Difference Between Contract Of Indemnity And Contract Of Guarantee

Understanding the difference between a contract of indemnity and a contract of guarantee is crucial in the realm of commercial dealings and legal agreements. While both contracts aim to mitigate risks and ensure financial security, they differ significantly in their purpose, scope, and parties involved. A contract of indemnity focuses on compensating for losses, while a contract of guarantee emphasizes ensuring the performance of obligations. This article delves into their definitions, key features, parties involved, and legal provisions under the Indian Contract Act, 1872, providing a clear comparison for better comprehension.

What Is A Contract Of Indemnity?

In indemnity contracts, one party called the indemnifier, indemnifies the other, which is called the indemnified. The indemnification is to the extent of compensating or indemnifying for the loss suffered or sustained. Such a kind of agreement is frequently used to offer financial protection in commercial dealings and insurance cases. Liability for the indemnitor only emerges in the event of a specific loss or contingency. The Indemnitor is not liable if such an incident does not occur. Such contracts can be protected due to the conduct of the promisor or by the conduct of any other person.

Example: A company, such as Zenoto. Pvt Ltd. hires a security agency, for example, Yakura Agency, for its premises. So, in a given scenario, Yakura Agency undertakes to indemnify Zenoto Pvt. Ltd. against any loss or damage caused by its security personnel during the performance of their duties. If any employee of Yakura Agency damages any equipment on the premises of Zenoto Pvt. Ltd. due to negligence or any such reason, then Yakura Agency is liable to compensate or indemnify Zenoto Pvt. Ltd. for the loss.

Terms/Parties To Consider

• The individual who pledges to cover the damages is known as the indemnifier.
• The individual who is shielded from loss is known as the one indemnified.
• A party to an indemnification contract who is entitled to get indemnified protection from losses or damages brought on by a particular incident or condition is known as an indemnity holder.

Indemnity Holder's Rights:

According to Section 125, an indemnity holder is entitled to damages they had to pay in court, any legal fees paid with the promisor's consent, or any amounts paid in settlements if they were made reasonably or with the promisor's consent.

Indemnifier’s Rights:

All means, and services that can protect the compensator from harm will be available to them once the indemnity holder has been compensated for the damage. Only then is indemnity possible when either such loss occurs or when it becomes inevitable that the other party will suffer a loss?

The Indian Contract Act or any other act explicitly does not stipulate any time frame for the indemnitor's liability. However, in the landmark case of Gajanan Moreshwar vs. Moreshwar Madan, 1942, the Bombay High Court established a timeframe related to the same. It held that the indemnified party has the right to require the indemnifier to release him from obligation and to pay off the debt if the indemnity is absolute.

Also Read : Rights Of Indemnifier

What Is A Contract Of Guarantee?

Here, three parties enter into a contract, ensuring that the third party will carry out their duties. This kind of contract is frequently used to give the creditor security in lending and credit operations. Let’s understand by an example.

Example: Let's assume that a loan of ₹7,00,000 is given by Awasya Bank to Mr. Ravi (Principal Debtor). Mr. Ravi's friend, Mr. Ronak (Surety), promises to repay on behalf of Mr. Ravi. If Mr Ravi does not pay it back, Awasya Bank will recover the same from Mr Ronak. In this case, Mr. Ravi is the Principal Debtor; Awasya Bank is the Creditor; & Mr. Ronak is the Surety.

Terms/Parties To Consider

As per section 126, such a contract involves:

• The person who guarantees the debt is the Surety.
• The person whose debt is guaranteed is known as the Principal Debtor.
• The person who’s guaranteed is known as the Creditor.

A guarantee can be given orally or in writing, and some consideration is required for the debtor's benefit. Additionally, in accordance with sections 142 and 143, the Surety's approval must not be acquired via misrepresentation or concealment.

Surety’s Rights & Liabilities:

Section 128 holds that on the default of the principal debtor, the liability of a surety is equal to that of the principal debtor. However, it can be processed right away, whereas the Surety's liability is always secondary.

As per section 141, the Surety's rights against debtors will include indemnification, notification, & recovery. Similarly, the rights against creditors include set-off, subrogation, termination of services, and demand for securities. The rights against co-sureties include shared security and contribution rights.

Difference Between A Contract Of Indemnity & Contract Of Guarantee

Conclusion

In summary, the difference between a contract of indemnity and a contract of guarantee lies in their core objectives, obligations, and legal frameworks. While indemnity contracts aim to compensate for losses arising from specific events, guarantee contracts ensure the fulfillment of obligations by a third party. Understanding these distinctions helps in selecting the appropriate legal instrument for financial security and risk mitigation. By aligning with the Indian Contract Act, 1872, these contracts serve as critical tools in safeguarding commercial and financial interests.

FAQs : Contracts Of Indemnity And Guarantee

Here are answers to some commonly asked questions about these contracts:

Q1. What is the key difference between a contract of indemnity and a contract of guarantee?

A contract of indemnity involves two parties and compensates for losses, while a contract of guarantee involves three parties and ensures debt repayment if the debtor defaults.

Q2. Is a contract of indemnity contingent on an event?

Yes, an indemnity contract is contingent upon a specific loss or event occurring, making the indemnifier liable only if such an event takes place.

Q3. Who is liable in a contract of guarantee if the principal debtor defaults?

In a contract of guarantee, the Surety becomes liable to the Creditor if the Principal Debtor fails to fulfill their obligation.

Q4. Can a surety in a contract of guarantee seek recovery from the debtor?

Yes, under Section 141 of the Indian Contract Act, the Surety has the right to recover from the Principal Debtor any amount paid to the Creditor.

Q5. Are contracts of indemnity and guarantee enforceable in India?

Yes, both contracts are enforceable under the Indian Contract Act, 1872, provided they meet the necessary legal requirements, including lawful consideration and mutual consent.