Contracts of indemnity and guarantee are two legal concepts that provide protection against loss. While they share some similarities, there are important distinctions between the two. 

Indemnity

An indemnity contract is a promise by one party to compensate the other for any loss or damage that may occur as a result of a specified event. The party providing indemnity is called the indemnifier, while the party receiving indemnity is called the indemnitee. In the case of Mr. Joe, he would be the indemnitee, and Alpha Ltd would be the indemnifier.

In an indemnity contract, the indemnifier agrees to compensate the indemnitee for any loss or damage, regardless of who is at fault. In the case of Mr. Joe and Alpha Ltd, if a third party presents the original share certificate, Mr. Joe would be compensated by Alpha Ltd for any loss or harm, regardless of whether the loss was due to Alpha Ltd’s fault or not. The cost of indemnity is usually higher than the cost of a guarantee because the indemnifier takes on more risk.

Guarantee

A guarantee is a promise by one party to pay a debt or fulfill an obligation if the other party fails to do so. The party providing the guarantee is called the surety, while the party receiving the guarantee is called the principal debtor. In the case of Mr. Joseph, he would be the surety, Mr. Harry would be the principal debtor, and the bank would be the creditor.

In a guarantee contract, the surety agrees to pay the debt or fulfill the obligation if the principal debtor defaults. The surety’s liability is usually limited to the amount of the debt or obligation. In the case of Mr. Joseph and Mr. Harry, if Mr. Harry defaults on his loan from the bank, Mr. Joseph would be liable to pay the debt. The cost of a guarantee is usually lower than the cost of indemnity because the surety takes on less risk.

How to Identify a Contract of Indemnity or Guarantee

Whether a contract is a contract of indemnity or a contract of guarantee depends on the specific terms of the agreement. One way to identify a contract of indemnity or guarantee is to look for specific language in the contract. If the contract is named as a contract of guarantee or indemnity, or if those terms are used repeatedly throughout the agreement, it is likely a contract of that type.

Another way to identify a contract of indemnity or guarantee is to look at the liability of the parties involved. If the liability of a party exists irrespective of the default of the principal debtor or where such liability is for a greater amount than the amount payable by the principal debtor, the contract may be a contract of indemnity. On the other hand, if the surety’s liability is limited to the amount of the debt or obligation, it is likely a contract of guarantee.

Key Difference Between Contract of Indemnity and Contract of Guarantee

Contracts of indemnity and contracts of guarantee are two important types of contracts in commercial law. Although both of them involve the transfer of liability, there are significant differences between the two. 

The difference between contract of indemnity and contract of guarantee are:

Parties

The primary difference between the two types of contracts lies in the parties involved. A contract of indemnity involves two parties, namely the indemnifier and the indemnity holder. On the other hand, a contract of guarantee involves three parties, namely the principal debtor, the creditor, and the surety.

No. of Contracts

A contract of indemnity consists of only one contract between the indemnifier and the indemnity holder. The indemnifier promises to indemnify the indemnified/indemnity holder in the event of a certain loss. In contrast, a contract of guarantee consists of three contracts- a contract between the principal debtor and creditor wherein the debtor promises to perform his obligation/make payment, a contract between the surety and creditor wherein the surety promises to perform the aforesaid obligation/make the payment if the principal debtor makes a default, and an implied contract between the surety and the principal debtor wherein the principal debtor bounds himself to indemnify the surety for the sum that he has paid under the guarantee undertaken by him.

Nature of Liability

Another difference between contract of indemnity and contract of guarantee lies in the nature of liability. The liability of the indemnifier is primary. The liability in a contract of indemnity is contingent in the sense that it may or may not arise. In contrast, the liability of the surety is secondary, i.e., his obligation to pay arises only when the principal debtor defaults. 

Liability in a contract of guarantee is continuing in the sense that once the guarantee has been acted upon, the liability of the surety automatically arises. However, the said liability remains in suspended animation until the debtor makes default.

Default of Third Person

The liability of an indemnifier is not conditional on the default of somebody else. The liability of a surety, however, is conditional on the default of the principal debtor.

Principal Debt

A principal debt is necessary in a contract of guarantee, whereas no such requirement exists in a contract of indemnity.

Whether Subsequent Recovery is Possible

Once the indemnifier indemnifies the indemnity holder, he cannot recover that amount from anybody else. After the surety has made the payment, he steps into the shoes of the creditor and can recover the sums paid by him from the principal debtor.

Whether a Contract has to be in Writing or can be Oral as well

In India, contracts of indemnity and contracts of guarantee may be either oral or written.

Conclusion

Contracts of indemnity and guarantee are similar in that they provide protection against loss. However, the key difference between the two is that in a contract of indemnity, the indemnifier agrees to compensate the indemnitee for any loss or damage, regardless of fault, while in a contract of guarantee, the surety agrees to pay the debt or fulfil the obligation only if the principal debtor defaults. Identifying whether a contract is a contract of indemnity or guarantee depends on the specific terms of the agreement and the liability of the parties involved.