Contents

01Chapter Overview 02Contract of Indemnity 03Rights of Indemnity Holder 04Contract of Guarantee 05Essentials of Guarantee 06Types of Guarantees 07Indemnity vs Guarantee 08Surety's Liability 09Discharge of Surety 10Rights of Surety 11Co-Sureties 12Case Law Recall 13Quick Revision 14Summary Infographic
01
FoundationChapter Overview

This unit covers two special contracts under the Indian Contract Act, 1872: contract of indemnity and contract of guarantee. Both deal with protection against loss, but their structure is different.

Indemnity means one person protects another from loss. Guarantee means one person promises to pay or perform if a third person defaults.
Sections 124-125Indemnity.
Sections 126-129Guarantee and types.
Sections 130-139Discharge of surety.
Sections 140-147Rights of surety.
02
Section 124Contract of Indemnity
Meaning
Indemnity means security against loss, making good the loss, or compensating the party who has suffered loss.

Under Section 124, a contract of indemnity is 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.

Indemnifier

The person who promises to compensate or save the other party from loss.

Indemnified / Indemnity Holder

The person whose loss is promised to be made good.

Example

A agrees to indemnify B against consequences of proceedings that C may take against B for ₹5,000 advanced by C to B. If B has to pay C, B can recover from A according to the indemnity.

Scope of Indemnity

The strict wording of Section 124 covers only loss caused by the conduct of the promisor himself or by the conduct of any other person. It does not directly cover loss by accident or act of God.

Gajanan Moreshwar Parelkar v. Moreshwar Madan Mantri
Bombay High Court, 1942
Case

The plaintiff had become liable under certain mortgage and charge transactions connected with property arrangements. The defendant had promised to keep the plaintiff harmless against those liabilities. Before the plaintiff had actually paid the money, he approached the court asking that the defendant should indemnify him and clear the liability.

Doubt

The doubt was whether an indemnity-holder can sue the indemnifier only after he has actually paid the loss, or whether he can claim indemnity once his liability has become clear, absolute and enforceable.

Held

The Court held that the indemnity-holder need not wait until actual payment if his liability has become certain. The indemnifier can be compelled to put him in a position to meet that liability.

Exam PrincipleFor CA Foundation, remember this as the practical rule on commencement of indemnifier's liability: liability begins when the indemnity-holder's liability becomes absolute and certain, not only after actual payment.

Mode of Contract of Indemnity

Mode 1
Express Indemnity

The promise to compensate is clearly stated in words, written or oral.

Mode 2
Implied Indemnity

The promise is inferred from conduct, relationship or circumstances.

Important

A contract of indemnity must satisfy all essentials of a valid contract. If the object is unlawful, the indemnity cannot be enforced.

Illegal Object Example

A asks B to beat C and promises to indemnify B against consequences. B cannot recover the fine from A because the object is unlawful.

Fire insurance and marine insurance are contracts of indemnity. Life insurance is not treated as a contract of indemnity because human life cannot be measured as an ordinary compensable loss.

03
Section 125Rights of Indemnity Holder When Sued

The indemnity holder, acting within the scope of authority, can recover the following from the indemnifier:

Damages

All damages which he may be compelled to pay in any suit.

Costs

All costs which he may be compelled to pay in bringing or defending the suit.

Compromise Sums

All sums paid under a lawful compromise of the suit.

Liability of indemnifier begins when the liability of the indemnity holder becomes absolute and certain, not necessarily only after actual payment.
04
Section 126Contract of Guarantee
Definition
A contract of guarantee is a contract to perform the promise, or discharge the liability, of a third person in case of his default.

A guarantee is a tripartite arrangement. There are three parties and three connected contracts.

Surety

The person who gives the guarantee.

Principal Debtor

The person in respect of whose default guarantee is given.

Creditor

The person to whom the guarantee is given.

Principal ContractBetween principal debtor and creditor.
Secondary ContractBetween creditor and surety.
Implied ContractBetween surety and principal debtor.
Example

A asks B to lend ₹10,000 to C and promises that if C fails to repay, A will pay B. Here, B is creditor, C is principal debtor and A is surety.

05
Valid GuaranteeEssential Features of a Guarantee
1. PurposeThere must be a recoverable debt or liability. Without principal debt, there is no valid guarantee.
2. ConsiderationConsideration received by principal debtor is sufficient for surety under Section 127.
3. Existing LiabilityThe liability or promise must be legally enforceable and not time-barred.
4. No MisrepresentationGuarantee obtained by material misrepresentation is invalid under Section 142.
5. No ConcealmentGuarantee obtained by silence about material circumstances is invalid under Section 143.
6. Oral or WrittenSection 126 allows guarantee to be oral or written.
7. Co-Surety ConditionIf guarantee is conditional on another co-surety joining, it is invalid if that person does not join.
Exam Trap

There need not be direct consideration between creditor and surety. Consideration to the principal debtor is enough. But past consideration is not enough for a fresh guarantee.

06
Section 129Types of Guarantees
Specific Guarantee
Single Transaction

A guarantee limited to one debt or one specific transaction. Surety's liability ends when that debt is paid or promise is performed.

Continuing Guarantee
Series of Transactions

A guarantee extending to a series of transactions. Surety's liability continues until revocation, subject to past transactions.

Continuing Guarantee Example

A guarantees payment to B up to ₹10,000 for tea supplied from time to time to C. B later supplies tea worth ₹20,000 and C fails to pay. A is liable up to ₹10,000.

Kay v. Groves
1829
Case

The surety gave a guarantee for the amount of five sacks of flour to be delivered to a buyer and payable in one month. The five sacks were supplied and paid for. Later, further supplies were made and the buyer failed to pay.

Doubt

The doubt was whether the guarantee covered only the first five sacks, or whether it continued to cover later supplies also.

Held

The Court held that the guarantee was a specific guarantee, not a continuing guarantee. Once the first five sacks were supplied and paid for, the surety's liability came to an end.

Exam PrincipleIf the wording points to one fixed transaction or fixed supply, treat it as a specific guarantee unless the language clearly shows a series of transactions.
07
ComparisonContract of Indemnity vs Contract of Guarantee
PointIndemnityGuarantee
Number of PartiesTwo: indemnifier and indemnity holder.Three: creditor, principal debtor and surety.
Nature of LiabilityPrimary and unconditional.Secondary and conditional on default of principal debtor.
Time of LiabilityArises on happening of contingency or when loss becomes certain.Arises on non-performance or non-payment by principal debtor.
RequestIndemnifier need not act at request of indemnity holder.Surety generally acts at request of principal debtor.
Right to Sue Third PartyIndemnifier cannot sue third party in his own name unless rights are assigned.Surety can proceed against principal debtor after discharging the debt.
PurposeReimbursement of loss.Security of creditor.
CompetencyAll parties must be competent.Guarantee may be valid even if principal debtor is minor, but surety must be competent.
08
Sections 128 and 132Nature and Extent of Surety's Liability

Under Section 128, the liability of the surety is co-extensive with that of the principal debtor, unless the contract provides otherwise.

Section 132

If two persons are primarily liable to a third person, their internal arrangement that one will be surety for the other does not affect their liability to the third person.

09
Sections 130-139, 142-144Discharge of Surety

Discharge means the surety's liability comes to an end. Once the surety is discharged, the creditor cannot recover the guaranteed amount from him, either fully or to the extent of discharge. In this topic, the main idea is simple: the surety should not be made liable when the guarantee is withdrawn, when the creditor changes the risk unfairly, or when the guarantee itself was obtained improperly.

Mode 1
By Revocation
  • Notice in continuing guarantee — Section 130.
  • Death of surety — Section 131.
  • Novation — Section 62.
Mode 2
By Conduct of Creditor
  • Variance in terms — Section 133.
  • Release/discharge of principal debtor — Section 134.
  • Composition, time or promise not to sue — Section 135.
  • Impairing surety's remedy — Section 139.
Mode 3
By Invalidation
  • Misrepresentation — Section 142.
  • Concealment — Section 143.
  • Co-surety condition not fulfilled — Section 144.

Mode 1: Discharge by Revocation

Revocation by Notice — Section 130

A continuing guarantee can be revoked by the surety by giving notice to the creditor. The notice works only for future transactions. The surety remains liable for transactions already entered into before the notice.

Example

A guarantees payment for all goods supplied by B to C. B supplies goods worth ₹2 lakh in January. In February, A gives notice revoking the guarantee. A remains liable for January supply, but not for goods supplied after the notice.

Key Point: Notice ends future liability, not past liability.
Revocation by Death — Section 131

Death of the surety automatically revokes a continuing guarantee for future transactions, unless the contract provides otherwise. The estate of the deceased surety remains liable only for obligations already incurred before death.

Example

A guarantees all future credit purchases by B. B buys goods before A's death and again after A's death. A's estate is liable only for the purchases made before death.

Key Point: Death stops future liability, but existing liability continues.
Novation — Section 62

Novation means replacing the old contract with a new contract. If the principal debtor and creditor substitute the original contract without the surety's consent, the surety is discharged because he guaranteed the old contract, not the new one.

Example

A guarantees B's loan of ₹10 lakh. Later, the bank and B cancel that loan and enter into a fresh agreement with new terms. If A has not agreed to the new contract, his guarantee comes to an end.

Key Point: New contract without surety's consent releases the surety.

Mode 2: Discharge by Conduct of Creditor

Variance in Terms of Contract — Section 133

A variance means a change in the terms of the contract between the creditor and the principal debtor. If such change is made without the surety's consent, the surety is discharged for transactions taking place after the change.

The reason is that the surety agreed to guarantee a particular contract. If that contract is altered without consulting him, he cannot be forced to guarantee the modified arrangement.

Example

A guarantees a loan of ₹10 lakh taken by B. Later, the bank increases the loan to ₹15 lakh and extends the repayment period without A's consent. A is not liable under the altered contract.

Key Point: Material alteration without surety's consent discharges the surety.
Release or Discharge of Principal Debtor — Section 134

The surety's liability is secondary and depends on the liability of the principal debtor. If the creditor voluntarily releases the principal debtor from liability, the surety is also discharged.

Once the principal debtor is no longer liable to the creditor, there is no debt left for the surety to guarantee.

Example

A guarantees B's bank loan. Later, the bank signs a settlement and completely releases B from repayment. The bank cannot thereafter recover the same amount from A.

Key Point: Voluntary release of the principal debtor also releases the surety.
Composition, Giving Time or Promise Not to Sue — Section 135

The surety is discharged if, without his consent, the creditor enters into a settlement with the principal debtor, gives him extra time to pay, or promises not to sue him.

Such arrangements may affect the surety's right to recover money from the principal debtor after making payment. Therefore, the law protects the surety.

Example

A guarantees B's loan. Without informing A, the bank gives B three additional years to repay. Since the repayment arrangement was changed without A's consent, A is discharged.

Key Point: Settlement or extra time without surety's consent discharges the surety.
Creditor Impairs Surety's Remedy — Section 139

After paying the debt, the surety has the right to recover the amount from the principal debtor. If the creditor does any act which destroys or weakens this right, the surety is discharged to that extent.

This usually happens when the creditor negligently loses, releases or weakens a security which could have helped the surety recover the amount.

Example

A bank accepts machinery as security for a loan but later releases it without the surety's consent. If the borrower defaults, the surety is discharged to the extent of the value of that security.

Key Point: If the creditor's act prejudices the surety's recovery right, the surety is discharged.

Mode 3: Discharge by Invalidation of Guarantee

Misrepresentation — Section 142

If the creditor obtains the guarantee by making a false statement about a material fact, the guarantee is invalid. The surety's consent must be free and based on correct information.

Example

A bank falsely tells C that B has always repaid loans on time. Relying on this, C becomes surety. If B had actually defaulted earlier, the guarantee is invalid.

Key Point: False statement by creditor makes the guarantee invalid.
Concealment — Section 143

If the creditor deliberately hides an important fact which should have been disclosed, the guarantee is invalid. Here, the problem is not a false statement, but suppression of the truth.

Example

An employer knows that an employee has earlier misappropriated money, but hides this fact while obtaining a guarantee for the employee's honesty. The surety is not liable.

Key Point: Section 142 is telling a lie; Section 143 is hiding the truth.
Co-surety Condition Not Fulfilled — Section 144

A person may agree to become surety only on the condition that another person will also join as co-surety. If that other person does not join, the guarantee is invalid.

Example

A agrees to guarantee B's loan only if C also signs as co-surety. The bank gives the loan without getting C's signature. A's guarantee cannot be enforced.

Key Point: Conditional consent is valid only when the condition is fulfilled.

Cases Where Surety Is Not Discharged

Agreement to Give Time to Third Person — Section 136

If the creditor agrees to wait, but the agreement is made with a third person and not with the principal debtor, the surety is not discharged.

The reason is that the principal debtor has not received any legal extension of time. The creditor can still proceed against him, so the surety's recovery rights are not affected.

Example

A guarantees B's loan. The bank agrees with C, B's relative, that it will wait for two months before taking action. Since the agreement is with C and not with B, A remains liable.

Key Point: Time given to principal debtor may discharge surety; time agreed with a third person does not.
Mere Forbearance to Sue — Section 137

Forbearance means delay in taking legal action. A creditor is not bound to sue the principal debtor immediately after default.

If the creditor merely waits and does not file a suit for some time, the surety is not discharged. The surety is discharged only when there is a binding agreement giving time or promising not to sue.

Example

A guarantees B's loan. B defaults, but the bank waits six months before filing recovery proceedings. This delay alone does not discharge A.

Key Point: Mere delay is not the same as a legal promise to give time.
State Bank of Saurashtra v. Chitranjan Rangnath Raja
Supreme Court, 1980
Case

The bank granted a cash credit facility to the principal debtor. The advance was backed by two securities: pledged groundnut oil tins kept under the bank's lock and key, and a personal guarantee by the surety. Later, the pledged goods were lost because of the bank's negligence. The bank then tried to recover the dues from the surety.

Doubt

The doubt was whether the surety remained liable even after the creditor had lost the pledged security, or whether the surety was discharged because the bank's negligence destroyed the security available to him.

Held

The Supreme Court held that the surety was discharged to the extent of the value of the security lost. Since the pledge and guarantee formed part of one composite transaction and the pledged goods were lost due to the bank's negligence, the surety could not be made liable for that loss.

Exam PrincipleUnder Section 141, the surety is entitled to the benefit of every security held by the creditor. If the creditor loses or parts with that security without the surety's consent, the surety is discharged to the extent of the value of that security.
10
Sections 140, 141 and 145Rights of Surety

Rights Against Principal Debtor

Right of Subrogation — Section 140

After the surety pays the guaranteed debt, he steps into the shoes of the creditor. This means he can use the creditor's rights against the principal debtor to recover what he has paid.

Key Point: Surety pays creditor first, then recovers from debtor as if he were the creditor.
Right of Indemnity — Section 145

The principal debtor has an implied duty to indemnify the surety. So, if the surety rightfully pays under the guarantee, he can recover that amount from the principal debtor.

Key Point: The real burden of debt must finally fall on the principal debtor.

Rights Against Creditor

Benefit of Securities — Section 141

The surety is entitled to every security which the creditor holds against the principal debtor. If the creditor loses or gives up such security without the surety's consent, the surety is discharged to that extent.

Key Point: Securities held by creditor are also protection for the surety.
Right to Set Off

The surety can use any valid defence or set-off which the principal debtor could have used against the creditor, because the surety's liability cannot normally be greater than that of the principal debtor.

Right to Share Reduction

If the creditor recovers part of the amount from the principal debtor or his estate, the surety is liable only for the balance, subject to the terms of the guarantee.

11
Sections 146 and 147Rights Against Co-Sureties
Co-Sureties
When two or more persons guarantee the same debt or the same duty, they are called co-sureties. If one of them pays more than his fair share, he can claim contribution from the others.
Equal Contribution — Section 146

Where co-sureties guarantee the same debt, they must contribute equally unless they have agreed on a different sharing arrangement.

The idea is fairness. If one surety pays the whole amount to the creditor, the final burden should still be shared among all co-sureties.

Example

A, B and C guarantee a debt of ₹3,00,000. A pays the full amount. A can recover ₹1,00,000 each from B and C.

Key Point: Same debt, same limit, no special agreement → equal sharing.
Different Maximum Limits — Section 147

Co-sureties may guarantee different maximum amounts. In such cases, they contribute equally as far as possible, but no surety can be forced to pay beyond his agreed limit.

This balances two rules: contribution should be fair, but each surety's maximum liability must be respected.

Example

A guarantees ₹1,00,000, B guarantees ₹2,00,000 and C guarantees ₹3,00,000. A cannot be asked to contribute more than ₹1,00,000 even if the total debt is higher.

Key Point: Equal contribution applies only within the promised limits.
12
Before ExamQuick Revision Points
  • Indemnity has two parties; guarantee has three parties.
  • Indemnifier's liability is primary; surety's liability is secondary but co-extensive.
  • Guarantee may be oral or written.
  • Consideration to principal debtor is sufficient consideration for surety.
  • Continuing guarantee can be revoked for future transactions by notice or death.
  • Variance in contract without surety's consent discharges surety for subsequent transactions.
  • Surety gets subrogation, indemnity, benefit of securities and contribution rights.
Summary Infographic

Unit 7 Memory Map

Read this as a flow: loss protection → third-party default → surety liability → discharge → rights after payment.
1. Contract of Indemnity
  • Sections 124-125.
  • Two parties: indemnifier and indemnity holder.
  • Promise to save from loss.
  • Loss by promisor or any other person.
  • Fire and marine insurance are indemnity contracts.
2. Rights of Indemnity Holder
  • Recover damages.
  • Recover suit costs.
  • Recover compromise sums.
  • Liability begins when loss becomes absolute and certain.
Core Memory: Indemnity = direct loss protection. Guarantee = promise to answer for another person's default.
3. Contract of Guarantee
  • Section 126.
  • Three parties: creditor, principal debtor, surety.
  • Three contracts: principal, secondary, implied.
  • May be oral or written.
  • Purpose is security of creditor.
4. Essentials of Guarantee
  • Recoverable debt or liability.
  • Consideration under Section 127.
  • No material misrepresentation.
  • No material concealment.
  • Co-surety condition must be satisfied.
5. Types
  • Specific guarantee: single transaction.
  • Continuing guarantee: series of transactions.
  • Continuing guarantee continues until revocation.
6. Surety Liability
  • Section 128.
  • Co-extensive with principal debtor.
  • Creditor may sue surety first.
  • Includes interest and charges where applicable.
7. Discharge of Surety
  • By revocation: notice, death, novation.
  • By creditor's conduct: variance, release, composition, impairment of remedy.
  • By invalidation: misrepresentation, concealment, co-surety not joining.
8. Rights of Surety
  • Against principal debtor: subrogation and indemnity.
  • Against creditor: securities, set off and share reduction.
  • Against co-sureties: equal contribution subject to agreed limits.
  • Key sections: 140, 141, 145, 146 and 147.
Last-Minute Recall: In guarantee questions, first identify the three parties. Then ask: Was there default? Was surety discharged? If surety paid, what right does he get?