26-04-2014 indemnity & guarantee 2 indemnity in a nutshell is the topic of business lawindemnity...

Indemnity & Guarantee

• The word indemnity means to compensate.

• “ A contract by on 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”.

• The person who promises to make good the loss is called the indemnifier (promisor).

• The person whose loss is to be made good is called the indemnity holder or indemnified (promisee).

• In other words a contract where one person promises to compensate the other from the loss which may arise due to the conduct of the promisor himself or any other person, is called a contract of indemnity.

• A contract of indemnity is made in order to protect the promise against anticipated loss. This contract depends upon happening of loss. Contract of insurance is example of indemnity. It must fulfill all the essential of a valid contract.

• Example– A parked his cycle at cycle stand. He lost his

token given by B. B refuses to return the cycle. To get the cycle A promises to compensate B against the loss he may suffer if any other person claims the cycle from B.

• Rights of indemnity holder– The following rights of indemnity-holder against the

indemnifier.• He can recover all damages which he may be compelled to

pay in respect of any suit filed against him.• He can recover expenses in respect of any suit filed by him

with the authority of indemnifier.• He can recover all expenses which he may have paid under

the terms of any compromise of any such suit, provided the compromise was made with consent of indemnifier.

Contract of Guarantee

• A contract of guarantee is a contract to perform the promise or discharge the liability of a third person in case of his default.

• A requests B to lend to C and guarantees that if C fails to pay, he will himself pay to B, there is a contract of guarantee.

Essentials features

• Secondary contract• Consideration• No misrepresentation• Writing not necessary

• Secondary contract

– The purpose of a guarantee is to secure a debt or goods on credit, etc. A contract of guarantee is an agreement between the principal debtor, the creditor and the surety.

– The three separate contracts exist between them. If the promise by the principal debtor is not fulfilled only then the liability of the guarantor arises.

– In a contract of guarantee there should be someone liable as a principal debtor and the surety should be liable on principal debtor’s default.

– The principal contract exists between the principal debtor and the creditor and the contract between creditor and surety is a secondary contract.

• X takes a loan of Rs.5,000 from Y on the guarantee of Z. The agreement between X and Y is the principal contract and the contract between Y and Z is a contract of a guarantee. The liability of Z to pay the amount will arise only when X fails to repay the loan.

Consideration

• A contract of guarantee, like every other contract must have essential elements of a valid contract, e.g. free consent, legality of object, competency of parties etc. it must also supported by some consideration.

• But there need not be direct consideration between the surety and the creditor and consideration received by the principal debtor is sufficient for the surety.

• B requests A to sell goods on credit. A agrees to do so, if C will guarantee for the payment. C guarantees. C’s promise to guarantee is the consideration for A’s promise to sell the goods.

• No misrepresentation– A guarantee obtained by means of

misrepresentation made by the creditor or with his knowledge and assent, concerning a material part of the transaction, is valid.

• H was invited to give a guarantee for the honesty of Lgo’s servant. The employer had already dismissed him for dishonesty, but did not disclose this fact to the surety. The servant committed an other embezzlement. The surety was held not liable.

• Writing not necessary– It is not necessary that contract of guarantee

must be in writing. It may be either oral or written. It may be express or implied from the conduct of parties.

A sells and delivers goods to B on the verbal guarantee of C. it is a valid guarantee.

Nature & extent of surety’s Liability

Kinds of Guarantee

• Ordinary guarantee• Continuing guarantee

• Ordinary guarantee– A guarantee which extends to a single debt or

transaction is called ordinary guarantee or specific guarantee. It comes to an end as soon as the liability under the transaction ends.

• For example– G guarantees K for the payment of 5 bags of

wheat purchased by C. C makes payment. Later on C again purchases 5 bags of wheat. C did not pay for that. K sued G. Held, G’s guarantee is specific guarantee and G is not libale.

• Continuing guarantee– A guarantee, which extends to a series of

transactions, is called continuing guarantee. In other words a guarantee which covers a number of transactions over a period of time is called continuing guarantee.

• For example– A guarantees to C for B’s Credit purchases

with a running balance of account not exceeding Rs.5,000. this is a continuing guarantee.

• Rights of surety– Rights against the creditor– Rights against the principal debtor– Rights against co-sureties

• Rights against the creditor– Right to securities– Right to claim set-off

• Right to securities– The surety at the time of payment, can demand the securities

which the creditor has received from the principal debtor at the time of creation of contract.

– Whether the surety knows of the existence of such securities or not.

– If creditor by negligence loses any security held by him, the surety is discharged to that extent from the payment of guaranteed sum.

– But if the security is lost due to unavoidable act, the surety would not be discharged.

– Surety can recover the securities only after making full payment. He cannot claim the benefit of a part of the securities if he has paid a part of the debt.

• For example– C advances B Rs.2 lac on the guarantee of X.

C also pledges B furniture. B fails to pay and X pays Rs.2 lac to C. X can get the furniture from C.

• Right to claim Set-off– It may happen that a debtor is also having

some claims against the creditor. In such a case a debtor can ask for the adjustment of his debts to the extent of his claims against the creditor. If the creditor sues surety for repayment the surety may have the benefit of the set off, if any that the principal debtors had against the creditor.

• For example– A supplies furniture of Rs. 2 lac to B on the

guarantee of C. B claims that some furniture is defective and refuses to pay Rs.20,000. on the demand of A. C can ask for adjustment of Rs.20,000.

• Right against the principal debtor– Right of subrogation– Right of indemnity

• Right of subrogation– When the surety has paid the guaranteed

debt on default of the principal debtor he is entitled to all the rights, which the creditor had against the principal debtor.

– The surety is entitled to all the remedies which are available to creditor against principal debtor.

• For example– X borrowed money from Y on the guarantee

of W and mortgaged his house to Y. X fails to pay and W paid. Now W is in position of Y and enforce the mortgage of the house against X.

• Right of indemnity– In every contract of guarantee there is an

implied promise by the principal debtor to indemnify the surety. This right enables the surety to recover from the principal debtor whatever sum he has rightfully paid under the guarantee, but no sums which he has paid wrongfully.

• For example– B is indebted to C, and A is surety for the

debt. B fails to pay. C demands payment from A. A refuses to pay. C sues A for the money. A defends the suit, on reasonable grounds but loses and has to pay debts with cost of suits A can recover the whole amount from B.

• Rights against co-sureties– Similar amount– Different amount

• Similar amount– Where there are sureties for the same debt

and the principal debtor has committed a default, each party is liable to contribute equally to the extent of the default.

• For example– A, B and C are sureties to D for the sum of

Rs.3000 let to E. E makes default in payment. A, B and C are liable, as between themselves, to pay Rs.1,000 each. If C is insolvent and could pay only Rs.500, then A and B will contribute equally to make good his loss.

• Different amount– Where there are sureties for the same debt

for different sums, they are bound to contribute equally subject to the limit fixed by their guarantee. They will not contribute proportionately.

Discharge of surety from liability

• Notice of revocation• Death of surety• Change in terms of contract• Release or discharge of principal debtor• Arrangement without surety’s consent• Creditor’s act or omission• Loss of security• Invalidation of the contract of guarantee

• Notice of revocation– An ordinary guarantee cannot be revoked if the

creditor has given the loan.– It can be revoked by notice if the liability has not been

incurred.– But a continuing guarantee may, be revoked by the

surety as to future transactions by giving a notice to the creditor.

– The liability of surety comes to an end regarding the future transactions after the surety has served the notice of revocation.

– The surety remains liable for transactions entered into prior to the notice.

• A lends B a certain sum on the guarantee of C, C cannot revoke the guarantee. But if A has not yet given the sum to B, C may revoke the guarantee by giving a notice.

• Death of surety– In specific guarantee the surety is not discharged

from his liability on his death if the liability has already occurred.

– But in case of a continuing guarantee, the death of surety discharges him from liability regarding the transactions after his death, unless there is a contract to the contrary.

– The deceased surety’s estate will not be liable for future transactions entered into after the death of surety, even if the creditor has no notice of the death.

• For example– A sells goods to B for Rs.1 lac. C guarantees

payment. A delivers goods cost Rs.50,000. afterwards, C dies. C’s property is liable up to Rs.50,000 only.

• Change in terms of contract– When any change is made in the terms of the

contract by the principal debtor and the creditor, without the surety’s consent, the surety stands discharged with respect to such contract. In continuing, guarantee the surety discharges as to the transaction made by the creditors and the principal debtor after such change.

• M contracts to lend N Rs.1 lac on March 1. S guarantees payment. M pays the amount on January 1. S is discharged from his liability, as the terms of contract have been changed.

• Release or discharge of principal debtor– The following two ways discharge the surety

from liability:• The surety is discharged by any contract between

the creditor and the principal debtor, by which the principal debtor is released. Any release of the principal debtor is a release of the surety also.

• The surety is also discharged by any act or omission of the creditor, the legal consequence of which is the discharge of the principal debtor.

• For example– A contracts to build a house for B. C

guarantees for the performance of the contract by A. if B releases A from the performances of the contract, the liability of C as a surety shall come to an end.

• Arrangement without surety’s consent– Where the creditor, without the consent of the

surety, makes an arrangement with the principal debtor for composition, or promises to give him time or not to sue him, the surety will be discharged.

– Where a contract to give time to the principal debtor is made by the creditor with a third person, and not with the principal debtor, the surety is not discharged.

• P purchased a motor car from C under a hire purchase agreement on guarantee of S for the due performance of the agreement. C for valuable consideration gives P further time for payment of one of the installments. Held, the giving of time to P discharged S from his liability.

• Creditor’s act or omission– If the creditor does any act which is inconsistent with

the rights of the surety, or omits to do, any act which his duty to the surety requires him to do and the eventual remedy of the surety himself against the principal debtor is impaired, the surety is discharged.

– It is the duty of the creditor to do every act necessary for the protection of the rights of the surety and if he fails in this duty, the surety is discharged.

• For example– B contracts to to build a ship for C for Rs.1

crore, to be paid by installments as the work reaches certain stages. A becomes surety to C for B’s performance of the contract. C, without the knowledge of A, prepays to B the last two installments. A is discharged by this prepayment.

• Loss of security– If the creditor loses or, without the consent of

the surety, parts with the security given by the principal debtor against the debt, the surety is discharged from liability to the extent of the value of security.

– If the security is lost due to an act of God, the surety would not be discharged.

• For example– A advances B Rs. 2 lac on the guarantee of

X. A gets an additional security of Rs.50,000 by a pledge of B’s car. A cancels the pledge and returns the car. B becomes an insolvent. X is discharged from the liability to the extent of value of car.

• Invalidation of the contract of guarantee– A surety is also discharged from liability when the

contract of guarantee is invalid.– A contract of guarantee is invalid in the following

cases:• Where the guarantee has been obtained by

misrepresentation.• Where the guarantee has been obtained by concealment of

material facts.• Where guarantee has been obtained under the impression

that co-sureties will join and if, no body joins.• Where it lacks one or more essential elements of a valid

contract, e.g. surety is incompetent to contract or the object is illegal.

• For example– A surety is also discharged from liability when

the contract of guarantee is invalid.