CMA Foundation · Fundamentals of Business Laws and Business Communication

Meaning of Indemnity, Guarantee, Pledge, Agent: formula sheet

Full chapter guide

Key formulas

Definition of indemnity (Section 124): Promise to save the other from loss caused by the promisor's conduct or by the conduct of any other person; This is the test. If there is a promise to make good a loss caused by human conduct, it is indemnity.
Parties: Indemnifier = promisor (gives the promise); Indemnity-holder = promisee (is protected); Questions often ask who is who. The one who promises to compensate is the indemnifier.
Rights of indemnity-holder (Section 125): Can recover from the promisor: (1) all damages he is compelled to pay in any suit in respect of any matter to which the promise to indemnify applies; (2) all costs he is compelled to pay in any such suit, if in bringing or defending it he did not contravene the promisor's orders and acted as he would have done if there had been no contract of indemnity, or if the promisor authorised him to bring or defend the suit; (3) all sums paid under a compromise of the suit, if the compromise was not contrary to the promisor's orders and was prudent, or was authorised by the promisor; The right arises when he is acting within the scope of the indemnity. Remember the three heads: damages, costs, compromise sums. Damages need the suit to be on a matter covered by the promise; costs and compromise sums carry extra conditions.
Nature of the contract: Indemnity = a contract with two parties; the promise is to compensate for loss; Guarantee has three parties. Keep the two-party versus three-party contrast ready.
Definition of guarantee (Section 126): Guarantee = contract to perform the promise or discharge the liability of a third person on his default; The word 'third person' is the key. Without a principal debtor, there is no guarantee.
Surety: Surety = person who gives the guarantee; His liability is secondary and arises on the default of the principal debtor.
Principal debtor: Principal debtor = person in respect of whose default the guarantee is given; He owes the primary liability to the creditor.
Creditor: Creditor = person to whom the guarantee is given; He can be the lender, seller or employer, depending on the facts.
Form of guarantee: Guarantee may be either oral or written; Writing is not compulsory under the Act.
Number of contracts: Three parties and three relationships: creditor-debtor, creditor-surety, surety-debtor; There is usually a contract between each pair, though the debtor-surety one is often implied.
Extent of surety's liability: Surety's liability is co-extensive with that of the principal debtor, unless the contract provides otherwise; This is the rule in Section 128. If the debtor owes ₹2,00,000, the surety is ordinarily liable for that amount, up to any limit agreed.
Consideration in guarantee: Anything done or promised for the principal debtor is sufficient consideration for the surety; The surety need not receive any benefit himself. This is the rule in Section 127.
Specific guarantee: Specific guarantee = guarantee for a single debt or transaction; Ends when that debt is paid or the transaction is over.
Continuing guarantee (Section 129): Continuing guarantee = guarantee extending to a series of transactions; One guarantee covers many dealings, such as running credit supply.
Revocation by notice (Section 130): Notice by surety to creditor → revokes for future transactions; Applies only to a continuing guarantee. Past transactions remain covered.
Revocation by death (Section 131): Death of surety → revokes for future transactions (unless contract says otherwise); Applies to a continuing guarantee. Liability for earlier transactions passes to the surety's estate.
Meaning of pledge: Pledge = bailment of goods as security for payment of a debt or performance of a promise; Bailor is called pawnor and bailee is called pawnee.
Essentials of a valid pledge: Movable goods + delivery of possession + security for debt or promise + a valid contract; No delivery means no pledge. Immovable property gives a mortgage, not a pledge.
Pawnee's right of retainer (Section 173): Pawnee may retain the goods for the debt or promised performance, interest on the debt and necessary expenses of possession or preservation; Retainer does not extend to other debts unless there is a contract to that effect.
Pawnee's extraordinary expenses (Section 175): Pawnee may claim extraordinary expenses incurred to preserve the goods; The pawnor must repay them. They are separate from the ordinary necessary expenses of keeping the goods.
Pawnee's right of sale (Section 176): Pawnor defaults at the stipulated time + reasonable notice to pawnor = right to sell the goods; If sale proceeds are less than the dues, the pawnor stays liable for the balance. Surplus goes to the pawnor.
Pawnee's right to sue (Section 176): Pawnee may sue on the debt and also retain the goods as collateral security; Suing does not by itself end the right to hold the goods.
Pawnee's duties: Take reasonable care + do not use the goods for own benefit + do not mix them with own goods + return them on payment; Failure to do so makes the pawnee liable for loss or damage.
Pawnor's duty and right (Sections 150 and 177): Pawnor, as bailor, must disclose known faults in the goods (Section 150). After default, pawnor may redeem the goods at any time before actual sale by paying the debt together with any expenses arising from the default (Section 177); Once the goods are actually sold, the right to redeem ends. After default, paying the debt alone is not enough; the expenses arising from the default must also be paid.
Pledge by mercantile agent (Section 178): Mercantile agent + possession of goods or documents of title with owner's consent + pledge made as a mercantile agent in the ordinary course of business + pawnee in good faith without notice of lack of authority = valid pledge; All four conditions must be met. The owner's consent relates to the agent's possession of the goods or documents of title.
Pledge by person with voidable title (Section 178A): Voidable contract not yet rescinded at the time of pledge + pawnee in good faith without notice = valid pledge; The pledge is good only if the owner has not rescinded the voidable contract before the pledge.
Pledge by pledgor with limited interest (Section 179): Pledgor with only a limited interest in the goods can pledge to the extent of that interest; The pawnee gets only that interest unless another exception applies.
Other non-owners in possession: Seller or buyer in possession: Sale of Goods Act, Sections 27 and 30. A co-owner can pledge only his own share unless the other co-owners authorise the pledge of the whole; Do not call seller or buyer in possession a Contract Act pledge exception. Cite the Sale of Goods Act sections.
Meaning of agent: Agent = person employed to do an act for another or to represent another in dealings with third persons; The one for whom the act is done or who is represented is the principal.
Who may employ an agent: Principal must be of the age of majority (as per the law to which he is subject) and of sound mind (S.183); These conditions apply to the principal, not to the agent.
Who may be an agent: Any person may become an agent, even a minor or person of unsound mind (S.184), but he is answerable to the principal only if he is a major and of sound mind; Such an agent is not responsible to the principal for his acts; the principal is still bound to third parties.
Consideration: No consideration is necessary to create an agency; A gratuitous agent is still a valid agent.
Modes of creation: Express, implied, necessity, estoppel (also called holding out in many texts), ratification, operation of law; Estoppel and holding out are treated as the same idea in many texts. Learn the list as given in your study material and match the facts to the mode.
Kinds by scope of authority (common-law classification): Special agent = a particular act; general agent = all acts in a particular business; The key word is the scope of work. The Act itself deals with agent, sub-agent and substituted agent. A 'universal agent' is outside the Act.
Sub-agent and substituted agent: Sub-agent = employed by the agent and under the agent's control (S.191); substituted agent = person named by an agent, holding authority to do so, to act for the principal in the business of agency; he becomes the principal's agent (S.194); Check whose control the second person works under. If the agent used the discretion of a man of ordinary prudence in choosing a substituted agent, he is not responsible to the principal for that person's acts or negligence (S.195).
Mercantile agent: Agent having authority to sell goods, consign goods for sale, buy goods or raise money on their security in customary course of business; Factor, broker and commission agent are common examples.
Del credere agent: Commission agent who also guarantees to the principal that the buyer will pay; He gets extra commission for taking the credit risk.
Creation of agency: No consideration is needed to create an agency; The principal must be a major and of sound mind (s.183). A person who is not a major or not of sound mind may be an agent (s.184), but is not responsible to the principal. The principal remains bound to third parties.
Types of authority: Express + Implied + Emergency; Implied authority arises from conduct, nature of the job or trade usage. Ostensible authority (holding out) is agency by estoppel, not a statutory type.
Agent's main duties: Obey directions, use skill and care, render accounts, communicate, no secret profit, no dealing on own account without consent, pay over sums received; Breach of a duty makes the agent liable to the principal.
Agent's rights: Remuneration + Retention (lien) + Indemnity; Indemnity applies to lawful acts done in good faith within authority.
Sub-agent vs substituted agent: Sub-agent: agent's own appointee. Substituted agent: named on the principal's instruction, acts for the principal.; The agent is liable to the principal for a sub-agent's acts. For a substituted agent, the agent is liable only for want of due care in choosing him.
Ratification: Ratification = acceptance by principal, with full knowledge, of an act done without authority; it may be express or implied by conduct (s.197); The act must be ratified as a whole. Under s.200 it cannot make a third person liable in damages or end a third person's right or interest. The principal must have been in existence and competent when the act was done.
Termination of agency: Agreement, expiry of time, revocation, renunciation, completion, death or insanity of either party, principal's insolvency; Agreement and expiry of time are accepted textbook modes. Section 201 lists revocation, renunciation, completion, death or insanity, and the principal's insolvency. No revocation when the agent has an interest in the subject matter (s.202). Reasonable notice of revocation or renunciation is needed (s.206).

Quick revision

Indemnity has two parties: the indemnifier and the indemnity-holder.
Guarantee has three parties: creditor, principal debtor and surety.
A guarantee needs a promise to perform or discharge another person's liability on default.
The surety's liability is secondary only in the sense that it arises when the principal debtor defaults. It is co-extensive with the debtor's liability, and the creditor can proceed against the surety directly.
A continuing guarantee covers a series of transactions.
A surety who pays the debt steps into the creditor's position against the principal debtor.
Bailment is delivery of goods for a purpose, to be returned or disposed of as directed.
The person delivering goods is the bailor, and the person receiving them is the bailee.
Pledge is bailment of goods as security for a debt or promise, with the pledgor and pledgee as parties.
An agent acts for a principal, and the principal is bound by the agent's acts within authority.
Agency can end by revocation by the principal, renunciation by the agent, completion of the business, death or unsoundness of mind of either party, or the principal being adjudicated insolvent. An agency may also end as its own terms provide, for example when it was made for a fixed period.
In every question, identify the parties first, then match the rule.

Common mistakes

Confusing indemnity with guarantee. Fix: Indemnity has two parties and the promise is to cover loss. Guarantee has three parties: creditor, principal debtor and surety.
Swapping indemnifier and indemnity-holder. Fix: The indemnifier is the one who promises. The indemnity-holder is the one who is protected and receives compensation.
Treating the creditor as the person who gives the guarantee. Fix: The creditor receives the guarantee. The surety gives it. Remember: surety = secure the loan.
Saying a guarantee must be in writing. Fix: Under the Indian Contract Act, a guarantee may be oral or written.
Thinking revocation cancels liability for transactions already made. Fix: Remember revocation works only for future transactions. Past ones remain the surety's liability.
Applying Section 131 to every guarantee. Fix: First classify the guarantee. Death revokes only a continuing guarantee, and even then only if no contrary contract exists.
Treating every bailment as a pledge Fix: Ask the purpose. If goods are given as security for a debt or promise, it is a pledge. Otherwise it is an ordinary bailment.
Saying the pawnee can sell immediately on default Fix: Always add that the pawnor must have defaulted at the stipulated time and that reasonable notice must be given to the pawnor before sale (Section 176).
Saying a minor cannot be an agent at all. Fix: Under S.184 a minor may be an agent and bind the principal to third parties. He just is not personally answerable to the principal.
Thinking consideration is required to create agency. Fix: Remember the specific exception: agency needs no consideration.

Exam tips

Learn the two-party versus three-party contrast between indemnity and guarantee. It is a regular MCQ pivot.
Memorise the three heads of Section 125: damages, costs, compromise sums. Watch for the conditions in each.
If an option says loss is caused only by the promisor, treat it as wrong because Section 124 covers other persons as well.
Read the party names carefully. Many MCQs just ask who is the indemnifier.
With no negative marking, attempt every question. Eliminate the options that mention a surety or creditor and you are likely left with indemnity.
Learn the Section 126 definition word for word: 'perform the promise or discharge the liability of a third person in case of his default'.
Expect role-identification MCQs. Assign roles by function, not by name or relationship.
Remember the three-party versus two-party contrast with indemnity, as it is a favourite comparison question.