Many a times, the parties to a contract are unable to fulfil their commitments under the contract. The aggrieved party which suffers a loss for no fault on its part, expects to be compensated for such loss at the hands of the defaulting party – where on its own or through a third party.
Risk mitigation and shifting of liability are two of the critical elements in protecting and preserving the economic interests of parties involved in a commercial contract.
A contractual obligation of indemnity and / or guarantee is thus an important provision towards achieving these objectives.
Both these concepts appear to be the same and are generally used interchangeably, but there lie some differences in the concept and implications.
Contract of indemnity means an economic commitment / assurance provided by a party to the other – that the former shall protect the latter from any loss or damage incurred by the latter arising out of acts or omissions of the former.
Party giving indemnity is called as Indemnitor and Party seeking indemnity is called as Indemnitee. Another striking feature of a contract / obligation involved with indemnity is that it is a two party agreement, with prime and sole liability on Indemnitor to protect Indemnitee from any economic risks and liabilities. In some contracts, both the parties may agree indemnify the other for their respective shortcomings.
On the other hand, unlike a contract of indemnity, contract of guarantee is mostly prevalent in economic and credit transactions and is a tripartite arrangement – i.e., between two main parties to a contract and a third party which is not a performing / active party in the contract. The said third party provides an assurance of contract performance or discharge of liability of one main party to another main party and in case of failure of main party (on whose behalf such third party is providing assurance) to perform the contract or discharge the liability.
The party which is providing the guarantee is called Surety, Party on whose behalf guarantee given is called as Principal Debtor and party to whom such guarantee given is called as Creditor.
Contract of indemnity is an obligation on Indemnitor to reimburse Indemnitee for loss or economic liability incurred due to any act of Indemnitor or any third party. Contract of guarantee, on the other hand. is a promise by Surety to make good the loss suffered by Creditor due to default or breach committed by Principal Debtor.
It is thus, evident that both contract of indemnity and contract of guarantee have slight variance in their application in context of risk mitigation and liability shift.
It is crucial to clearly understand these concepts and implications thereof on parties in agreeing to these concepts from economic and liability perspective – it will ensure parties are mindful of implications of these provisions and their respective risks and exposure.
