Page 91 - DMGT102_MERCANTILE_LAWS_I

Unit 7: Contracts of Guarantee and Indemnity

Objectives Notes

After studying this unit, you will be able to:

z Discuss meaning and purpose of the contracts of indemnity and guarantee
z Explain essential features of both the indemnity and guarantee
z Describe different kinds of guarantee
z State difference between indemnity and guarantee

Introduction

In last unit, you studied about Contract Act and breach and anticipatory breach of contract.
When a company needs some money for its business it approaches a bank. The bank requires
that the managing director M promises to repay the loan personally should the company
default. When the directors of the company including M execute the promissory note on behalf
of the company, they sign as company’s offi cials. M, the managing director signs again as an
individual. The relationship between M and the bank is called a guarantee or surety ship. It is a
contractual relationship resulting from the unconditional promise of M (known as the surety or
guarantor) to repay the loan to the creditor (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. The law relating to the contracts of guarantee is given in the Indian Contract
Act, 1872 (Ss.126-147). The sections quoted in this unit refer to the contract of guarantee and
contract of indemnity.

7.1 Purpose and Meaning of the Contracts of Guarantee

In this unit our primary concern is with the contracts of guarantee which are used for securing
loan.

7.1.1 Purpose of Guarantee

The contracts of guarantee are among the most common business contracts and are used for a
number of purposes. These are:

1. The guarantee is generally made use of to secure loans. Thus, a contract of guarantee is for
the security of the creditor.
2. The contracts of guarantee are sometimes called performance bonds.

Example: In the case of a construction project, the builder may have to find a surety to
stand behind his promise to perform the construction contract.
Also employers often demand a type of performance bond known as a fi delity bond
from employees who handle cash, etc., for the good conduct of the latter. If an employee
misappropriates then the surety will have to reimburse the employer.
3. Bail bonds, used in criminal law, are a form of contract of guarantee. A bail bond is a device
which ensures, that a criminal defendant will appear for trial. In this way a prisoner is
released on bail pending his trial. If the prisoner does not appear in the court as desired
then the bond is forfeited.

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