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SPECIAL CONTRACTS

Special Contracts are called as such because one or the other elements of a
contract are missing and yet it is a valid contract. For example in the case of an
agency contract it is not necessary for consideration to be there. Similarly when we
leave our car with our neighbor while on vacation no doubt he is contractually
bound to return the car and take good care of the car even if there is no
consideration. Special Contracts are Bailment/Indemnity/Pledge/Surety and
Agency.

UNDERSTANDING CONTRACTS OF BAILMENT

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 INDEMNITY (SECTIONS 124-125)

What is a contract of indemnity

 A contract of indemnity is a contract whereby one party promises to save the

other from loss caused to him by the conduct of the promissor himself or by the
conduct of any other party.
 A contract of indemnity may arise either (1) by an express promise or (2) by
operation of law i.e. the duty of a principal to indemnify an agent from
consequences of all lawful acts done by him as an agent.1

1
See page ___ for agency contracts.
 RIGHTS OF INDEMNIFIED (THE INDEMNITY HOLDER)

The indemnity holder is entitled to recover from the promisor

a) All the damages which may be compelled to pay in any suit in respect of any
matter to which the promise to indemnify applies
b) All costs of suit which he may have to pay to such third party provided in
bringing or defending the suit (i) he acted under the authority of the indemnifier
or (ii) he did not act in contravention of the orders of the indemnifier and in such
a such as a prudent man would act in his own case.
c) All sums which he may have paid under the terms of any compromise of any
such suit, if the compromise was not contrary to the orders of the indemnifier,
and was one which it would have been prudent for the promisee to make.

RIGHTS OF INDEMNIFIER

 The Contract Act makes no mention of the rights of the indemnifier. It has been
held in Jaswant Singh Vs. Section of State 14 Bom 299 that the indemnifier
becomes entitled to the benefit of all the securities, which the creditor has
against the principal debtor whether he was aware of them, or not.

Similarities and Difference between Indemnity and Surety/Guarantee

In both there is an element of compensation in the event of a loss. In indemnity

there are two parties and only one contract while in surety there are three parties
and there are two contracts. The simplest example to understand the difference
contracts is that while insurance is an indemnity contract a student loan from a
bank guaranteed by a third party is an example of a surety/guarantee contract.
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What is Contract of Guarantee

GUARANTEE /SURETY

 A 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. (for example if a
student fails to pay his loan to the bank his surety or guarantor say his father or
Uncle or whosever stood guarantee would be contractually bound to pay the
loan to the bank.)
 The person who gives the guarantee is called the “Surety”, the person for whom
the guarantee is given is called the “Principal Debtor” and the person to whom
the guarantee is given is called the “Creditor”.

Requirement of two contracts

 It must be noted that in a contract of guarantee there must, in effect be two
contracts,
(i) a principal contract - the principal debtor and the creditor ; and
(ii) a secondary contract - the creditor and the surety.
Essential and legal rules for a valid contract of guarantee
The contract of guarantee must satisfy the requirements of a valid contract

(i) There must be someone primarily liable

(ii) The promise to pay must be conditional

Kinds of guarantee

(i) Specific Guarantee i.e for one transaction.

(ii) Continuing Guarantee i.e for a series of transactions

RIGHTS AND OBLIGATION OF CREDITOR/SURETY

PARTY RIGHTS OBLIGATIONS

Credito The creditor is entitled to demand The obligations of a creditor are:

r payment from the surety as soon  Not to change any terms of the
as the principal debtor refuses to Original Contract.
pay or makes default in payment.  Not to compound, or give time
to, or agree not to sue the
In other words the creditor is not Principal Debtor
obliged to exhaust other legal  Not to do any act inconsistent
remedies which may be available with the rights of the surety
to him.

Surety 1. Rights against the Creditor  The liability of a surety is called

In case of fidelity guarantee, the as secondary or contingent, as
surety can direct creditor to his liability arises only on default
dismiss the employee whose by the principal debtor.
honesty he has guaranteed, in  But as soon as the principal
the event of proved dishonesty debtor defaults, the liability of
of the employee. the surety begins and runs co-
2. Rights against the Principal extensive with the liability of the
Debtor principal debtor, in the sense that
(a) Right of Subrogation (stepping the surety will be liable for all
into the shoes of the original) those sums for which the
Where a surety has paid the principal debtor is liable. The
guaranteed debt on its creditor may file a suit against
becoming due or has performed the surety without suing the
the guaranteed duty on the principal debtor.
 default of the principal debtor,  Where the creditor holds
he is invested with all the securities from the principal
rights, which the creditor has debtor for his debt, the creditor
against the debtor. need not first exhaust his
(b) Right to be indemnified remedies against the securities
The surety has the right to recover before suing the surety, unless
from the principal debtor, the the contract specifically so
amounts which he has rightfully provides.
paid under the contract of DISCHARGE OF SURETY
guarantee. 1. By notice of revocation in case of
a continuing guarantee
Rights of Contribution 2. By death of surety in case of
Where a debt has been continuing guarantee unless
guaranteed by more than one otherwise provided.
person, they are called as co- 3. By variation in terms of contract
sureties. When a surety has without consent of surety.
paid more than his share, he 4. By release or discharge of
has a right of contribution from Principal Debtor
the other sureties who are 5. By compounding with, or giving
equally bound to pay with him. time to, or agreeing not to sue,
Principal Debtor
6. By creditor's act or omission
impairing Surety's eventual remedy
7. Loss of (principal debtor’s)
Security by the creditor.

Dabhol Power Corporation(DPC) Part Two

In the earlier part “Misrepresentation” was used by the MSEB to avoid the
performance of the contract. But the contract between MSEB and DPC had
more intrigues. Enron the main 51 % shareholder of DPC had envisaged a
possibility of default in payment by MSEB because of the high rates of power
and therefore had an in built safeguard in its dealings with MSEB. It had
insisted on a guarantee by the Maharashtra Government that stipulated that
in case of a default in payment form MSEB the Maharashtra Government
would ensure payment. Realizing that the Maharashtra Government and
MSEB are two sides of the same coin the DPC further insisted on a counter
guarantee from the Central Government. Needless to add all these
guarantees and counter guarantees were quickly provided by the respective
governments. Guarantee is similar here to surety that is the guarantor
contracts to compensate in the event of a default by the party concerned.

When MSEB avoided the contract on grounds of misrepresentation DPC

alleged breach of contract and invoked its guarantees both with Maharashtra
Government as well as the Central Government. Not honoring a guarantee
by the government puts it in bad light in front of the international
community as well as the investment community. It shows that the
Government does not honor its word.

On the subject of guarantee it is interesting to narrate a similar incident

which happened to our steel exporters exporting to China before the Beijing
Olympics. The international price of steel was high and contracts to export
steel were executed with Chinese importers. However as is the norm in
international sales a guarantee is obtained from a bank since parties are not
too familiar with each other. So guarantees were executed. Now, when the
steel actually reached the shores of China the international price of steel had
fallen and Chinese importers wanted to renegotiate the price which is
essentially a breach of contract. The exporters invoked their guarantees with
the banks. But here is the catch. Since the banks were Chinese banks and
since they are state owned banks they favored their importers and asked the
Indian exporters to renegotiate. The mistake made by our importers was
that they should have insisted on guarantees from foreign banks.

Internationally MNC’s entering into big contracts do not rely on local courts and
insist on Arbitration at an International forum where only the law as in the contract
is adhered to and not sentiment be it Indian or Chinese. For example the
automobile company Maruti Udyog Limited was initially a Joint Venture between the
Government of India and Suzuki Motor Corportaion and the agreement specified
that disputes if any would be resolved in an International Arbitration forum in
London which is a neutral place.

UNDERSTANDING THE DILEMMA of LAW

Take the case of a bank locker in which a customer hires to keep his valuables. The
locker is locked with two keys which operate jointly and while one key is held by the
bank the other is held by the customer. The customer pays an annual rental. The
bank has no record of the valuables or is not even witness to the contents of the
locker. Is it a contract of bailment or rental? What is the extent of the bank’s
liability with regard to the contents of the locker? What if the customer falsifies its
contents and claims loss or the opposite situation when the bank or its employees
collude with others to cheat the locker holder?
Courts have dealt with these cases and clarified that the bank locker does not
constitute a contract of bailment under S 148 because the bank has not been given
exclusive possession of the property. However if the bank fails to fulfill the terms of
their contract of rent in terms of providing care of the locker or the bank’s
agents /employees attempt to defraud in any manner then the bank would be liable
for negligence under its contract of providing a safe locker but not bailment.
But then here comes the dilemma: A bank’s locker in Mumbai was found with illegal
arms kept by a customer who was not traceable. What is the role of a bank in such
a case? The contents in a locker are not in their direct control. The Reserve Bank of
India worried about security and terrorism implications have through its directive
made bank lockers as a contract of bailment making the banks responsible for the
goods in a locker but the Contract Act still does not make it a bailment. The RBI
directive is more of an administrative diktat than law.

PLEDGE

Dabhol Power Corporation (Part 3)

(Part One on page ___ and Part two on page ___)

The story of Dabhol Power Corporation should actually be filmed. It was

done in part in the film Sarkar 2 but the plot was not DPC. DPC which had a
contract with MSEB to supply power through its Dabhol plant was owned by
ENRON which had 51 % shares while the remaining shares were with MSEB (
26 % ) and the rest with the suppliers of equipment to Dabhol viz
GE/Bechtel. Interestingly the FDI which ENRON brought was a mere Rs 250
crores (approx). The actual funding of Dabhol Power Corporation running to
the tune of Rs 6000 crores was obtained from IDBI as a loan in return for
the PLEDGE of ENRON shares with IDBI.

So if the reader is following the story correctly so far ; the money for the
power plant was from Indian banks but the profits from the power plant
because of high tariffs ( discussed in Part one ) would undoubtedly go to
ENRON.

Pledge and The Satyam Saga

Hypothetically if you were the only and complete owner of a company and if you
had to fly to Mumbai on say an official visit would you fly business or economy or
charter a plane for yourself. Most likely you would fly economy. But if you were fifty
percent owner then you would be tempted to fly first class because only 50% of the
expenses are yours. And what if you are owning only 8 % shares and yet
 controlling the company as Mr Ramalingam Raju did. And what if those shares had
been pledged to a lender who in turn has sold the loan to someone else. Then you
just might do what Mr Raju did which is to defraud Satyam.

• S 172."Pledge" "pawnor",and "pawnee" defined.-The bailment of

goods as security for payment of a debt or performance of a promise is called
“Pledge”. The bailor is called “pawnor”. The bailee is called the "pawnee".

• Pledge is a Special Contract because bailee/pledgee/pawnee has right to

sell pledged goods in case bailor/pawnor/pledgor fails to pay. Though
pledgee does not have ownership can sell the goods to recover his dues
provided notice is given to the pledgor.

• The rights and duties of the Pledgee (pawnee) are shown below.

RIGHTS DUTIES

• Right to sue the pledgor on • Taking care of goods.

default. • Not putting the goods to
• Right to sell the things pledged on unauthorised use.
giving suitable notice. • Return of goods including
• Right to claim damages because accruals.
of non disclosure of any default or
fault. Note: Pledge is normally for moveable
• Right to claim damages suffered goods such as jewellery and shares while
because of defective title of the mortgage is used for immoveable
pledgor. property. Mortgage is dealt separately
• Pledgee’s rights are not limited to under Transfer of Property Act.
his interest in goods.
• Right to recover any extraordinary
expenditure.