Recently, I appeared for an interview. Though, disqualified, I was impressed by the simplicity of questions on contract law asked during the interview. What is the difference between indemnity and guarantee? What's the difference between representations and warranties in a contract? We don't come across such basic questions after law school. Hence, an experience like this, especially followed by a rejection, motivates one to go back to the basics and find the correct answers. My first post on the blog of JUDICIALLY YOURS is to revise the simple principles of Contract law.
Question: What is the difference between a contract of Indemnity and a contract of Guarantee?
Indemnity: Section 124 of the Contract Act, 1872 defines a contract of Indemnity as "a contract by which one party promises to save the other from loss caused to him by the contract of the promisor himself, or by the conduct of any other person." In simple words, an indemnity is a promise to compensate for another's loss.
a) There are two parties to a contract viz. the indemnifier and the indemnified.
b) A contract of indemnity is restricted to cover the loss caused to the 'indemnity-holder' or 'indemnified' by the act of indemnifier (promisor) himself or to cover the loss caused by any third person.
c) It is original and independent, personal security undertaking given by a third party and is independent of the debtor / creditor relationship.
d) Thus, the liability of the indemnifier to the indemnified is a primary liability, independent of the presence or default by a third party.
For example -
a). If the value of shares goes below the purchase price of Rs. 180, I will compensate you for the loss caused due to decline in prices.
b). An insurance contract is also a contract to indemnify.
Guarantee: Section 126 of the Contract Act, 1872 defines a contract of Guarantee as "a contract to perform the 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". A guarantee may be either oral or written."
a) Essentially, there are three parties to a contract of Guarantee.
b) The liability under a contract of Guarantee arises only if the principal borrower or debtor defaults in fulfilling his obligation.
c) A contract of guarantee is a conditional promise by the surety that if the principal debtor defaults he shall be liable to the creditor.
d) The liability of the surety to the creditor is collateral or secondary the primary liability being that of the principal debtor.
A will lend money to B, subject to C providing security by guaranteeing the loan. The guarantor C will become liable under the contract of guarantee only if the debtor B, defaults.
a) In a contract of indemnity there are two parties i.e. indemnifier and indemnified. A contract of guarantee involves three parties i.e. creditor, principal debtor and surety.
b) The indemnifier doesn't need to act at the request of the indemnified. In a contract of indemnity the liability of the indemnifier is primary and arises when the contingent event occurs. In case of contract of guarantee, the liability of a surety is secondary and arises only when the principal debtor defaults.
c) The possibility of any loss is the only contingency against which the indemnifier undertakes to indemnify. In case of guarantee, there is an existing debt or duty to perform which is guaranteed by the surety.
d) The indemnifier after performing his part of the promise has no rights against the third party and he can sue the third party only if there is an assignment in his favour. Whereas in a contract of guarantee, the surety steps into the shoes of the creditor on discharge of his liability, and may sue the principal debtor.
An indemnity, by contrast, provides for concurrent liability with the principal throughout and there is no need to “look first” to the principal. In essence it is an agreement that the surety will hold the financier harmless against all losses arising from the contract between the principal and the financier.
Generally speaking, a guarantee provides for a liability co-extensive with that of the principal. In other words, the guarantor cannot be liable for anything more than the client. The document will be construed as a guarantee if, on its true construction, the obligations of the surety are to “stand behind” the principal and only come to the fore once an obligation has been breached as between the principal and the financier. The obligation is a secondary one, reflexive in character.
An indemnity arises on occurrence of an event, whereas a guarantee arises on default by a third party.