Unit 3: Special contracts

I. Contract of Indemnity and Guarantee

This section deals with contracts that are contingent in nature, designed to protect a party from potential financial loss.

A. Contract of Indemnity

1. Definition and Core Concept (Section 124)

A Contract of Indemnity is a contract by which one party promises to save the other from loss caused to him by the conduct of the promisor himself, or by the conduct of any other person.

• Purpose: To protect the promisee against an anticipated loss.
• Parties:
  • Indemnifier: The person who makes the promise to compensate for the loss (the promisor).
  • Indemnity-holder / Indemnified: The person whose loss is to be compensated (the promisee).

Example:
A enters into a contract to indemnify B against the consequences of any proceedings which C may take against B in respect of a certain sum of money. This is a contract of indemnity. Most insurance contracts (except life insurance) are contracts of indemnity.

2. Essential Features of a Contract of Indemnity

1. Two Parties: Indemnifier and Indemnity-holder.
2. Protection from Loss: The primary purpose is to save the indemnity-holder from a loss. The loss must be caused by the conduct of the indemnifier or a third party. It generally does not cover losses from accidents or events not attributable to human conduct unless explicitly stated (as in insurance contracts).
3. Express or Implied: The promise to indemnify can be either expressly stated or implied from the circumstances of the case.
4. Essentials of a Valid Contract: It must fulfill all the requirements of a valid contract under the Indian Contract Act, 1872 (e.g., lawful consideration, free consent, lawful object).

3. Rights of the Indemnity-holder (Section 125)

When the indemnity-holder is sued, they are entitled to recover the following from the indemnifier:

1. All Damages: All damages which they may be compelled to pay in any suit in respect of any matter to which the promise to indemnify applies.
2. All Costs: All costs which they may be compelled to pay in bringing or defending such a suit. The indemnity-holder must have acted prudently and not contrary to the indemnifier's orders.
3. All Sums Paid in Compromise: All sums which they may have paid under the terms of any compromise of any such suit, provided the compromise was not contrary to the orders of the indemnifier and was a prudent one.

4. Commencement of Indemnifier's Liability

The Indian Contract Act, 1872 is silent on when the indemnifier's liability commences. However, various High Court judgments have established that the liability commences as soon as the liability of the indemnity-holder becomes absolute and certain. The indemnity-holder need not wait until they have actually paid for the loss.

Case Law Principle: Gajanan Moreshwar vs. Moreshwar Madan (1942)
The Bombay High Court held that if the indemnified has incurred an absolute liability, he is entitled to call upon the indemnifier to save him from that liability and pay it off.

B. Contract of Guarantee

1. Definition and Core Concept (Section 126)

A Contract of Guarantee is a contract to perform the promise, or discharge the liability, of a third person in case of his default.

• Purpose: To provide additional security to a creditor in the form of a promise from a third party (the surety).
• Parties:
  • Surety: The person who gives the guarantee.
  • Principal Debtor: The person in respect of whose default the guarantee is given.
  • Creditor: The person to whom the guarantee is given.

Example:
A requests B to lend ₹10,000 to C. A promises B that if C fails to repay the loan, A will repay it. Here, A is the Surety, C is the Principal Debtor, and B is the Creditor.

2. Essential Features of a Contract of Guarantee

1. Three Parties: Creditor, Principal Debtor, and Surety.
2. Three Contracts:
   • Primary Contract: Between the Principal Debtor and the Creditor.
   • Secondary Contract: Between the Surety and the Creditor (Contract of Guarantee).
   • Implied Contract: Between the Surety and the Principal Debtor (Principal Debtor is obligated to indemnify the surety if the surety has to pay).
3. Primary and Secondary Liability: The liability of the Principal Debtor is primary and absolute. The liability of the Surety is secondary and arises only upon the default of the Principal Debtor.
4. Existing Debt or Promise: The guarantee is given for a debt or a promise whose performance is due.
5. Essentials of a Valid Contract: It must satisfy all the essentials of a valid contract. However, consideration received by the principal debtor is sufficient consideration for the surety (Section 127). No direct consideration need flow from the creditor to the surety.
6. Writing Not Necessary: A contract of guarantee may be oral or written.

3. Types of Guarantee

1. Specific Guarantee: A guarantee given for a single, specific transaction. The surety's liability ends once that transaction is complete.

   • Example: S gives a guarantee to C for the payment of ₹5,000 worth of goods sold to P. C sells goods worth ₹5,000 to P. P pays for them. The guarantee is now discharged.

2. Continuing Guarantee (Section 129): A guarantee which extends to a series of transactions. The surety's liability extends to all transactions within the scope of the guarantee until it is revoked.

   • Example: S guarantees payment to C, a tea-dealer, for any tea he may supply to P up to a value of ₹1,00,000. C supplies P with tea to the value of ₹1,00,000, and P pays C. C later supplies P with tea worth ₹2,00,000. P fails to pay. S's guarantee is a continuing one, and he is liable to C up to ₹1,00,000.

4. Revocation of a Continuing Guarantee

A continuing guarantee can be revoked in the following ways:

1. By Notice (Section 130): The surety can revoke the guarantee for future transactions by giving notice to the creditor. The surety remains liable for transactions already entered into before the notice.
2. By Death of the Surety (Section 131): The death of the surety operates as a revocation of a continuing guarantee for future transactions, unless there is a contract to the contrary.

C. Distinction between Contract of Indemnity and Guarantee

D. Rights of a Surety

A surety has rights against the other parties to the contract.

1. Rights against the Principal Debtor

• Right of Subrogation (Section 140): Upon payment of the debt, the surety is "subrogated" to all the rights that the creditor had against the principal debtor. The surety steps into the shoes of the creditor.
• Right of Indemnity (Section 145): In every contract of guarantee, there is an implied promise by the principal debtor to indemnify the surety. The surety is entitled to recover from the principal debtor whatever sum he has rightfully paid under the guarantee.

2. Rights against the Creditor

• Right to Securities (Section 141): A surety is entitled to the benefit of every security which the creditor has against the principal debtor at the time when the contract of suretyship is entered into. If the creditor loses or parts with such security without the consent of the surety, the surety is discharged to the extent of the value of the security.
• Right to Set-off: The surety can claim any set-off or counterclaim which the principal debtor might have against the creditor.

3. Rights against Co-sureties

• Right to Contribution (Sections 146-147): When two or more persons are co-sureties for the same debt, they are liable to contribute equally to the payment of that debt (or in the proportion specified in their agreement). If one co-surety pays more than his share, he has a right to claim contribution from the others.

E. Discharge of Surety's Liability

A surety is discharged from his liability under the following circumstances:

1. By Revocation:
   • Revocation by notice for future transactions in a continuing guarantee (Sec 130).
   • Revocation by surety's death in a continuing guarantee (Sec 131).
2. By Conduct of the Creditor:
   • Variance in Terms of Contract (Section 133): Any variance made without the surety’s consent in the terms of the contract between the principal debtor and the creditor discharges the surety as to transactions subsequent to the variance.
   • Release or Discharge of Principal Debtor (Section 134): The surety is discharged by any contract between the creditor and the principal debtor, by which the principal debtor is released, or by any act or omission of the creditor, the legal consequence of which is the discharge of the principal debtor.
   • Compounding with, or giving time to, the Principal Debtor (Section 135): If the creditor, without the surety's consent, makes a composition with, or promises to give time to, the principal debtor, the surety is discharged.
   • Impairing Surety's Remedy (Section 139): If the creditor does any act which is inconsistent with the rights of the surety, or omits to do any act which his duty to the surety requires him to do, and the eventual remedy of the surety himself against the principal debtor is thereby impaired, the surety is discharged.
3. By Invalidation of the Contract of Guarantee:
   • Guarantee obtained by Misrepresentation (Section 142): When the guarantee has been obtained by means of misrepresentation made by the creditor concerning a material part of the transaction.
   • Guarantee obtained by Concealment (Section 143): When the guarantee is obtained by means of keeping silence as to a material circumstance.
   • Failure of Co-surety to join (Section 144): Where a person gives a guarantee upon a contract that a creditor shall not act upon it until another person has joined in it as co-surety, the guarantee is not valid if that other person does not join.

II. Contract of Agency

A. Definition and Core Concept (Section 182)

An Agent is a person employed to do any act for another or to represent another in dealings with third persons. The person for whom such act is done, or who is so represented, is called the Principal.

• Core Principle: Qui facit per alium facit per se (He who acts through another does the act himself). The acts of the agent are considered the acts of the principal.
• Purpose: To enable the principal to conduct business and enter into contracts with third parties through the medium of an agent.

1. Essential Features of a Contract of Agency

1. Principal and Agent: There must be two distinct parties.
2. Agreement: An agreement (express or implied) whereby the agent is appointed to act on behalf of the principal.
3. Intention to Represent: The agent must be appointed with the intention of representing the principal in dealings with third parties.
4. Capacity of Principal: The principal must be of the age of majority and of sound mind (competent to contract) (Section 183).
5. Capacity of Agent: An agent need not be competent to contract. Even a minor can be an agent, but they will not be personally liable for their acts (Section 184).
6. Consideration Not Necessary: No consideration is necessary to create an agency (Section 185).

B. Creation of Agency

An agency can be created in several ways:

1. By Express Agreement

When the authority is given to the agent by words, spoken or written. This is the most common method. A formal written agreement is known as a Power of Attorney.

2. By Implied Agreement

Agency that arises from the conduct, situation, or relationship of the parties.

• Agency by Estoppel: Where a person, by his words or conduct, leads a third party to believe that another person is his agent, he is later estopped (prevented) from denying the agency.
• Agency by Holding Out: A form of estoppel where the principal has previously "held out" a person as his agent, even if the agency has been terminated (without notice to the third party).
• Agency by Necessity: Arises in an emergency where a person is entrusted with another's property and it becomes necessary to act to protect that property, even without express authority. Key conditions:
  • Inability to communicate with the principal.
  • The act must be done to prevent loss to the principal.
  • The agent must have acted in good faith and in the best interest of the principal.

3. By Ratification (Section 196)

Where a person (the agent) acts on behalf of another (the principal) without their knowledge or authority, the principal may later choose to ratify (accept or adopt) the act. If ratified, the act has the same effect as if it had been performed with prior authority.

• Conditions for Valid Ratification:
  • The agent must have purported to act for a named or identifiable principal.
  • The principal must have been in existence and competent to contract at the time the act was done.
  • The principal must have full knowledge of the material facts.
  • The act to be ratified must be lawful.
  • Ratification must be of the whole transaction, not just a part of it.

4. By Operation of Law

Agency can also arise by operation of law, such as when a partner in a partnership firm acts as an agent for the other partners.

C. Duties and Rights of an Agent

1. Duties of an Agent to the Principal

• To follow Principal's directions (Sec 211): An agent must conduct the business according to the principal's directions, or according to the custom of trade if there are no directions.
• To act with reasonable care and skill (Sec 212): The agent must act with the skill generally possessed by persons engaged in similar business.
• To render proper accounts (Sec 213): The agent is bound to render proper accounts to his principal on demand.
• To communicate with the Principal (Sec 214): In cases of difficulty, the agent must use all reasonable diligence to communicate with the principal and seek instructions.
• Not to deal on his own account (Sec 215): The agent must not deal on his own account in the business of the agency without first obtaining the consent of the principal.
• Not to make any secret profit (Sec 216): An agent must not make any secret profit from the agency business. If he does, the principal can claim it.
• To pay sums received for the Principal (Sec 218): The agent must pay to the principal all sums received on his account.
• Not to delegate authority (Sec 190): An agent cannot lawfully employ another to perform acts which he has expressly or impliedly undertaken to perform personally (Delegatus non potest delegare - a delegate cannot further delegate).

2. Rights of an Agent

• Right to Remuneration (Sec 219): An agent is entitled to the agreed remuneration, or a reasonable remuneration if none is fixed, upon the completion of the act.
• Right of Retainer (Sec 217): An agent may retain, out of any sums received on account of the principal, all monies due to himself in respect of advances made or expenses properly incurred.
• Right of Lien on Principal's Property (Sec 221): An agent has the right to retain the principal's goods, papers, and other property until the amount due to him for commission, disbursements, and services has been paid.
• Right to be indemnified (Sec 222): The agent has a right to be indemnified by the principal against the consequences of all lawful acts done in the exercise of his authority.

D. Agent's Authority

1. Actual / Express Authority

Authority given by the principal to the agent in writing or by spoken words.

2. Implied Authority (Section 187)

Authority which is inferred from the circumstances of the case, the nature of the business, or the conduct of the parties. It includes doing all lawful things necessary to carry out the express authority.

3. Apparent / Ostensible Authority

This is not actual authority but is the authority an agent appears to have to a third party. If a principal's words or conduct lead a third party to reasonably believe that the agent has authority, the principal will be bound by the agent's acts. This is based on the principle of estoppel.

E. Sub-agents and Substituted Agents

• Sub-agent (Section 191): A person employed by, and acting under the control of, the original agent in the business of the agency.

  • The principal is bound by the acts of a properly appointed sub-agent.
  • The agent is responsible to the principal for the acts of the sub-agent.
  • There is no privity of contract between the principal and the sub-agent.

• Substituted Agent (Section 194): An agent appointed by the original agent, on the authority of the principal, to act for the principal in a part of the agency business.

  • A substituted agent is an agent of the principal, not the original agent.
  • There is privity of contract between the principal and the substituted agent.
  • The original agent's duty is only to exercise due care in selecting the substituted agent.

F. Termination of Agency

An agency can be terminated in two ways:

1. By Act of the Parties

• Agreement: By mutual agreement between the principal and the agent.
• Revocation by the Principal (Sec 203): The principal may revoke the agent's authority at any time before the authority has been exercised so as to bind the principal.
• Renunciation by the Agent (Sec 206): The agent may renounce the business of the agency by giving reasonable notice to the principal.

2. By Operation of Law (Section 201)

• Completion of the business of agency.
• Expiry of the time period for which the agency was created.
• Death or insanity of either the principal or the agent.
• Insolvency of the Principal.
• Destruction of the subject matter of the agency.

3. Irrevocable Agency (Section 202)

An agency cannot be terminated to the prejudice of the agent's interest in the subject matter. This is called "agency coupled with an interest".

• Example: A gives authority to B to sell A's land and to pay himself, out of the proceeds, the debts due to him from A. A cannot revoke this authority, nor can it be terminated by his insanity or death.