LAW OF CONTRACT - II

Faculty – Shradha BaranwalAssistant Professor, COLS

sbaranwal@ddn.upes.ac.in

CONTRACT OF INDEMNITY AND GUARANTEE

Section 124 –promise to save the other from loss caused • By the conduct of the promisor himself, • By the conduct of any other person, is called a

‘contract of indemnity’.

English Law – covers loss caused • By any act done at the request of Promisor• By any accident, event not dependent on the conduct

of any person

INDEMNIFIER AND INDEMNIFIED

Promise of indemnity could be in three ways –• Express or implied contract of indemnity• Relation of the parties• By statute

EXAMPLES OF INDEMNITY

A, a joint Promisor pays off the whole debt and sues B for half the due amount.

Liability of directors of the company to compensate for the loss suffered by a person whose name appears as director without his consent or the consent has been withdrawn.

Liability towards partner of a firm in respect of payments made by him on behalf of the firm in the ordinary course of business.

COMMENCEMENT AND EXTENT OF LIABILITYEarlier position in English Law –

no indemnity till the actual losses have been suffered

Difficulty with the earlier positionEquitable Principle

Law commission of India observed that indemnity is a claim and not mere reimbursement. (See thirteenth report)

Osman Jamal And Sons Ltd. vs Gopal PurshottamAIR 1929 Cal 208

Gajanan Moreshwar Parelkar vs Moreshwar Madan Mantri (1942) 44 BOMLR 703

LIMITATION ON CONTRACT OF INDEMNITY

Indemnifier cannot sue the debtor in his own name for want of Privity of contract

Creditor also cannot sue the promisor of the contract of indemnity

RIGHT OF INDEMNITY HOLDER WHEN SUED

Section 125 reads,The promisee in a contract of indemnity, acting within the scope

of his authority is entitled to recover from the promisor –• All damages (judgment is conclusive for indemnification)• All costs (to be reasonable)• All sums (notice may be given)

Limitation Act – 3 years time limit for recovery

Conditions are –• Orders of the promisor should not have been contravened • Action of a prudent man in absence of contract of indemnity

Rights of the indemnifier

Based on the natural equity

Where one person has agreed to indemnify another, he will, on making good the indemnity, be entitled to succeed to all the ways and means by which the person indemnified might have protected himself against, or reimbursed himself for the loss.

CONTRACT OF GUARANTEE

Sec. 126 defines contract of guaranteeIncludes –Performance of a promise – corresponds to a dutyDischarge of a liability – corresponds to a debt –

Either oral or writtenOperative only in case of default

Surety

principal debtor creditor

Essentials of contract of guarantee

• Three necessary parties – debtor, surety, creditor

• Default by principal debtor• Liability voluntarily taken by another person

Contract of Guarantee by Company• By writing under its common seal• By any person on behalf of a company viz.,

Director

129. Continuing guaranteeA guarantee which extends to a series of

transaction, is called, a "continuing guarantee".– The nature of Guarantee is a question of the intention

inferred by language, surrounding circumstances and relative position of the parties.

Guarantee and indemnity (similarity)Broadly both insures against losses

Differences – Guarantee and Indemnity1. Parties and formation2. Difference in liability3. Existing debt or duty4. Formalities – – Contract of Guarantee with the knowledge of the principle

debtor (can avail 140, 141 and 145)– Without the knowledge of principal debtor (can not avail

145)

Nature of contract of Guarantee• Collateral or conditional contract• Something auxiliary to an antecedent obligation.• There are two classes of guarantee – a promise

which becomes effective if the debtor fails to perform his obligation and a promise that the debtor will perform his obligation. Guarantee in the latter case are effectively unconditional.

• A contract of Guarantee is not one uberrimae fidei, but a contract of strictissima juris.

• An arrangement under which the promisor undertakes an obligation which replaces and/or extinguishes the principal-debtor’s liability, whether by novation or otherwise, is not a guarantee.

• The principal-debtor may be a party to the contract by implication.

• Surety against minor’s contract is treated as Principal debtor.

• Liability should be legally enforceable• Surety’s liability equivalent to that of a principal.• Liability subject to condition if provided – Hence can

be limited.

• For filing the suit for enforcing entitlement it is not necessary for the creditor to exhaust suit against principal debtor.

• Liability to be proved in the same manner as PD• Contract of guarantee without consideration –

voidCriteria to determine whether contract of

Guarantee or Indemnity• Use and frequency of use of words• Nature of liability

CONSIDERATION

Section 127 Consideration for guaranteeAnything done, or any promise made, for the

benefit of the principal debtor, may be a sufficient consideration to the surety for giving the guarantee.Legal detriment incurred by the Promisee at the promisor’s request-irrespective of benefit to the promisor

LIABILITY UNDER CONTRACT OF GUARANTEE

Section 128 Surety's liabilityThe liability of the surety is co-extensive with

that of the principal debtor, unless it is otherwise provided by the contract.

Section 132Liability of two persons primarily liable, not

affected by arrangement between them that one shall be surety on other’s default.

Section 144. Guarantee on contract that creditor shall not act on it until co-surety joins –

Section 146. Co-sureties liable to contribute equally –

Section 147. Liability of co-sureties bound in different sums –

• Liability for void or voidable contract (surety against minor’s debt)

• Discharge of principal debtor by operation of law does not discharge the surety e.g. insolvency.

• Statutory reduction or extinguishment of liability• Filing a suit and execution of a decree• Effect of acknowledgement by a principal debtor

does not bind the surety unless specifically empowered.

• Document of release in favour of PD without reserving right against surety.

REVOCATION OF CONTRACT130. Revocation of continuing guaranteeA continuing guarantee may at any time be revoked by the

surety, as to future transactions, by notice to the creditor.

• By giving notice guarantor can avoid future liability. • Where a continuing relationship is constituted on the

faith of guarantee, it cannot be revoked during the continuance of that relationship. However a material change in the guaranteed situation may justify revocation viz., proved misconduct of servant.

• Prescribed mode of revocation• Change in the status of creditor would terminate the

guarantee unless agreed otherwise.

131. Revocation of continuing guarantee by surety' death -

The death of the surety operates, in the absence of any contract to the contrary, as a revocation of the continuing guarantee, so far as regards future transactions.

• In the absence of any contract in contrary• Joint and several liability

DISCHARGE OF SURETY (SEC 133-135 &139)

Also consider General ways for discharge of contractSection 133• Discharge of surety by variance in terms of contract

(variance without the consent of surety) Rule of strict interpretation

• Variance should be substantial• Cases of ambiguity – rule of contra proferentem

Section 134Discharge of surety by release or discharge of principal• A surety is discharged if the creditor without his consent,

unconditionally release the principal debtor.

• Release of the principal debtor by a complete novation or otherwise – terminates the guarantee

• Acceptance of second surety by the creditor• Consent decree/ Compromise

Sec. 135 Contract between principal debtor and the creditor to give time to, agreement not to sue…etc would discharge the surety.

Section 139. discharge of surety by creditor’s act or omission impairing surety’s eventual remedy –

Section 139 includes –-does an act inconsistent with the rights of the

surety; or- Omits to do any act which his duty to the surety

requires him to do, and as a result the surety’s eventual remedy against the principal debtor is thereby impaired.

Section 139 is residuary in nature which ensures that no contrary arrangement is made

Cases which can be covered under section 139 –• Where the creditor consented to the release of attachment

over the properties;• Where creditor failed to convey property in purchase, the

price of which was guaranteed by the guarantor ;• Sale of mortgaged property in favour of creditor without

there being any occasion for the same;• Loss of pledged goods;• Failure of creditor to bring on record the LRs of the dead

principal debtor resulting into abatement of proceedings against him.

• Security not returned in the same condition as given to the creditor

THE ONUS LIES ON SURETY

Essentials• Guarantee for several and distinct contracts.• Waiver of right.• Liability to remain when change is inoperative.• Only substantial variance need not to be the

actual case of prejudice.• Effect of novation.• Surety is the best judge of his interest.

SURETY WHEN NOT DISCHARGED

Section 136. Surety not discharged when agreement made with third person to give time to principal-debtor-

Section 137. Creditor’s forbearance to sue does not discharge surety –

Section 138. Release of one co-surety does not discharge others –

RIGHTS OF THE SURETY

Section 140. Rights of surety on payment or performance –….Surety becomes invested with all the rights which the

creditor had against the principal debtor.

• Entitlement for part payment• Based on the principal of equity• In counter guarantee for reimbursement the rights are

transferred to the counter guarantor.• Priority in cases of liquidation and winding up.• Rights before demand of payment once the liability

accrues• Injunction even before the payment

Section 141. Surety’s right to benefit of creditor’s security-

Surety is entitled to all the securities creditor had at the time of entering into contract of surety irrespective of the knowledge of the same – any impairment in the same would discharge the surety

Section 145. Implied promise to indemnify surety Based on equity

• Rightfully paidIncludes property, assignment of rights

• Entitlement runs till full indemnification is done including payment towards interest.

• Recovery of costIncludes cases where surety has defended the debtor under his authority, for his benefit, or under circumstances which were unavoidable

GUARANTEE OBTAINED BY MISREPRESENTATION

Section 142. Guarantee obtained by misrepresentation, invalid –

Section 143. Guarantee obtained by concealment, invalid –

Circumstances in which necessary disclosure is made to the surety –

• Where the surety has asked specific question to the creditor;

• Where the bank misleads the surety by volunteering only part of the truth;

• Where the surety makes a statement in the creditor’s presence that demonstrates that the he entirely misunderstood the principal debtor’s position;

• Where there is anything that might not naturally be expected to take place between the principal debtor and the creditor

CASE LAWS ON GUARANTEE

• Gas Authority of India Ltd., New Delhi v Official Liquidator, Mumbai AIR 2004 Bom 220

• Syndicate Bank v Pamidi Somaiah (Died) AIR 2002 AP 12• M. S. Anirudhan vs The Thomco'S Bank Ltd on 1963 AIR

746• Ram Narain vs Lt. Col. Hari Singh And Anr. AIR 1964 Raj 76• State Bank Of India & Anr vs Mula Sahakari Sakhar

Karkhana Ltd on 6 July, 2006• Syndicate Bank vs Channaveerappa Beleri & Ors on 10

April, 2006• United Bank Of India vs Satyawati Tondon & Ors. on 26

July, 2010

Class exercise1. A, introduced B to C for certain business leading

to execution of a contract between B and C. Later C breached the contract – Decide the liability of A

Whether A is liable for indemnify or stands as Guarantee (Refer Chanana Steel Tubes Pvt. Ltd. v. Messrs Jaitu Steel Tubes Pvt. Ltd. AIR 2000 HP 48)

2. X invited Y for celebrating his marriage. Y promised to gift X a watch. Z a common friend to X and Y guaranteed the same in case Y defaults. Y defaulted in his promise. Decide the liability of Z.

3. X agreed to sell 500 pieces of shoes to Y for a consideration of 30,000 Rs. Y received the goods but failed in payment of the amount. Z a friend to Y entered into a contract with X for the payment of the due amount in consideration of discharging the liability of Y. Decide the status of Z whether he stands as surety to the contract between X and Y?

4. A agreed with B to pay off all the losses B would suffer due to payment against sale B concluded with C. The agreement between A and B was worded as follows:

This Agreement of Guarantee is been concluded between A and B whereby A guarantees to make payment in case of loss suffered by B on account of payment against sale concluded between B and C.

Decide the nature of contract between A and B

5. X borrowed Rs. 50,000 from Y. Z deposited his property papers to secure the payment without there being any express agreement. Decide the liability of Z in case of non payment by X.

6. In a writing by X to Y in the presence of Z: “Please lend Rs. 1200 to Z; there will be no trouble in the payment of your money. Be assured, if there by any trouble, I undertake to indemnify you and would stand as equally liable”. Decide whether contract of Guarantee or indemnity?