Contract of indemnity is an agreement between two individuals or parties. It refers to legal exemption from liability for damages where one party agrees to pay for loss or damages suffered to another party even if the former had no role to play in the damages caused, or the latter himself was also partly responsible for the loss caused to him.
For example, a school XYZ is being established and XYZ contracts with a manufacturer for swings and slides for its park. However, the manufacturer asks XYZto enter into an indemnity bond too, which states that if any of the guardian of the student files a complaint against the manufacturer for any damages caused by the slides or swings due to any default, the school will step in to protect the manufacturer. Here the school is the indemnifier and the manufacturer is the indemnified.
The best example of the Contract of Indemnity is contract with the insurance company. Here one party pays money in installments to the insurance company and when the party suffers loss or damages, the insurance company pays for it.
Contents of Contract of indemnity
1. Indemnifier is the party who agrees to pay for the damages.
2. Indemnified is the party who suffers the loss or damages.
Since indemnity is a “contract”, it should fulfill the necessities of a valid contract. For example, there should be a consent of both the parties involved, both should have entered with a sound mind, no duress should be involved, and so on. Basically, it should fulfill the essentials of The Indian Contract Act as described in the Indian constitution. Time maybe an essential to the contract of indemnity. It depends on the nature and contents of the contract entered into. Primary purpose of the contract is to protect the indemnified from the loss or damages.
What does The Indian Contract Act,1872 say?
According to section 124 of the Indian Contract Act 1872, 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”.
Further, According to Section 125 of the Indian Contract Act, The promisee in a contract of indemnity, acting within the scope of his authority, is entitled to recover from the promisor:
125(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;
125(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 authorized him to bring or defend the suit;
125(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 authorized him to compromise the suit.
Cases on Contract of Indemnity
Cases relating to Contract of Indemnity have shown up in the courts a lot of times. The landmark case of Gajanan Moreshwar Parelkar vs Moreshwar Madan Mantri on 1 April, 1942 where it was held that since every Contract of insurance other than life insurance is a contract of Indemnity, the definition does not apply if the loss caused is due to human agency.
Also, in Moreshwar v Moreshwar, the courts held that one particular kind of indemnity which arises from a promise made by an indemnifier to save the indemnified from the loss caused to him by the conduct of the indemnifier himself or by the conduct of any other person, but does not deal with those classes of cases where the indemnity arises from loss caused by events or accidents which do not depend upon the conduct of indemnifier or any other person.
Contract of Guarantee
Contract of guarantee includes three parties: Surety (say A), Principal debtor (say B), and Creditor (say C).In this contract A promises to pay off the debts of B to C, in case of any default on the part of B. In other words, C lends B goods or money on the surety of A.
According to Section 126 of Indian Contract Act,1872, Contract of guarantee is a contract to perform the promise or discharge the liability of a third person in case of his default.
For example, X is a friend of Y and applies for a loan. However, X has no property for surety to get the loan. Hence, Y becomes X’s guarantor for the loan and gets into an agreement with the bank where Y is the surety; X is the Principal Debtor; and bank is the creditor. Here, on the default of X(when X fails to pay back the loan) the liability to pay off the loan will come onto Y.
Another classic example is, Raj is an agent and brings Suraj(a buyer) to Laxman (a wholesaler). Here, when Suraj buys something from Laxman and promises to pay back later if Laxman asks for a guarantee and Raj willingly enters into the contract to become the guarantee on whose credit Suraj could buy some asset from Laxman, all of them enter into the Contract of guarantee where Raj is the Surety, Suraj the principal debtor and Laxman the creditor. On the non-payment of Suraj, Raj will be held liable.
Contents of Contract of Guarantee
1. Suretyis the party gives the guarantee for the principal debtor.
2. Principal Debtor is the party for whom the guarantee is provided.
3. Creditoris the party who lends the money to the principal debtor.
4. The contract of guarantee may be written or oral. It should be a valid contract as per the Indian Contract Act (similar to contract of indemnity mentioned above). It is necessary that, in a contract of guarantee the principal debtor primarily defaults, only then will the creditor have the right to move against the surety. Consideration between principal debtor and creditor should be there for entering into contract of guarantee and it must be lawful.
Cases on Contract of Guarantee
Nothing could better explain laws than the case laws themselves. Cases have emerged time in and out making the provisions of the act clearer. People tend to find loopholes in the laws and to cover up the loopholes courts interpret the provisions of the act. In the case of P. J. Rajappan v. AssociatedIndustries (P) Ltd, the guarantor was trying to wash off its liabilities just because he didn’t sign a written contract. However, the courts held that if the involvement of the guarantor is proved, there wasn’t any need for a written contract.
Furthermore, in the case of Ram Narain v. Ltd. Col. Hari Singh, the court held that even if the Contract of Guarantee is executed between the principal debtor and the creditor, without consideration the contract stands void. Also, the consideration should be contemporary in nature and not past benefits to the principal debtor.
Difference between Contract of Indemnity and Guarantee.
Point of difference
1.No of Parties involved
Two parties: Indemnifier and Indemnified.
Three parties: Surety, Principal Debtor and creditor.
2. Role of the parties
1. The indemnifier is free to enter into the Contract without anyone’s consent.
2.With the absence of any third party, the role of indemnifier is given priority.
1. The Surety can enter into the contract only when asked by the Principal Debtor.
2.Since there is a Principal Debtor involved, his default and role is given priority and the Surety’s role is secondary.
Irrespective of the differences, both the Contract of Indemnity and the Contract of Guarantee in its essence should be a valid contract with no duress involved and without any unlawful elements. If any of the above influences these contracts, it will be rendered void according to the Indian Contract Act.
Cases for Reference
1. Gajanan Moreshwar v. Moreshwar Madan
(1942) 44 BOMLR 703
2. P.J. Rajappan V Associated Industries (P) Ltd [1990 All India Banking Law Judgments 321]
3. Ram Narain V Lt. Col. Hari Singh, AIR 1964 Rajasthan 76
List of References:
What does indemnity mean?
An indemnity is a promise, usually made in a contract, to pay money on the happening of a specified event.
What does it mean to indemnify someone?
To indemnify another party is to compensate that party for losses that party has incurred or will incur as related to a specific incident.
Who is the indemnifier and indemnified?
The person who promises to indemnify for a loss is the indemnifier while the person whose losses the indemnifier promises to make good is the indemnified.
What is contract of guarantee?
Contract of guarantee is a contract to perform the promise or discharge the liability of a third person in case of his default. In this contract A promises to pay off the debts of B to C, in case of any default on the part of B. In other words, C lends B goods or money on the surety of A.
Who is a guarantor?
The person who promises to fulfil the obligation of the other party incase it fails to perform.
What is the basic difference between indemnity and guarantee?
Under an indemnity contract, two parties are involved while under a contract of guarantee, three parties are involved.
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