INDEMNITY & GUARANTEE

CONTRACT OF INDEMNITY

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.

CONTRACT OF GUARANTEE

It is 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’.

The economic function of guarantee

The function of a contract of guarantee is to enable a person to get a loan, or goods on credit or an employment.

‘Guarantees are usually taken to provide a second pocket to pay if the first should be empty’

Essential Features

Principal Debt:

When the debt itself is void.

Swan V Bank of Scotland (1836)

Payment of overdraft by bank’s customer was guaranteed -those days overdrafts were contrary to statute-penalty was imposed upon parties  to such drafts & the overdraft was void-customer having defaulted, surety was sued-he was held not liable as no debt was due.

Garrard V James (1925)

Directors of Company guaranteed their company’s loan which was void as being ultra Vires, they were nevertheless liable.

Consideration:

A contract of guarantee is made without consideration.

There should be no misrepresentation or concealment:

A contract of guarantee is not a contract of absolute good faith.

Any guarantee obtained by means of misrepresentation made by the creditor, or with his knowledge and assent, concerning a material part of the transaction is invalid.

A guarantee which the creditor has obtained by means of keeping silence as to material circumstances is invalid.

There should be no misrepresentation or concealment:

London General Omnibus Co V Holloway (1912)

Defendant invited to guarantee for the fidelity of a servant-Employer had earlier dismissed him for dishonesty but did not disclose this fact to the surety-the servant committed another embezzlement-surety was held not liable.

Writing is not necessary:

In the Indian context, a guarantee may be either oral or written.

In English Law, under the provisions of the Statute of Frauds, a guarantee is not enforceable unless it is ‘in writing and signed by the party to be charged’.

The extent of Surety’s Liability

• It is co-extensive with that of the principal debtor, unless it is otherwise provided by the contract.
• When there is a condition precedent to the surety’s liability, he will not be liable unless that condition is first fulfilled.(when another person has to join as a co-surety)
• ‘The surety has no right to dictate terms to the creditor and ask him to pursue his remedies against the principal in the first instance. The surety is a guarantor, and it is his business to see that the principal pays, and not that of the creditor’ Supreme Court in Bank of Bihar Ltd V Damodar Prasad (1969)
• ‘Even if the decree is a composite one against the principal debtor, mortgaged property & the guarantor, the creditor/decree holder can proceed as he liked i.e. he could proceed against the guarantor if he so wished’ Supreme Court in State Bank of India V Indexport Registered(1992)
• ‘In case of a company in liquidation, the principal debtor can claim from the surety & need not claim from the liquidation proceedings of the company’ Supreme Court in MSEB, Bombay V Official Liquidator, H C Ernakulam (1982)
• Ganga Kushan's appeal, Supreme Court, May 2012 (Guarantor liable to repay loan if debtor defaults)Ganga Kishun, who had stood as a guarantor to a bank loan, raised by one Ganga Prasad, who had died without clearing it. Ganga Kishun had come to the apex court against the Uttar Pradesh government's decision to recover the loan arrears from him after the death of principal debtor Ganga Prasad.While dismissing Ganga Kishun's appeal, the apex court, however, faulted the government's decision to auction Ganga Kishun's entire stretch of land for Rs 25,000 to recover an arrear worth Rs 8,500 only and not confining the auction to only 1/3rd of the land which could have fetched the arrears.Impact: Provoke people into thinking twice before becoming a guarantor for a bank loan

• Continuing Guarantee:Covers a number of transactions over a period of time.The surety undertakes to be answerable to the creditor for his dealings with the debtor for a certain time.

Discharge of Surety From Liability

• By revocation: Ordinarily, a guarantee is not revocable when once it is acted upon.A continuing guarantee may at any time be revoked by the surety, as to the future transactions, by notice to the creditor.

• By the death of Surety: The death of the surety operates as a revocation of a continuing guarantee so far as regards future transactions. The surety’s heirs can be sued for liability already incurred.

• By Variance: Any variance made without the surety’s consent, in the terms of the contract between the principal debtor and the creditor, discharges the surety as to transactions subsequent to the variance.

Bonar V Macdonald (1850)Guarantee of good conduct of Bank Manager-afterwards salary raised-condition that Manager would be liable for 1/4^th of losses on discount allowed by him-no communication of new arrangement to surety-substitution of a new agreement for the former discharged the surety.

While the general principle is that if the agreement of the surety is altered in a single line, the surety is entitled to be discharged, but the law now accepts that where it is self-evident that the alteration is unsubstantial or for the benefit of the surety, he is not discharged from his liability.

M S Anirudhan V Thomco’s Bank Ltd. (1963)Supreme court heard the appeal-defendant guaranteed repayment of loan-guarantee paper showed the loan to be Rs.25,000-bank refused to accept-principal reduced the amount to Rs.20,000  without intimation to surety gave it to the bank which was then accepted by bank-principal failed to pay-bank sued surety-question was whether the alteration had discharged him- held by a majority that the surety was not discharged.

• By release or discharge of Principal Debtor:
• The surety is discharged by any contract between creditor and the principal debtor, by which the principal debtor is released, or by any act or omission of the creditor, the legal consequence of which is the discharge of the principal debtor.
• Any release of the Principal Debtor is a release of the surety also.
• Where, however, the Principal Debtor is discharged by operation of insolvency laws or, in case of a company, by the process of liquidation, that does not absolve the surety of his liability.

Act or Omission:

Example: Act of the creditor in terminating the agreement of Hire-Purchase by taking possession of goods discharges the surety. There is a contract for the construction of a building, which is guaranteed by the surety, and the creditor has to supply the building material. An omission on the part of the creditor to supply the material would discharge the contractor and so would the surety be discharged.

Compromise, an extension of time and promise not to sue:

A contract between the creditor and the principal debtor, by which the creditor makes a composition with, or promises to give time to, or not to sue the principal debtor, discharges the surety, unless the surety assents to such contract.

(Mere forbearance to sue does not discharge the surety)

By Impairing surety’s remedy:

If the creditor does any act which is inconsistent with the right of the surety, or omits to do any act which his duty to the surety requires him to do, and the eventual remedy of the surety himself against the principal debtor is thereby impaired, the surety is discharged.

M R Chakrapani Iyengar V Canara Bank (1997)

The  principal debtor disposed of the hypothecated property, the surety submitted all the particulars to the creditor but the latter took no steps to seize the property or to issue a criminal process against the debtor, the surety became discharged.

Chistovan Vaz V Indian Overseas Bank (1998)

Sale of seized vehicles after  4 years’ exposure to sun and rains, considerable diminution in value, the liability of surety to be reduced to that extent.

Union Bank of India V M P Sreedharan Kartha (1993)

A hypothecation, being not a possessory security, not much duty can be expected from the creditor towards the care of the security. Accordingly, where the contents of a hypothecated godown are lost  and the banker was not aware of any such loss otherwise than in the ordinary course of business, the guarantor was held to be not discharged to the extent of the value of the security.

State Bank of Saurashtra v Chitranjan Ranganath Raja (1980)

A pledge, being a possessory security, duty can be expected from the creditor towards the care of the security. Accordingly, where the creditor was utterly negligent with regard to the safe keeping & handling of the goods pledged & the security was lost on account of the negligence of the bank, the guarantor was held to be discharged to the extent of the value of the security.

Rights of the Surety

Against the Principal Debtor:

• Right of subrogation: The surety steps into the shoes of the creditor when he has paid all that he is liable for, or performed all he is liable for
•  Right to Indemnity:In every contract of guarantee there is an implied promise by the principal debtor to indemnify the surety. The right enables the surety to recover from the principal debtor whatever sum he has rightfully paid under the guarantee.

Against the Creditor:

•  Right to securities:
• The surety steps into the shoes of the creditor and gets the right to have the securities, if any, which the creditor has against the principal debtor, irrespective of the fact whether the surety knows of the existence of such security or not.
• If the creditor loses or without the consent of the surety, parts with such security, the surety is discharged to the extent of the value of the security.

State of M P V Kaluram (1967)

The state sold a lot of felled timber to a person-price payable in 4 instalments-payment guaranteed by defendant-if there was a default in payment of an instalment, State would prevent further removal of timber & sell remaining timber for the realisation of price-buyer defaulted but even so State allowed him to remove the timber-Surety was then sued for the price-held not liable-by allowing goods to be removed by the buyer the security was lost.

• If the securities are burdened with further advances it will not affect the rights of the surety

Forbes V Jackson 1882

Mortgage of leasehold premises & insurance policy for a loan of £ 200-principal debtor borrows further sums upon same security from creditor without knowledge of surety-defaults on payment-surety pays amount with interest & claims the securities

• Right of set-off:

If the creditor sues the surety, the surety may have the benefit of the set-off, if any, that the principal debtor had against the creditor.

He is entitled to use the defences of the debtor against the creditor.

Against Co sureties:

Release by the creditor of one of the co sureties do not discharge the others; neither does it free the surety so released from his responsibility to the other sureties.

The co sureties, in the absence of a contract to the contrary, are liable, as between themselves, to pay each an equal share of the whole debt, or that part of it which remains unpaid by the principal debtor.