Indemnity

The dictionary meaning of the term ‘indemnity’ is protection against future loss. Indemnity is the protection
against loss in the form of a promise to pay for loss of money, goods, etc. It is security against or
compensation for loss incurred.
Guarantee
Guarantee enables a person to get a loan, to get goods on credit, etc. Guarantee means to give surety or
assume responsibility. It is an agreement to answer for the debt of another in case he makes default.
Section 124 : Contract of indemnity
Section 124 of the Act defines a contract of indemnity as a contract wherein 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.
A contract of indemnity can provide protection against loss caused—
1. By the conduct of promisor, or
2. By the conduct of any other person.
Under Indian law, a contract of indemnity can only provide for losses caused by human agency whereas in
England, it includes a promise to save the other person from loss caused whether by acts of promisor or of any
other person or any other event like fire, accident, etc.
Indemnifier
The person who makes a promise to indemnify against the loss or to make good the loss (promisor) is called
an indemnifier.
Indemnity-holder
The person in whose favour such a promise to indemnify is made (promisee) is called indemnity-holder.
For example, Anil enters into a contract with Swapnil to indemnify him against the consequences of any
proceedings which Mrinal may initiate against Swapnil in respect of a certain sum of Rs. 2000/-. In this
contract, Anil is the indemnifier and Swapnil is the indemnity-holder.
Main features
1. It involves two parties i.e. promisor being the indemnifier and promisee being the indemnity holder.
2. Object of the contract of indemnity is to protect from a loss.
3. As per the Indian Contract Act, the contract of indemnity must be to indemnify against a loss caused by
any act or conduct of the promisor himself or by the conduct of any other person.
4. It is not contingent on the default of some third person.
What are the rights of an indemnity holder
Section 125 of the Act covers ‘Rights of indemnity-holder when sued’. This Section provides for the right of the
indemnity holder to recover the damages and costs that he may have been compelled to pay in a suit filed
against him, in a case where the indemnity-holder has promised such indemnity, i.e., where a contract of
indemnity to that effect exists. The rights of the indemnity holder are-
 1. Right to recover from the promisor, the damages that he may be compelled to pay in any suit in
respect of any matter to which the promise to indemnify applies.
2. Right to recover from the promisor all the costs that he may be compelled to pay in any suit, provided
—
1. that he did not contravene any of the orders of the promisor in filing or defending such suit, and
2. that he acted in a manner as would have been prudent for him to act in the absence of any such
contract of indemnity, or
3. that the promisor had authorised him to file or defend such a suit.
4. Right to recover from the promisor all such sums that he paid under the terms of any compromise of
any such suit, provided-
1. the compromise was not contrary to orders of the promisor, and
2. such compromise is one as the promisee would have made while acting in a prudent manner even if
such contract of indemnity did not exist, or
3. that the promisor had authorised the promisee to compromise the suit.
When liability commences
A pertinent question that arises with regard to a contract of indemnity is, ‘when does the liability to indemnify
commence/arise’. Originally, under English law, the rule was that the indemnity holder cannot recover the
amount unless he had suffered actual loss i.e. ‘you must be damnified before you can claim to be
indemnified’. However, this position of the law changed. In Richardson Re, Ex parte the Governors of St.
Thomas’s Hospital (1911), it was held that indemnity is not necessarily given by repayment after payment, but
it requires that the party to be indemnified shall never have to pay. This principle was followed by the Calcutta
High Court in Osman Jamal & Sons Ltd. v. Gopal Purshottam (1928).
Contract of guarantee
Section 126 of the Indian Contract Act defines the term contract of guarantee, surety, principal debtor and
creditor. The purpose behind a contract of guarantee is to give additional security to the creditor that his
money will be paid back by the surety if the debtor makes a default.
Contract of guarantee : Section 126
A contract of guarantee is a contract to perform the promise or discharge the liability of a third person in case
of his default.
The contract of guarantee has three parties involved, namely, the principal debtor, the creditor, and the
surety.
Surety
The person who gives the guarantee is called the Surety. The liability of the surety is secondary, i.e., he has to
pay only if the principal debtor fails to discharge his obligation to pay.
Principal debtor
The person in respect of whose default the guarantee is given is the Principal debtor. The principal debtor has
the primary liability to pay.
Creditor
The person to whom the guarantee is given is called the creditor.
For example, Anil orders certain goods of the value of Rs. 2000/- from Swapnil on credit. Mrinal guarantees
that, if Anil will not pay for the goods, she will. This is a contract of guarantee. Here, Rs. 2000 is the principal
debt, Anil is the principal debtor, Mrinal is surety and Swapnil is the creditor.
Main features
1. A contract of guarantee may be oral or written: According to Section 126, a contract of guarantee may
be oral or in writing. However, under English law, for a contract of guarantee to be valid, it has to be in
writing and signed.
2. There must be a principal debt: The existence of a principal debt is necessary for a contract of
guarantee. If there is no principal debt, then there is no existing obligation to pay. As a result of the
absence of such obligation to pay, there cannot be any promise/guarantee. If there is a promise to pay
for compensating some loss without there being any principal debt, such a contract will become a
contract of indemnity.
3. Contract of guarantee is tripartite in nature: There being three parties involved in a contract of
guarantee, three contracts take place in a contract of guarantee-
 The principal debtor promises to make payment to the creditor.
 Surety undertakes to pay the creditor in event of default of payment by the principal debtor.
 An implied promise by the principal debtor in favour of surety to indemnify him in case he discharges
the liability of the principal debtor.
4. There is a promise to pay upon default of payment by the debtor: In a contract of guarantee, the
surety’s promise to pay is dependent on the default of the debtor i.e. surety pays only when the debtor
defaults.
5. The consideration is the benefit to the debtor: As per Section 127, anything done or promise made for
the benefit of the principal debtor may be a sufficient consideration to the surety for giving the
guarantee. For example, Anil sells and delivers certain goods worth Rs. 5000 to Swapnil. Mrinal
afterward requests Anil to refrain from suing Swapnil for a year and promises that if he does so, she
will pay for the goods in default of payment by Swapnil. Anil agrees. The forbearance by Anil to sue is
of benefit to Swapnil (the debtor) and that constitutes sufficient consideration for Mrinal (surety) for
giving the guarantee.
6. The consent of the surety should not have been obtained by misrepresentation or concealment of
material facts: Section 142 of the ICA, 1872 provides that a guarantee obtained using
misrepresentation made by the creditor or with his knowledge or assent, concerning a material part of
the transaction is invalid.
Section 143 provides that a guarantee obtained by the creditor by keeping silent as to some material
circumstance is also invalid.
Difference between contract of indemnity and contract of guarantee

BASIS OF
CONTRACT OF INDEMNITY CONTRACT OF GUARANTEE
DISTINCTION

There are two parties in a contract of There are three parties in a contract of
Parties indemnity, namely the indemnifier and the guarantee, namely the principal
indemnity holder. debtor, the creditor, and the surety.

It consists of three contracts-A

contract between principal debtor and
creditor wherein the debtor promises
to perform his obligation/make
payment. The contract between surety
It consists of only one contract between and creditor wherein the surety
the indemnifier and the indemnity holder. promises to perform the aforesaid
No. of contracts The indemnifier promises to indemnify the obligation/make the payment if the
indemnified/indemnity holder in event of a principal debtor makes a default. An
certain loss. implied contract between the surety
and the principal debtor. The principal
debtor bounds himself to indemnify
the surety for the sum that he has paid
under the guarantee undertaken by
him.

The liability of the surety is a

secondary one, i.e., his obligation to
pay arises only when the principal
debtor defaults. Liability in a contract
The liability of the indemnifier is
of guarantee is continuing in the sense
3. Nature of primary. The liability in a contract of
that once the guarantee has been
liability indemnity is contingent in the sense that it
acted upon, the liability of the surety
may or may not arise.
automatically arises. However, the
said liability remains in suspended
animation until the debtor makes
default.
 The liability of an indemnifier is not Liability of surety is conditional on the
conditional on the default of somebody default of the principal debtor. For
else. For example, Mrinal promises the example, Anil buys goods from a seller
Default of third shopkeeper to pay, by telling him that, “Let and Mrinal tells the seller that if Anil
person Anil have the goods, I will be your doesn’t pay you, I will. This is a
paymaster”. This is a contract of indemnity contract of guarantee. Thus, the
as the promise to pay by Mrinal is not liability of Mrinal is conditional on
conditional on default by Anil. non-payment by Anil.

Principal debt is necessary. (refer to

Principal debt No requirement of the principal debt.
the previous example)

Whether After the surety has made the

Once the indemnifier indemnifies the
subsequent payment, he steps into the shoes of
indemnity holder, he cannot recover that
recovery is the creditor and can recover the sums
amount from anybody else.
possible paid by him from the principal debtor.

Whether a
contract has to
In India, contracts of indemnity may be In India, a contract of guarantee may
be in writing or
either oral or written. be either oral or written.
can be oral as
well

Conclusion
Both the contract of indemnity and contract of guarantee are similar in the sense that they provide protection
against loss. However, as mentioned above, there is an important distinction between the two. Whether a
contract is a contract of indemnity or a contract of guarantee is a question of construction in each case. One of
the ways to identify such a contract might be the description of the agreement as to whether it is named as a
contract of guarantee or indemnity and if those terms are mentioned in the contract a few times or more.
However, that cannot be considered conclusive enough. Another way might be to see if under the contract,
the liability of a person exists irrespective of the default of the principal debtor or where such liability is for a
greater amount than the amount payable by principal debtor. In that case, the contract may be construed as a
contract of indemnity. Thus, it will depend on a case to case basis and while analysing the facts/agreement,
one must keep in mind the relevant points of distinction between the two concepts.