Business LawChapter 5 Indemnity and Guarantee
Contract of Indemnity Definition and nature The term indemnity means to compensate or make good the loss. Section 124 provides that, “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.” The person who promise to make good the loss is called the indemnifier (Promisor). The person whose loss is to be made good is called the indemnity holder or indemnified (promisee).
Conti… A contract of indemnity is made to protect the promisee against anticipated (expected) loss. It depends upon happening of loss. Contract of insurance is example of indemnity. Examples In the case of home insurance, the homeowner pays insurance premiums to the insurance company in exchange for the peace of mind of knowing that he or she will be indemnified if the house sustain (protect) damage from fire, natural disasters or other danger specified in the insurance agreement. In the unfortunate event that the home is damaged significantly, the insurance company will undertake to bring it back to its original state, either by means of repairs undertaken by its authorized contractors, or by reimbursing the homeowner for expenditures incurred in connection with such repairs.
Essentials of contract of indemnity Following are the essential of a valid contract of indemnity: • It must contain all the essentials of a valid contract. • It is a contract between two parties. One person promises to save the other from any loss which he may suffer. • The loss may be caused by the conduct of the promisor himself or any other person.
Contract of Guarantee Definition Section 126 provides that, “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 contract of guarantee is made to enable a person to get a loan or goods on credit or an employment etc. It may be oral or written. It is a promise to perform the promise of the other, on his failure to do so. The person who gives guarantee is called the surety or guarantor. The person to whom the guarantee is given is called the creditor. The person in respect of whose default the guarantee is given is called the principal debtor.
Conti… Examples • A requests B to lend 500,000 AFN to C and guarantees that if C fails to pay, he will pay to B, there is a contract of guarantee. • A, on the request of B promises to the employer of B that if B Commits a fraud, he shall be liable. It is a contract of guarantee.
Essentials Following are the essential of contract of guarantee: • Tripartite (Three parties) Contract It is an agreement between the principal debtor, creditor and surety. The three separate contracts exist between them. If the promise by principal debtor is not fulfilled, the liability of the surety arises. In a contract of guarantee the principal debtor is liable and the surety will be liable on principal debtor’s default. The principal contract exists between the principal debtor and the creditor and the contract between creditor and surety is a secondary contract.
Conti… Example: X takes a loan of 5,000 AFNfrom Y on the guarantee of Z. The agreement between X and Y is the principal contract and the contract between Y and Z is a contract of guarantee. The liability of Z will arise only when X fails to repay the loan. • Consideration A contract of guarantee like other contracts must fulfill essentials of a valid contract. It must be supported by some consideration. It is not necessary that there must be direct consideration between the surety and the creditor. The consideration received by the principal debtor is sufficient for the surety. (Sec.127)
Conti… Examples • A sells goods on credit to B on C’s guarantee. C’s promise to guarantee is the consideration for A’s promise to sell the goods. • A sells goods to B. X requests A not to sue B for a week, and promises to pay, if B does not pay. It is a consideration for X promise.
Conti… • Misrepresentation A 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. If the consent of surety will be obtained by misrepresentation, the surety is discharged from his liability. (Sec.142) Example H was invited to give a guarantee for the honesty of L’s servant. The employer had already dismissed him for dishonesty but did not disclose this fact to the surety. The servant committed embezzlement (theft or fraud). The surety was held not liable. (LgoCo. Vs. Holloway)
Conti… • Concealment Any guarantee which the creditor obtains by means of keeping silence to material circumstance is invalid. The expression keeping silence means intentional concealment of the facts. The creditor should disclose to the surety the facts which are likely to affect the surety’s liability. (Sec. 143) Example: A employs B to recover money. B misappropriates the money, Later, A asks C for surety. C being unaware of B’s previous record gives guarantee for B. B again misappropriates the money. C‘s guarantee is invalid because A concealed the Facts.
Kinds of Guarantee A guarantee may be specific or continuing: • Simple guarantee A guarantee which extends to a single debt or transaction is called ordinary, simple or specific guarantee. It comes to an end as soon as the liability under the transaction ends. Example: G guarantees K for the payment of 5 bags of wheat purchased by C. C makes payments. Later, C again purchase 5 bags of wheat. C did not pay. K sued G. Held, G’s guarantee is specific guarantee and G is not liable. (Kyk vs. Groves 1829)
Conti… • Continuing guarantee A guarantee which extends to a series of transactions is called continuing guarantee. In other words a guarantee which covers a number of transaction over a period of time is called continuing guarantee. It is like a standing offer which is accepted by the creditor every time a subsequent transaction takes place. ( Sec. 129)
Conti… Examples: • A guarantees to C for B’s credit purchase with a running balance of account not exceeding 5,000 AFN. This is a continuing guarantee. • A guarantees to C for B’s purchases from C for six months to the extent (amount, level) of 5,000 AFN. This is a continuing guarantee.
Rights of Surety A surety has the following rights: • Rights against creditor The surety has the following rights against the creditor: • Right to Securities The surety at the time of payment can demand the securities which creditor has received from principal debtor at the time of creation of contract, whether surety is aware of such securities or not. If creditor by negligence loses any security held by him, the surety is discharged to the extent from the payment of guaranteed sum. (Sec. 141)
Conti… Example: C gives loan of 200,000 AFN to B on the guarantee of X. C also pledges (security will be with lender) B’s car. B fails to pay and X pays 200,000 AFN to C. X can get the car from C. b) Right to Claim Set-off If the principal debtor has some claims against the creditor, the debtor can ask for adjustment of his debts to the extent of his claims. If creditor sues surety for repayment, the surety can claim set off, if any which principal debtors had against creditor.
Conti… Example: A supplies furniture of 200,000 AFN to B on the guarantee of C. B claims that some furniture is defective and refuses to pay 20,000 AFN. C can ask for adjustment of 20,000 AFN.
Conti… • Rights against Principal Debtor The surety has the following rights against principal debtor: a) Right of Subrogation (Substitute) When surety has paid the guaranteed debt on default of principal debtor he/she is entitled to all the rights, which creditor had against principal debtor. The surety is entitled to all the remedies which are available to creditor against principal debtor. (Sec. 140)
Conti… Example: X borrowed money from Y on the guarantee of W and mortgaged his house to Y. X failed to pay and W paid. Now W can enforce the mortgage of the house against X. b) Right of compensation In every contract of guarantee there is a promise by principal debtor to compensate surety. The surety is entitled to recover from principal debtor whatever sum he has rightfully paid under the guarantee, but no sum which he has paid wrongfully. (Sec. 145)
Conti… Example: B get lone of 100,000 AFN from C, and A is the surety. B fails to pay. C demands payment from A. A refuses to pay. C sues A for the money, A defends the suit on reasonable grounds but loses and pays debts with cost of suits. A can recover the whole amount form B.
Discharge of Surety from Liability A Surety is discharged form liability in the following ways. 1. Notice of Revocation A specific guarantee can be revoked by notice if the liability has not arisen. But a continuing guarantee may at anytime be revoked by surety as to future transactions by giving a notice to creditor. The surety remains liable for transactions entered into prior to the notice. (Sec. 130) Example: A lends B a certain sum on the guarantee of C, C cannot revoke the guarantee. But if A has not yet given the sum to B, C may revoke the guarantee by giving a notice.
Conti… 2. Death of Surety In specific guarantee the surety is not discharged from his liability on his death if the liability has already occurred. But in a continuing guarantee the death of surety discharges him from liability regarding the transaction after his death, unless there is a contract to the contrary. The deceased surety’s estate will remain liable for the past transaction. (Sec. 130) Example: X sells goods to Y for 100,000 AFN, Z guarantee payment. X delivers goods worth 50,000 AFN. Latter, Z dies. Z’s property is liable up to 50,000 AFN.
Conti… 3. Change in Term of Contract When any change is made in the terms of the contract by principal debtor and creditor without the surety’s consent, the surety stands discharged with respect to transaction subsequent to the change. (Sec. 133) Example: M contracts to lend N 100,000 AFN on 1st December. S guarantees payment. M pays the amount on 1st January. S is discharged from his liability.
Conti… 4. Release or discharge of Principal Debtor The surety is discharged by any contract between creditor and principal debtor, by which principal debtor is released or by any act to omission (error) of creditor, the legal consequence of which is the discharge of principal debtor. (Sec. 134)
Conti… Examples: a) A contracts to build a house for B. C guarantees for the performance, if B releases A from the performance of the contract, the surety is discharged. b) A contracts to build house for B. B is liable to supply wood. C guarantees A’s performance of the contract. B fails to supply wood. C is discharged from his liability.
Conti… 5. Arrangement without Surety’s consent Where the creditor, without the consent of surety, makes an arrangement with principal debtor for composition (arrangement), or promises to give him time or not to sue him, the surety will be discharged. (Sec. 135) Where a contract to give time to principal debtor is made by the creditor with a third person, and not with principal debtor, the surety is not discharged. (Sec. 136)
Conti… Examples: a) P purchased a car form C on guarantee of S. C gave P more time for payment. Held, the giving of time of P dis- charged S from liability. (M.M Showroom Ltd vs. Newman 1929) b) A lends one million to B for 1 year on the guarantee of C. A, promises X a friend of B to give more time to B to return the loan. C is not discharged from his liability.
Conti… 6. Creditor’s act or Omission If the creditor does any act which is inconsistent (changeable) with the rights of the surety, or omits (fails, neglect) to do any act which his duty to the surety requires him to do, and the eventual (final) remedy of the surety himself against the principal debtor is impaired (decreased), the surety is discharged. (Sec. 139)
Conti… Examples: a)L contracts to build a ship for M for 1 million dollar which will be paid by installments as the work reaches certain stages. N guarantees to M for L’s performance. M without telling N, prepays the last two installments to L. N is discharged by this payment. b)A employs B as a cashier on the guarantee of M. A promises to count the cash of B at least once a month. A does not count the cash. B commits fraud. M is not liable to A.
Conti… 7. Loss of Security If the creditor loses or without the consent of the surety, parts with the security given by the principal debtor against the debt, the surety is discharged from liability to the extent of the value of security. If the security is lost due to any unexpected natural event, the surety would not be discharged. (Sec. 141) Example: A advances 200,000 AFN to B on the guarantee of X. A gets an additional security of 50,000 AFN of B’s Car. A cancels the pledge and returns the car. B become insolvent. X is discharged from the liability to the extent of value of car.