Contract of Indemnity & Guarantee — Contract II (Special Contracts) Notes

Contract of Indemnity

In 1942 the Bombay High Court decided Gajanan Moreshwar v. Moreshwar Madan. A man had taken on a liability to a builder at a friend’s request, on the friend’s promise to cover him. He had not yet paid a rupee — but he was already being pressed. Could he force his friend to clear the liability before he himself suffered the actual out-of-pocket loss? The court said yes: an indemnity-holder need not ruin himself first and claim afterwards. That single idea — you can be protected before the axe falls — is what makes indemnity more than a bare promise to reimburse.

What is a Contract of Indemnity?

Think of everyday life first. You agree to sell a car on behalf of a friend, and you worry: what if the real owner turns up and sues me? Your friend says, “Go ahead — if you lose anything, I’ll make it good.” That promise is an indemnity. It is the law’s tool for one person to shoulder another’s risk of loss.

Section 124 of the Indian Contract Act, 1872 defines it. 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. The person who promises is the indemnifier (or indemnitor); the person protected is the indemnity-holder (or indemnified).

Notice what s.124 does not cover. On its bare words it speaks only of loss caused by human conduct — the promisor’s or another person’s. It does not, in its literal text, mention loss caused by an accident or an act of God (fire, flood). Courts in India, however, have read indemnity more widely in practice to include such promises, and an insurance contract (fire, marine) is treated as a contract of indemnity even though the loss is by natural event. So for the exam: the statutory definition is limited to loss by human conduct; the judge-made understanding is broader.

The essentials of a valid contract of indemnity — each one matters:

• All the essentials of a valid contract (s.10) — free consent, lawful consideration, competent parties, lawful object. An indemnity is a contract, so it needs everything an ordinary contract needs.
• A promise to save from loss — the core promise. Without an undertaking to bear loss, it is not indemnity.
• The loss must be caused by the promisor or by another person — this is the s.124 trigger.
• It may be express or implied — the promise need not be in writing or in set words; it can be inferred from conduct and circumstances (for example, where one person acts at the request of another, the law implies a promise to indemnify).

Rights of the indemnity-holder (s.125). This is the part examiners love, so learn the three rights as a set. When the indemnity-holder is sued in respect of the matter covered, he may recover from the indemnifier:

• All damages which he is compelled to pay in any suit in respect of any matter to which the indemnity applies (s.125(1)).
• All costs which he is compelled to pay in any such suit, provided he acted prudently, or with the indemnifier’s authority (s.125(2)).
• All sums paid under the terms of any compromise of any such suit, again provided the compromise was prudent or authorised (s.125(3)).

Commencement of the indemnifier’s liability — when does it start? The bare s.125 speaks of sums the indemnity-holder is “compelled to pay”. Read literally, that suggests he must actually pay first. But equity, applied in Gajanan Moreshwar, holds otherwise: once the indemnity-holder’s liability has become absolute and certain, he can compel the indemnifier to meet it — he need not first pay out of his own pocket and then sue. This is the practical heart of the topic.

🧩 WORKED EXAMPLE — indemnity before actual payment

Facts. A, at B’s request, guarantees C’s overdraft; B promises to indemnify A for anything A must pay. The bank obtains a decree against A for ₹5 lakh. A has not yet paid.

Rule. Under s.124–125 and Gajanan Moreshwar v. Moreshwar, once A’s liability is absolute (here, a decree exists), A may require B to put him in funds; he need not first pay ₹5 lakh from his own resources and then recover.

Apply. A’s liability is now fixed by the decree. So A can call on B to discharge it directly.

Conclusion. B must indemnify A now; A is not left to bear the loss first and claim later.

Section 124, Indian Contract Act 1872: “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’.”

In Simple Terms: One person (the indemnifier) promises to cover the other (the indemnity-holder) for any loss that the promisor or someone else causes. It is a two-party promise about loss.

flowchart TD
    A["Contract of Indemnity (s.124)"]
    A --> B["Indemnifier<br/>(promises to save from loss)"]
    A --> C["Indemnity-holder<br/>(protected person)"]
    C --> D["Rights (s.125)"]
    D --> E["Damages"]
    D --> F["Costs (if prudent)"]
    D --> G["Sums paid on compromise"]
    classDef box fill:#e8f0fe,stroke:#333,color:#111;
    class A,B,C,D,E,F,G box;

Case Laws

• [C-1] Gajanan Moreshwar v. Moreshwar Madan (1942) — the indemnity-holder can compel the indemnifier to meet a liability once it is absolute, before actually paying.
• Adamson v. Jarvis (1827) — one who acts on another’s request and is thereby exposed to loss is entitled to be indemnified (basis of implied indemnity).
• Osman Jamal & Sons v. Gopal Purshottam (1929) — an indemnity-holder may sue the indemnifier before discharging the liability, once it is ascertained.

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Contract of Guarantee

A shopkeeper will not give a young worker goods on credit — he does not know him. The worker’s employer steps in: “Let him have goods up to ₹10,000; if he doesn’t pay, I will.” That one sentence creates three relationships at once, and the whole law of guarantee flows from it.

What is a Contract of Guarantee?

A guarantee is the law’s answer to a simple commercial problem: a creditor is willing to lend or supply, but only if someone he trusts will stand behind the borrower. So a third person promises to answer for the borrower’s default.

Section 126 defines it. A contract of guarantee is a contract to perform the promise, or discharge the liability, of a third person in case of his default. Three parties are always involved:

• the principal debtor — the person whose debt or default is guaranteed;
• the creditor — the person to whom the guarantee is given (who is owed);
• the surety (or guarantor) — the person who gives the guarantee.

A guarantee may be oral or written (s.126). This is different from English law, which requires writing; under the Indian Act an oral guarantee is valid.

Essentials of a valid guarantee — each explained:

• A principal debt must exist (or be contemplated). The surety’s promise is secondary: it backs a primary liability of the principal debtor. If there is no enforceable principal debt, in general there is nothing to guarantee (but see the minor’s-debt point in Topic 4).
• All three parties and a concluded contract — there must be a debtor, a creditor and a surety, and the tri-partite arrangement must be complete.
• Consideration (s.127). Anything done, or any promise made, for the benefit of the principal debtor is sufficient consideration to the surety for giving the guarantee. The surety need not receive anything personally; the benefit to the principal debtor is enough. But the consideration must move at or after the guarantee — a benefit already conferred on the principal debtor before the guarantee was given is past consideration and is insufficient (s.127, illustration (c)).
• Consent must be free — no misrepresentation or concealment (ss.142–143). A guarantee obtained by misrepresentation of a material fact, or by keeping silent about a material circumstance, is invalid.
• The liability of the surety is co-extensive with that of the principal debtor unless the contract provides otherwise (s.128) — treated fully in Topic 7.

Kinds of guarantee. Two main classifications:

• Specific (or simple) guarantee — given for a single transaction or debt; it ends when that transaction is over.
• Continuing guarantee (s.129) — extends to a series of transactions (treated in Topic 6).

🧩 WORKED EXAMPLE — is there a valid guarantee?

Facts. A bank lends ₹2 lakh to D. S orally promises the bank: “If D defaults, I will pay.” Nothing is given to S personally.

Rule. Under s.126 a guarantee may be oral; under s.127 consideration to the surety may be the benefit conferred on the principal debtor.

Apply. The loan to D is the consideration; S need not be paid anything. The oral form is valid in India.

Conclusion. There is a valid contract of guarantee; S is bound as surety.

Section 126, Indian Contract Act 1872: “A ‘contract of guarantee’ 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’. A guarantee may be either oral or written.”

In Simple Terms: A guarantee is a three-party promise. The surety tells the creditor: if the principal debtor does not pay or perform, I will. Unlike indemnity, it is about someone else’s default, and it needs an existing or contemplated principal debt.

flowchart TD
    A["Contract of Guarantee (s.126)"]
    A --> B["Principal Debtor<br/>(owes the debt)"]
    A --> C["Creditor<br/>(is owed)"]
    A --> D["Surety<br/>(backs the debt)"]
    A --> E["Kinds"]
    E --> F["Specific / simple<br/>(one transaction)"]
    E --> G["Continuing (s.129)<br/>(series of transactions)"]
    classDef box fill:#e8f0fe,stroke:#333,color:#111;
    class A,B,C,D,E,F,G box;

Case Laws

• Swan v. Bank of Scotland (1836) — a surety’s liability depends on a valid principal debt; if the principal transaction is void, the surety is generally not liable.
• M.S. Anirudhan v. Thomco’s Bank (1963) — an alteration to the guarantee document beneficial to the surety does not discharge him.

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Indemnity vs Guarantee

Two promises sound almost the same: “I’ll cover your loss” and “if he doesn’t pay, I will.” But one has two parties and one has three; one is primary and one is secondary. Examiners set this distinction more often than almost anything else in Unit I, because getting the number of parties and the nature of liability right proves you understand both contracts at once.

How do they differ?

Both are ways of shifting risk, but they are built differently. Start from the two anchors: how many parties, and whose liability comes first.

In an indemnity there are two parties (indemnifier and indemnity-holder) and one contract; the indemnifier’s liability is primary and original — he is answering for a loss he has undertaken to bear. In a guarantee there are three parties (principal debtor, creditor, surety) and, in effect, three contracts; the surety’s liability is secondary and collateral — it arises only on the principal debtor’s default, and the primary liability rests on the principal debtor.

Learn the distinction as a table — that is exactly what “distinguish” wants:

💡 EXAM TIP — how to win the “distinguish” question

The trap. Most candidates define both contracts and stop, or give only two or three points of difference.

What to write. Open with s.124 and s.126 definitions in one line each, then a 6–7 row comparison table (parties, contracts, nature of liability, existing debt, purpose, request, subrogation), and close with one illustration of each.

Why it scores. The examiner is testing whether you can hold both contracts in view at once; the table proves it and is fast to write.

Section 124 & 126 (read together): indemnity = “save the other from loss” (two parties); guarantee = “discharge the liability of a third person in case of his default” (three parties).

In Simple Terms: Indemnity is a straight promise between two people about loss; guarantee is a three-cornered promise where the surety only pays if the real debtor defaults.

flowchart LR
    A["Risk-shifting contracts"]
    A --> B["Indemnity<br/>2 parties, primary liability"]
    A --> C["Guarantee<br/>3 parties, secondary liability"]
    C --> D["Needs an existing/contemplated principal debt"]
    B --> E["No existing debt needed"]
    classDef box fill:#e8f0fe,stroke:#333,color:#111;
    class A,B,C,D,E box;

Case Laws

• Punjab National Bank v. Sri Vikram Cotton Mills (1970) — the surety’s liability is secondary and arises on the principal debtor’s default.
• Gajanan Moreshwar v. Moreshwar Madan (1942) — illustrates the primary, direct nature of the indemnifier’s obligation (contrast with a surety).

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