This article has been written by Aaditya Kapoor, a law student of Vivekananda Institute of Professional Studies. Through his research, Aaditya strived to shed light upon contingent contracts, with special emphasis on two of its types: indemnity and guarantee.
According to Section-31 of the Indian Contract Act, the term ‘Contingent Contract’ is defined as a contract that requires action or abstinence from action, depending upon occurrence or non-occurrence of some event contingent to said contract. Simply put, contingent contracts are those where the Promiser only fulfils his obligation when certain conditions are met. While a contingent contract is based on an absolute commitment to do something in the event of a particular future occurrence, the agreement is conditional in the sense that the party is only liable to fulfil if the event happens (or does not occur).
This article shall shed light on two major types of Contingent Contracts: Indemnity and Guarantee.
CONTRACT OF INDEMNITY
An indemnity contract is one of the most significant types of trade contracts. Many businesses depend on such contracts, such as the insurance industry. This is because such contracts are of a sort. We ultimately allow companies to account for their losses, and therefore increased their risks. That is extremely important for both small and large enterprises. An insurance deal ultimately includes one party agreeing to make up its damages to the other. Such losses may occur either because of the other party’s actions or someone else’s. To compensate for something basically implies to make a loss fine. In other terms, one party must reimburse the other in the event that it experiences any damages. For instance, A promises to deliver some goods to B every month for Rs 2,000. C steps in and offers compensation for the damages of B if A fails to produce the product in this way. That is how B and C enter into mutual indemnity agreements.
An insurance policy is somewhat close to that of benefit contracts. The insurer here agrees to indemnify the insured for his damages. He gets appreciation in return in the form of a premium. However, this sort of exchange is not exclusively regulated by the Contract Act. This is because there are unique requirements for insurance contracts in the Insurance Act and other similar rules.
ESSENTIAL ELEMENTS OF INDEMNITY CONTRACT
1. Parties to Contract: There must be two parties, namely, the promisor or compensator, and the promisor or compensator.
2. Protection of Loss: An indemnity contract is concluded with a view to protecting the promisee from the loss. The loss may be caused by the Promiser’s or any other person’s actions.
3. Express/Implied Clause: The indemnity contract either be explicit (i.e. worded or written) or implied (i.e. inferred from the actions of the parties or the circumstances of the particular case).
4. Essentials of Legal Contract: Special kind of contract is an indemnity contract. These are similar to the principles of general contract law found in Sections 1 to 75 of the Indian Contract Act, 1872 and therefore, it must include all the basic elements of a legal contract.
RIGHTS OF INDEMNITY HOLDER
Pursuant to Section 125 of the Indian Contract Act, 1872, the following rights are available to the Promisee / Indemnified / Indemnified Holder against the Promisor / Indemnifier, given that he has behaved within the limits of his control.
Right to Recover Damages Paid in an Action [Section 125(1)]: An
indemnity-holder has the right to recover from the indemnifier any damages
which he might be forced to pay in any action in respect of any matter to which
the contract of indemnity relates.
RIGHT TO RECOVER Expenses INCURRED IN DEFENDING A SUIT [SECTION 125(2)]: an indemnity holder shall be entitled to recover from the indemnifier all expenses which he might be liable to pay in any such suit if, in bringing it in or defending it, he did not contravene the promiser ‘s orders and behaved as it would have been wise for him to act in the absence of any insurance deal.
2. Right to Recover Amount Paid under Compromise [Section 125(3)]: An indemnity holder shall also be entitled to recover from the indemnifier all amounts which he may have paid under any compromise of any such action, provided that the compromise was not contrary to the promiser’s orders and was one which the promised holder would have been prudent in the absence of any compensation contract.
CONTRACT OF GUARANTEE
The Contract Act also governs warranty contracts aside from indemnity contracts. Those contracts may seem similar to contracts for compensation but there are some differences between them. One party issues a guarantee contract to fulfil a third party commitment or discharge a third party liability. This will occur in case the third party refuses to meet its commitments and defaults. The burden of discharging the debt would, therefore, fall first on the defaulting third party.
The person granting the guarantee is the Surety. On the other hand, the principal debtor is the individual the Surety gives the guarantee for. Likewise, the person to whom he grants such a guarantee is the Creditor.
Example: A delivers products to B on C which guarantees payment from B to A. That means C would be liable to pay if B fails to pay. This is a “Guarantee Contract.” Here B is the principal debtor, C the guarantor, and A the creditor.
ESSENTIALS OF CONTRACT OF GUARANTEE
1. Agreement between all the parties: All three parties, namely the principal debtor, the creditor and the surety, must agree to enter into such a contract.
2. Liability: The liability of the surety is secondary in a guaranteed contract, i.e. the creditor must first proceed against the debtor and if the latter fails to fulfil his promise, then only he can proceed against the surety.
3. There’s a Debt: A guarantee contract pre-assumes the existence of a legal enforceable liability. If there is no such liability, then there can be no guarantee contract. So where the debt that is sought to be secured is already time-barred or invalid, there is no liability for the surety.
4. Consideration: Between the creditor and the guarantor there must be consideration to make the contract enforceable. The argument, too, must be true. In a guaranteed contract, the consideration that the principal debtor receives is taken as being the appropriate consideration for the protection.
5. Essentials of a Valid Contract: It must have all the essential elements of a valid contract, such as offer and acceptance, intention to establish a legal relationship, contracting capacity, genuine and free consent, legal object, legal consideration, certainty and possibility of performance and legal formality.
6. No Concealment of Facts: The creditor should disclose to the security the facts which are likely to affect the liability of the guarantor. The guarantee obtained from disguising such facts is invalid. Thus, if the borrower obtains it by concealing relevant evidence, the guarantee is null.
RIGHTS OF SURETY
1. Rights vs. Creditor: A borrower is liable for any protection that the creditor has against the principal debtor as per section-141. This holds true even if the security was unaware of the existence of such security at the time of entering into the guarantee contract.
2. Rights against the Principal Debtor: Once the surety discharges the debt, he obtains the rights of a creditor against the principal debtor. Now, due to the main debtor’s default, he can sue the principal debtor for the amount of debt he pays to the creditor.
3. Surety’s rights against the co-guarantees: When a surety pays the creditor more than its share, he has the right of co-guarantees to contribute, who are equally liable to pay.