CMA Foundation – Meaning of Indemnity Guarantee, Pledge, Agent Lesson 2.7

In business and commerce, people often enter into agreements where one person promises to protect another from loss, guarantee someone’s performance, pledge goods for a loan, or act on another’s behalf. These are called special contracts, and they play a vital role in everyday business dealings. Understanding these contracts—Indemnity, Guarantee, Pledge, and Agency—is essential because they form the backbone of commercial law and financial transactions. You’ll learn all about these contracts in Lesson 2.7 – Meaning of Indemnity Guarantee, Pledge, Agent.

Contract of Indemnity

A contract of indemnity means a promise by one person to protect another from loss. According to Section 124 of the Indian Contract Act, 1872,

“A contract by which one party promises to save the other from loss caused to him by the conduct of the promisor or by the conduct of any other person is called a contract of indemnity.”

Example:
P agrees to indemnify Q against the consequences of any proceedings that R may take against Q. Here, P is the indemnifier, and Q is the indemnified.

Objective : The main objective of a contract of indemnity is to protect the promisee from unexpected losses.

Parties to the Contract

There are two parties:

1. Indemnifier (Promisor) – the person who promises to bear the loss.
2. Indemnified (Promisee) – the person whose loss is covered.

In the above example, P is the indemnifier, and Q is the indemnified.

Essentials of a Contract of Indemnity

1. Two Parties – The indemnifier and the indemnified must be clearly identified.
2. Protection Against Loss – The contract must aim to protect the promisee from loss caused by the promisor or another person.
3. Express or Implied – The promise can be either spoken/written (express) or understood from conduct (implied).
4. Valid Contract – All elements of a valid contract (offer, acceptance, consideration, etc.) must exist.
5. Single Contract – There is only one contract between the indemnifier and the indemnified.

Rights of the Indemnified (Section 125)

1. Right to Recover Damages – The indemnified can recover all damages paid in any suit covered by the indemnity.
2. Right to Recover Legal Costs – He can recover all court costs incurred while defending a case, if done within the authority of the indemnifier.
3. Right to Recover Compromise Amounts – He can recover any amount paid in compromise, if done prudently or with the indemnifier’s consent.
4. Right to Specific Performance – The indemnified can ask the indemnifier to directly pay the liability if it becomes absolute.

Case Example:
In Gajanan Moreshwar v. Moreshwar Madan (1942), the court held that if the indemnified has incurred an absolute liability, he can compel the indemnifier to make payment even before he actually suffers loss.

Contract of Guarantee

A contract of guarantee means a contract to perform the promise or discharge the liability of a third person in case he fails to do so. (Section 126, Indian Contract Act, 1872)

Example:
X gives a loan of ₹25,000 to Y. Z promises to repay the amount if Y fails. Here, X is the creditor, Y is the principal debtor, and Z is the surety.

Essential Elements

1. Valid Contract – It must meet all essentials of a valid contract.
2. Consideration – Anything done for the benefit of the principal debtor is sufficient consideration for the surety.
3. Competent Parties – All parties must be capable of contracting.
4. Recoverable Debt – There must be a valid, recoverable debt.
5. No Misrepresentation – The contract must be free from fraud or concealment.
6. Conditional Liability – The surety’s liability arises only when the debtor defaults.
7. Three Parties’ Consent – All three parties must agree.
8. Form – It may be oral or written.

Kinds of Guarantee

1. Specific Guarantee – Given for a single debt or transaction.
2. Continuing Guarantee – Covers a series of transactions until revoked.
3. Prospective or Retrospective – Given for future or past obligations.
4. Entire or Partial Debt – May cover the whole or part of the liability.

Revocation of Continuing Guarantee

1. By Notice – The surety can revoke future transactions by giving notice.
2. By Death – Death of the surety revokes the guarantee for future dealings.

Nature and Extent of Surety’s Liability

• Secondary – Arises only after the debtor defaults.
• Co-extensive – Same extent as the principal debtor unless agreed otherwise.
• Contingent – Depends on the debtor’s failure.
• Immediate – Surety is liable immediately on default.

Rights of Surety

As Against Principal Debtor

• Right of Subrogation – After paying the debt, the surety steps into the shoes of the creditor.
• Right of Indemnity – Surety can recover from the debtor all amounts paid.
• Right to Insist on Payment – Can demand that the debtor pays first.

Against Creditor

• Right to Benefit of Securities – Surety can claim the benefit of securities held by the creditor.
• Right to Ask Creditor to Proceed First Against Debtor.

Against Co-sureties

• Right to Contribution – When several sureties are liable, each must contribute equally.

Discharge of Surety

A surety is discharged from liability:

1. By Revocation – Notice, death, or novation (new contract).
2. By Creditor’s Act – Changing contract terms, releasing debtor, or giving more time.
3. By Invalid Contract – Misrepresentation, concealment, or lack of consent.

Pledge

A pledge is a bailment of goods as security for payment of a debt or performance of a promise. The person who pledges is called the pawnor, and the one to whom it is pledged is the pawnee.

Example:
B borrows ₹50,000 from A and gives his gold chain as security. This is a pledge.
B is the pawnor, and A is the pawnee.

Essentials of a Pledge

1. There must be a bailment for security.
2. The subject matter must be goods.
3. The goods must exist at the time of pledge.
4. There must be delivery of possession.

Rights of Pawnee

1. Right to Retain Goods (Sec. 173) – Until the debt, interest, and expenses are paid.
2. Right to Subsequent Debts (Sec. 174) – May retain goods for later advances if agreed.
3. Right to Extraordinary Expenses (Sec. 175) – Can recover expenses incurred for preserving goods.
4. Right on Default (Sec. 176) – May sue the pawnor or sell goods after giving reasonable notice.

Duties of Pawnee

• Take reasonable care of goods.
• Not make unauthorised use.
• Return goods on repayment.
• Not mix pledged goods with personal goods.
• Return any increase or accretion.

Rights of Pawnor

• Right to Redeem (Sec. 177) – Can redeem goods any time before sale, by paying due amount and expenses.

Pledge by Non-Owners

In certain cases, non-owners can make valid pledges:

1. By Mercantile Agent – If in possession of goods with the owner’s consent.
2. By Possessor of Limited Interest – Can pledge to the extent of his interest.
3. By Co-owner in Possession – With consent of others.

Contract of Agency

An agent is a person employed to act or represent another (called the principal) in dealings with third parties. Agency is based on the principle that “he who acts through another, acts himself.”

Creation of Agency

1. By Express Agreement (Sec. 186) – In writing or orally.
2. By Implied Agreement (Sec. 187) – Inferred from conduct or circumstances.
   • Agency by Estoppel – When someone allows another to appear as their agent.
   • Agency by Holding Out – When a person knowingly allows another to act for him.
   • Agency by Necessity – Created in emergencies (e.g., a carrier protecting goods).
3. By Ratification (Sec. 196) – Principal approves an act done on his behalf without prior authority.
4. By Operation of Law – Automatically arises in legal relationships like husband and wife.

Extent of Agent’s Authority

• Actual Authority (Sec. 188) – What the principal has given.
• Implied Authority – What is necessary to carry out duties.
• Sub-agent (Sec. 191) – A person appointed by the agent to assist in the business.
• Substituted Agent (Sec. 194) – Appointed with the principal’s consent, directly representing the principal.

Liability of Principal and Agent

• The principal is bound by lawful acts of the agent within authority.
• If the agent acts beyond authority, only the authorized part binds the principal.
• Personal Liability of Agent (Sec. 230) – Normally, agents are not personally liable unless:
  • Acting for a foreign principal.
  • Principal is undisclosed or cannot be sued.
  • Trade customs or contract specify otherwise.

Example : If A authorizes B to buy 500 sheep, but B also buys 200 lambs, A is not bound to accept the whole deal and can reject it.

Conclusion

Contracts of Indemnity, Guarantee, Pledge, and Agency form the foundation of commercial law under the Indian Contract Act, 1872. They ensure security, trust, and accountability in financial and business relationships.

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