MBA -Unit-4

8/2/2019 MBA -Unit-4

http://slidepdf.com/reader/full/mba-unit-4 1/24

Contracts of Guarantee and

Indemnity

MBA-Unit-4

8/2/2019 MBA -Unit-4


Introduction• In this unit you come to know when a company needs some money for

its business it approaches a bank.

• The bank requires that the managing director M promises to repay theloan personally should the company default.

• When the directors of the company including M execute thepromissory note on behalf of the company, they sign as company’s

officials. M, the managing director signs again as an individual.

• The relationship between M and the bank is called a guarantee orsuretyship.

• It is a contractual relationship resulting from the unconditional promiseof M (known as the surety or guarantor) to repay the loan to thecreditor (the bank) for the obligation of the principal debtor (the

company) should it default.• If the company fails to repay the loan, the bank can approach M for the

payment.

8/2/2019 MBA -Unit-4


Purpose of guarantee

• The contracts of guarantee are among the most common business contracts

and are used for a number of purposes. These are:

• i) The guarantee is generally made use of to secure loans. Thus, a contract

of guarantee is for the security of the creditor.

• ii) The contracts of guarantee are sometimes called performance bonds.

• iii) Bail bonds, used in criminal law, are a form of contract of guarantee.

8/2/2019 MBA -Unit-4


Definition and nature of the contract of

guarantee

• A contract of guarantee is defined as “a contract to perform thepromise, or discharge the liability, of a third person in case of hisdefault”.

• The person who gives the guarantee is called „surety‟; the person

for whom the guarantee is given is called the „principal debtor‟, andthe person to whom the guarantee is given is called the „creditor‟.

• A contract of guarantee may be either oral or in writing.

• It is clear that in a contract of guarantee there must, in effect, be twocontracts, a principal contract between the principal debtor and

creditor, and a secondary contract between the creditor and thesurety.

• In a contract of guarantee there are three parties, viz., the creditor,the principal debtor and the surety.

• Therefore, there is an implied contract also between the principal

debtor and the surety.

8/2/2019 MBA -Unit-4


• The contract of surety is not a contract collateral to the contract of the

principal debtor, but is an independent contract.

• There must be a distinct promise on the party of the surety to be assumable

for the debt.

• It is not necessary that the principal contract, between the debtor and the

creditor, must exist at the time the contract of guarantee is made; the original

contract between the debtor and creditor may be about to come into

existence.

• Similarly, under certain circumstances, a surety may be called upon to pay

though principal debtor is not liable at all.

• Also, where a person gives a guarantee upon a contract that the creditor shall

not act upon it until another person has joined in it as co-surety, the

guarantee is not valid if that other person does not join

8/2/2019 MBA -Unit-4


Fiduciary relationship

• A contract of guarantee is not a contract “uberrimae fidei” (requiringutmost good faith).

• Nevertheless, the suretyship relation is one of trust and confidence andthe validity of the contract depends upon good faith on the part of thecreditor.

• A creditor must disclose all those facts which, under the circumstances,the surety would expect not to exist.

• So where guarantee is given for good conduct of an employee, theemployer‟s failure to inform the surety of any breach on the part of employee, will discharge the surety.

•

Similarly, where X guarantees the existing and future liabilities of A toB upto a certain amount which limit has already been exceeded, thecontract of guarantee can be avoided on the ground of concealment of amateriel fact.

• However, it should be noted that it is no part of the creditor‟s duty toinform the surety about all his previous dealings with the debtor.

8/2/2019 MBA -Unit-4


Kinds of Guarantee• 1 Oral or written guarantee

• A contract of guarantee may either be oral or in writing (Sec.126), though acreditor should always prefer to put it in writing to avoid any disputeregarding the terms, etc. In case of an oral agreement the existence of theagreement itself is very difficult to prove.

• 2 Specific and continuing guarantee

• From the point of view of the scope of guarantee a contract of guaranteemay either by specific or continuing. A guarantee is a “specific guarantee”,if it is intended to be applicable to a particular debt and thus comes to endon its repayment. A specific guarantee once given is irrevocable.

• 3 A guarantee may either be for the whole debt or a part of the debt

•

Difficult questions arise in case of guarantee for a limited amount becausethere is an important distinction between a guarantee for only a part of thewhole debt and a guarantee for the whole debt subject to a limit.

8/2/2019 MBA -Unit-4


Rights and Obligations of the Creditor•

Rights of a creditor• 1. The creditor is entitled to demand payment from the surety

as soon as the principal debtor refuses to pay or makes defaultin payment.

• The liability of the surety cannot be postponed till all other

remedies against the principal debtor have been exhausted. Inother words, the creditor cannot be asked to exhaust all otherremedies against principal debtor before proceeding againstsurety.

•

The creditor also has a right of general lien on the securities of the surety in his possession. This right, however, arises onlywhen the principal debtor has made default and not before that.

• 2. Where surety is insolvent, the creditor is entitled to proceedin the surety‟s insolvency and claim the pro rata dividend.

8/2/2019 MBA -Unit-4


• Obligations imposed on a creditor in a contract of guarantee

• 1. Not to change any terms of the original contract. The creditor should

not change any terms of the original contract without seeking the consent of

the surety. Sec.133 provides. “any variance made, without the surety‟sconsent, in the terms of the contract between the principal debtor and the

creditor, discharges the surety as to the transactions subsequent to the

variance”.

• 2. Not to release or discharge the principal debtor. The creditor is under

an obligation not to release or discharge the principal debtor. Sec.134

states: “The surety is discharged by a contract between the creditor and

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”.

• 3. Not to compound, or give time to, or agree not to sue the principal

debtor. Sec.135 provides, “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 use the principal debtor, discharges the

surety, unless the surety assents to such contract”.

8/2/2019 MBA -Unit-4


• If the time for repayment is extended, the debtor may die or become insane orinsolvent or his financial position may become weaker in the meanwhile, withone effect that the surety‟s remedy to recover the money in case the principaldebtor defaults, may be impaired. However, there are certain exceptions. These

are:• a) Sec.136 states that if the creditor makes an agreement with a third party, but

not with the principal debtor, to give extension of time to the principal debtor,surety is not discharged even if his consent has not been sought.

• b) Mere forbearance on the part of creditor to sue the principal debtor, or toenforce any other remedy against him, does not, in the absence of a provision to

the contrary, discharge the surety (Sec.137).• c) If the creditor releases one of the co-sureties, the other co-surety (or co-

sureties) thereby is not discharged. The co-surety released by the creditor is alsonot released from his liability to the other sureties (Sec.138).

• 4. Not to do any act inconsistent with the rights of the surety (Sec.139). Where

C lends money to B on the security of a joint and several promissory note madein C‟s favour by B and by A as surety for B, together with a bill of sale of B‟sfurniture, which gives power to C to sell the furniture and apply the proceeds indischarge of the note. Subsequently, C sells the furniture, but owing to hismisconduct and willful negligence, only a small price is realised, then A isdischarged from liability on the note.

8/2/2019 MBA -Unit-4


Rights, Liabilities and Discharge of Surety

• Rights of a surety may be classified under three heads:

• (i) rights against the creditor,

• (ii) rights against the principal debtor and

•

(iii) rights against co-sureties.

8/2/2019 MBA -Unit-4


• Rights against the creditor

• In case of fidelity guarantee, the surety can direct creditor to

dismiss the employee whose honesty he has guaranteed, in the

event of proved dishonesty of the employee.

• The creditor‟s failure to do so will exonerate the surety from

his liability.

8/2/2019 MBA -Unit-4


• Rights against the principal debtor

• a) Right of subrogation:

• Sec.140 lays down that where a surety has paid the guaranteed debt

on its becoming due or has performed the guaranteed duty on thedefault of the principal debtor, he is invested with all the rightswhich the creditor has against the debtor.

• In other words, the surety is subrogated to all the rights which thecreditor had against the principal debtor.

•So, if the creditor loses, or without the consent of the surety parts

with any securities (whether known to the surety or not) the surety isdischarged to the extent of the value of such securities (Sec.141).

• Further, the creditor must hand over to the surety, the securities inthe same condition as they formerly stood in his hands.

• b) Right to be indemnified: The surety has a right to recover fromthe principal debtor the amounts which he has rightfully paid underthe contract of guarantee.

8/2/2019 MBA -Unit-4


• Rights against co-sureties

• a) Right of contribution . Where a debt has been guaranteed by

more than one person, they are called co-sureties. Sec.146

provides for a right of contribution between them. When a*surety has paid more than his share or a decree has been passed

against him for more than his share, he has a right of

contribution from the other sureties who are equally bound to

pay with him.• b) Where, the co-sureties have guaranteed different sums, they

are bound under Sec.147 to contribute equally, subject to the

limit fixed by their guarantee and not proportionately to the

liability undertaken.

8/2/2019 MBA -Unit-4


• Liability of surety

• Unless the contract provides otherwise, the liability of the surety isco-extensive with that of the principal debtor (Sec.128). In otherwords, the surety is liable for all those amounts the principal debtor

is liable for.• The liability of a surety is called as secondary or contingent, as his

liability arises only on default by the principal debtor.

• But as soon as the principal debtor defaults, the liability of thesurety begins and runs co-extensive with the liability of the principaldebtor, in the sense that the surety will be liable for all those sumsfor which the principal debtor is liable.

• The creditor may file a suit against the surety without suing theprincipal debtor.

• Further, where the creditor holds securities from the principaldebtor for his debt, the creditor need not first exhaust his remedies

against the securities before suing the surety, unless the contractspecifically so provides.

• The creditor is even not bound to give notice of the default to thesurety, unless it is expressly provided for.

8/2/2019 MBA -Unit-4


• Discharge of surety

• The liability of surety under a contract of a guarantee comes to an end under any one of thefollowing circumstances:

• 1. By notice of revocation (Sec.130). A continuing guarantee may at any time be revokedby the surety, as to future transactions, by notice to the creditor.

•

2. By the death of surety (Sec.131). The death of the surety operates, in the absence of anycontract to the contrary, as a revocation of a continuing guarantee, so far as regards futuretransactions.

• 3. By variance in terms of the contract (Sec.133). Any variance, made without the surety‟sconsent, in the terms of the contract between the principal debtor and the creditor,discharges the surety as to transactions subsequent to the variance.

• 4. By release or discharge of principal debtor (Sec.134). The surety is discharged by anycontract between the creditor and principal debtor, by which the principal debtor isreleased, or by any act or omission of the creditor, the legal consequence of which is thedischarge of the principal debtor.

• 5. By compounding with, or giving time to, or agreeing not to sue, principal debtor(Sec.135). A contract between the creditor and the principal debtor by which the creditormakes a composition with, or promises to give time to, or not to sue the principal debtor,discharges the surety. The surety shall, however, be not discharged if (a) he assents to suchcontract, (b) the contract to give time to the principal debtor is made by the creditor with a

third person and not with the principal debtor.• 6. By creditor’s act or omission impairing surety’s eventual remedy (Sec.139). If the

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

• 7. Loss of security. If the creditor loses or parts with any security given to him by theprincipal debtor at the time the contract of guarantee was made, the surety is discharged to

the extent of the value of the security, unless the surety consented to the release of suchsecurity

8/2/2019 MBA -Unit-4


Contract of Indemnity• 1 Meaning of indemnity

•

Secs.124 and 125 provide for a contract of indemnity.• Sec.124 provides that a contract of indemnity is a contract whereby one

party promises to save the other from loss caused to him (the promisee)by the conduct of the promisor himself or by the conduct of any otherperson.

•A contract of insurance is a glaring example of such type of contracts.

• A contract of indemnity may arise either by

• (i) an express promise r

• (ii) operation of law, e.g., the duty of a principal to indemnify an agentfrom consequences of all lawful acts done by him as an agent.

• The contract of indemnity, like any other contract, must have all theessentials of a valid contract.

• These are two parties in a contraction of identity indemnifier andindemnified.

•

The indemnifier promises to make good the loss of the indemnified

8/2/2019 MBA -Unit-4


Rights of the indemnified• He is entitled to recover from the promisor:

• (i) All damages which he may be compelled to pay in any suit in

respect of any matter to which the promise to indemnify applies;

• (ii) All costs of suit which he may have to pay to such third party,

provided in bringing or defending the suit

• (a) he acted under the authority of the indemnifier or

• (b) if he did not act in contravention of orders of the indemnifier

and in such a way as a prudent man would act in his own case;

• (iii) All sums which may have been paid under the terms of any

compromise of any such suit, if the compromise was not contrary

to the orders of the indemnifier and was one which it would have

been prudent for the promisee to make.

8/2/2019 MBA -Unit-4


Rights of the indemnifier

• The Act makes no mention of the rights of indemnifier.

• However, his rights, in such cases, are similar to the rights of a

surety under Sec.141, viz., he becomes entitled to the benefit

of all the securities which the creditor has against the principal

debtor whether he was aware of them or not.

8/2/2019 MBA -Unit-4


Commencement of indemnifier’s liability

• Indemnity requires that the party to be indemnified shall never

be called upon to pay. Indemnity is not necessarily given by

repayment after payment.

• The indemnified may compel the indemnifier to place him in

a position to meet liability that may be cast upon him without

waiting until the promisee (indemnified) has actually

discharged it.

8/2/2019 MBA -Unit-4


• Distinction between a contract of guarantee and a contract of indemnity. L.C.Mather in his book “Securities Acceptable to the Lending Banker” has verybriefly, but excellently, brought out the distinction between indemnity andguarantee by the following illustration.

• A contract in which

A says to B, „If you lend £20 to C, I will see that your money comes back‟ is anindemnity. On the other hand undertaking in these words, “If you lend £20 to Cand he does not pay you, I will is a guarantee.

• Thus, in a contract of indemnity, there are only two parties, indemnifier andindemnified. In case of a guarantee, on the other hand, there are three parties,the „principal debtor‟, the „creditor‟ and the „surety‟. Other points of differenceare:

• 1. The liability of a promisor is primary and independent in a contract of indemnity. In a contract of guarantee, the liability of the surety is secondary, theprimary liability being that of the principal debtor.

• 2. In the case of guarantee, there is an existing debt or obligation, theperformance of which is guaranteed by the surety. In case of indemnity thepossibility of any loss happening is a contingency against which the

indemnifier undertakes to indemnify.• 3. In a contract of guarantee, after discharging the debt, the surety is entitled to

proceed against the principal debtor in his own name while in case of indemnity, the indemnifier cannot proceed against third parties in his ownname, unless there is an assignment in his favour.

8/2/2019 MBA -Unit-4


Mini-case • "I didn‟t receive the products. The supplier said the goods were

detained in the Customs Office because Customs didn‟t find theoriginal invoice attached to the goods. The supplier explained thatit‟s his company‟s policy was to issue original invoices only whenquantities are above 5 units. He told me to pay for another 2 unitsfor another $150 USD, but I have refused. I paid by Western Union.He registered on your website as a US company, but actually it is

Chinese Company.• All his information is fraudulent. His is a fraudulent company!"

• If you think their price is very attractive and want to deal with them,it is very necessary for you to verify that they are legitimatecompany and their contact information is correct. In this case, the

fraudster is pretending to be a US company, but all his registeredinformation is false. This can be judged easily by calling hiscompany telephone number or by searching the company name onrelated state government websites.

8/2/2019 MBA -Unit-4


• Western Union is a dangerous payment method, it can be picked up anywhere in the recipient‟s country, with no way of tracing the person who picked it up. The criminal remains

anonymous. So it is a commonly used payment method forcon-artists. So try to avoid adopting this payment method andconsider other more secure payment methods like escrow.

• Questions

•

1. What would you understand if the seller requests you tosend payment to another country instead of his registeredcountry showed on the website? ( Hint: Refer First Para of case)

• 2. Analyze the ways in which a person can find out the

whether the company is fraudulent. ( Hint: Take fullknowledge about the product and company if you use virtualmode of transaction).

8/2/2019 MBA -Unit-4


• THANK YOU

Documents

MBA -Unit-4