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LAW OF CONTRACT - II
Faculty Shradha Baranwal
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CONTRACT OF INDEMNITY AND
GUARANTEE
Section 124 A contract by which one partypromises to save the other from loss causedto him by the conduct of the promisor
himself, or by the conduct of any otherperson, is called a contract ofindemnity.
Claim subsists against the action of promisoror any other person
Indemnifier andindemnified
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Promise to recompense i.e. compensate for any loss orliability
Promise could be in three ways
1. Contract of indemnity[could be express orimplied (e.g.encumbrances)]
2. Relation of the parties
(principalagent/
employer-employee etc)
3. By statute
(liability of railway in case of loss suffered by the consignor due towrong specifications given by the railway, liability towards aperson for loss suffered by him whose name has wrongly appearedin the prospectus)
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NATURE OF CONTRACT OF INDEMNITY
Original and independent obligation i.e. primary
responsibility
Right to indemnity vs. right to damages
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EXAMPLES OF INDEMNITY
A, a joint promisor pays off the whole debt and sues Bfor half the due amount.
Liability of directors of the company to compensate forthe loss suffered by a person whose name appearsas director without his consent or the consent hasbeen withdrawn.
Liability towards partner of a firm in respect ofpayments made by him on behalf of the firm in theordinary course of business.
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COMMENCEMENT AND EXTENT OF LIABILITY
No clear provision under India Contract Act, 1872
Earlier position in English Law
no indemnity till the actual losseshave been suffered
Difficulty with the earlier position
Later development of Equitable Principle
...If payments is a condition precedent to recovery,the contract may be of little value to the person tobe indemnified, who may be unable to meet theclaim in the first instance.
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Views of different High Courts with respect to the
commencement of liability
Calcutta High Court equitable principle
Bombay High Court actual damage suffered
Law commission of India held indemnity as a claim
and not mere reimbursement. (See thirteenth report)
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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
Payment without actual loss absolute liability
Payment only after loss where the liability is
not absolute but a relative one.
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RIGHT OF INDEMNITY HOLDER WHEN SUED
Section 125 reads,
The promisee in a contract of indemnity, acting within thescope of his authority is entitled to recover from the
All damages
All costs
All sums
Conditions are
Orders of the promisor should not have been contravened
Action of a prudent man in absence of contract ofindemnity
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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 himselfagainst, or reimbursed himself for the loss.
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Case laws
1. State Bank Of India & Anr vs Mula Sahakari
Sakhar Karkhana Ltd on 6 July, 2006, SupremeCourt
Nature of contract of indemnity
2. Gajanan Parelkar v. Moreshwar Madan MantriAIR 1942 BoMoreshwar m 302
3. Osman Jamal & Sons Ltd. v. Gopal Purshottam1928 ILR 56 Cal 262
Commencement of liability
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CONTRACT OF GUARANTEE
Sec. 126 defines contract of guarantee
Includes Performance of a promise corresponds to a duty
Discharge of a liabilitycorresponds to a debt
Either oral or written
Operative only in case of default
Surety
principal debtor creditor
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Essentials of contract of guarantee
Three necessary parties debtor, surety, creditor
Failure to discharge of liability under legal
obligation by the 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
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Guarantee and indemnity (similarity)
Broadly both insures compensation to the
creditor in case of loss
Differences Guarantee and Indemnity
1. Parties and formation
2. Difference in liability
3. 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)
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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 ofstrictissima juris.
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An arrangement under which the promisor
undertakes an obligation which replaces and/or
extinguishes the principal-debtors liability, whether
by novation or otherwise, is not a guarantee.
The principal-debtor may be a party to the contract
by implication.
Nature of liability under Contract of Guarantee
Guild & Co. v Conrad (1894) 2 QB 885
There is a plain distinction between a promise to pay the creditor if
the principal-debtor makes default in payment and promise to keepa person who has entered or about to enter, into a contract of
liability indemnified against that liability independently of the
question whether a third person makes default.
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Liability should be legally enforceable
Suretys liability equivalent to that of a principal.
Liability subject to condition if provided For filing the suit for enforcing entitlement it is not
necessary for the creditor to exhaust suit againstprincipal debtor he can directly proceed against the
surety and such suit is maintainable. (State Bank ofIndia v Indexport (1992) 3 SCC 159)
Criteria to determine whether contract of Guarantee
or Indemnity Use and frequency of use of words
Nature of liability
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Effect of contract of Guarantee
Suretys liability arises only in case of default
Surety entitled to all the rights viz., discharge,
indemnity from the principal debtor as per sec.
133 to 145
If a person becomes surety without theknowledge and consent of the principal debtor,
the only rights which he acquires in that case
are those given by section 140 and 141, and notthose given by section 145.
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Performance Bond, Bank Guarantee or letter of
credit
Could be conditional or unconditional
Honored on first demand without any condition
of proof
Subsequent happenings in the establishment
would not restrain Bank to honor the
Guarantee.
EXCEPTIONS
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Section 127 Consideration for guarantee
Anything done, or any promise made, for the
benefit of the principal debtor, may be asufficient consideration to the surety for giving
the 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.
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Nature of liability
Co extensive means to the that extent
Surety cannot insist on exhausting the liability of
principal debtor.
The extent of liability would depend upon the
terms of the contract.
Any express or implied conditions precedent the
suretys liability must be fulfilled before
recourse can be had to him. Where the liabilityarises under the contract only on the happening
of a contingency, the surety is not liable until
the contingency has taken place.
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Liability for void or voidable contract (surety
against minors debt)
Discharge of principal debtor by operation oflaw does not discharge the surety
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 unlessspecifically empowered.
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129. Continuing guarantee
A guarantee which extends to a series of
transaction, is called, a "continuing guarantee". The nature of Guarantee is a question of the intention of the
parties to the contract.
Language, surrounding circumstances and relative position of
the parties are the guiding factors in determining the status
of guarantee.
130. Revocation of continuing guarantee
A continuing guarantee may at any time berevoked by the surety, as to future transactions,
by notice to the creditor.
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By giving notice guarantor can avoid future
liability.
Where a continuing relationship is constitutedon the faith of guarantee, it cannot be revoked
during the continuance of that relationship.
However a material change in the guaranteedsituation may justify revocation viz., proved
misconduct of servant.
Prescribed mode of revocation Continuing guarantee and change in the status
of creditor would terminate the guarantee
unless agreed otherwise.
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131. Revocation of continuing guarantee by
surety' death -
The death of the surety operates, in the absenceof 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
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Section 132
Liability of two persons primarily liable, not affectedby arrangement between them that one shall besurety on others default.
Discharge of surety (Sec 133-139)
General ways for discharge of contract
Section 133Discharge of surety by variance in terms of contract
(variance without the consent of surety)
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Rule of strict interpretation
Variance should be substantial
Cases of ambiguity rule ofcontra preferentem
Section 134
Discharge 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 orotherwise terminates the guarantee
Acceptance of second surety by the creditor Consent decree
Bishal Chand Jain v Chatlur Sen AIR 1967 All 506
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Section 136. Surety not discharged when agreement
made with third person to give time to principal-
debtor-
Section 137. Creditorsforbearance to sue does not
discharge surety
Section 138. Release of one co-surety does not
discharge others
Section 139. discharge of surety by creditors act of
omission impairing suretys eventual remedy
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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 suretys
eventual remedy against the principal debtor isthereby impaired.
Section 139 is residuary in nature which ensuresthat no contrary arrangement is made
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Cases which can be covered under section 139
Where the creditor consented to the release ofattachment over the properties;
Where creditor failed to convey property in purchase, theprice of which was guaranteed by the guarantor ;
Sale of mortgaged property in favour of creditor withoutthere 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 proceedingsagainst him.
Security not returned in the same condition as given to
the creditor
THE ONUS LIES ON SURETY
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Section 140. Rights of surety on payment or
performance
.Surety becomes invested with all the rights whichthe creditor had against the principal debtor.
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
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Section 141. Suretys right to benefit of creditors
security-
Surety is entitled to all the securities creditor had atthe time of entering into contract of surety
irrespective of the knowledge of the same any
impairment in the same would discharge the surety
Section 142. Guarantee obtained by
misrepresentation, invalid
Section 143. Guarantee obtained by concealment,
invalid
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Circumstances in which necessary disclosure ismade to the surety
Where the surety has asked specific question tothe creditor;
Where the bank misleads the surety byvolunteering only part of the truth;
Where the surety makes a statement in thecreditors presence that demonstrates that the heentirely misunderstood the principal debtors
position;
Where there is anything that might not naturallybe expected to take place between the principaldebtor and the creditor
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Section 144. Guarantee on contract that creditor shallnot act on it until co-surety joins
Section 145. Implied promise to indemnify surety
Based on equity
Rightfully paidIncludes property, assignment of rights
Entitlement runs till full indemnification is doneincluding payment towards interest.
Recovery of costIncludes cases where surety has defended the debtorunder his authority, for his benefit, or undercircumstances which were unavoidable.
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Section 146. Co-sureties liable to contribute
equally
Section 147. Liability of co-sureties bound in
different sums
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Radha Kanta Pal v. United Bank of India AIR 1955Cal 217
Gas Authority of India Ltd., New Delhi v OfficialLiquidator, Mumbai AIR 2004 Bom 220
Annandana Jadaya Gounder v Konammal AIR 1933Mad 309
Bharat Nidhi v Bhagwandas Mehra CA SC 939
Syndicate Bank v Pamidi Somaiah (Died) AIR 2002AP 12
Cl i
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Class exercise
1. A, introduced B to C for certain business leading
to execution of a contract between B and C.Later C breached the contract Decide theliability of A
Whether A is liable for indemnify or stands asGuarantee (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 friendto X and Y guaranteed the same in case Ydefaults. Y defaulted in his promise. Decide theliability of Z.
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3. X agreed to sell 500 pieces of shoes to Y for aconsideration of 30,000 Rs. Y received the goodsbut failed in payment of the amount. Z a friend to
Y entered into a contract with X for the paymentof the due amount in consideration of dischargingthe liability of Y. Decide the status of Z whether hestands as surety to the contract between X and Y?
4. A agreed with B to pay off all the losses B wouldsuffer due to payment against sale B concludedwith C. The agreement between A and B was
worded as follows:This Agreement of Guarantee is been concluded between A andB whereby A guarantees to make payment in case of losssuffered by B on account of payment against sale concludedbetween B and C.
Decide the nature of contract between A and B
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5. X borrowed Rs. 50,000 from Y. Z deposited his
property papers to secure the payment without
there being any express agreement. Decide theliability 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 notrouble 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?