LAW OF

CONTRACT-II

WEEK-I & II
ADITYA GANDOTRA
ASSISTANT PROFESSOR
JINDAL GLOBAL LAW SCHOOL
 AGENDA
 Contract of indemnity defined
 Is an insurance contract a contract of indemnity?
 Rights of indemnity holder
 When can an indemnifier be made liable?
 Contract of guarantee
 Main features of a contract of guarantee
 Distinction between contract of indemnity and guarantee
 Liability of surety: Nature and Extent
 Prior action against pledged goods not necessary
 Liability of co-surety
 Continuing guarantee
 Discharge of surety from liability
 CONTRACT OF INDEMNITY DEFINED
 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, is called a “contract of indemnity.”

 Illustration:
Party A contracts to indemnify B against the consequences of any proceedings that C may
take against B in respect of a certain sum of 200 rupees. This is a contract of indemnity.

 The object of obtaining a contract of indemnity is to protect the indemnity holder from a claim
made by a third party.

 An indemnity holder is entitled to sue the indemnifier even before incurring any actual damage or
loss and indemnity is not necessarily invoked after payment.
 IS INSURANCE CONTRACT A CONTRACT
OF INDEMNITY?
 Section 124 recognizes only such contracts as a contract of indemnity where there is a promise to
save another person from loss which may be caused by the conduct of the promisor himself or by
conduct of any other person.

 It does not cover a promise to compensate for loss not arising due to human agency.

 Thus, if under a contract of insurance, an insurer promises to pay compensation in the event of loss
by fire, such a contract does not come within the purview of Section 124. Such contracts are valid
contracts, as being contingent contracts as defined in Section 31.

 Other insurance contracts except Life Insurance are contracts of indemnity.

 RIGHTS OF INDEMNITY HOLDER

 All damages which he may be compelled to pay in any suit in respect of any matter to which the promise
to indemnify applies;

 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 authorized him to bring or defend the suit;

 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 authorized him to
compromise the suit.
 WHEN CAN AN INDEMNIFIER BE MADE
LIABLE
 Whether the indemnifier can be asked to indemnify before the indemnity-holder has actually suffered
the loss?

 Chagla, J. while delivering the judgment in the Bombay High Court decision of Gajanan Moreshwar
v. Moreshwar Madan, observed:

"The Court of equity held that if his (indemnity-holder's) liability had become absolute, then he was
entitled either to get the indemnifier to pay off the claim or to pay into Court sufficient money which
would constitute a fund for paying off the claim whenever it was made...I have already held that
Sections 124 and 125 of the Contract Act, are not exhaustive of the law of indemnity and the Courts
here would apply the same equitable principle that the Courts in England do. Therefore, if the
indemnified has incurred a liability and that liability is absolute, he is entitled to call upon the
indemnifier to save him from that liability and to pay it off."
 CONTRACT OF GUARANTEE
 Section 126 of the Indian Contract Act of 1872, defines a contract of guarantee as under:
A "contract of guarantee" is a contract to perform the promise, or discharge the liability, of a
third person in case of his default.”

 The Section further provides that :

 The person who gives the guarantee is called the "surety", the person in respect of whose default the
guarantee is given is called “principal debtor” and the person to whom the guarantee is given is called the
"creditor”
 A guarantee may be either oral or written.

 The object of a contract of guarantee is to provide additional security to the creditor in the form of a
promise by the surety to fulfil a certain obligation, in case the principal debtor fails to do that.

 In every contract of guarantee, there are three parties, the creditor, the principal debtor and the
surety.
 MAIN FEATURES OF A CONTRACT OF
GUARANTEE

 The contract may be either oral or in writing

 There should be a principal debt

 Benefit to the principal debtor is sufficient consideration

 Consent of the surety should not have been obtained by misrepresentation or

concealment
 DISTINCTION BETWEEN CONTRACT OF
INDEMNITY AND GUARANTEE
INDEMNITY GUARANTEE
1. There are two parties in a contract of indemnity There are three parties in a contract of guarantee

2. A contract of indemnity consists of only one There are three contracts in a contract of guarantee
contract
3. A contract of indemnity is made to protect the The object of a contract of guarantee is the security
promisee against some likely loss of the creditor

4. The liability of the indemnifier in a contract of In a contract of guarantee, the liability of the surety
indemnity is a primary one is only a secondary one
5. In a contract of indemnity, the loss falls on the In a contract of guarantee, after the surety has
indemnifier and, therefore, after the indemnifier has discharged his liability and paid to the creditor, he
indemnified the indemnity-holder, he cannot steps into the shoes of the creditor and he can
recover the amount from anybody realize the payments made by him, from the
principal debtor
 LIABILITY OF SURETY: NATURE AND
EXTENT
 The provision that the surety's liability is coextensive with that of the principal debtor means that his
liability is exactly the same as that of the principal debtor.

 If the principal debtor's liability is reduced, e.g., after the creditor has recovered a part of the sum
due from him out of his property, the liability of the surety is also reduced accordingly.

 If the principal debtor's liability is affected by illegality, so is also that of the surety.

 If the principal debtor happens to be a minor and the agreement made by him is void, the surety too
cannot be made liable in respect of the same because the liability of the surety is coextensive with
that of the principal debtor.
 PRIOR ACTION AGAINST PLEDGED
GOODS NOT NECESSARY
 It has been held in State Bank of India v. Gautmi Devi Gupta, that if there is a decree in
favour of the creditor bank and certain goods have been hypothecated, it is not necessary
that the decree holder bank should proceed to recover the decretal amount first from the
hypothecated goods and then proceed against the surety.

 The liability of the principal debtor and the surety is joint and several. The creditor can,
therefore, sue either both of them together or either of them individually. If after an action
against both, the creditor obtains a decree against both of them, he is free to enforce the
decree in the first instance against the surety.

 When the creditor files a suit against both the principal debtor and the surety, and the suit
against the principal debtor is dismissed, that would not automatically discharge the surety
from liability, and the suit can proceed against the surety.
 LIABILITY OF CO-SURETY

 The liability of sureties is coextensive with that of the principal debtor. It implies that
the creditor can proceed against the principal debtor or the surety, at his discretion,
unless it is otherwise provided in the contract. The same principle is applicable with
regard to the rights and liabilities of the co-sureties.

 In State Bank of India v. G.J. Herman, it has been held that when there is a composite
decree against the principal debtor and the sureties, the creditor has the discretion to
decide against whom he wants to proceed.

 Neither the court nor a co-surety can insist that the creditor should first proceed against
another surety before proceeding against him. Such a direction would go against the
co-extensiveness of the liability of the sureties with that of the principal debtor.
 CONTINUING GUARANTEE
 A guarantee which extends to a series of transactions is called a "continuing guarantee.'' Such
guarantee may be in respect of a series of transactions during a fixed period, e.g., for one year.

 The surety may either guarantee the conduct of the principal debtor in respect of a particular
transaction, for example, he guarantees the repayment of a loan of Rs. 5,000 which the
principal debtor may have taken from the creditor, or he may undertake to be answerable for
the conduct of the principal debtor in respect of a series of transactions. The former is known
as 'Specific Guarantee', whereas the latter is known as 'Continuing Guarantee’.

 EXAMPLE:

 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.
 DISCHARGE OF SURETY FROM LIABILITY
 The modes of discharge of a surety, as recognized by the Indian Contract Act are as under:

1. Revocation by the surety. (Section 130)

2. By surety's death. (Section 131)

3. By variance in the terms of the contract. (Section 133)

4. By release or discharge of the principal debtor. (Section 134)

5. When the creditor compounds with, gives time to, or agrees not to sue, the principal debtor.
(Section 135)

6. By creditor's act or omission impairing surety's eventual remedy. (Section 139)