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Difference between contract of indemnity and contract of Guarantee

Difference Between Contract of Indemnity & Contract of Guarantee

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Indemnity in English law is defined as “a promise to keep a person harmless from the consequences of an act”. The promise may be express or implied. Going as per the basic dictionary meaning of the terminology ‘indemnify’, it means “to compensate someone for the harm or loss caused”. This is how the word is interpreted in English law as well as in Indian Law It can be easily understood from the case of Adamson v. Jarvis1, the facts of which are as follows:

  • The Plaintiff, an auctioneer, sold the Defendant’s livestock as per the instructions provided by the Defendant.
  • Subsequently, it was brought to the attention of all the concerned parties that the Defendant had no title to the livestock that was sold in the first place through an auction conducted by the Plaintiff.
  • Due to this the person who bought the livestock sued the Plaintiff (the auctioneer).
  • Eventually, the Plaintiff sued the Defendant for indemnity for the losses that he had thus incurred by acting as per the instructions given by the Defendant.
  • The Hon’ble Court held that the Plaintiff should be indemnified by the Defendant since the former i.e. the Plaintiff, acted in accordance with the directions of the latter (the Defendant) and as such the Plaintiff was entitled to assume that if due to his conduct he were to suffer a loss, he would be indemnified by the Defendant as such conduct and loss suffered would be a result caused due to the Defendant’s instructions.

Now, as per Section 124 of the Indian Contract Act, 1872, a contract of indemnity means a contract where one of the contracting parties promises to save the other from any loss which may be caused either:

  1. By the conduct of the promisor himself; or
  2. By the conduct of any other person.

The person who gives the indemnity is called the “indemnifier” whereas the person for whose protection the indemnity is given is called the “indemnity holder” or “indemnified”.

Difference between the English Law & Indian Law regarding Contract of Indemnity

Under the English law, the definition of the word ‘indemnity’ is quite wide and takes a gamut of other provisions and rules under its ambit. Under the Indian law, a contract of indemnity does not include a promise to indemnify another person for the loss caused by the events or accidents which do not or may not depend on the act of the indemnifier or any other person.

For example- Any loss caused due to fire, flood, thunderstorm, etc. whereas under the English Law, a contract of indemnity includes a promise to save another person due to any of the aforementioned reasons.

  1. Insurance Contract

To understand the difference we can take the example of insurance. Under English law, a contract of insurance (other than life insurance) is a contract of indemnity whereas as per the Indian Law, an insurance contract is not considered to be an indemnity contract. Therefore, as per the provisions of the contract of indemnity under Indian law, if an insurance company which has signed an insurance contract with any person/ individual/ entity tries to seek the defence that since the loss was caused to that specific person due to fire or floods etc. i.e. an accident, they are or should not be held liable to indemnify the other person, then, in that case, the court would hold their defence as invalid and inappropriate.

The above comparison can be given more clarity with the case of United India Insurance Company v. M/s. Aman Singh Munshilal2, the gist of the case is as follows:

  • The contract between the concerned parties was to deliver a set of goods.
  • On its way to the destination, the goods were to be stored in a storage facility/ godown and thereafter, on a succeeding day, were supposed to be delivered to the destination.
  • During the transit and before being brought to the destination, the goods were kept in the storage facility/ godown as per the agreed terms between the parties, however, the goods destroyed due to the outbreak of fire in the said storage facility/ godown.
  • The Hon’ble Court held that since the goods were destroyed during the transit stage itself, the insurance company would be liable to indemnify for the goods destroyed.
  1. Liability of indemnifier (Whether he can be asked to indemnify before the indemnifier has suffered any loss)

This issue has always been in a grey area, as to whether the indemnifier can be asked to indemnify before the indemnity holder has suffered any loss, or his liability arises only after the loss has been suffered by the indemnity holder. Comparing the aforementioned controversial point with respect to the English Law & Indian Law, it can be inferred that both have contradictory provisions regarding it.

The original English rule was that the indemnity was payable only after the indemnity holder has suffered any loss. The liability of the indemnifier commenced only after the loss has been suffered by the indemnified. It followed the maxim “you must be damnified before you claim to be indemnified”.

Under Indian Law, contradictory opinion was given by Changla J. in the case of Gajanan Moreshwar v. Moreshwar Madan3 in which it was held that:

  • If the indemnity holder in a suit has to pay damages to the other party for which he was indemnified by the indemnifier in the first place then, the value of that indemnity deteriorates & becomes less significant.
  • The value of the indemnity deteriorates because the indemnity holder cannot enforce his indemnity until he has actually paid the loss.
  • So firstly, the indemnified has to wait for the pronouncement of the judgment in the first case, thereafter he can sue for his indemnity to recover the loss for which he was indemnified.
  • All of these circumstances might throw unbearable circumstances upon the indemnity holder.
  • If the liability of the indemnity holder has become absolute then he is entitled to either get the indemnifier to pay for the loss suffered or get him to pay an adequate amount of money to the court’s treasury to establish a fund that can be later utilized to pay off the claim.

Introduction to Contract of Guarantee

Keeping the legal interpretation of a contract of guarantee aside, if one is a layman looks into the dictionary meaning of the word ‘guarantee’, it means giving someone a formal assurance that some work would be done or certain conditions would be fulfilled.

Exactly in the same context, this definition is applied in Section 126 of the Indian Contract Act, 1872, which defines a contract of guarantee as:

“A contract of guarantee is a contract to perform the promise or discharge the liability, of a third person in case of his default”

This section further defines certain terms used in any contract of guarantee, which are:

  • Surety – The person who gives the guarantee.
  • Principal debtor – The person for whom the guarantee is given.
  • Creditor – The person to whom the guarantee is given by the surety.

The usage of these terms can be understood through an illustration-

‘X’ takes a loan from a bank and promises to repay the loan at the earliest. Thereafter, ‘Y’ also makes a promise to the bank that if ‘X’ defaults on his payment then he would pay the loan on his behalf. In this case, ‘Y’ is the surety because he imposes liability on himself to repay the loan in case ‘X’ fails to do so. ‘X’, who undertakes to repay the loan, is the principal debtor. The bank is the creditor as the guarantee has been given to it by the surety. Now, in the aforementioned illustration if ‘X’ defaults on his payment to the bank then ‘Y’ in the capacity of a surety in the contract would be liable to repay the loan to the creditor. Later on, the principal debtor shall indemnify the surety for the promise which he has fulfilled on the former’s behalf.

The main 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. To summarize the basics of a contract of guarantee, we can say that it is a blend of three different promises which are:

  • The principal debtor makes a promise to the creditor to perform a promise etc.
  • Surety undertakes a liability to perform the whole or part of the promise if the surety makes default in his performance.
  • An implied promise by the principal debtor in favour of the surety that in case the surety has to discharge the liability of the default of the principal debtor, the principal debtor shall indemnify the surety for it. The same was held in the case of Nagpur N.S. Bank v. Union of India4.

Main features of Contract of Guarantee

Some main features of a contract of the guarantee are as follows:

  1. The contract may be either oral or in writing

According to Section 126 of the Indian Contract Act, 1872, a guarantee may be either oral or written whereas under the English Law, to make a contract of guarantee a valid one, it has to be in a written form and must be signed by the parties.

  1. There should be a principal debt

There must be a debt or an obligation to be discharged by the principal debtor. The surety undertakes a liability to perform the promise or part of the promise in case the principal debtor fails to do so. But, if there is no principal debt to be paid or there is no obligation to be discharged by the principal debtor then there is no presence of a valid contract of guarantee.

  1. The benefit to the principal debtor is sufficient consideration

As in any other contract, some consideration is also needed for a contract of guarantee. As per Section 127 of the Indian Contract Act, for the surety’s promise, it is not necessary that there should be direct consideration between the creditor and the surety. The creditor has done something for the benefit of the principal debtor is adequate consideration regarding the surety’s promise made to the creditor.

  1. Consent of the surety should not have been obtained by misrepresentation or concealment

As per Section 142 & Section, 143 of the Indian Contract Act, 1872, the creditor should not obtain guarantee either by any misrepresentation or concealment of any material facts concerning the transaction. If the guarantee has been obtained in any fraudulent way then, the guarantee, as well as the contract of guarantee, stands invalid.

The distinction between a contract of Indemnity & Guarantee

S.NoPoint of differenceIndemnityGuarantee
1.Number of partiesTwo parties: Indemnifier & indemnity holder.Three parties: Surety, principal debtor & creditor.
2.Number of contractsIt consists of only one contract between the indemnifier & the indemnity holder.It consists of total three contracts i.e. between:Firstly, Principal debtor & Creditor.Secondly, Surety & Creditor.Thirdly, Surety & Principal debtor.
3.The object of the contractProtect the promisee against some likely loss.Security of the creditor.
4.Nature & arise of liabilityThe liability of the indemnifier is primary. It arises only when some loss has been caused to the promisee by the promisor or any other person.The liability of surety is secondary. It arises when the principal debtor makes a default
5.Recovery of the amount paidAfter the indemnifier has indemnified the indemnity holder he cannot recover the amount from anybody.After the surety has discharged the liability on behalf of the principal debtor, he can recover the payment made by him to the creditor from the principal debtor.

Conclusion

To encapsulate the difference between a contract of indemnity and a contract of guarantee, a sole illustration summarizes it all-

  • ‘A’ and ‘B’ go to a shop.
  • ‘A’ purchases some goods and ‘B’ tells the seller that “if ‘A’ does not pay you, I will”. This is a contract of guarantee.
  • On the other hand, if ‘B’ would have told the seller that “let ‘A’ have the goods, I’ll pay you for everything”, then this would have resulted in a contract of indemnity.

Endnotes

  1. (1827) 4 Bing 66: 29 RR 503.
  2. A.I.R. 1994 P. & H. 206.
  3. A.I.R. 1942 Bom, 302, at 304.
  4. A.I.R. 1981 A.P. 153, at 158.
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Siddhant Srivastava

Student, ILS Law College, Pune

Siddhant is an aspiring lawyer who is pursuing his final year of 3 years LL.B from ILS Pune. He is a diligent & meticulous person who possesses experience in both Corporate & Litigation sector and wishes to aware the general public regarding some crucial aspects of law in as simple language as possible. Siddhant is always willing to groom himself and prove to be a valuable asset to any organization he becomes a part of.

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