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JAVAID TALIB
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STUDY MATERIAL
LLM . IV SEMESTER
LAW OF CONTRACT –II

UNIT – I

1.CONTRACT OF INDEMNITY
Introduction

Contract of indemnity‖ defined. -A contract by 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‖.

Meaning of Indemnity under Indian Contract Act, 1872

According to Section 124 of the Indian Contract Act, a contract of indemnity means "a contract
by which one party promises to save the other from loss caused to him by the conduct of the
promisor himself or by conduct of any other person." This Provision incorporates a contract
where one party promises to save the other from loss which may be caused, either

(i) by the conduct of the promisor himself, or,

(ii) by the conduct of any other person.

Illustration to Section 124.-

A contracts to indemnify B against the consequences of any proceedings which C may take
against B in respect of a certain sum of 200 rupees. This is a contract of indemnity.

Indemnier and Indemnied

In a Contract of Indemnity, the person who promises to indemnify is known as "Indemnifier",

and the person in whose favour such a promise is made is known as "Indemnified" or "Indemnity
Holder".[2]

Is insurance contract a contract of indemnity?

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It includes a contract to save the promise from a loss, whether it be caused by human agency or
any other event like an accident and fire. Under English law, a contract of insurance(other than
life insurance) is a contract of indemnity.
Indemnity in insurance compensates the beneficiaries of the policies for their actual economic
losses, up to the limiting amount of the insurance policy. It generally requires the insured to
prove the amount of its loss before it can recover. Recovery is limited to the amount of the
provable loss even if the face amount of the policy is higher. This is in contrast to, for example,
life insurance, where the amount of the beneficiary's economic loss is irrelevant. The death of the
person whose life is insured for reasons not excluded from the policy obligate the insurer to pay
the entire policy amount to the beneficiary. Most business interruption insurance policies contain
an Extended Period of Indemnity Endorsement, which extends coverage beyond the time that it
takes to physically restore the property. This provision covers additional expenses that allow the
business to return to prosperity and help the business restore revenues to pre-loss levels.[1]

Meaning of Insurance

In law and economics, insurance is a form of risk management primarily used to hedge against
the risk of a contingent, uncertain loss. Insurance is defined as the equitable transfer of the risk of
a loss, from one entity to another, in exchange for payment. An insurer is a company selling the
insurance; an insured, or policyholder, is the person or entity buying the insurance policy. The
insurance rate is a factor used to determine the amount to be charged for a certain amount of
insurance coverage, called the premium. Risk management, the practice of appraising and
controlling risk, has evolved as a discrete field of study and practice. The transaction involves
the insured assuming a guaranteed and known relatively small loss in the form of payment to the
insurer in exchange for the insurer's promise to compensate (indemnify) the insured in the case
of a loss. The insured receives a contract, called the insurance policy, which details the
conditions and circumstances under which the insured will be compensated.[3]

Historical Development of principle of indemnity

1. Indemnity was restricted only to the loss occured by human agency only.

In Gajanan Moreshwar vs. Moreshwar Madan.[4] It is stated :This definition covers indemnity
for loss caused by human agency ONLY. It does not deal with those classes of cases where the
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indemnity arises from loss caused by events or accidents which do not or may not depend upon
the conduct of the indemnifier or any other person, or by reason of liability incurred by
something done by the indemnified at the request of the indemnifier.

2. Contractual document must state clearly the terms and conditions of indemnity.

In State Bank of India and another vs. Mula Sahkari Sakhar Karkhana Ltd.[5],

. It is stated : A document, as is well known, must be construed on the basis of the terms and
conditions contained therein. It is also trite that while construing a document the court shall not
supply any words which the author thereof did not use. The document in question is a
commercial document. It does not on its face contain any ambiguity. The High Court itself said
that ex facie the document appears to be a contract of indemnity. Surrounding circumstances are
relevant for construction of a document only if any ambiguity exists therein and not otherwise.
The said document as per Supreme Court, constitutes a document of indemnity and not a
document of guarantee as is clear from the fact that by reason thereof the appellant was to
indemnify the co-operative society against all loses, claims, damages, actions and costs which
may be suffered by it. The document does not contain the usual words found in a bank guarantee
furnished by a Bank as, for example, "unequivocal condition", "the co-operative society would
be entitled to claim the damages without any delay or demur" or the guarantee was
"unconditional and absolute" as was held by the High Court. It is beyond any cavil that a bank
guarantee must be construed on its own terms. It is considered to be a separate transaction.

Relation Between Indemnity and Insurance Position in India

It has been noted above that section-124 recognizes only such contract as a contract of indemnity
where there is a promise to save another person from loss which may be caused by the conduct
of the promisor himself or by conduct of any other person. It does not cover a promise to
compensate for loss not arising due to human agency. Therefore, a contract of insurance is not
covered by the definition of section-124. Thus, if under a contract of insurance, an insurer
promises to pay compensation in the event of loss by fire, such a contract does not come within
the purview of section 124 Such contracts are valid contracts as being contingent contracts as the
purview of section-124. Such contracts are valid contracts, as being contingent contracts as
defined in section-31.
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In United India Insurance Co. vs. M/s. Aman Singh Munshilal [6].

The cover note stipulated delivery to the consigner. Moreover, on its way to the destination the
goods were to be stored in a godown and thereafter to be carried to the destination. While the
goods were in the godown, the goods were destroyed by fire. It was held that the goods were
destroyed during transit, and the insurer was liable as per the insurance contract.

Position in England

Under English law, the word ―indemnity‖ carries a much wider meaning than given to it under
the Indian Contract Act. It includes a contract to save the promise from a loss, whether it be
caused by human agency or any other event like an accident and fire. Under English law, a
contract of insurance(other than life insurance) is a contract of indemnity. Life Insurance contract
is, however, not a contract of indemnity, because in such a contract different considerations
apply. A contract of life insurance, for instance, may provide the payment of a certain sum of
money either on the death of a person, or on the expiry of a stipulated period of time (even if the
assured is still alive). In such a case, the question of amount of loss suffered by the assured, or
indemnity for the same, does not arise. Moreover, even if a certain sum is payable in the event of
death, since, unlike property, the life of a person cannot be valued, the whole of the amount
assured becomes payable. For that reason also, it is not a contract of indemnity.

Rights of Indemnity Holder

The law protects the needs and position of the indemnity holder. Section 125 of the Act is as
follows-

―125. Rights of indemnity-holder when sued.—The promisee in a contract of indemnity,

acting within the scope of his authority, is entitled to recover from the promisor—
(1) all damages which he may be compelled to pay in any suit in respect of any matter to which
the promise to indemnify applies;
(2) all costs which he may be compelled to pay in any such suit if, in bringing or defending it, he
did not contravene the orders of the promisor, and acted as it would have been prudent for him to
act in the absence of any contract of indemnity, or if the promisor authorized him to bring or
defend the suit;
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(3) all sums which he may have paid under the terms of any compromise of any such suit, if the
compromise was not contrary to the orders of the promisor, and was one which it would have
been prudent for the promisee to make in the absence of any contract of indemnity, or if the
promisor authorized him to compromise the suit.‖
These are the statutory rights so expressly provided by the law. But the remedies provided in this
provision are not exhaustive since all the reliefs are not being set out over here. This shows that
a certain area is kept untouched for equitable reliefs. Also, this section throws light on the
situation when the indemnity holder is sued.
Conclusion

Indian Contract Act does not specifically provide that there can be an implied contract of
indemnity. The Privy Council has, however, recognized an implied contract of indemnity also
(Secretary of State vs. The Bank of India Ltd.)[7]. The Law Commission of India in its Report
(13th Report, 1958, on Indian Contract Act, 1872) has recommended the amendment of section
124. According to its recommendation, ―the definition of the ‗Contract of Indemnity‘ in section
124 be expanded to include cases of loss caused by events which may or may not depend upon
the conduct of any person. It should also provide clearly that the promise may also be implied.‖

Citations

1. Adjusting Today The Extended Period of Indemnity Endorsement

2. Indian Contract Act 1872, by Dr. R.K. Bangia, Edition-2009
3. Insurance Fundamentals by Dr. B.S. Bodla, edition-2004
4. A.I.R. 1942 Bom. 302, at p.303
5. 2006 (3) SCCD 1662
6. A.I.R. 1994 P. & H. 206.
7. A.I.R. 1938 P.C. 191

2 . CONTRACT OF GUARANTEE

Introduction

A contract of Guarantee is governed mainly by the provisions of the Indian Contract Act, 1872
(―Contract Act‖). Section 126 of the Contract Act defines a it as a contract to perform the
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promise or discharge the liability of a third person in case of his default. The person who gives
the guarantee is called the ―surety‖, the person in respect of whose default the guarantee is given
is called the ―principal debtor‖ and the person to whom the guarantee is given is called the
―creditor‖. The Contract Act uses the word ‗surety‘ which is same as a ‗guarantor‘.

Essentials of a valid contract of guarantee

1.Essentials of a valid contract:

Since a contract of guarantee is a species of contracts, the general principles governing
contracts are applicable here. Thus, all the essential requirements of a valid contract (such
as free consent, valid consideration, etc.) are required to be fulfilled.
2.A principal debt must pre-exist:
A contact of guarantee seeks to secure payment of a principal debt. Thus, it is necessary
that a recoverable principal debt must pre-exist. There cannot be a contract to guarantee a
time barred debt. The House of Lords, as early as 1836, in the Scottish case of Swan vs.
Bank of Scotland [(1836) 10 Bligh NS 627] held that if there is no principal debt, there can
be no valid guarantee.
3.Consideration:
Consideration received by the principal debtor is sufficient for the surety. Anything done,
or any promise made for the benefit of the principal debtor can be taken as sufficient
consideration to the surety for giving guarantee.

4. Misrepresentation and concealment:

A contract of guarantee is not a contract uberrimae fides or one of complete good faith..
Where a customer had a precarious credit position. The surety wasn‘t aware of this and acted
as a guarantor of the customer. It was held that the bank is under no obligation to disclose
this fact to the surety. However, it is the duty of a party taking guarantee to provide the surety
with important facts so that he can make an informed decision. Facts which will affect his
responsibility under the contract of guarantee.
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.Writing not necessary: Section 126 says that a guarantee may be either oral or written. In
England, guarantee is not enforceable unless it is ―In writing and signed by the party to be
charged‖.

Contract of Guarantee is a specific performance contract. It is called specific performance

because it is an equitable relief. This is not the usual legal remedy where compensation for
damages is adequate. Damages and specific performance are both remedies available upon
breach of obligations by a party to the contract; the former is a ‗substitutional remedy‘, and the
latter a ‗specific remedy‘.

The law prescribes that in an event where the actual damage for not performing the contract
cannot be measured or monetary compensation is not adequate, one party can ask the court to
direct the other party to fulfil the requirements of the contract.

It is also a discretionary relief, that is, it is left to the court to decide whether specific
performance should be given to a party asking for it.

Why Contract of Guarantee is Specific performance?

Contract of Guarantee is Specific performance because the remedy is not the damages awarded
by the court. The party has to fulfil its obligation under the contract i.e. perform a certain action
he promised to do, instead of just paying money for his failure to fulfil obligations under the
contract. It is the guarantor who commits to pay in case of default by the person for whom he has
guaranteed. The nature of relief is of specific nature since guarantor has to perform the specific
obligation, which he had undertaken under the agreement i.e. pay the assured.

Contract of Guarantee

Section 126 defines the Contract of Guarantee– A contract of guarantee involves three parties. It
relates to the performance of contract on behalf of the third person whereby fulfilling his
obligation under the contract by the guarantor
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The person who gives the guarantee is called the ‗‘Surety‘‘; the person in respect of whose
default the guarantee is given is called the ‗‘Principal Debtor‘‘, and the person to whom the
guarantee is given is called the ―Creditor‖. A guarantee may be either oral or written.

Purpose of Contract of Guarantee

It enables a person to get a loan, or goods on credit or employment. Some person comes forward
and ensures the lender or the supplier or the employer that he may be trusted and in case of any
untoward incident, ―I undertake to be responsible‖.

In the old case of Birkmyr v Darnell the court said: Where a collateral guarantee arises when two
persons come to shop, one of them to buy, the other to give credit, thereby promising the seller
stating if he doesn‘t pay I will‘‘. This is a collateral guarantee.

In English law, a guarantee is defined as ‗‘a promise to pay for the debt, default or failure of
another‘‘. ―Guarantees are a backup when the principal fails the guarantee act as second
pockets‘‘.

Parties

The person who gives the guarantee is called the Surety, the person in respect of whose default
the guarantee is given is called the Principal Debtor and the person to whom the guarantee is
given is called the Creditor.

Independent liability different from guarantee

There must be a conditional promise to be liable on the default of the principal debtor. A liability
which is incurred independently of a default is not within the definition of guarantee.

This principle was applied in Taylor v Lee where a landlord and his tenant went to the plaintiff‘s
store. The landlord said to the plaintiff: Mr Parker will be on our land this year, and you will sell
him anything he wants, and I will see it paid.
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This was held to be an original promise and not a collateral promise to be liable for the default of
another and, therefore, not a guarantee.

Illustration:

A sells and delivers goods to B. C afterwards requests A to forbear to sue B for the debt for a
year, and promise that, if he does so, C will pay for them in default of payment by B. A agrees to
forbear as requested. This is a sufficient consideration for C‘s promise.

The extent of the Surety’s Liability

Section 128 speaks about one of the cardinal principles relating to the contract of guarantee. It
states that the liability of the surety is co-extensive with that of the principal debtor. The surety
may, however, by an agreement place a limit upon his liability.

Section 128- The liability of the surety is co-extensive with that of the principal debtor unless it
is otherwise provided by the contract.

Illustration-

A guarantees to B the payment of a bill of exchange by C, the acceptor. The bill is dishonoured
by C. A is liable not only for the amount of the bill but also for any interest and charges which
may have become due on it.

1. Co-extensive: The first principle governing surety‘s liability is that it is co-extensive

or common with that of the principal debtor. He is liable for the whole amount for
which the principal debtor is liable and he is liable for no more. Where the principal
debtor acknowledges liability and this has the effect of extending the period of
limitation against him the surety also becomes affected by it.
2. Condition precedent: Where there is a condition precedent to the surety‘s liability, he
will not be liable unless that condition is first fulfilled. Section 144 to an extent is
based on this principle: Where a person gives a guarantee upon a contract that creditor
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shall not act upon it until another person has joined it as co-surety, the guarantee is not
valid if that other person does not join.

An illustration in point is National Provincial Bank of England v Brackenbury: The defendant

signed a guarantee which was intended to be a joint and several guarantees of three other persons
with him. One of them did not sign. There is no agreement between the bank and the co-
guarantors to dispense with his signature, the defendant was held not liable.

Proceeding against surety without exhausting remedies against the debtor

The defendant guaranteed a bank‘s loan. A default had taken place, the defendant was sued. The
trial court decreed that the bank shall enforce the guarantee in question only after having
exhausted its remedies against the principal debtor. The Supreme Court overruled it stating that
the very object of the guarantee is defeated if the creditor is asked to postpone his remedies
against the surety. Solvency of the principal is not a sufficient ground for restraining execution of
the decree against the surety.

Suit against surety alone

A suit against the surety without even prosecuting the principal debtor has been held to be
maintainable. In this case, the creditor, in his affidavit, had shown sufficient reasons for not
proceeding against the principal debtor.

Death of Principal debtor

A suit was filed against the principal debtor and surety. The suit against the principal debtor was
found to be void ab initio because of his death even before the institution of the suit. The surety
was held to be not discharged.

2. Surety‘s right to limit his liability or make it conditional

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The surety may restrict his liability in the agreement. He can do this by expressly declaring his
guarantee to be limited to a fixed amount. In such a case the surety cannot be liable for any
amount beyond what is stated in the agreement. There might be a possibility that the principal
debtor owes a greater amount but the surety will not be responsible for the amount exceeding
what is stated in the agreement.

Impossibility of main contract

A loan for development and maintenance of bee culture was guaranteed. The surety undertook to
be liable jointly and severally to pay off his instalments in case of failure on the part of the
debtor. The bees died in consequence of a viral infection. There was a total failure of business.
The debtor became disabled from paying instalments. The surety could not escape liability under
the doctrine of impossibility of performance.

The creditor’s right to recover money from the guarantor doesn’t depend on the possibility
of guarantor able to recover the amount from the principal debtor.

Continuing Guarantee

Continuing Guarantee- A guarantee which operates on a number of transactions within a

particular period, is called a ‗‘Continuing Guarantee‘‘.

This type of guarantee includes a number of transactions over a period of time. A creditor can
hold the surety responsible for the default of the principal debtor for transactions that happen
within a period of time.

Illustration-

A guarantees payment to B, a mobile dealer, to the amount of $100, for any mobile he may
supply to C as required by C over a period of time. B supplies C with mobile above the value of
$100, and C pays B for it. Afterwards B supplies C with mobile to the value of $200 . C fails to
pay. The guarantee given by A was a continuing guarantee, and he is accordingly liable to B to
the extent of $100.
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The essential feature of a continuing guarantee is that it doesn‘t restrict to a specific number of
transactions, but to any number of them and makes the surety liable for the unpaid balance at the
end of the guarantee.

In Chorley & Tucker the distinction is explained: ―A specific guarantee provides for securing of
a specific advance or for advances up to a fixed sum, and ceases to be effective on the repayment
thereof, while a continuing guarantee covers a fluctuating account such as ordinary current
account at a bank, and secures the balance owing at any time within the limits of the
guarantee…‘‘

A guarantee for the conduct of a servant appointed to collect rents has been held by the Calcutta
High Court to be a continuing guarantee.

Joint -Debtors and suretyship

Section 132- This Section speaks about a situation when there are two guarantors who are liable
to the creditor as joint-debtors. It says that the liability of the creditor is not affected by any
private arrangement (Order of their liability) between the two debtors regarding one being the
surety of the other even if the creditor knows of this arrangement. The creditor is not concerned
with their mutual agreement that on would be a principal and the other surety.

Discharge of Surety From Liability

When the surety is no longer liable under the agreement the surety is said to be discharged from
liability.

The Act recognises the following modes of discharge:

 By Revocation (Section-130)Revocation of continuing guarantee: The surety can

revoke continuing guarantee by notifying the creditor with respect to the future
transactions.
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Revocation becomes effective for the future transactions while the surety remains liable for
transactions already entered into.

Illustration- A guarantees for B making purchases from C to an extent of 10000rupees. After one
month A revokes guarantee by giving notice to C. A will be liable for the supplies till the point
he revoked his guarantee. Let‘s say until revocation C supplied B with goods worth 6000rupees.
A is under obligation to pay 6000 to C.

 By death of surety (Section 131): A continuing guarantee is also terminated by the

death of the surety unless parties have expressed contrary intention.The termination is
only with respect to the future transactions and the heirs of surety are liable for
transactions that have already taken place.
 By variance (Section 133)- The contract of guarantee once formed becomes a contract
of utmost good faith. This duty is imposed on the creditor. The surety is held
discharged when, without his consent, the creditor makes any charge in the nature or
terms of his contract with the principal debtor. ‗‘The surety is discharged as soon as
the original contract is altered without his consent‘‘.
 Discharge of surety by release or discharge of principal debtor (Section 134) – A
surety can be discharged if there is any contract between principal debtor and the
creditor, which releases the principal debtor. Any act or failure on creditor‘s part
which has the legal effect of discharging the principal debtor also absolves surety.

Illustration- A contracts with B for a fixed price to build a house for B within a given time, B
supplying the necessary timber, C guarantees A‘s performance of the contract. B omits to supply
the timber. C is discharged from his suretyship.

 Release of principal debtor: The Section provides for two kinds of discharge from
liability. The first one where creditor enters into an agreement with the principal
debtor by which the latter is released, the surety is discharged. Where the creditor
arrives at a compromise and releases the principal debtor, the surety is likewise
released.
 Act or omission: The second scenario envisaged by the Section is when the creditor
does ‗‘any act or failure the legal effect of which is the absolve the principal debtor,‘‘
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the surety would also be released from his liability. For example, Where the payment
of rent due under a lease is guaranteed and the creditor terminates the lease, the effect
would be the release of the surety also.

Discharge: (Section 135) Discharge of surety when creditor compounds with, gives time to or
agrees not to sue principal debtor-. A contract where the creditor and principal debtor arrive at an
arrangement which results in creditor making a composition with grants principal debtor with
more time or undertakes not to sue the principal debtor absolves the surety. For this to operate
the surety shouldn‘t have assented to this arrangement between creditor and principal debtor.

The Section provides for three modes of discharge from liability:

 Composition
 Promise to give time, and
 Promise not to sue the principal debtor

Composition

If the creditor makes a composition with the principal debtor, without consulting the surety, the
latter is discharged. Composition results in altering the original contract, and, therefore, the
surety is discharged.

For Example- A settlement was entered into between the principal borrower and bank for one-
time settlement without reference to the guarantor. The court said that this resulted to novation of
the contract between the creditor and principal debtor to the exclusion of guarantor. The liability
of the guarantor ceased to exist.

Promise to give time- Promise to give time: when there is a fixed time, according to the
agreement for the repayment of the debt. It is one of the duties of the creditor towards the surety
not to allow the principal debtor more time for payment. Although, giving time to the principal
will benefit the surety but it will be against the spirit of the contract of guarantee, without the
consent of the surety.
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Thus, where the principal debtor was to make payment for gas supplied within fourteen days and
on one occasion he having failed to pay, the supplier took a promissory note from him, this
amounted to extension of time and thereupon the surety was discharged.

By impairing surety‘s remedy (Section 139): The creditor shouldn‘t act in a way which is
prejudice to surety‘s interest. The remedy of the surety shouldn‘t be affected by creditor‘s action
otherwise surety may be discharged.

It is one of the fundamental duties of the creditor not to do anything inconsistent with the rights
of the surety. A surety after paying off the creditor, to secure his payment from the principal
debtor.

This responsibility also directs the creditor to preserve the securities, if any, which he has against
the principal debtor.

In Darwen & Pearce, The principal debtor was a shareholder in a company. His shares were
partly paid and the payment of the unpaid balance was guaranteed by the surety. The shareholder
defaulted in the payment of calls and the company forfeited his shares.

By reason of the forfeiture, the shares became the property of the company. If they had not been
forfeited they would have belonged to the surety on payment of the outstanding calls. Thus, the
forfeiture deprived the surety of his right to the shares and he was accordingly discharged.

Rights of Surety

Rights against the principal debtor

Right of Subrogation(S.140):

Rights of surety on payment or performance- The surety after paying the creditor or fulfilling his
obligation under the contract takes the place of the creditor. He has all rights vested in him which
the creditor had against the principal debtor.
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When the surety has carried out all his obligations under the contract, he is conferred with all the
rights which the creditor had against the principal debtor. The surety steps into the shoes of the
creditor.

In Babu Rao Ramchandra Rao v Babu Manaklal Nehmal: ―If the liability of the surety is
coextensive with that of the principal debtor, his right is not less coextensive with that of the
creditor after he satisfies the creditor‘s debt‘‘.

Rights before payment

The surety may possess certain rights even before payment. We have a case where the Calcutta
High Court decided on similar lines. The surety found that the amount had become due, the
principal debtor was disposing of his personal properties one after the other lest the surety, after
paying, may seize them and sought a temporary injunction to prevent the principal debtor from
doing so. The court granted the injunction.

2. Right to indemnity:

Section (145) Implied promise to indemnify surety- In every contract of guarantee, there is an
implicit promise by the principal debtor to save the surety from harm. The surety is entitled to
claim from the principal debtor whatever sum he had agreed to pay under the guarantee, but no
sums which he wasn‘t obligated to pay under the contract.

Illustration: A guarantees to C, to the extent of 2000 rupees, payment for the rice to be supplied
by C to B. C supplies to B rice to a less amount than 2000 rupees, but obtains from A payment of
the sum of 2000 rupees in respect of the rice supplied. A cannot recover from B more than the
price of the rice actually supplied.

Rights Against creditor

 Right to securities- Surety‘s right to benefit of creditor‘s securities(Section 141):

Surety has a right over the security which the creditor has in his possession at the time
when the contract of guarantee was constructed. It doesn‘t matter whether surety was
aware of the security or not. The creditor, if without the consent of the surety gets rid
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of the security, the surety‘s obligation is reduced to the extent of the value of the
security disposed of.

The Section identifies the general rule of equity as observed in a case that the surety is entitled to
redress which the creditor has against the principal debtor, including enforcement of every
security.

On paying off the creditor the surety is exactly in the same positions as the creditor was against
the principal debtor. The right exists irrespective of the fact whether the surety knows of the
existence of such security or not.

The plaintiffs lent to B and P, who were traders, $300 for the payment of which the defendant
became surety. At the time of the loan B and P assigned by deed as security for the debt, the
lease of their business premises and plant, fixtures and things thereon. The plaintiff had the right
to sell on default by giving a month‘s notice. The default took place, but the defendant did not
enter into possession. He received notice of the debtor‘s insolvency but allowed them to continue
in possession. Consequently, the assets were seized and sold by the receiver. It was held that the
plaintiffs, by their omission to seize the property assigned on default, had deprived themselves of
the power to assign the security to the surety. He was, therefore, discharged to the amount that
the goods were worth.

1. Right of set-off: If the creditor owes anything to the principal debtor, the amount
owed can be adjusted in the creditor‘s claim against the surety. The surety can charge
from the amount to be given to the creditor if the creditor has to pay the principal
debtor back.
2. Right to share reduction: Reduction here refers to insolvency. A gives loan to B, C is
the guarantor. Subsequently, B becomes insolvent. The property of B is attached to
recover the loan he had taken. The official receiver in this particular case will create a
list of creditors and pay them proportionate to the sum lent by them. The surety can
ask the receiver about the amount given to A. The amount received by A through this
process can be deducted by the surety.

For example, B was given the loan by the A of rupees 10,000/-, C, who is a surety in this
contract gave a guarantee. A, became insolvent and when his property and assets was realised,
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when it was distributed by the official receiver and assignee, A got 1,000/- rupees. Now surety
who is C in this case when he will make a payment to the A of rupees 10,000/-will ask the A to
deduct the rupees 1,000/- which he has received from the official receiver and assignee. This
right is the right available with the surety and it is known as a right to share reduction.

Right against Co-sureties

Where a debt has been guaranteed by more than one person, they are called co-sureties.

 Effect of releasing a Surety( Section 138): Release of one co-surety does not discharge
others– If there are co-sureties involved and one of them is released by the creditor,
the others are still liable and the surety so released is responsible to other co-sureties
in the event of default.

The released co-surety will remain liable to others for contribution in the event of default.

 Right to contribution( Section 146): Co-sureties liable to contribute equally-.This

Section says when there are two or more co-sureties then each has to contribute
equally to the debt or a part of the debt. If there is no inconsistent agreement between
the co-sureties.

Illustration:

A and B are co-sureties for the sum of 2000 rupees which has been given to D by the bank. D
defaults, A and B are liable 1000 rupees each among themselves.

 Liability of co-sureties bound in different sums: Co-sureties who have different

obligations with respect to the amount is liable to pay equally as long as it isn‘t
beyond their respective obligation.

Illustration:

A, B and C as sureties for D, enter into three several Bonds each in a different penalty, namely,
A in the penalty of 10,000 rupees, B in that of 20,000 rupees, C in that of 40,000 rupees,
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conditioned for D‘s duly accounting to E. D makes default to the extent of 30,000 rupees. A, B
and C are liable to pay 10, 000 rupees.

Difference between Contract of Indemnity and Contract of Guarantee

In the case of State Bank of India v. Mula Sahakari Sakhar Karkhana (2006), the Supreme
Court was of the view that whether a contract is one of guarantee or of indemnity is a question of
construction in each case. The difference between the two types of contract are enumerated
below:

Contract of Indemnity Contract of Guarantee

It refers to a Contract by which one party promises It refers to a Contract to perform the promise or
to save the other from loss caused by conduct of discharge the liability of a third person in case of
the promisor or another person. his default.

In contract of guarantee, the primary liability is of

In contract of indemnity, the liability of the
principal debtor and the liability of surety is
promisor is primary.
secondary.

Contract between surety and principal debtor is

Contract between the indemnifier and the
implied and between creditor and principal debtor
indemnity holder is express and specific.
is express.

In contract of indemnity there are two parties In contract of guarantee there are three parties i.e.
indemnifier and the indemnity holder. creditor, the principal debtor and surety.

In contract of guarantee there are three agreements

In Contract of indemnity there is only one
i.e. agreement between the creditor and principal
agreement i.e. the agreement between indemnifier
debtor, the creditor and surety and surety and
and indemnity holder.
principal debtor.
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Contract of indemnity protects the promise from Contract of guarantee is for the surety of the
loss. creditor.

In Contract if indemnity, the promisor cannot file In contract of guarantee, the surety does not require
the suit against third person until and unless the any relinquishment for filing of suit. The surety
promisee relinquishes his right in favour of the gets the right to file suit against the principal debtor
promisor. as and when the surety pays the debt.

Conclusion

Therefore, with the conclusion of the contract of guarantee between the guarantor and the
creditor, the debtor will be acquitted of obligation and the guarantor will be indebted. ...
Therefore, after the realization of the guarantee, the debtor will not have any commitment to the
creditor anymore.

Suggested readings:

Dutta :Indian Contract Act ;iv Ed

Chitty: Contract Vol .II (XXIVth Ed)
R.K. Bangia: Indian Contract Act
MULLA The Indian Contract Act, 13th Edition 2011.
Indian Contract Act, 1872 (Bare Act).