Characteristics or essentials of contract of guarantee

Following are the characteristics or essentials of contract of guarantee:

i. Tripartite agreement: In a contract of guarantee, there are three parties namely: principal creditor, creditor and surety. Under this contract, three separate contracts are made among them and consent of all the three parties is necessary. The contracts connecting each-other as contract between:

a. the principal debtor and creditor,

b. the creditor and surety, and

c. the surety and principal debtor,


ii. Liability: Under such contract the primary liability is of the principal debtor and only secondary liability is of the surety. As a conditional contract, liability of the surety arises only when the principal debtor (primarily liable) defaults.

iii. Essentials of valid contract: It is also as same as other general contract in respect of essentials. All the requirements for valid contract, i.e. free consent, consideration, lawful object, competency of the parties etc. are necessary to form this kind of contract. But, in respect of consideration, no direct consideration in the contract between the surety and creditor. Consideration of principal debtor is considered to be adequate for the surety.

iv. Written form: A contract relating to guarantee must be concluded in writing in Nepal and England. But, the Indian legal framework does not compel to form such contract in written form. Both written and oral is valid in India.

Contract of Guarantee

Meaning and definition

A guarantee means a contract of a promise to be responsible for something, to perform the promise or to discharge the liability of a third person, in case of his default. Such a contract involves three parties. They are:

i. Creditor: the person to whom the guarantee is given;

ii. Surety: the person who gives the guarantee.

iii. Principal debtor: the person, in respect of whose default, the guarantee is given.

Section 15(1) of NCA, 'A contract relating to a guarantee shall be deemed to have been concluded if it provides that, if any person in the repayment of loan obtained by him or fulfillment of the obligation accepted by him, it will be repaid or fulfilled by a third person.'

Section 126 of ICA, A contract of guarantee is a contract to perform the promise to discharge the liability of a third person in case of his default.

A clear definition was made regarding a guarantee by English Court in the case of Bricknyrs v. Darmell (1704), 'A contract of guarantee is a contract by one person to discharge the debt, fault or miscarriage of another.'

A contract of guarantee is entered into with the object of enabling a person to get a loan or goods on credit or an employment.

Example: If 'A' advances a loan of Rs. 5000/- to 'B' and 'C' promises to 'A' that if 'B' does not repay the loan, 'C' will do so. Here, this is a contract of guarantee.

It will be noticed that in a contract of guarantee there are three separate contracts, i.e.- i. between the principal debtor and creditor, ii. between the creditor and surety, and iii. between the surety and principal debtor, wherein the principal debtor requests the surety to act as surety and impliedly to indemnify the surety in case the surety incurs liability. Thus, the contract of guarantee is of tripartite nature. The primary liability is of the principal debtor. The secondary liability is of the surety which arises only when the principal debtor defaults. The surety must have to know all the facts regarding the contract. If any alteration regarding the terms of the contract are made without the consent of the surety, it terminates automatically.

Sec. 15(3) of NCA states that such a contract must be made in written form. The English law also accepts this rule but the Indian law accepts both written and oral contract of guarantee.

The Muluki Ain, 1963, Chapter on 'Jamani garneko', Chapter on 'Court Management', Chapter on 'Punishment' and Government Contract Arrangement Act, have made some legal provisions in this regard.

Rights and duties of indemnifier

Rights of the indemnifier:

The rights of the indemnity-holder are the duties of indemnifier, and duties of the indemnity-holder are the rights of the indemnifier. There are not prescribed any specific rights of the indemnifier either in Nepalese law or in Indian law. However, he is not liable for indemnity.

i. If indemnity-holder acts negligently.

ii. If indemnity-holder is acting with the intention of causing any loss or damage.

iii. If he is acting against the instructions of the other party (promisor).


Duties of indemnifier:
The duties of an indemnifier arise in the following circumstances:

i. There must be a loss in accordance with the contract to make the indemnifier liable.

ii. There must be an occurrence of the anticipated event. Without any occurrence of the prescribed event, there is no indemnity by the indemnifier.

iii. Where the right of indemnity is used by the indemnity-holder prudently and the instruction of the indemnifier is not contravened or when there is no breach of contract.

iv. If the costs demanded by the indemnifier are not caused by negligence, haphazard behaviour.

Rights and duties of indemnity-holder

Rights of indemnity-holder [Sec. 22(1) of NCA]

A person whose loss is to be made good is called the indemnity-holder. He has some rights against the indemnifier in accordance with the legal provisions incorporated under the Nepalese and Indian Contract Acts. But, the duties of the indemnity-holder have not been mentioned under the Acts. The indemnity-holder is entitled to recover any or all of the amounts of compensation under the contract. They are as follows:

i. All the indemnity amount (damage) prescribed in the contract.

ii. All the damages he may be compelled to pay a third party for the loss.

iii. All the costs spent on the case filed or defended by him in connection with the contract relating to indemnity.

iv. All the costs of legal actions, if it becomes necessary to initiate such an action for a failure to pay the amount mentioned in all the above clauses.

Duties of indemnity-holder

Except otherwise is mentioned in the contract, the indemnifier will not liable for the loss in the following circumstances. They are called duties of indemnity-holder too.

i. Duty to work prudently: Except otherwise is mentioned in the contract, the indemnifier will not liable for the loss caused by the negligence work of the indemnity-holder. In other words, it is the duty of indemnity-holder to work prudently.

ii. Duty not to act to cause harm or loss: If the indemnity-holder acting with the intention of causing any loss or damage, the indemnifier will not liable for such loss. In other words, it is the duty of indemnity-holder not to act to cause harm or loss.

iii. Duty to comply with the intention of promisor: If the indemnity-holder acting against the instruction of the other party or promisor, the indemnifier will not liable for the loss caused by such against act to his instruction. In other words, it is the duty of indemnity-holder to comply with the intention of promisor.

Kinds of contract of indemnity

A contract of indemnity can be classified into two categories on the basis of expression of the parties at time of its formulation as express and implied.

i. Express contract of indemnity: When the parties to contract expressly enter into a contract of indemnity. A party expressly promises to indemnify the other party from loss.

Example: A promise to compensate B if B’s goods are damaged due to the conduct of C.

ii. Implied contract of indemnity: When the contract of indemnity deemed to have concluded by the conduct of the parties or from the circumstances of the particular case, it is known as implied contract of indemnity.

Example: A hires a motorcycle from the B’s shop to use for one day. The motorcycle gets damaged due to the accident. Here, A has to compensate for damage to B, although he has not agreed expressly to do so.

Essentials or features of a contract of indemnity

A valid contract of indemnity should fulfill the following conditions:

i. Anticipated loss: A contract of indemnity is a security for an anticipated loss.

ii. Requirements of valid contract: Contract of indemnity being a species of contract must have all essentials of a valid contract like free consent, competence of the parties, consideration, etc.

iii. To save other party: There must be a promise to save the other party from some loss.

iv. Covers only the actual loss: It covers only the actual loss may be due to the promisor himself or any other person and it covers only the loss caused by an event mentioned in the contract. The event mentioned in the contract must happen.

v. May be express or implied: The contract of indemnity may be express or implied. An express promise is one where a person promises to compensate the other party in express term. Implied promise is one where the conduct of the promisor shows his intention to indemnify the other party from loss.

vi. Depend on good faith: This contract depends on good faith.

Distinctions between contract of indemnity and indemnity for breach