. Formalities

Contract of Guarantee with the knowledge of the principle

debtor (can avail 140, 141 and 145)

Without the knowledge of principal debtor (can not avail

145)


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Nature of contract of Guarantee

Collateral or conditional contract

Something auxiliary to an antecedent obligation.

There are two classes of guarantee a promise

which becomes effective if the debtor fails to

perform his obligation and a promise that the

debtor will perform his obligation. Guarantee in

the latter case are effectively unconditional.

A contract of Guarantee is not one uberrimae

fidei, but a contract ofstrictissima juris.


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An arrangement under which the promisor

undertakes an obligation which replaces and/or

extinguishes the principal-debtors liability, whether

by novation or otherwise, is not a guarantee.

The principal-debtor may be a party to the contract

by implication.

Nature of liability under Contract of Guarantee

Guild & Co. v Conrad (1894) 2 QB 885

There is a plain distinction between a promise to pay the creditor if

the principal-debtor makes default in payment and promise to keepa person who has entered or about to enter, into a contract of

liability indemnified against that liability independently of the

question whether a third person makes default.


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Liability should be legally enforceable

Suretys liability equivalent to that of a principal.

Liability subject to condition if provided For filing the suit for enforcing entitlement it is not

necessary for the creditor to exhaust suit againstprincipal debtor he can directly proceed against the

surety and such suit is maintainable. (State Bank ofIndia v Indexport (1992) 3 SCC 159)

Criteria to determine whether contract of Guarantee

or Indemnity Use and frequency of use of words

Nature of liability


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Effect of contract of Guarantee

Suretys liability arises only in case of default

Surety entitled to all the rights viz., discharge,

indemnity from the principal debtor as per sec.

133 to 145

If a person becomes surety without theknowledge and consent of the principal debtor,

the only rights which he acquires in that case

are those given by section 140 and 141, and notthose given by section 145.


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Performance Bond, Bank Guarantee or letter of

credit

Could be conditional or unconditional

Honored on first demand without any condition

of proof

Subsequent happenings in the establishment

would not restrain Bank to honor the

Guarantee.

EXCEPTIONS


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Section 127 Consideration for guarantee

Anything done, or any promise made, for the

benefit of the principal debtor, may be asufficient consideration to the surety for giving

the guarantee.

Section 128 Surety's liabilityThe liability of the surety is co-extensive with that

of the principal debtor, unless it is otherwise

provided by the contract.


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Nature of liability

Co extensive means to the that extent

Surety cannot insist on exhausting the liability of

principal debtor.

The extent of liability would depend upon the

terms of the contract.

Any express or implied conditions precedent the

suretys liability must be fulfilled before

recourse can be had to him. Where the liabilityarises under the contract only on the happening

of a contingency, the surety is not liable until

the contingency has taken place.


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Liability for void or voidable contract (surety

against minors debt)

Discharge of principal debtor by operation oflaw does not discharge the surety

Statutory reduction or extinguishment of

liability Filing a suit and execution of a decree

Effect of acknowledgement by a principal

debtor does not bind the surety unlessspecifically empowered.


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129. Continuing guarantee

A guarantee which extends to a series of

transaction, is called, a "continuing guarantee". The nature of Guarantee is a question of the intention of the

parties to the contract.

Language, surrounding circumstances and relative position of

the parties are the guiding factors in determining the status

of guarantee.

130. Revocation of continuing guarantee

A continuing guarantee may at any time berevoked by the surety, as to future transactions,

by notice to the creditor.


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By giving notice guarantor can avoid future

liability.

Where a continuing relationship is constitutedon the faith of guarantee, it cannot be revoked

during the continuance of that relationship.

However a material change in the guaranteedsituation may justify revocation viz., proved

misconduct of servant.

Prescribed mode of revocation Continuing guarantee and change in the status

of creditor would terminate the guarantee

unless agreed otherwise.


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131. Revocation of continuing guarantee by

surety' death -

The death of the surety operates, in the absenceof any contract to the contrary, as a revocation

of the continuing guarantee, so far as regards

future transactions.

In the absence of any contract in contrary

Joint and several liability


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Section 132

Liability of two persons primarily liable, not affectedby arrangement between them that one shall besurety on others default.

Discharge of surety (Sec 133-139)

General ways for discharge of contract

Section 133Discharge of surety by variance in terms of contract

(variance without the consent of surety)


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Rule of strict interpretation

Variance should be substantial

Cases of ambiguity rule ofcontra preferentem

Section 134

Discharge of surety by release or discharge of principal

A surety is discharged if the creditor without his consent,unconditionally release the principal debtor.

Release of the principal debtor by a complete novation orotherwise terminates the guarantee

Acceptance of second surety by the creditor Consent decree

Bishal Chand Jain v Chatlur Sen AIR 1967 All 506


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Section 136. Surety not discharged when agreement

made with third person to give time to principal-

debtor-

Section 137. Creditorsforbearance to sue does not

discharge surety

Section 138. Release of one co-surety does not

discharge others

Section 139. discharge of surety by creditors act of

omission impairing suretys eventual remedy


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Section 139 includes

-does an act inconsistent with the rights of the

surety; or- Omits to do any act which his duty to the surety

requires him to do, and as a result the suretys

eventual remedy against the principal debtor isthereby impaired.

Section 139 is residuary in nature which ensuresthat no contrary arrangement is made


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Cases which can be covered under section 139

Where the creditor consented to the release ofattachment over the properties;

Where creditor failed to convey property in purchase, theprice of which was guaranteed by the guarantor ;

Sale of mortgaged property in favour of creditor withoutthere being any occasion for the same;

Loss of pledged goods; Failure of creditor to bring on record the LRs of the dead

principal debtor resulting into abatement of proceedingsagainst him.

Security not returned in the same condition as given to

the creditor

THE ONUS LIES ON SURETY


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Section 140. Rights of surety on payment or

performance

.Surety becomes invested with all the rights whichthe creditor had against the principal debtor.

Based on the principal of equity In counter guarantee for reimbursement the rights

are transferred to the counter guarantor.

Priority in cases of liquidation and winding up. Rights before demand of payment once the liability

accrues

Injunction even before the payment


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Section 141. Suretys right to benefit of creditors

security-

Surety is entitled to all the securities creditor had atthe time of entering into contract of surety

irrespective of the knowledge of the same any

impairment in the same would discharge the surety

Section 142. Guarantee obtained by

misrepresentation, invalid

Section 143. Guarantee obtained by concealment,

invalid


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Circumstances in which necessary disclosure ismade to the surety

Where the surety has asked specific question tothe creditor;

Where the bank misleads the surety byvolunteering only part of the truth;

Where the surety makes a statement in thecreditors presence that demonstrates that the heentirely misunderstood the principal debtors

position;

Where there is anything that might not naturallybe expected to take place between the principaldebtor and the creditor


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Section 144. Guarantee on contract that creditor shallnot act on it until co-surety joins

Section 145. Implied promise to indemnify surety

Based on equity

Rightfully paidIncludes property, assignment of rights

Entitlement runs till full indemnification is doneincluding payment towards interest.

Recovery of costIncludes cases where surety has defended the debtorunder his authority, for his benefit, or undercircumstances which were unavoidable.


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Section 146. Co-sureties liable to contribute

equally

Section 147. Liability of co-sureties bound in

different sums


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Radha Kanta Pal v. United Bank of India AIR 1955Cal 217

Gas Authority of India Ltd., New Delhi v OfficialLiquidator, Mumbai AIR 2004 Bom 220

Annandana Jadaya Gounder v Konammal AIR 1933Mad 309

Bharat Nidhi v Bhagwandas Mehra CA SC 939

Syndicate Bank v Pamidi Somaiah (Died) AIR 2002AP 12

Cl i


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Class exercise

1. A, introduced B to C for certain business leading

to execution of a contract between B and C.Later C breached the contract Decide theliability of A

Whether A is liable for indemnify or stands asGuarantee (Refer Chanana Steel Tubes Pvt. Ltd. v.Messrs Jaitu Steel Tubes Pvt. Ltd. AIR 2000 HP 48)

2. X invited Y for celebrating his marriage. Y

promised to gift X a watch. Z a common friendto X and Y guaranteed the same in case Ydefaults. Y defaulted in his promise. Decide theliability of Z.


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3. X agreed to sell 500 pieces of shoes to Y for aconsideration of 30,000 Rs. Y received the goodsbut failed in payment of the amount. Z a friend to

Y entered into a contract with X for the paymentof the due amount in consideration of dischargingthe liability of Y. Decide the status of Z whether hestands as surety to the contract between X and Y?

4. A agreed with B to pay off all the losses B wouldsuffer due to payment against sale B concludedwith C. The agreement between A and B was

worded as follows:This Agreement of Guarantee is been concluded between A andB whereby A guarantees to make payment in case of losssuffered by B on account of payment against sale concludedbetween B and C.

Decide the nature of contract between A and B


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5. X borrowed Rs. 50,000 from Y. Z deposited his

property papers to secure the payment without

there being any express agreement. Decide theliability of Z in case of non payment by X.

6. In a writing by X to Y in the presence of Z:

Please lend Rs. 1200 to Z; there will be notrouble in the payment of your money. Be

assured, if there by any trouble, I undertake to

indemnify you and would stand as equally

liable. Decide whether contract of Guarantee

or indemnity?

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