Both contracts deal with compensating loss and securing performance of an obligation, but they are distinct in nature and legal consequences.
Contract of Indemnity (Section 124)
A contract of indemnity is a contract wherein one party promises to save the other from loss caused by the conduct of the promisor or any third party.
Essentials
- Two parties involved: indemnifier and indemnified
- Loss must be caused by the conduct of promisor or third party
- The loss must be legal
Rights of Indemnified
Once the indemnified suffers loss, they are entitled to:
- Recover damages paid in a suit
- Recover legal costs incurred
- Recover sums paid under compromise (if done prudently and with authority)
Example
A contracts to indemnify B against consequences of any legal action that C may take against B. If C sues B and B suffers loss, A must compensate B.
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 their default.
Parties Involved
- Principal Debtor – the person who is primarily liable
- Creditor – the person to whom the guarantee is given
- Surety – the person who gives the guarantee
Types of Guarantee
- Specific Guarantee: For a single transaction
- Continuing Guarantee: For a series of transactions
Rights of Surety
- Against Principal Debtor: Right to recover payment made on default
- Against Creditor: Right to benefit from securities held by creditor
- Against Co-sureties: Right to claim proportionate contribution
Liability of Surety
- Co-extensive with that of principal debtor unless otherwise agreed
- Becomes liable when principal debtor defaults
Revocation of Guarantee
- By notice (in case of continuing guarantee)
- By death of surety (unless contract states otherwise)
Example
A lends ₹10,000 to B on the guarantee of C. If B fails to repay, A can recover the amount from C.
Difference between Indemnity and Guarantee
| Basis | Contract of Indemnity | Contract of Guarantee |
|---|---|---|
| Number of Parties | Two (Indemnifier & Indemnified) | Three (Creditor, Principal Debtor, Surety) |
| Nature of Liability | Primary liability of indemnifier | Surety’s liability is secondary |
| Time of Liability | Liability arises when loss occurs | Liability arises on default of debtor |
| Purpose | To save from loss | To ensure performance of obligation |
Important Case Law
Osman Jamal & Sons Ltd. v. Gopal Purshottam (1928)
Held that a contract of indemnity does not require actual loss to enforce it, promisee can ask for security in anticipation of loss.
State Bank of India v. Premco Dalal (1977)
Held that the surety is liable when principal debtor fails to pay, and the creditor can proceed directly against surety.