Difference between Contract of Indemnity and Guarantee

When two parties formally come together for business and enter into a contract, the main intention for both parties is to get protection from any sort of loss or damage. Careful drafting of a contract and managing proper financial arrangements can help in achieving the goal of protection for both parties. The Contract of Indemnity and Contract of Guarantee are contracts that are related to such special circumstances, where they establish the duties and rights for the parties in a contract in the event of any uncertainty. A Contract of Guarantee is an agreement to fulfill an agreed promise. Here three parties are involved, and the Contract of Indemnity establishes that one party will pay the other in case of any losses or case of an unprecedent event. Indian Contract Act, 1872 contains the provision related to the Contract of Indemnity and Guarantee under Sections 124 to 147.

What is Indemnity?

According to the provisions of Section 124 of the Indian Contract Act, 1872, a Contract of Indemnity is a type of contract where one party contracts with another party to save the other party from loss caused due to the conduct of the promisor or due to any other person. This arrangement between parties is called a Contract of Indemnity.

In a typical Contract of Indemnity, two parties are party to the contract. The party who makes a promise to indemnify against the loss is called an Indemnifier and the party in whose favor such a promise to indemnify is made is called an Indemnity Holder. Insurance is a well-known example of a Contract of Indemnity, where the insurance company promises the insurer that they will bear all expenses and pay for the damages in case of any event specified in the policy document, here the insurer pays the premium to subscribe to the policy.

For Example, A and B are partners in a business firm. C who is a relative of A, wants to join A and B as a business partner; however, B is hesitant to admit C as a partner in the firm. A promises to B, that in case of any wrongdoing by C, A will bear the loss and will indemnify B for any loss that happens due to the act of C. In continuance of their business, C made a wrong business decision and the firm realized a loss of ₹1,00,000 from the deal due to C. So, as per the contract between A and B, A will indemnify with the amount of ₹1,00,000 to cover up for the loss that happened due to C. A is the promisor, as he has promised B to indemnify the losses which arise due to the fault of C. B is the Indemnity holder, to whom the promise to save from losses has been made.

What is Guarantee?

According to the provisions of Section 126 of the Indian Contract Act, 1872, a Contract of Guarantee is a type of contract where one party promises the other party to perform the promise or to discharge the liability which is incurred by the third party due to his default. Contract of Guarantee can be either an Oral Contract or a Written Contract.

Under the Contract of Guarantee, there are three parties involved:

• The person who promises the guarantee is known as Surety.
• The one in whose respect, the guarantee by surety is given is known as Principal Debtor.
• The person to whom the guarantee by surety is given is called a Creditor.

Under the Contract of Guarantee, there exists three different contracts, Primary contract between the Principal Debtor and Creditor, Surety and Creditor, and Surety and Principal Debtor, as the Surety has the right to claim all the rightful amount he has paid to the Creditor. This is an Implied contract between the Surety and the Principal Debtor, even if the Creditor doesn’t sue the Principal Debtor or does not demand any amount from the Principal Debtor.

For Example, Anil obtains a loan from XYZ bank, and Brijesh promises the bank that if Anil fails to repay the loan amount, he will pay off the amount to the bank. This is a Contract of Guarantee. In any case, where Anil fails to pay off the loan amount, the bank can recover the amount from Brijesh and Brijesh will be liable to pay off the dues. Also, Brijesh will have the right to claim the amount he has paid to the bank from Anil. Here in this case, Anil is the Principal Debtor, and in his respect, Brijesh has given a guarantee to the bank. XYZ bank is the Creditor, Brijesh has given XYZ bank the guarantee, and the bank can recover the loan amount in case of default. Brijesh is the Surety, as he has given the guarantee to the bank in respect of Anil.

Difference between Indemnity and Guarantee

Basis of Difference	Contract of Indemnity	Contract of Guarantee
Definition	It is a contractual obligation where one party promises to pay for the loss or damages incurred by another party.	It is a legal promise made by a third party to pay off a debt or obligation of another party if the debtor fails to fulfill his obligation.
Purpose	The purpose of a Contract of Indemnity is to get compensated for loss by any event.	The purpose of the Contract of Guarantee is to get assurance that the performance of the contract will be done.
Nature of Obligation	Indemnity is a primary and independent obligation. Obligation here is contingent, the event may or may not happen.	Guarantee is a secondary obligation that comes into light only if the Debtor who holds primary responsibility makes a default.
Number of Parties Involved	An indemnity contract typically involves two parties which are the Indemnifier and the Indemnity Holder.	Guarantee contract typically involves three parties which are the Creditor, the Principal Debtor, and the Surety.
Number of Contracts	It consists of a single contract, which happens between the Indemnifier and the Indemnity Holder in case of loss.	Here, three contracts exist; between the Principal Debtor and Creditor, between the Surety and the Creditor in case of any default by the Debtor, and between the Surety and Principal Debtor.
Subsequent Recovery	Once the Indemnifier pays off the Indemnity holder, he can’t recover the amount from any third party.	Once the Surety has paid the Creditor, he has the right to recover from the Principal Debtor all the rightful amount he has paid to the creditor.
Requirement of Principal Debt	In a Contract of Indemnity, principal debt is not required.	In a Contract of Guarantee, the presence of principal debt is essential.

Conclusion

The Contract of Indemnity and Contract of Guarantee somehow fulfill the same purpose, but are distinct from each other. The main purpose of both contracts is to get assurance and protection for the parties to the contract. These types of contracts are widely used in businesses that are prone to risk and uncertainty. Here the idea is to get protected from losses. These contracts help parties to avoid default on payments, services, losses, or other actions of the contract. A person or party becomes responsible when the terms are not fulfilled as per the original agreement and becomes liable for their default. One of the basic differences between the two is that under a Contract of Indemnity, the principal debt is not required; whereas, under a Contract of Guarantee, principal debt is required.