Business Law

Difference between a contract of indemnity and a contract of guarantee When getting a bank loan, a person is often asked to provide a guarantee. Guarantee an indemnity are often used to reinforce each other.

Contract of indemnity contract of guarantee  A contract of indemnity is one in  A contract of guarantee is an which the party sought to be undertaking by which a person made liable him or herself accepts what is sometimes undertakes a primary liability to called a secondary liability to make good another’s loss, which answer for the debt or default of loss may or may not result from another person who is primarily the act of another (third) liable to a third. The contract of person. guarantee is between the first and the third persons.  It is original and independent. Example: X will loan money to Y, subject to Z providing security by guaranteeing the loan. The guarantor Z will only become liable under the guarantee if the principal debtor, Y, defaults.

 An indemnity is a personal security undertaking given by a third party, but under an indemnity the surety’s obligation is independent of debtor/creditor relationship. It is  A contract of guaranty is a collateral undertaking, and therefore a primary liability, not presupposes an original dependent on the debtor’s contract. default.  In a guarantee the liability  Indemnity is not given by arises at the point of time when repayment after payment. the principal borrower or debtor Indemnity requires that the defaults on his obligation. party to be indemnified shall Where there is liability even never be called upon to pay. though there is no default or  In a contract of indemnity not breach by the principal debtor, it only is there no requirement for is not a contract of guarantee. a default by a third party as a condition of liability but there may not even be a third party involved for either the creation or exercise of the right.

Example: By way of illustration, an insurance contract is an indemnity contract. A person who buys an insurance policy insures his property against damage. If and when the damage occurs, the insured is entitled to call upon the insurer to pay him.

The difference between indemnity and guarantee can be illustrated by example: If X says to Y: ‘Supply goods to Z and if he does not pay, I will’, X’s undertaking is a contract of guarantee, as payment by X is conditional on Y’s default. But if X says to Y: ‘Supply goods to Z and I will see you paid’, this is a contract of indemnity because X’s liability to pay is not contingent on Y’s default.

Conclusion:The essence of the matter is that there is a difference between a promise to pay the creditor if the debtor defaults on payment as compared to a promise to make payment irrespective of any default by anybody so long as the recovery of the money is unsuccessful. A guarantee involves a default by a third party and indemnity arises on the occurrence of an event.