UNIT - 1

CONTRACT-II
CONTRACT OF INDEMNITY
CONTRACT OF INDEMNITY
● Contract of indemnity meaning is a special kind of contract. The term
‘indemnity’ literally means “security or protection against a loss” or
compensation. According to Section 124 of the Indian Contract Act,
1872 “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.”
Example: P contracts to indemnify Q against the consequences of any
proceedings which R may take against Q in respect of a certain sum
of money.

● The term “indemnity” comes from the Latin word “indemnis,” which means
“unhurt” or “free from loss.”
OBJECTIVE OF CONTRACT OF INDEMNITY
● The objective of entering into a contract of indemnity is to
protect the
promisee against unanticipated losses.
PARTIES TO THE CONTRACT OF INDEMNITY
● A contract of indemnity has two parties.
1. The promisor or indemnifier
2. The promisee or the indemnified or indemnity-holder
The promisor or indemnifier: He is the person who promises to
bear
the loss.
● The promisee or the indemnified or indemnity-holder: He is
the
person whose loss is covered or who are compensated.
ESSENTIALS OF CONTRACT OF INDEMNITY
1. PARTIES TO A CONTRACT: There must be two parties, namely,
promisor or indemnifier and the promisee or indemnified or
indemnity-holder.
2. PROTECTION OF LOSS: A contract of indemnity is entered into
for the purpose of protecting the promisee from the loss. The loss may
be caused due to the conduct of the promisor or any other person.
3. EXPRESS OR IMPLIED: The contract of indemnity may be
express (i.e. made by words spoken or written) or implied (i.e.
inferred from the conduct of the parties or circumstances of the
particular case).
4. ESSENTIALS OF A VALID CONTRACT: A contract of
indemnity is a special kind of contract. The principles of the general
law of contract contained in Section 1 to 75 of the Indian Contract
Act, 1872 are applicable to them. Therefore, it must possess all the
essentials of a valid contract.
5. NUMBER OF CONTRACTS: In a contract of Indemnity, there is
only one contract that is between the Indemnifier and the Indemnified.
CASE LAWS

● In the case of Adamson v Jarvis , where the plaintiff was sued by the
defendant for conversion. The plaintiff sued the defendant back as he had
acted as per the instructions of the defendant and was entitled to
compensation as per the indemnity contract entered between the two.

● In the case of United India Insurance Company v. M/s. Aman Singh Munshilal
(1994), goods were stored in godowns, from where they had to be carried to
their destination after some time. While in storage, the goods were destroyed
by fire. The Court, in this case, held that the goods were destroyed during
transit, and the insurer must pay as the contract of insurance.
 RIGHTS OF PROMISEE/ THE INDEMNIFIED/
INDEMNITY HOLDER
● As per Section 125 of the Indian Contract Act, 1872 the following
rights are available to the promisee/ the indemnified/ indemnity-
holder against the promisor/ indemnifier, provided he has acted within
the scope of his authority.

1. RIGHT TO RECOVER DAMAGES PAID IN A SUIT

[SECTION 125(1)]:
● An indemnity-holder has the right to recover from the indemnifier all
damages which he may be compelled to pay in any suit in respect of any
matter to which the contract of indemnity applies.
● The promisee can claim reimbursement for any damages or losses incurred due to
the promisor’s conduct or that of any other person. If the promisee has acted within
the scope of authority, they can seek compensation.
2. RIGHT TO RECOVER COSTS INCURRED IN DEFENDING A SUIT [SECTION
125(2)]: An indemnity-holder has the right to recover from the indemnifier 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.
. 3. RIGHT TO RECOVER SUMS PAID UNDER COMPROMISE [SECTION
125(3)]: An indemnity-holder also has the right to recover from the indemnifier 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
4. RIGHT TO SUE FOR SPECIFIC PERFORMANCE- The indemnity holder is
entitled to sue for specific performance if he has incurred absolute liability and the
contract covers such liability.
COMMENCEMENT OF LIABILITY OF PROMISOR/
INDEMNIFIER
● Indian Contract Act, 1872 does not provide the time of the commencement of
the indemnifier liability under the contract of indemnity.
● But different High Courts in India have held the following rules in this regard:
1. Indemnifier is not liable until the indemnified has suffered the loss.

2. Indemnified can compel the indemnifier to make good his loss although he has
not discharged his liability.

3. In the leading case of Gajanan Moreshwar vs. Moreshwar Madan(1942), an

observation was made by the judge that “ If the indemnified has incurred a liability
and the liability is absolute, he is entitled to call upon the indemnifier to save him
from the liability and pay it off”.
● Thus, Contract of Indemnity is a special contract
in which one party to a contract (i.e. the
indemnifier) promises to save the other (i.e. the
indemnified) from loss caused to him by the
conduct of the promisor himself, or by the conduct
of any other person. Section 124 and 125 of the
Indian Contract Act, 1872 are applicable to these
types of contracts.
Duties and liabilities of indemnifier
● Indemnify all damages

The indemnifier has a duty to pay for damages suffered by the indemnity
holder due to the loss for which he promised in the contract. The question of
whether the indemnity holder suffered direct or indirect loss is immaterial in
this case. It was held in the case of Nallappa Reddi v. Vridhachala Reddi
and Anr. (1914) that the duty to indemnify arises as and when the decree has
been passed against him, and he must fulfil his duty and the promise made to
the indemnity holder.
● Indemnify the costs
An indemnity holder can compel the indemnifier to pay for the costs if he did not
breach the terms and conditions of the indemnifier and the contract. In this situation,
if the indemnity holder proves that there was no fault on his end, the indemnifier has
a duty to pay for the costs that he incurred while reducing the claims. The
indemnifier must also compensate the indemnity holder for all the amounts paid by
the indemnity holder during any proceedings in a case.
● Illustration
X gave his house to Y for auction and promised to pay for any loss or damage
suffered during the auction, and Y was unaware of the fact that X is not the real
owner of the property. As soon as Y realised who the real owner was, he paid him
the amount because of which he suffered damages and sued X. X had to pay all the
damages and costs incurred by Y.
● Indemnify amount payable in case of compromise

The indemnifier has a duty to pay that amount to the indemnity holder, which he
paid as compensation in a suit, but the condition is that the promisee did not act
against the orders of the promisor. The Madras High Court, in the case of
Venkatarangayya Appa Rao v. Varaprasada Rao Naidu (1920), gave certain
conditions that must be fulfilled if an indemnity holder has to be paid in case of a
compromise. Only when these conditions are fulfilled is the indemnifier liable to
pay. The conditions are:

1. Compromise must be done in a bonafide manner.

2. No collusion in a settlement.
3. It must not be an immoral bargain.
Duties and liabilities of indemnity holder
1. Duties of the Indemnity Holder:
○ Act Prudently: The indemnity holder must act reasonably. Negligence on their part may
absolve the indemnifier from liability.
○ Avoid Harm or Loss: The indemnity holder should not intend to deceive or harm the
indemnifier. Acting in good faith is crucial.

2. Liabilities of the Indemnity Holder:

○ Damages: The indemnity holder can claim damages from the indemnifier for losses covered
by the contract of indemnity.
○ Costs: If the indemnity holder faces legal costs due to the indemnified event, the indemnifier
must cover those expenses.
CASE LAWS
● State Bank of India v. Mula Sahakari Sakhar Karkhana Ltd. (2007)
- Facts of the case

The respondent, a cooperative society, entered into a contract with a company for the installation of a paper mill.
The company gave a bank guarantee or indemnity for the release. 10% of the retention money from the invoices
for materials to be used in the installation reached the location. However, some disputes arose between them, and
the respondent terminated the contract and invoked a bank guarantee against the company.

- Issues involved in the case

• Whether the company is liable for bank guarantee in this case?

• Whether such a claim be honoured by the bank?

- Judgment

The Court in this case relied on the contract, which stated that the indemnity holder would be indemnified against
all losses, damages, etc., and made the supplier liable to pay. The Hon’ble Supreme Court stated that the terms of
the contract reveal that it is not a contract of guarantee but a contract of indemnity. The Court also ordered the
Bank not to honour the claim made on the contract’s termination without any proof or evidence.
 ● Dodika Ltd. and Ors. v. United Luck Group Holdings Ltd. (2020)
- Facts of the case
This is a case that was decided by the England and Wales High Court. In this case, there was a sale
and purchase agreement between the parties that related to the disposal of the seller’s share in a
company. Dodika demanded final payment because the tax covenant indemnified the buyer for
undisclosed tax liabilities. Under the agreement, in order to claim money and be indemnified, it was
necessary to serve the notice containing all the necessary details on the other party. This notice was not
served by the buyer, i.e., Dodika, to the seller, i.e., United Luck Group. After investigation, notice was
served.
- Issues involved in the case
Whether the notice served by Dodika to United Luck Group was sufficient to attract the claim according
to the agreement?
- Judgment of the Court
The Court observed that the notice served by the buyer contained a chronology of events but did not
explain how investigations would be done or what the next steps were. The Court held the notice
insufficient, and no claim could be made under the agreement. It further held that whether a notice is
sufficient enough to claim indemnity under the agreement will be decided on the basis of the terms and
words used therein and the details provided in it.
Landmark judgments on the contract of indemnity
● Dugdale v. Lovering (1827)
● Gajanan Moreshwar v. Moreshwar Madan (1942)
● Chand Bibi v. Santosh Kumar Pal (1933)
● Osman Jamal & Sons v. Gopal (1928)
Contract of guarantee
● The contract of guarantee is defined under Section 126 of the Indian Contract Act,
1872. It is a contract under which a person discharges liability on behalf of a
third party who is at fault. For example, P takes a loan from a bank and promises
to repay it within the stipulated time. R comes and says that he will pay the loan if P
fails to do so. Thus, R is liable to pay the loan back to the bank on behalf of P in
case he fails to discharge his liability.
● The person who gives the guarantee or promises to discharge liability on the default
of any person is called the surety. A person in whose default the surety promises to
act is the principal debtor, and a person to whom this guarantee is given is the
creditor. Thus, in the above example, P is the principal debtor, R is the surety, and
the bank is the creditor.
● The aim of a contract of guarantee is to provide extra security to the creditor that
a surety will fulfil the obligations made by the principal debtor in case he fails to do
so. Thus, a guarantee contract is tripartite in nature as it involves three parties.
However, it is not mandatory for the principal debtor to be a party to an express
contract.
 CONTRACT OF GUARANTEE
● Contract of Guarantee means a contract to perform the promises
made or discharge the liabilities of the third person in case of his
failure to discharge such liabilities.
● As per section 126 of Indian Contract Act, 1872, a contract of guarantee
has three parties: –
1. Surety: A surety is a person giving a guarantee in a contract of
guarantee. A person who takes responsibility to pay a sum of money,
perform any duty for another person in case that person fails to perform
such work.
2. Principal Debtor: A principal debtor is a person for whom the
guarantee is given in a contract of guarantee.
3. Creditor: The person to whom the guarantee is given is known as the
creditor.
For example, Mr. X advances a loan of 25000 to Mr. Y and Mr. Z
promise that in case Mr. Y fails to repay the loan, then he will repay the
same. In this case of a contract of guarantee, Mr. X is a Creditor, Mr. Y
is a principal debtor and Mr. Z is a Surety.
Features of a contract of guarantee
The following are the features or essentials of a contract of guarantee:
● The contract of guarantee may either be oral or written. However, it is
mandatory that it fulfils all the conditions of a valid contract.
● There must be a principal debtor who is obliged to discharge the duties
promised by him. If he is unable to do so, a surety is liable on his behalf.
● The consideration in the contract of guarantee needs not to be direct. If the
creditor does something for the benefit of the principal debtor, it is regarded
as a sufficient consideration. For example, A takes a loan from B, and B gives
the money. Thus, the loan given by B to A is a valid consideration for the
contract of guarantee.
● Surety must give his consent voluntarily, and it must not be obtained
forcefully or by misrepresentation of facts.
ESSENTIAL

1. Essentials of valid contract

2. Consideration for guarantee

3. Competency of the parties

4. Existence of a recoverable debt

5. No misrepresentation or concealment of facts

6. Conditional liability of surety

7. Concurrence of all the three parties

8. Mode of creation of contract

Difference between a contract of indemnity and guarantee
Basis of difference Contract of Indemnity
Provisions It is given under Section 124 of the
Indian Contract Act, 1872.
Number of parties In a contract of indemnity, there are two
parties, namely, the indemnifier (who
promises to pay for the losses) and the
indemnity holder (in whose favour such
a promise is made).
Number of contracts There is only one contract in the case
of indemnity, which is between the
indemnifier and the indemnity holder.
Contract of Guarantee
It is defined under Section 126 of the
Act
There are three parties. These are:
Principal debtor, Surety, Creditor.
There are three contracts between the
parties: The first contract is between
the principal debtor and the creditor,
which makes it obligatory for the
principal debtor to perform his duties.
The second contract is between the
surety and the creditor, which binds the
surety to act on behalf of the principal
debtor. The third contract is between
the principal debtor and surety, by
which the principal debtor is bound to
pay the surety the amount that he paid
on his behalf.
Aim The aim is to protect a person from
potential loss by humans or
agencies.
Liability The indemnifier has primary liability
because he promised to pay for the
loss incurred by the indemnity
holder.
Recovery of money/loss paid The indemnifier cannot recover the
amount that he paid for the loss
from any person.
Example A promises B that he will pay for
losses incurred by him due to his
actions or those of a third party.
This contract aims to provide the
creditor with the security that in the
absence of the principal debtor or if
he fails to perform the obligations,
the same will be done by a surety.
The liability of the surety is
secondary, as it is the principal
debtor who is initially responsible for
performing the obligations. The
surety’s liability arises when the
principal debtor fails to do so.
If surety pays money on behalf of
the principal debtor, he/she is liable
to recover from him.
C takes out a loan from B and
promises to return the money within
3 years. A promises to be a surety
in this case. If C is unable to pay the
money within the stipulated time, it
is the duty of A to do so.
 REVOCATION OF CONTINUING GUARANTEE

1. By notice

2. By death of surety
NATURE AND EXTENT OF SURETY‘S LIABILITY
1. Secondary
2. Contingent or dependent
3. Arises immediately on the default of the principal debtor
4. Coextensive
5. Entitled to limit his liability
6. Continuing guarantee
7. Where the original contract between the principal debtor and
creditor become void or voidable
 RIGHTS OF SURETY
1. Against the principal debtor
a. Right of subrogation
b. Right of indemnity
c. Right to insist the principal debtor to honour his obligation
d. Right to securities with the creditor
2. Against the creditor
a. Right to request the creditor to proceed against the debtor
b. Right of set off
c. Right to benefit of creditor’s securities
3. Against co-sureties

a. When liable to contribute equally

b. Bound to pay in different sums

c. Right to share benefits of securities

d. Effect of release of surety

 DISCHARGE OF SURETY
1. By revocation
a. By notice
b. By death of surety
c. By novation
2. By act or conduct of creditor
a. Variation in the terms of the contract
b. Release or discharge of principal debtor
c. Compounding with or giving time to the principal debtor
d. Creditors act or omission impairing surety eventual
remedy
e. Loss of security
3. By invalidation of contract of guarantee
a. Obtained by misrepresentation
b. Obtained by concealment
c. Co-sureties does not join
d. Lacks essential element of a valid contract
Exceptions
a. Agreement made with third person
b. Mere forbearance to sue
c. Release of one co-surety
d. Death or insolvency of principal debtor
CASE LAWS
● P.J. Rajappan v Associated Industries(1983) the guarantor, having not signed the
contract of guarantee, wanted to wriggle out of the situation. He said that he did not
stand as a surety for the performance of the contract. Evidence showed the
involvement of the guarantor in the deal and had promised to sign the contract later.
The Kerala High Court held that a contract of guarantee is a tripartite agreement,
involving the principal debtor, surety and the creditor. In a case where there is
evidence of the involvement of the guarantor, the mere failure on his part in not
signing the agreement is not sufficient to demolish otherwise acceptable evidence of
his involvement in the transaction leading to the conclusion that he guaranteed the
due performance of the contract by the principal debtor. When a court has to decide
whether a person has actually guaranteed the due performance of the contract by
the principal debtor all the circumstances concerning the transactions will have to be
necessarily considered.
● Maharaja of Benares v. Har Narain Singh, where the plaintiffs ‘the creditor
in this case’ had asked for interest on the liabilities owed by the principal
debtor to the defendants’ the surety’. In the contract of guarantee, there was
no mention of any interest on the rent for the principle liability nor the surety,
thereby the court declared that the liability of the surety is coextensive to the
principal debtor and since there was no specific mention of interest for the
surety in the contract, it was not payable.
● “Union Bank of India vs AP Bhonsle 1991 Mah HC“: CONCEPT OF CONTRACT OF
GUARANTEE
● In State Bank of India v Premco Saw Mill(1983), the State Bank gave notice to the
debtor-defendant and also threatened legal action against her, but her husband agreed
to become surety and undertook to pay the liability and also executed a promissory
note in favor of the State Banka nd the Bank refrained from threatened action. It was
held that such patience and acceptance onthe bank’s part constituted good
consideration for the surety.
● If the contract of guarantee includes a clause that a notice of a certain period
of time is required before the contract can be revoked, then the surety must
comply with the same as said in Offord v Davies (1862
 Kinds of guarantee
● Contracts of guarantees may be classified into two types: Specific guarantee
and continuing guarantee.
● When a guarantee is given in respect of a single debt or specific transaction
and is to come to an end when the guaranteed debt is paid or the promise is
duly performed, it is called a specific or simple guarantee.
● However, a guarantee which extends to a series of transactions is called a
continuing guarantee (Section129). The surety’s liability, in this case, would
continue till all the transactions are completed or till the guarantor revokes the
guarantee as to the future transactions.
Illustrations
a) S is a bookseller who supplies a set of books to P, under the contract that if P
does not pay for the books, his friend K would make the payment. This is a
contract of specific guarantee and K’s liability would come to an end, the moment
the price of the books is paid to S.
b) On M’s recommendation S, a wealthy landlord employs P as his estate
manager. It was the duty of P to collect rent every month from the tenants of S and
remit the same to S before the 15th of each month. M, guarantee this arrangement
and promises to make good any default made by P. This is a contract of continuing
guarantee.
Guarantee Types:
1. Specific Guarantee (Simple Guarantee):
Covers a single debt or transaction.
Ends when the guaranteed debt is paid or the promise is fulfilled.
2. Continuing Guarantee S.129:
Applies to a series of transactions entered into by the principal debtor.
Surety's liability continues until all transactions are completed or the guarantee is
revoked (for future transactions only).
Revocation of Continuing Guarantee
● So far as a guarantee given for an existing debt is concerned, it cannot be
revoked, as once an offer is accepted it becomes final. However, a continuing
guarantee can be revoked for future transactions. In that case, the surety
shall be liable for those transactions which have already taken place.
● A contract of guarantee can be revoked in the following two ways-

1) By giving a notice (Section 130)

2) 2) By Death of Surety(Section 131)

1) By giving a notice (Section 130)
- Continuing guarantees can be revoked by giving notice to the Creditor but this
applies only to future transactions. Just by giving a notice the surety cannot
waive off his responsibility and still remains liable for all the transactions that
have been placed before the notice was given by him. If the contract of
guarantee includes a clause that a notice of a certain period of time is
required before the contract can be revoked, then the surety must comply with
the same as said in Offord v Davies (1862).

● Illustration
A guarantees to B to the extent of Rs. 10,000, that C shall pay for all the goods
bought by him during the next three months. B sells goods worth Rs. 6,000 to C. A
gives notice of revocation, C is liable for Rs. 6,000. If any goods are sold to C after
the notice of revocation, A shall not be, liable for that.
 2) By Death of Surety(Section 131)

● Unless there is a contract to the contrary, the death of surety operates as a

revocation of the continuing guarantee in respect to the transactions taking place
after the death of surety due to the absence of a contract.
● However, his legal representatives will continue to be liable for transactions
entered into before his death.
● The estate of deceased surety is, however, liable for those transactions which
had already taken place during the lifetime of the deceased. Surety’s estate will
not be liable for the transactions taking after the death of surety even if the
creditor had no knowledge of surety’s death.