Indemnity and Guarantee Part 1
Section 124. Contract of indemnity defined.
A contract of indemnity is one in which one party promises to protect the other from loss caused either by:
The conduct of the promisor himself.
The conduct of any other person.
Illustration:
A agrees to indemnify B against any legal action C may take against B for a sum of 200 rupees.
This agreement is a contract of indemnity, as A promises to save B from potential loss.
Section 125. Rights of indemnity-holder when sued.
In a contract of indemnity, the promisee (the indemnity-holder) can recover from the promisor the following, provided he acts within the scope of his authority:
Any damages he is compelled to pay in a suit relating to the matter covered by the indemnity.
Any costs he is compelled to pay in such a suit, if he:
Did not act against the orders of the promisor, and
Acted prudently as he would have in the absence of an indemnity, or
Was authorized by the promisor to bring or defend the suit.
Any amount paid to settle such a suit, provided the compromise:
Was not contrary to the promisor’s orders, and
Was a prudent decision as he would have made in the absence of an indemnity, or
Was authorized by the promisor.
Section 126. Contract of guarantee, Surety, Principal Debtor and Creditor.
A contract of Guarantee is an agreement in which one person promises to perform the promise or discharge the liability of a third person if that third person fails to do so.
Surety is the person who gives the guarantee.
Principal Debtor is the person whose default is being guaranteed.
Creditor is the person to whom the guarantee is given.
A contract of guarantee can be either oral or written.
Section 127. Consideration for guarantee.
A consideration for a guarantee exists if anything is done, or any promise is made, for the benefit of the principal debtor.
This consideration makes the surety’s promise enforceable.
Illustrations:
(a).
B requests A to sell goods on credit.
A agrees only if C guarantees payment.
C promises to guarantee in consideration of A delivering the goods.
(b).
A sells goods to B.
Later, C asks A to forbear suing B for a year, promising to pay if B defaults.
Forbearing means agree not to enforce their legal right to claim payment
A agrees, creating a valid guarantee.
(c).
A sells goods to B.
Later, C promises to pay for B without any consideration.
This guarantee is void, as there is no benefit to the principal debtor or detriment to the creditor.
Section 128. Surety’s liability.
The surety’s liability is generally co-extensive with the liability of the principal debtor, unless the guarantee contract specifically limits it.
It essentially states that:
A surety is usually responsible for the same amount as the principal debtor.
The surety’s responsibility is limited only if the guarantee says so.
So, the surety steps into the shoes of the principal debtor and is responsible for all obligations arising from the principal debt, unless the contract restricts this.
Illustration:
A guarantees to B the payment of a bill of exchange by C.
C dishonours the bill.
A is liable for:
The principal amount of the bill
Any interest and charges that have accrued
Section 129. Continuing Guarantee.
A continuing guarantee is a guarantee that applies to a series of transactions, not just a single transaction.
A continuing guarantee covers ongoing or future transactions until revoked or limited, whereas a guarantee for a single transaction is specific and limited.
Illustrations:
(a).
A promises B to be responsible for up to ₹5,000 for the proper collection and payment of rent by C over time.
This is a continuing guarantee.
(b).
A guarantees B (a tea dealer) payment up to £100 for tea supplied to C from time to time.
B supplies C tea worth more than £100.
C pays part but then defaults on £200. A is liable only up to £100.
(c).
A guarantees the price of five sacks of flour supplied by B to C.
After payment for the first five sacks, B delivers four more sacks which C does not pay for.
This is not a continuing guarantee, so A is not liable for the four sacks.
Section 130. Revocation of continuing guarantee.
A continuing guarantee can be revoked by the surety at any time for future transactions by giving notice to the creditor.
Revocation does not affect transactions already entered into before the notice.
Revocation applies only to future obligations, not past transactions covered by the continuing guarantee.
Illustrations:
(a).
A guarantees B that bills discounted for C will be paid, up to ₹5,000, for twelve months.
B discounts bills worth ₹2,000.
After three months, A revokes the guarantee.
So , A is discharged from liability for future bills, but remains liable for the ₹2,000 already discounted.
(b).
A guarantees to B, up to ₹10,000, that C will pay all bills drawn by B.
B draws a bill, C accepts it, then A revokes the guarantee.
The bill is dishonoured at maturity.
So, A is still liable for the bill drawn before the revocation.
Section 131. Revocation of continuing guarantee by surety’s death.
If a surety dies, the continuing guarantee is automatically revoked for future transactions, unless there is an express contract stating otherwise.
The surety’s estate is not liable for obligations arising after the death, but remains liable for transactions entered into before death.
Section 132. Liability of two persons, primarily liable, not affected by arrangement between them that one shall be surety on other’s default.
When two people make a contract with a third party, each of them is fully responsible to the third party.
Even if the two agree between themselves that one will pay only if the other defaults, the third party is not bound by this agreement.
The third party can hold either or both responsible under the original contract.
Illustration:
A and B execute a joint and several promissory note to C
A is actually acting as a surety for B, and C knows this.
Despite this, C can sue A for payment, as A is primarily liable to C.
Note:
Promissory Note:
It is a signed document.
It contains a written promise to pay a certain amount.
The payment is to be made to a specific person or the bearer.
The payment is due on a specified date or on demand.
Section 133. Discharge of surety by variance in terms of contract.
If the terms of the contract between the debtor and creditor are changed without the surety’s consent, the surety may be affected.
The surety is discharged from liability for any transactions that happen after the change.
Changes made with the surety’s consent do not discharge the surety.
Illustrations:
(a).
A is surety for B as a bank manager for C.
Later, B and C agree, without A’s consent, to raise B’s salary and make him liable for part of overdraft losses.
A is discharged from liability for losses after this change.
(b).
A promises to protect C if B misbehaves in a certain official job.
Later, the law changes B’s job duties in a big way.
If B misbehaves after the job has changed, A does not have to pay anymore.
The guarantee only covers B’s misconduct under the old rules, not after the duties are changed by law.
(c).
A becomes surety for B, a clerk paid by salary.
Later, B and C agree to pay B by commission instead of salary, without A’s consent.
A is not liable for misconduct after this change.
(d).
A gives a continuing guarantee for oil supplied by C to B on credit.
Later, B and C agree, without A’s knowledge, that C will supply for ready money only (cash on spot), applied to existing debts.
A is not liable for goods supplied after the new arrangement.
(e).
C was supposed to lend B ₹5,000 on March 1.
A guaranteed repayment based on this arrangement.
C instead gave the money early, on January 1.
A did not agree to this change.
Giving the loan earlier changes the risk for A.
Since the loan terms were changed without A’s consent, A is released from the guarantee.
Section 134. Discharge of surety by release or discharge of principal debtor.
If the creditor releases the principal debtor from the debt, the surety is also released.
This release can happen through a contract between creditor and debtor.
It can also happen if the creditor does something (or fails to do something) that legally frees the principal debtor.
Once the principal debtor is discharged, the surety cannot be held liable.
Illustrations:
(a).
A guarantees B’s debt to C.
B later becomes insolvent and enters an arrangement with creditors, including C, to assign property in return for release from debts.
A is discharged because B is released.
(b).
A contracts with B to grow indigo on A’s land.
C guarantees A’s performance
B diverts water, preventing A from raising indigo.
C is discharged because A cannot perform due to B’s act.
(c).
A contracts with B to build a house.
B supplies timber.
C guarantees A’s performance.
B fails to supply timber.
C is discharged, as the principal debtor cannot perform due to B’s omission.
Section 135. Discharge of surety when creditor compounds with, gives time to, or agrees not to sue, principal debtor.
If the creditor makes a contract with the principal debtor to:
Accept a composition (settlement) of the debt.
Give time for payment.
Agree not to sue the debtor.
Then the surety is discharged from liability unless the surety consents to that contract.
Section 136. Surety not discharged when agreement made with third person to give time to principal debtor.
If the creditor makes an agreement with a third person (not the principal debtor) to give time to the principal debtor, the surety’s liability remains intact.
Illustration:
C holds an overdue bill of exchange drawn by A as surety for B and accepted by B.
C contracts with M to give time to B.
In this case, A is not discharged.
Section 137. Creditor’s forbearance to sue does not discharge surety.
Just not suing the principal debtor or not enforcing a remedy does not release the surety.
The surety remains responsible unless the guarantee specifically says otherwise.
Illustration:
B owes a debt to C, guaranteed by A.
The debt becomes payable, but C does not sue B for a year.
A is still responsible as the surety.
Section 138. Release of one co-surety does not discharge others.
If there are multiple sureties, releasing one surety by the creditor does not release the others.
The surety who is released still remains liable to the other co-sureties for their share.
Section 139. Discharge of surety of creditor’s act or omission impairing surety’s eventual remedy.
If the creditor acts in a way that goes against the rights of the surety, the surety may be affected.
If the creditor fails to do something necessary for the surety, it can also harm the surety’s position.
When such actions impair the surety’s ability to recover from the principal debtor, the surety is discharged from their obligations.
Illustrations:
(a).
B contracts to build a ship for C, to be paid in instalments.
A is surety for B.
C prepays the last two instalments without A’s knowledge. A is discharged.
(b).
C lends money to B, secured by a promissory note signed by B and A (as surety) and a bill of sale of furniture.
C sells the furniture negligently, realizing only a small amount.
A is discharged.
(c).
A guarantees M’s fidelity as B’s apprentice.
B promised to supervise M monthly but fails, and M embezzles.
A is not liable.
