BUSINESS LAWS QUESTION BANK CHAPTER - 2: U7

CA NIKESH AGRAWAL
BUSINESS LAWS QUESTION BANK CHAPTER – 2: U7

Chapter: 2 – Indian Contract Act, 1872

Unit: 7 – Contract of Indemnity & Guarantee
(Covers All RTP, MTP, PYQ, ICAI SM, MDTP till Jan 2025)

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BUSINESS LAWS QUESTION BANK CHAPTER – 2: U7

15 - Mr. R extended a loan to Mr. D with X, Y, and Z as sureties. Each surety executed
a bond with varying penalty amounts, X with a penalty of ` 10,000, Y with ` 20,000 and Z
with ` 40,000, in the event of Mr. D's failure to repay the borrowed money to Mr. R.
Examine the liabilities of the sureties in accordance with the Indian Contract Act, 1872,
when Mr. D defaults to the tune of ` 42,000. Additionally, assess the situation, if there
is no contractual arrangement among the sureties. 4)a)i)MDTP2,7, 4)a)i)4m,MTP1,Jan2025

Ans - As per section 146 of the Indian Contract Act, 1872, when two or more persons are co-
sureties for the same debt either jointly, or severally and whether under the same or different
contracts and whether with or without the knowledge of each other, the co-sureties in the
absence of any contract to the contrary, are liable, as between themselves, to pay each an equal
share of the whole debt, or of that part of it which remains unpaid by the principal debtor.

Section 147 provides that the principle of equal contribution is, however, subject to the
maximum limit fixed by a surety to his liability. Co-sureties who are bound in different sums are
liable to pay equally as far as the limits of their respective obligations permit.

In the given question, Mr. D makes a default of ` 42,000, and X, Y and Z as sureties have
executed the bond with varying penalty amounts. Hence, X is liable to pay ` 10,000, and Y and Z
` 16,000 each.

In the given case, if there is no contractual arrangement among the sureties, they would be
liable for equal contribution. Hence, X, Y and Z will be liable to pay ` 14,000 each.

14 – Answer the following as per the provisions of the Indian Contract Act, 1872:

i) Unit 9

ii) State the rights of Indemnity-holder when sued.

6)b)ii)2m,MDTP10, 6)b)ii)2m,MTP2,Jan2025, 6)b)ii)2m,Sept2024, ICAI Module

Ans – Rights of Indemnity-holder when sued (Section 125 of the Indian Contract Act,
1872): The promisee in a contract of indemnity, acting within the scope of his authority, is
entitled to recover from the promisor/indemnifier—

(a) all damages which he may be compelled to pay in any suit

(b) all costs which he may have been compelled to pay in bringing/ defending the suit and

(c) all sums which he may have paid under the terms of any compromise of suit.

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13 - Explain any four differences between Contract of Indemnity and

Contract of Guarantee. 6)b)ii)4m,Sept2024

Ans –

Point of distinction Contract of Indemnity Contract of Guarantee

Number of party/ There are only two parties namely There are three parties-
parties to the the indemnifier [promisor] and the creditor, principal debtor and
contract indemnified [promisee] surety.

Nature of liability The liability of the indemnifier is The liability of the surety is
primary and unconditional. secondary and conditional as the
primary liability is that of the
principal debtor.

Time of liability The liability of the indemnifier The liability arises only on the
arises only on the happening of a non performance of an existing
contingency. promise or non-payment of an
existing debt.

Time to Act The indemnifier need not act at The surety acts at the request
the request of indemnity holder. principal debtor.

Right to sue third Indemnifier cannot sue a third Surety can proceed against
party party for loss in his own name as principal debtor in his own right
there is no privity of contract. because he gets all the right of a
Such a right would arise only if creditor after discharging the
there is an assignment in his debts.
favour.

Purpose Reimbursement of loss For the security of the creditor

Competency to All parties must be competent to In the case of a contract of

contract contract. guarantee, where a minor is a
principal debtor, the contract is
still valid.

12 - Due to urgent need of money amounting to ` 3,00,000, Pawan approached Raman and
asked him for the money. Raman lent the money on the guarantee of Suraj and Tarun.
Pawan makes default in payment and Suraj pays full amount to Raman. Suraj, afterwards,
claimed contribution from Tarun but Tarun refused to contribute on the basis that there is
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no contract between Suraj and him. Examine referring to the provisions of the Indian
Contract Act, 1872, whether Tarun can escape from his liability.

4)a)ii)3m,MDTP5, 4)a)ii)3m,MTP1,Sept2024

Ans - Equality of burden is the basis of Co-suretyship. This is contained in section 146 of the
Indian Contract Act, 1872, which states that “unless otherwise agreed, each surety is liable to
contribute equally for discharge of whole debt or part of the debt remains unpaid by debtor.

Accordingly, on the default of Pawan in payment, Tarun cannot escape from his liability. Both the
sureties Suraj and Tarun are liable to pay equally, in absence of any contract between them.

11 - ‘Sooraj’ guarantees ‘Vikas’ for the transactions to be done between ‘Vikas’ & ‘Nikhil’
during the month of March 2023. ‘Vikas’ supplied goods of ` 30,000 on 01.03.2023 and of
` 20,000 on 03.03.2023 to ‘Nikhil’. On 05.03.2023, ‘Sooraj’ died in a road accident. On
10.03.2023, being ignorant of the death of ‘Sooraj’, ‘Vikas’ further supplied goods of `
40,000. On default in payment by ‘Nikhil’ on due date, ‘Vikas’ sued legal heirs of ‘Sooraj’
for recovery of ` 90,000. Describe, whether legal heirs of ‘Sooraj’ are liable to pay `
90,000 under the provisions of Indian Contract Act, 1872. What would be your answer, if
the estate of ‘Sooraj’ is worth ` 45,000 only? RTP,Sept2024

Ans - According to section 131 of Indian Contract Act, 1872, in the absence of a contract to
contrary, a continuing guarantee is revoked by the death of the surety as to the future
transactions. The estate of deceased surety, however, liable for those transactions which had
already taken place during the lifetime of deceased. Surety’s estate will not be liable for the
transactions taken place after the death of surety even if the creditor had no knowledge of
surety’s death.

In this question, ‘Sooraj’ was surety for the transactions to be done between ‘Vikas’ & ‘Nikhil’
during the month of March, 2023. ‘Vikas’ supplied goods of ` 30,000, ` 20,000 and of ` 40,000
on 01.03.2023, 03.03.2023 and 10.03.02023 respectively. ‘Sooraj’ died in a road accident, but
this was not in the knowledge of ‘Vikas’. When ‘Nikhil’ defaulted on payment, ‘Vikas’ filed suit
against legal heirs of ‘Sooraj’ for recovery of full amount i.e. ` 90,000.

On the basis of above, it can be said in case of death of surety (‘Sooraj’), his legal heirs are
liable only for those transactions which were entered before 05.03.2023 i.e. for ` 50,000. They
are not liable for the transaction done on 10.03.2023 even though Vikas had no knowledge of
death of Sooraj.

Further, if the worth of the estate of deceased is only ` 45,000, the legal heirs are liable for
this amount only.

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10 - R owns an electronics store. P visited the store to buy a water purifier priced at
54,000/-. He specifically requested R for a purifier with a copper filter. As P wanted to
buy the purifier on credit, with the intention of paying in 9 equal monthly instalments, R
demands a guarantor for the transaction. S (a friend of P) came forward and gave the
guarantee for payment of water purifier. R sold P, a water purifier of a specific brand. P
made payment for 4 monthly instalments and after that became insolvent. Explain with
reference to the Indian Contract Act 1872, the liability of S as a guarantor to pay the
balance price of water purifier to R.

What will be your answer, if R sold the water purifier misrepresenting it as having a copper
filter, while it actually has a normal filter? Neither P nor S was aware of this fact and
upon discovering the truth, P refused to pay the price. In response to P's refusal, R filed
the suit against S, the guarantor. Explain with reference to the Indian Contract Act 1872,
whether S is liable to pay the balance price of water purifier to R?

1)a)7m,MDTP7,9, 1)a)7m,MTP1,Jan2025, RTP,Jan2025, 1)a)7m,June2024

Ans - As per section 126 of the Indian Contract Act, 1872, the contract of guarantee is defined
as a contract to perform the promise or discharge the liability of a third person in case of his
default.

In this case, S has given a guarantee for P's payment obligation towards R. When P defaulted
after making four monthly instalments and became insolvent, S's liability as a guarantor will come
into existence.

According to Section 128 of the Act, the liability of the surety is co extensive with that of the
principal debtor, unless it is otherwise provided by the contract.

Since P failed to pay the remaining instalments due to insolvency, S, as the guarantor, is liable to
pay the balance price of the water purifier to R. In the given situation, S will have to pay the
balance amount of ` 30,000 to R. [54,000-(4x6,000)]

In the second situation, R sold the water purifier misrepresenting it as having a copper filter,
while it actually has a normal filter; this changes the situation significantly.

According to Section 142 of the Act, any guarantee which has been obtained by means of
misrepresentation made by the creditor, or with his knowledge and assent, concerning a material
part of the transaction, is invalid. Here, guarantee is obtained by means of misrepresentation
made by the creditor (R), and therefore the guarantee is invalid.

Furthermore, under Section 143, any guarantee which the creditor has obtained by means of
keeping silence as to material circumstances, is invalid.
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Here R misrepresented the filter type and both P and S were unaware of this fact. The creditor
(R) has obtained the guarantee by remaining silent as to material circumstances. Therefore, the
guarantee obtained from S will be considered to be invalid.

Consequently, S cannot be held liable to pay the balance price of the water purifier to R.

09 - Explain in brief with reference to the provisions of the Indian Contract Act, 1872,
what are the rights enjoyed by Surety against the Creditor, the Principal Debtor and Co-
Sureties?

3)c)6m,MDTP8,9, 3)c)6m,MTP2,Jan2025, 3)c)6m,June2024

Ans - In terms of the provisions of the Indian Contract Act, 1872, the surety enjoys the
following rights:

(a) Rights against the creditor;

(b) Rights against the principal debtor;

(c) Rights against co-sureties.

Right against the Creditor

a) Surety’s right to benefit of creditor’s 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, whether the surety knows of the existence of such
security or not; and, if the creditor loses, or, without the consent of the surety, parts with such
security, the surety is discharged to the extent of the value of the security.

b) Right to set off: If the creditor sues the surety, for payment of principal debtor’s liability,
the surety may have the benefit of the set off, if any, that the principal debtor had against the
creditor.

c) Right to share reduction: The surety has right to claim proportionate reduction in his liability
if the principal debtor becomes insolvent.

Right against the principal debtor

a) Rights of subrogation [Section 140 of the Indian Contract Act, 1872]: Where, a guaranteed
debt has become due, or default of the principal debtor to perform a guaranteed duty has taken
place, the surety, upon payment or performance of all that he is liable for, is invested with all
the rights which the creditor had against the principal debtor.

This right is known as right of subrogation. It means that on payment of the guaranteed debt, or
performance of the guaranteed duty, the surety steps into the shoes of the creditor.
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b) Implied promise to indemnify surety [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, but
not sums which he paid wrongfully.

Rights against co-sureties

“Co-sureties (meaning)- When the same debt or duty is guaranteed by two or more persons,
such persons are called co-sureties”

a) Co-sureties liable to contribute equally (Section 146): Unless otherwise agreed, each surety is
liable to contribute equally for discharge of whole debt or part of the debt remains unpaid by
debtor.

b) Liability of co-sureties bound in different sums (Section 147): The principal of equal
contribution is, however, subject to the maximum limit fixed by a surety to his liability. Co-
sureties who are bound in different sums are liable to pay equally as far as the limits of their
respective obligations permit.

08 - Define contract of indemnity and contract of guarantee and state the conditions when
guarantee is considered invalid?

6)b)6m,MDTP4, 6)b)6m,MTP3,June2024, ICAI Module

Ans - Section 124 of the Indian Contract Act, 1872 states that “A contract by which one party
promises to save the other from loss caused to him by the conduct of the promisor himself, or
the conduct of any person”, is called a “contract of indemnity”.

Section 126 of the Indian Contract Act, 1872 states that “A contract to perform the promise
made or discharge liability incurred by a third person in case of his default” is called a “contract
of guarantee”.

The conditions under which the guarantee is invalid, or void is provided in section 142, 143 and
144 of the Indian Contract Act, 1872. These include:

i) Guarantee obtained by means of misrepresentation.

ii) Guarantee obtained by means of keeping silence as to material circumstances.

iii) When a contract of guarantee is entered into on the condition that the creditor shall not act
upon it until another person has joined in it as co-surety and that other party fails to join as
such.

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07 - Sarthak is employed as a cashier on a monthly salary of ` 50,000 by ABC bank for a

period of three years. Mohit gave surety for Sarthak’s good conduct. After nine months,
the financial position of the bank deteriorates. Then Sarthak agrees to accept a lower
salary of ` 40,000 per month from the Bank. Two months later, it was found that Sarthak
had misappropriated cash from the time of his appointment. What is the liability of Mohit
taking into account the provisions of the Indian Contract Act, 1872?

RTP,June2024, Sim,ICAI Module

OR

Mr. Chetan was appointed as Site Manager of ABC Constructions Company on a two years’
contract at a monthly salary of ` 50,000. Mr. Pawan gave a surety in respect of Mr.
Chetan's conduct. After six months the company was not in position to pay ` 50,000 to
Mr. Chetan because of financial constraints. Chetan agreed for a lower salary of ` 30,000
from the company. This was not communicated to Mr. Pawan. Three months afterwards it
was discovered that Chetan had been doing fraud since the time of his appointment. What
is the liability of Mr. Pawan during the whole duration of Chetan's appointment.

ICAI Module

Ans - According to section 133 of the Indian Contract Act, 1872, where there is any variance in
the terms of contract between the principal debtor and creditor without surety’s consent, it
would discharge the surety in respect of all transactions taking place subsequent to such
variance.

In the instant case, the creditor has made a variance (i.e. change in terms) without the consent
of surety. Thus, surety is discharged as to the transactions subsequent to the change.

Hence, Mohit is liable as surety for the loss suffered by the bank due to misappropriation of
cash by Sarthak during the first nine months but not for misappropriations committed after the
reduction in salary.

OR

In the instant case, Mr. Pawan is liable as a surety for the loss suffered by ABC Constructions
company due to misappropriation of cash by Mr. Chetan during the first six months but not for
misappropriations committed after the reduction in salary.

Hence, Mr. Pawan, will be liable as a surety for the act of Mr. Chetan before the change in the
terms of the contract i.e., during the first six months. Variation in the terms of the contract (as
to the reduction of salary) without consent of Mr. Pawan, will discharge Mr. Pawan from all the
liabilities towards the act of the Mr. Chetan after such variation.

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06 - A contracts with B for a fixed price to construct a house for B within a stipulated
time. B would supply the necessary material to be used in the construction. C guarantees
A’s performance of the contract. B does not supply the material as per the agreement. Is
C discharged from his liability. ICAI Module

Ans - According to Section 134 of the Indian Contract Act, 1872, the surety is discharged by
any contract between the creditor and the principal debtor by which the principal debtor is
discharged or by any act or omission for the creditor the legal consequence of which is the
discharge of the principal debtor.

In the given case, B omits to supply the necessary construction material. Hence, C is discharged
from his liability.

05 - Mr. D was in urgent need of money amounting to ` 5,00,000. He asked Mr. K for the
money. Mr. K lent the money on the sureties of A, B and N without any contract between
them in case of default in repayment of money by D to K. D makes default in payment. B
refused to contribute, examine whether B can escape liability? ICAI Module

Ans - Co-sureties liable to contribute equally (Section 146 of the Indian Contract act,
1872):

Equality of burden is the basis of Co-suretyship. This is contained in section 146 which states
that “when two or more persons are co-sureties for the same debt, or duty, either jointly, or
severally and whether under the same or different contracts and whether with or without the
knowledge of each other, the co-sureties in the absence of any contract to the contrary, are
liable, as between themselves, to pay each an equal share of the whole debt, or of that part of it
which remains unpaid by the principal debtor”.

Accordingly, on the default of D in payment, B cannot escape from his liability. All the three
sureties A, B and N are liable to pay equally, in absence of any contract between them.

04 - A agrees to sell goods to B on the guarantee of C for the payment of the price of
goods in default of B. Is the agreement of guarantee valid in each of the following
alternate cases:

Case 1. If A is a Minor

Case 2: If B is a Minor

Case 3: If C is a minor ICAI Module

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Ans - Case 1: The agreement of guarantee is void because the creditor is incompetent to
contract.

Case 2: The agreement of guarantee is valid because the capability of the principal debtor does
not affect the validity of the agreement of the guarantee.

Case 3: The agreement of guarantee is void because the surety is incompetent to contract.

03 - S asks R to beat T and promises to indemnify R against the consequences. R beats T

and is fined ` 50,000. Can R claim ` 50,000 from S. ICAI Module

Ans - R cannot claim ` 50,000 from S because the object of the agreement was unlawful. A
contract of indemnity to be valid must fulfil all the essentials of a valid contract.

02 - Manoj guarantees for Ranjan, a retail textile merchant, for an amount of ` 1,00,000,
for which Sharma, the supplier may from time to time supply goods on credit basis to
Ranjan during the next 3 months.

After 1 month, Manoj revokes the guarantee, when Sharma had supplied goods on credit
for ` 40,000. Referring to the provisions of the Indian Contract Act, 1872, decide
whether Manoj is discharged from all the liabilities to Sharma for any subsequent credit
supply. What would be your answer in case Ranjan makes default in paying back Sharma for
the goods already supplied on credit i.e. ` 40,000? ICAI Module

Ans - Discharge of Surety by Revocation: As per section 130 of the Indian Contract Act, 1872, a
continuing guarantee may, at any time, be revoked by the surety, as to future transactions, by
notice to the creditor, but the surety remains liable for transactions already entered into.

As per the above provisions, liability of Manoj is discharged with relation to all subsequent
credit supplies made by Sharma after revocation of guarantee, because it is a case of continuing
guarantee.

However, liability of Manoj for previous transactions (before revocation) i.e. for ` 40,000
remains. He is liable for payment of ` 40,000 to Sharma because the transaction was already
entered into before revocation of guarantee.

01 - 'C' advances to 'B', ` 2,00,000 on the guarantee of 'A'. 'C' has also taken a
further security for the same borrowing by mortgage of B's furniture worth ` 2,00,000
without knowledge of 'A'. C' cancels the mortgage. After 6 months 'B' becomes insolvent
and 'C' 'sues ‘A’ his guarantee. Decide the liability of 'A' if the market value of furniture
is worth ` 80,000, under the Indian Contract Act, 1872. ICAI Module

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BUSINESS LAWS QUESTION BANK CHAPTER – 2: U7

Ans - Surety’s right to benefit of creditor’s securities: According to section 141 of the Indian
Contract Act, 1872, 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,
whether the surety knows of the existence of such security or not; and, if the creditor loses, or,
without the consent of the surety, parts with such security, the surety is discharged to the
extent of the value of the security.

In the instant case, C advances to B, ` 2,00,000 rupees on the guarantee of A. C has also taken a
further security for ` 2,00,000 by mortgage of B’s furniture without knowledge of A. C cancels
the mortgage. B becomes insolvent, and C sues A on his guarantee. A is discharged from liability
to the amount of the value of the furniture i.e. ` 80,000 and will remain liable for balance `
1,20,000.

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