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THE words "guarantee" and "indemnity" are commonly used. These words are frequently encountered in hire purchase and loan agreements and in many other transactions. However, what these words mean is not always a matter of immediate concern.

When getting a bank loan, a person is often asked to provide a guarantee. Similarly those who obtain other facilities or scholarships have to provide guarantors. Sometimes the word "indemnity" is also added on in the document and one tends to think that it probably has something to do with the guarantee.

But a guarantee and indemnity do not mean the same thing. In its wider sense a contract of indemnity could include a contract of guarantee. However, beyond that a contract of indemnity certainly differs from a contract of guarantee. What is the difference?

As stated by Holroyd Pearce L.J. in Yeoman Credit Ltd vs Latter, an indemnity is a contract by one party to keep the other harmless against loss but a contract of guarantee is a contract to answer for the debt default or miscarriage of another who is to be primarily liable to the promisee.

The concept of an indemnity and guarantee is reflected in our law as contained in the Contracts Act 1950. Section 77 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 by the conduct of any other person, is called a contract of indemnity."

On the other hand, a contract of guarantee "is a contract to perform the promise, or discharge the liability of a third person in case of his default. The person who gives the guarantee is called the surety, the person in respect of whose default the guarantee is given is called the principal debtor, and the person to whom the guarantee is given is called the creditor. A guarantee may be either oral or written."

According to the Contracts Act, it would appear that a guarantee can be oral. However, the provision on indemnity is silent on this aspect. Does it mean that an indemnity must be in writing? It could be argued that an indemnity could be oral too.

In a guarantee the liability arises at the point of time when the principal borrower or debtor defaults on his obligation. Where there is liability even though there is no default or breach by the principal debtor, it is not a contract of guarantee.

This difference is explained by Lopez L.J. in Guild & Co vs Conrad, an English decision of the Court of Appeal, where it is stated that a promise to be liable for a debt conditionally on the principal debtor making default is a guarantee. On the other hand, a promise to become liable for a debt whenever the person to whom the promise is made should become liable, is a different matter to be viewed separately. 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.

In many jurisdictions, the words "guarantee" and "indemnity" are used interchangeably as if they mean the same thing, but the difference is in the fact that in a guarantee one agrees to assume responsibility for the obligation or debt of another if that other person defaults. However, in the case of an indemnity, one assumes a direct and primary obligation on the basis more of the occurrence of an event rather than a default.

In a contract of indemnity not only is there no requirement for 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.

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. Of course, there may be conditions as to what can be claimed. The question of default does not arise.

Another example is where a dealer enters into an agreement to provide an item which is not  essential to an infant. He may ask for an indemnity if the infant does not pay. This is because if the infant does not pay he cannot be said to be in breach because the agreement will not be enforceable at all.

However, if a third party has agreed to indemnify the dealer for the loss, the indemnity will prevail and a person who has undertaken such an obligation will have to pay. But there is no breach or default by the infant. On the other hand, if in such a situation the third party had signed a guarantee, it would not be enforceable.

Thus a guarantee involves a default by a third party whilst an indemnity arises on the occurrence of an event. And whether a document is a guarantee or indemnity will depend on its contents and not on the title given to the document.