5

Unit Objectives
Introduction
Learning Outcomes

5.1 Contract of Indemnity and Guarantee

5.2 Discharge of Surety
5.3 Difference Between Contract of Indemnity and Contract of
Guarantee
5.4 Contract of Bailment and Pledge
5.5 Difference Between Bailment and Pledge
5.6 Contract of Agency
5.7 Keywords
5.8 Summary
BUSINESS LAWS

After Studying this unit, you will be able to:

• Understand the concept of Indemnity Contract in case of uncertainty.

• Understand the concept of Guarantee Contract, liability of surety in case of
default by principal debtor.
• Understand the concept of Bailment Contract, where the possession of
goods is transferred.
• Understand the concept of Pledge Contract, where the possession of goods
is handed over as security.
• Understand the concept of Agency Contract, where the person works on
behalf of a principal as an agent.

INTRODUCTION

The second aspect of the Indian Contract Act, 1872, highlights about the special
contracts like Contract of Indemnity, Contract of Guarantee, Contract of
Bailment, Contract of Pledge, and Contract of Agency.

Contract of Indemnity comes in picture in case of contingency, when the party

faces some losses or injury. Contract of indemnity works on the lines of as
Insurance companies do work. In case of Guarantee contract, third party comes
into action as surety, if the Principal debtor fails to repay the money to the
creditor. The Contract of Bailment is where one party the Bailor transfers the
possession of goods to the Bailee other than as security, while the Contract of
Pledge involves transfer of goods to the other party as a security to recover debt
or for any performance. In Contract of Agency, there is a person named agent,
who works on behalf of someone else named as Principal. The Agent works as
per the instructions of the Principal and on behalf and representing the Principal.

The content and assessments of this unit have been developed to achieve the
following learning outcomes:

1. Understand that the liability of the surety is co-extensive with that of the
principal debtor.
2. In contract of Indemnity, there are two parties and in case of Guarantee,
there are three parties.
3. Know the difference between Contract of Bailment and Contract of
Pledge.
4. Know the rights and duties of parties to the contract of Bailment and
Pledge.
5. Know the rights and duties of an agent towards the principal.
6.
 THE INDIAN CONTRACT ACT, 1872. (PART IV)

5.1 CONTRACT OF INDEMNITY AND GUARANTEE

Contract of Indemnity and Guarantee are the special types of contracts given
under sections 124 to 147 of the Indian Contract Act, 1872.

CONTRACT OF INDEMNITY
The word indemnify basically means to assure, cover, or underwrite. It is a contractual
responsibility of one party to pay the loss incurred to the other party due to the acts of any
other party. It is a contract, where there is a high probability of risk and chance, in case if
the original person does not honor his duty, then the other person will be responsible to
honor the same. In terms of Section 124 of the Act, '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”'. This is also a known as
typical form of contingent contract.
There are two parties in this form of contract. The party who promises to indemnify save
the other party from loss is known as 'indemnifier', whereas the party who is promised to
be saved against the loss is known as 'indemnified'.
Examples:
(1) A may contract to indemnify B against the consequences of any proceedings, which
C may take against B in respect of a sum of Rs. 5000/- advanced by C to B. In
consequence, when B who is called upon to pay the sum of money to C fails to do so,
C would be able to recover the amount from A as provided in Section 124.
(2) X, a shareholder of a company lost his share certificate. He applied for a duplicate.
The company agreed to issue the same on the term that X will compensate the
company against the loss where any holder produces the original certificate. Here
there is contract of indemnity between X and the company.
In a contract of indemnity, the promisee i.e., indemnity-holder acting within the scope of
his authority is entitled to recover from the promisor i.e., indemnifier the following
rights:
(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.
(c) all sums which he may have paid under the terms of any compromise of suit.
It may be understood that the rights contemplated under Section 125 are not exhaustive.
The indemnity holder/indemnified has other rights besides those mentioned above. If he has
incurred a liability and that liability is absolute, he is entitled to call upon his
indemnifier to save him from the liability and to pay it off.

CONTRACT OF GUARANTEE
A contract of guarantee is a contract to perform the promise made or discharge liability
incurred by a third person in case of his default (Section 126).
There are three parties in a contract of guarantee. Surety- person who gives the
guarantee, Principal debtor- person in respect of whose default the guarantee is given,
Creditor- person to whom the guarantee is given. Any guarantee given may be oral or
written.
BUSINESS LAWS

Examples:
(1) Where 'A' obtains housing loan from LIC Housing and if 'B' promises to pay LIC
Housing in the event of 'A' failing to repay, it is a contract of guarantee.
(2) X and Y go into a car showroom where X says to the dealer to supply latest model
of Alto to Y. In case of his failure to pay, he will be paying for it. This is a contract of
guarantee because X promises to discharge the liability of Y in case of his defaults.
The principle of implied promise to indemnify surety (one who gives guarantee) is
contained in Section 145 of the Act, which provides that 'in every contract of guarantee
there is an implied promise by the principal debtor to indemnify the surety and the
surety is entitled to recover from the principal debtor whatever sum he has rightfully
paid under the guarantee but no sum which he has wrongfully paid.
The right of surety is not affected by the fact that the creditor has refused to sue the
principal debtor or that he has not demanded the sum due from him.
What constitutes consideration in a case of guarantee is an important issue and is laid
down in Section 127 of the Act. As per Section 127 of the Act, “Anything done, or any
promise made for the benefit of the principal debtor may be sufficient consideration to the surety for
giving the guarantee.”
For example, 'A' had advanced money to 'B' on a bond hypothecating B's property
stating that C is the surety for any balance that might remain due after realization of B's
property. C was not a party to the bond. He, however signed a separate surety bond
two days subsequent to the advance of the money. It was held that the subsequent
surety bond was void for want of consideration (Nanak Ram vs. Mehinlal 1877, I
Allahabad 487).
As per 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. Thus, it can be seen
that:
(i) The liability of surety is the same as that of principal debtor.
(ii) Where a debtor cannot be held liable on account of any defect in the document,
the liability of the surety also ceases.
(iii) surety's liability continues even if the principal debtor has not been sued or is
omitted from being sued. This is for the reason that the liability of the surety is
separate on the guarantee.

A guarantee which extends to a series of transactions is called a 'continuing guarantee.'

Example: Where 'A' promises 'B' to be responsible, so long as 'B' employs only 'C' to
collect his rentals from tenants for an amount of Rs. 5000/-, there is a continuing
guarantee by A to B so long 'C' is employed as rent collector. In other words, A stands as
a guarantor to 'B' for rent collected by 'C'.
In the continuing guarantee, the liability of surety continues till the performance or the
discharge of all the transactions entered into or the guarantee is withdrawn. There are
two important aspects regarding the revocation of continuing guarantee, and they are:
1. The first aspect is “the continuing guarantee may at any time be revoked by the
surety as to future transactions by notice to creditors”. However, no revocation is
possible where a continuing relationship is established. For instance, 'A' becomes
 THE INDIAN CONTRACT ACT, 1872. (PART IV)

surety of 'C' for B's conduct as manager in C's bank and 'B' is appointed on the faith
of this guarantee, 'A' is precluded from annulling the guarantee so long as B acts as
manager in C's bank.

2. The second aspect is upon the death of surety, the continuing guarantee is
revoked for all future transactions in the absence of any contract to the contrary.

5.2 DISCHARGE OF SURETY

Sections 133 to 139 of the Act lays down the law as to when a surety would be
discharged. They are as follows:
(i) 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. For example, 'A' stands to 'C'
as surety for 'B' for rent payable by 'B' to 'C' for 'C's house and if B & C agree on a
higher rent without A's consent, 'A' would stand discharged for the entire rent
amount accruing after the date of variance.
(ii) The surety is discharged if the principal debtor is discharged by:
a) a contract or
b) any act or
c) any omission that results in the discharge of the principal debtor.
For example, 'A' contracts with 'B' to build a house for him and if 'C' stands as
surety for 'B', 'C' as surety will stand discharged if 'A' discharges 'B' of his
obligation to build house. Yet another example could be where 'A' agrees to build
a house for 'B' if 'B' supplies the necessary timber and if 'C' stands as surety for
A's performance. If 'B' fails to supply the timber, both 'A' and 'C' stand
discharged.
There are certain exceptions to the above rule. These are given hereunder:
(a) A mere forbearance on the part of a creditor to sue the debtor or to enforce any
other remedy would not discharge the surety in the absence of any specific
provision.
(b) Even where the claim is barred by limitation, surety is still responsible. In
Krishto Kishore vs. Radha Romun I.L.R. 12 Cal.330, the plaintiff sued the
principal debtor and the surety for arrears of rent. The plaintiff also made the
legal representatives of the principal debtor a party after knowing about the
death of the principal debtor to avoid the debt being barred by limitation. It was
held that even if debt is barred by limitation on account of death of principal
debtor, the surety is still liable. The same view was confirmed by Privy Council
in Mahant Singh vs U Ba Yi A.I.R 1939 P.C 110 where it was held that omission
of the creditor to sue within the period of limitation does not discharge the
surety.
(c) Where the principal debtor compounds [settles] with the creditor regarding the
amount or promises not to sue, the surety will be discharged. But a contract for
giving time to a debtor is entered into with a third party, the surety will not be
BUSINESS LAWS

discharged. Where there are co-sureties release of one co-surety would not
automatically discharge the other co- sureties. Further in between other co-
sureties, the released co-surety is not absolved of his liability vis a vis other co-
surety.
(d) The surety would be discharged if the creditor does anything or acts in a manner
which:
i. Is inconsistent with the rights of surety, and
ii. Impairs the eventual remedy of the surety.

RIGHTS OF SURETY AGAINST THE PRINCIPAL DEBTOR AND

CREDITOR

After the performing of the promise or discharging of the liability of the principal debtor,
surety acquires various rights against the parties.

(1) Rights Against the Principal Debtor

(a) Right of Subrogation: 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 vested with all the
rights which the creditor had against the principal debtor. The right of the
surety is known as the right of subrogation namely the right to stand in the
shoes of the creditor.
(b) Right to Securities: The surety is entitled to the benefit of all securities made
available to the creditor by the principal debtor whether the surety was aware
of its existence or not.
(c) Right to Recover the Amount Paid or Right to Indemnity: The surety is
entitled to recover from the principal debtor whatever sums he has rightfully
paid. In this connection the following principles were laid down in Reed vs.
Norris:
(i) The claim of the surety is restricted to that smaller amount which he may
have paid under the principle of “accord and satisfaction”. Surety is not
entitled for higher amount than what he has paid.
(ii) Surety can also claim indemnity for any special damages, which he has
suffered while discharging his duties.
(iii) surety can claim even if he has paid a time barred debt as it is a rightful
payment though there are contrary views on this issue.
In all the above instances surety can claim reimbursements only if actual payments have
been made and not where he has merely executed promissory notes. [Panth Narayana
Murthy vs. Marimuthu (1902) 26 Mad. 322, 328]

Where surety becomes surety without the knowledge of principal debtor, he is entitled
for all the rights against the principal debtor but not the right to claim an indemnity
against the principal debtor.
 THE INDIAN CONTRACT ACT, 1872. (PART IV)

(2) Sureties Right Against the Creditor

(a) Right of Subrogation: The surety gets the right of subrogation for all payments
and performances he is liable. This right would accrue only when the surety has
paid the amount of liability in full. For example where a creditor had the right to
stop the goods or sellers lien, surety would enjoy the same right after he has
paid the amount [Imperial Bank vs. SL Kathereine Docks 1877 5 Ch.D].
(b) Right to Securities: Surety is entitled for all securities which the debtor has
provided to creditor whether surety is aware of it or not. Where a creditor loses
any of the security by default or negligence the liability of the surety abates
proportionately. If a creditor does not hand over the securities to surety he can
be compelled to do so. Classic examples of surety's right are that he is entitled
for all mortgage rights which the secured creditor has. But the surety is not
entitled for any security provided subsequent to the contract of guarantee.
(c) Right to Sue: Surety has a right to require the creditor to sue for and recover the
guaranteed debt. This right of surety is known as right to file a 'Quia timet
action' against the debtor. There is of course an inherent risk of having to
indemnify the creditor for delay and expense.
(d) Right to Dismiss: Surety has a right to call upon the creditor to dismiss the
person from service if the person whose fidelity is guaranteed by surety is
persistently dishonest.
(e) Right to Claim Set-Off: Surety has a right of set off against the principal debtor
exactly as a creditor would have.
(f) Right of Option on the Claim of the Funds: Surety also can compel the creditor
where he has claim on two funds, to resort to that fund first on which surety has
no claim.
(g) Right to Claim: Surety can claim that he is not liable on the guarantee to the
creditor, if it can be proved that principal debtor was incapable of entering into
a contract, say because he was a minor.

CONTRIBUTION AS TO BETWEEN CO-SURETY

As per Section 146 of the Act, “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”.
A co-surety gets the right to recover from other sureties only when he has paid more than
his share of debt to the creditor.

DIFFERENCE BETWEEN CONTRACT OF INDEMNITY

5.3 AND CONTRACT OF GUARANTEE

I. Number of Parties: In a contract of indemnity there are only two parties namely
the indemnifier [promisor] and the indemnified [promisee]. In a contract of
guarantee there are three parties: creditor, principal debtor, and surety.
BUSINESS LAWS

ii. Extent of Liability: The liability of the indemnifier is primary and independent.
The liability of the surety is secondary as the primary liability is that of the
principal debtor.
iii. Time of Liability: The liability of the indemnifier arises only on the happening of
a contingency. In the case of guarantee, liability is already in existence but
specifically crystallizes when principal debtor fails.
iv. Time to Act: The indemnifier need not necessarily act at the request of
indemnified. In case of guarantee surety must act by extending guarantee at the
request of debtor.
v. Right to Sue Third-Party: In case of contract of indemnity, indemnifier cannot
sue a third party for loss in his own name as there is no privity of contract. Such a
right would arise only if there is an assignment in his favor. On the other hand,in
the case of contract of guarantee surety can proceed against principal debtor inhis
own right because he gets all the right of a creditor after discharging the debts.

5.4 CONTRACT OF BAILMENT AND PLEDGE

A) CONTRACT OF BAILMENT
It is basically legal relationship between parties, where physical possession of the
property is transferred from one party to another but not the ownership of the property.
Bailment etymologically means 'handing over' or 'change of possession'. It is an act
whereby goods are delivered by one person to another for some purpose, on a contract,
that the goods shall, when the purpose is accomplished, be returned or otherwise
disposed of according to the directions of the person delivering them. The person who
delivers the goods is the bailor and the person to whom the goods are delivered is the
bailee. Example: 'X' delivers his car for repair to 'Y', 'X' is the bailor and 'Y' is the bailee.

ESSENTIAL CHARACTERISTICS OF BAILMENT

(a) Bailment is based upon a contract. Sometimes it could be implied by law as it happens
in the case of finder of lost goods.
 THE INDIAN CONTRACT ACT, 1872. (PART IV)

(b) Bailment is only for moveable goods and never for immovable goods or money.
(c) In bailment possession of goods changes. Change of possession can happen by
physical delivery or by any action which has the effect of placing the goods in
the possession of bailee.
(d) In bailment bailor continues to be the owner of goods as there is no change of
ownership.
(e) Bailee is obliged to return the goods physically to the bailor. The bailee cannot
deliver some other goods, even not those of higher value.

GENERAL ISSUES
In bailment both custody and possession must change but not the ownership. But where
a person is in custody without possession, he does not become a bailee. For example,
servants of a master who are in custody of goods of the master do not become bailees.
Possession and custody do not however mean physical delivery of goods. Constructive
delivery could also create a bailor and bailee relationship. This arises in situations where
the bailee is already in possession of goods but agrees to be a bailee through a contract.
Deposit of money in a bank is not bailment since the money returned by the bank would
not be identical currency notes.
Similarly, depositing ornaments in a bank locker is not bailment, because ornaments are
kept in a locker whose key are still with the owner and not with the bank. The ornaments
are in possession of the owner though kept in a locker at the bank.

DIFFERENT FORMS OF BAILMENT

Following are the popular forms of bailment:
(1) Delivery of goods by one person to another to be held for the bailor's use.
(2) Goods given to a friend for his own use without any charge
(3) Hiring of goods.
(4) Delivering goods to a creditor to serve as security for a loan.
(5) Delivering goods for repair with or without remuneration.
(6) Delivering goods for carriage.

DUTIES OF BAILOR
The duties of bailor are spelt out in a number of sections. These are enumerated
hereunder:

(I) The bailor must disclose all defects/faults in the goods bailed. If the bailor does not
disclose, he would be responsible for any loss or damage suffered by the bailee while
keeping the goods in his custody. The bailor is particularly responsible for defects in
goods hired to bailee whether bailor was aware of such defects or not.
BUSINESS LAWS

(ii) Where the bailment is gratuitous, the bailor must reimburse the bailee for any
expenditure incurred in keeping the goods.
(iii) The bailor should reimburse any expense which the bailee may incur by way of
loss in the process of returning the goods or complying with other directions for
returning the goods.
(iv) The bailor must compensate the bailee for the loss or damage suffered by the
bailee that is in excess of the benefit received, where he had lent the goods
gratuitously and decides to terminate the bailment before the expiry of the period
of bailment.
(v) The bailor is bound to accept the goods after the purpose is accomplished. If bailor
fails, he is responsible for any loss or damage to the goods and has to reimburse for
expenses incurred by the bailee for keeping the goods safely.

RIGHTS OF BAILOR
The following are the rights of bailor:
(1) Bailor has a right to enforce the duties of the bailee such as:
(a) Right to claim damages for loss caused to the goods by the negligence of
bailee.
(b) Right to claim compensation for loss caused by an unauthorized use of the
goods bailed.
(c) Right to claim damages arising out of mixing the goods of the bailor with his
own goods.
(2) Bailor has a right to terminate the contract if the bailee does anything, which is
inconsistent with the conditions of bailment. For example, 'A' lets on hire his horse
to 'B' for his own riding, but 'B' uses the horse for driving his carriage. 'A' has a right to
terminate the contract of bailment.
(3) Bailor in the case of gratuitous bailment has a right to demand the goods back even
before the expiry of the period of bailment. If in the process, loss is caused to the
bailee, bailor is bound to compensate.
(4) Bailor has a right to claim the increase or profit from the goods bailed which may
have occurred from the goods value. For example, where 'A' bails his cow to 'B' and
if the cow gives birth to a calf, 'B' is bound to return the cow and the calf to 'A'.

DUTIES OF BAILEE
The bailee is bound to take as much care of the goods bailed to him as a man of ordinary
prudence with regard to quantity, bulk and value would take.
In such a case he will not be responsible, in the absence of special contract, for any special
loss or destruction or deterioration of the goods bailed, since he has taken as much care as
a man of ordinary prudence.
For example if X bails his ornaments to 'Y' and 'Y' keeps these ornaments in his own locker
at his house along with his own ornaments and if all the ornaments are lost/stolen in a
riot 'Y' will not be responsible for the loss to 'X'. If on the other hand 'X' specifically
 THE INDIAN CONTRACT ACT, 1872. (PART IV)

instructs 'Y' to keep them in a bank, but 'Y' keeps them at his residence, then 'Y' would be
responsible for the loss [caused on account of riot].
Bailee has Right to Terminate: The bailee has the right to terminate a contract of bailment
if the bailor does anything inconsistent with bailment conditions.
In addition to the two important duties of having to take care of the goods bailed and
being responsible for loss/injury/damage to goods, bailee has other following duties
under the Act.
(i) Bailee has no right to make unauthorized use of goods bailed.
(ii) Bailee has no right to mix the goods bailed with his own goods without the
consent of the bailor.
(iii) Bailee has to return the goods on expiration of period of bailment.
(iv) Bailee has a duty to return any extra profit accruing from goods bailed. Where A
bails his cow to 'B' and if the cow gives birth to a calf, 'B' must return both the cow
and the calf to 'A'.
(v) Bailee has duty not to do anything inconsistent with the condition of bailment.

RIGHTS OF BAILEE
The bailee has the following rights and the duties of the bailor:
(i) To claim compensation for any loss arising from non-disclosure of known defects
in the goods.
(ii) To claim indemnification for any loss or damage as a result of defective title.
(iii) To deliver back the goods to joint bailors according to the agreement or directions.
(iv) To deliver the goods back to the bailor whether or not the bailor has the right to the
goods.
(v) To exercise his 'right of lien'. This right of lien is a right to retain the goods and is
exercisable where charges due in respect of goods retained have not been paid.
The right of lien is a particular lien for the reason that the bailee can retain only
these goods for which the bailee has to receive his fees/remuneration.
(vi) To take action against third parties if that party wrongfully denies the bailee of his
right to use the goods.

B) CONTRACT OF PLEDGE
Pledge is a variety or specie of bailment. It is bailment of goods as security for payment of
debt or performance of a promise. The person who pledges [or bails] is known as pledgor
or also as pawnor, the bailee is known as pledgee or also as pawnee. In pledge, there is no
change in ownership of the property. Under exceptional circumstances, the pledgee has a
right to sell the property pledged. Section 172 to 182 of the Indian Contract Act, 1872,
deals specifically with the bailment of pledge.
For example, A lends a money to B in lieu of a jewellary deposited by B as security to A.
This bailment of jewellary is a pledge as security for lending the money. B is a pawnor and
the A is a pawnee.
BUSINESS LAWS

Let us now examine the essentials of pledge and the rights of a pawnee and pawnor.

ESSENTIALS OF CONTRACT OF PLEDGE

There must be bailment for security for payment of debt/performance of promise. Goods
must be the subject matter of the contract of pledge. The goods pledged must be in
existence. There must be a delivery of goods from pawnor to pawnee.

PAWNEE'S RIGHTS
a) Right of Retainer: Pawnee has right to retain the goods pledged not only for
payment of debt or performance of a promise but also for recovery of debts and
all expenses incurred for preservation of goods pledged. Where 'M' pledges
stock of goods for a certain loan from a bank, the bank has a right to retain the
stock not only for adjustment of the loan but also for payment of interest.
b) Right to Retention to Subsequent Debts: Pawnee has a right to retain the
goods pledged towards subsequent advances as well, however subject to such
right being specifically contemplated in the contract.
c) Right to Seek Reimbursement of Extraordinary Expenses: Pawnee has a right
to seek reimbursement of extraordinary expenses incurred. However, his right
to retain the goods shall not extend to such extraordinary expenses but is
restricted to ordinary expenses.
d) Right to Sue: In the event of the pawnor failing to redeem the debt or perform
the promise, the pawnee has a right to sue the goods which he has retained. He
can in the alternative, under certain circumstances, sell the goods after giving a
reasonable notice, to the pledgor. The two rights namely the right to sue and the
right to sell are alternative rights and not cumulative rights.

RIGHTS OF A PAWNOR
a) Right to Redeem: Pawnor has the basic right to redeem the goods pledged by
performing his promise.
b) Right to Sue: Pawnor has a right to sue, but within a period of 3 years in view of
provision of Limitation Act only in the event of pawnee refusing to return the
goods even after payment of debt etc.
c) Right to Take Care of the Goods: Pawnor has a right to demand a pawnee to
take all reasonable care and preservation of the goods pledged.
d) Right to Receive Increase or Profit from the Goods: Pawnor is entitled to
receive the increase or profit from the goods if there is any increase/profit
relating to it during the pledged period.

5.5 DIFFERENCE BETWEEN BAILMENT AND PLEDGE

There are three distinctions between bailment and pledge. These are:
a) As to Purpose: Pledge is a variety of bailment. Under pledge goods are bailed as
a security for a loan or a performance of a promise. In regular bailment the
 THE INDIAN CONTRACT ACT, 1872. (PART IV)

goods are bailed for other purpose than the two referred above. The bailee
takes them for repairs, safe custody etc.
b) As to Right of Sale: The pledgee enjoys the right to sell only on default by
the pledgor to repay the debt or perform his promise, that too only after
giving due notice. In bailment the bailee, generally, cannot sell the goods.
He can either retain or sue for non-payment of dues.
c) As to Right of Using Goods: Pledgee has a right to use goods. A bailee can,
if the terms so provide, use the goods.
d) Consideration: In pledge there is always a consideration whereas in a
bailment there may or may not be consideration.
e) Discharge of Contract: Pledge is discharged on the payment of debt or
performance of promise whereas bailment is discharged as the purpose is
accomplished or after specified time.

5.6 CONTRACT OF AGENCY

In the modern world, conduct of business is not possible without the help of agents.
Therefore, it is necessary to know the law relating to agency. The law of agency is
contained in Sections 182 to 238 of the Indian Contract Act,1872.

WHAT IS AN AGENCY?
The Indian Contract Act, 1872 does not define the word 'Agency'. However, the word
'Agent' is defined as “a person employed to do any act for another or to represent another in
dealings with third persons.” The third person for whom the act is done or is so represented
is called “Principal”.
Thus, 'Agency' is a comprehensive word used to describe the relationship between one
person and another, where the first mentioned person brings the second mentioned
person into legal relation with others.
BUSINESS LAWS

The rule of Agency is based on the maxim “Quit facit per alium, facit per se” i.e., he who
acts through an agent is himself acting.

SALIENT FEATURES OF AGENCY

Following are the four salient features of agency:
i. Basis: The basic essence of 'agency' is that the principal is bound by the acts of
the agent and is answerable to third parties.
ii. Consideration not necessary: Unlike other regular contracts, a contract of
agency does not need consideration. In other words, the relationship between
the 'principal' and 'agent' need not be supported by consideration.
iii. Capacity to employ an agent: A person who is competent to contract alone can
employ an agent. In other words, a person in order to act as principal must be a
major and of sound mind.
iv. Capacity to be an agent: A person in order to be an agent must have authority to
contract. So, minor has no capacity to contract but may have authority to act as
agent. An agent brings about a contractual relationship between the principal
and third persons and therefore his contractual capacity is immaterial.

There are five general methods of creating an agency. They are:

(i) agency by actual authority
(ii) agency by ratification
(iii) agency of ostensible authority
(iv) agency by necessity
(v) agency by actual authority and apparent authority
Let us briefly discuss these five modes of creation of agency.

I. Agency by Actual Authority: A contract of agency can be express or implied. Whether

it is express or implied, it can be by words spoken or written. While the express
contract is often expressed in clear terms, implied contracts are created by
circumstances. For example, 'A' owns a shop and 'B' manages that shop. Though 'A'
being the owner orders purchases for that shop and pays through his bank account,
'B' by virtue of his position can also purchase as an agent, express or implied.

ii. Agency by ratification: Agency is also created by subsequent ratification or

approach. The subsequent ratification becomes necessary because the agent acts
without the knowledge or the approval of the principal. Following are the rules of
ratification:
a. Ratification can be made only by a person who was in existence at the time of act.
b. Ratification must be by a person for whom the act was done, professing him to be
a principal. This implies competency on the part of the person ratifying the act.
c. Ratification would date back to the date of the act and validate it.
 THE INDIAN CONTRACT ACT, 1872. (PART IV)

d. Ratification may either be express or even implied by the conduct of the person on
whose behalf the act was done.
e. Ratification must be of the whole act and not just for a part of the act.
f. Ratification [by the purported principal] of the acts of an agent cannot be such as
to create any liability to third parties or cause any injury or damage to third
parties.
g. Ratification cannot be done if the person ratifying is in knowledge of facts which
are materially defective.
h. Illegal acts cannot be ratified.
i. Acts which are void ab initio cannot be ratified
j. Ratification would be restricted to certain limitations to which original acts are
limited and ratification can be to that portion of exceeded authority by the agent.

iii. Agency by Ostensible Authority: Where the authority of the principal is inferred by
the conduct of the principal, there the agency through ostensible authority is born.
Here, the agent's authority is ostensible, and the principal is bound by the act of the
agent. Ostensible authority happens on account of estoppel and holding out. Let us
analyze these two types with examples:

1. Agency by Estoppels: If a person permits or represents another to act on his behalf,

so that a reasonable person would infer that the relationship of principal and agent
had been created then he will be stopped from denying his agent's authority and
getting himself relieved from his obligations to a third party by proving that no such
relationship in fact existed.
For example, where 'A' informs 'B' in the presence and within hearing of 'P' that 'P' is
his agent. Later 'B' enters into contract with 'P' thinking that 'P' is the agent of 'A'. In a
situation like this neither 'P' nor 'A' can refuse the obligations under the contract. 'P'
had become the agent of 'A' by estoppel. 'P' will be treated as agent of 'A' even if he
was not an agent at all.
Where a master permits his servant to pledge his credit, there is an agency on
account of estoppel. Even if the servant had on occasion pledged without the
authority of master, the master is still bound because of estoppel. Similarly, where a
married woman co-habits with her husband, there is a presumption that she has the
authority to pledge his credit for necessaries.
A principal cannot privately revoke or restrict the authority of his agent, which he
has allowed in public.
2. Agency by Holding Out: Under the principle of holding out, anyone who holds
himself out as an agent of another, then a relationship of agent and principal gets in
place. The process of holding out happens through willful conduct done to create a
deliberate impression. In such a case person concerned is estopped from denying
that he is the agent of a principal. The doctrine of holding out is also applicable in
case of partnerships. The law of partnership also adopts the principle of agency to a
large extent. However, under the “holding out” principle following conditions are
required to be present:
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a. statement or conduct of misrepresentation

b. a genuine not necessarily a fraudulent misrepresentation
c. the third person should prove that he entered into the transaction believing the
statement so made.

iv. Agency by Necessity: Sometimes circumstances would compel, and a relation of

agency would fall in place. This is often out of necessity. For example, a captain of a
ship can borrow money at other ports where there are no agent to act on behalf of the
owner, to carryout repairs. The captain becomes an agent by necessity. To constitute
an agency by necessity following conditions must be fulfilled:
a. agent should be in a position of not being able to communicate in time with the
principal.
b. there must have been an actual and definite commercial necessity.
c. the agent must have acted bonafide and for the benefit of principal.
d. the agent must have adopted most reasonable and practicable course of action.

v. Actual Authority and Apparent Authority: Actual authority to act as agent stems
from a consent. The consent to act may be oral or in writing. Sometimes, the authority
can also be 'implied authority'. The implied authority is incidental or usual or
customary. It would depend on the circumstance of the case.
The authority of the agent is 'apparent' where the principal represents or is regarded
by law as having represented that another has authority. Under the doctrine of
'apparent authority', the 'principal' is bound to third parties by the acts of that person
though he had not given such authority or had limited the authority by instructions
not made known to third party. The notion of apparent authority is essentially
confined to relationship between the principal and third party.

DUTIES AND RESPONSIBILITIES OF AN AGENT

Following are the duties of an agent:
1. Duty in Conducting Principal's Business: The agent should conduct the business of
the principal as per directions of the principal or in the absence of any directions as
per the custom prevalent in the business.

2. Liability in Case of Non-Compliance: The agent is liable to the principal for any loss
if he deviates from the above duty/ obligation where he did not act according to
instruction of the principal. It was held by the Supreme Court in a case that the agent
had to compensate the principal where the agent did not act according to the
instructions of the principal. In the given case the agent was under instruction to
insure the goods of the principal, but he did not. There was an explosion in the
Bombay dock and as a result all the goods of the principal, along with others, was
destroyed. The Government passed an ordinance that wherever there was a fire
insurance policy, full amount would be paid to the owners and where there was no
insurance cover, half the amount would be repaid. The principal was paid half the
losses and he sued the agent for the balance loss and the agent was ordered by courtto
pay the balance amount to compensate him for loss.
 THE INDIAN CONTRACT ACT, 1872. (PART IV)

3. Requirements as to Skill and Diligence: Agent must act always as a person with
diligence and skill normally exercised in the trade. He would otherwise be
responsible to compensate the principal for any loss suffered by the principal for
want of his skill. Example: Where 'A' acts as an agent for 'B' and sells rice to 'C' in the
usual course of business without verifying about C's solvency and if 'C' goes
insolvent, then 'A' is responsible for losses arising to 'B'.
4. Agents Duty to Account: The agent has to maintain and render proper accounts to
principal whenever demanded. He is bound to pay the principal all sums received.
He is bound to maintain accounts even if the contract is illegal or void.
5. Duty to Communicate: The agent must in order to obtain instruction, communicate
and contact the principal as a man of ordinary diligence.

RIGHTS OF AN AGENT
1. Right of Lien on Principal's Property: An agent is entitled to retain the goods,
properties and books for any remuneration, commission etc. due to him. The
possession of such property should be however lawful.
2. Right of Indemnification for Lawful Acts: The principal is bound to indemnify the
agent against all consequences of lawful acts done in exercise of his authority. For
example, 'A' of Delhi appoints 'B' of Mumbai as agent to sell his merchandise. As a
result, 'B' contracts to deliver the merchandise to various parties. But 'A' fails to send
the merchandise to 'B' and 'B' faces litigations for non-performance. Here, 'A' is
bound to protect 'B' against the litigations and all costs, expenses arising out of that.
3. Right of Indemnification Against Acts Done in Good Faith: Where the agent acts in
good faith on the instruction of principal, agent is entitled for indemnification of any
loss or damage from the principal. Where 'P' appoints 'A' as his agent and directs him
to sell certain goods which in fact turned out to be not those belonging to 'P' and if
third parties sue 'A' for this act, 'A' is entitled for reimbursement and indemnification
for such act done in good faith. However, the agent cannot claim any
reimbursement or indemnification for any loss arising out of acts done by him in
violation of any penal laws of the country.
4. Right of Retention: The agent can retain, out of the sums received from the principal,
such amounts towards reimbursement of expenditure, remuneration and advances
paid by him on account towards the business and render accounts only for the
balance.
5. Right of Remuneration: The agent in the normal course is entitled for remuneration
as per the contract. In the absence of any agreed amount of remuneration, he is
entitled for usual remuneration which is customary in the business. However, he is
not entitled for any remuneration for acts done through misconduct/negligence.

PERSONAL LIABILITY OF AN AGENT

We have already seen that basic principle of agency is that agent acts on behalf his
principal and therefore cannot personally enforce the contract. Similarly, he is also not
personally bound for any act.
However, under certain circumstances like, where the agent exceeds his authority, or has
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no authority or the principal does not ratify the act of the agent, the agent is personally
liable. This is known as doctrine of implied warranty of authority. The rules with regard
to personal liability of an agent are set out hereunder:
(i) Where the contract expressly provides for personal liability of the agent.
(ii) Where the agent signs the negotiable instrument without indicating that he is
signing it for the principal.
(iii) Where the agent works for a foreign principal.
(iv) Where the agent acts for a principal who cannot be sued viz Ambassador of a
country etc.
(v) Where a Govt. servant enters into a contract on behalf of Union of India in
disregard of Article 299(1).
(vi) Where according to usage in trade in certain kinds of business agents are
personally liable.
(vii) Where the agency is coupled with interest. An agency will be treated as such
where the agent himself has interest in the subject matter. The 'interest' of the
agent to come under this category should not be an ordinary 'interest' like
towards remuneration etc. but should be a special interest.

The liability of the principal to third parties would fall under following categories:
a. When Agent Acts Within the Scope of His Authority: The principal is liable for
the acts of the agent done within the scope of his actual or apparent authority.
Where there are specific restrictions on the authority of the agent, then the
principal is not bound by it.
b. Principal is Bound by Notice Given to the Agent: The principal is bound by the
notice given to the agent. Knowledge of the agent is knowledge of the principal.
Knowledge of a bank manager is knowledge of the bank. Therefore, the principal
is bound except where the agent does acts that are fraudulent.
c. Liability by Estoppels: Where the agency is by the doctrine of estoppel, the
principal is bound by the same doctrine.
d. Liability for Misrepresentation: The principal is liable for any fraud or
misrepresentation done by the agent within his authority regardless of the fact
that the act has resulted in benefit to the agent or the principal.
 THE INDIAN CONTRACT ACT, 1872. (PART IV)

5.7 KEYWORDS

• Contract Of Indemnity: 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.
• Discharge Of Surety: The death of a surety as regards future transactions in case of a
continuing guarantee in the absence of a contract to the contrary.
• Bailment: A "bailment" is the delivery of goods by one person to another for some purpose,
upon a contract that they shall, when the purpose is accomplished, be returned, or
otherwise disposed of according to the directions of the person delivering them.
• Bailor: The person delivering the goods is called the "bailor".
• Contract Of Agency: Agency can be defined as the relationship between two persons,
wherein a person has the authority to act on behalf of another.

5.8 SUMMARY

• Contract of Indemnity comes in picture in case of contingency, when the party

faces some losses or injury.
• Contract of indemnity works on the lines of as Insurance companies do work.
• The word indemnify basically means to assure, cover, or underwrite. It is a
contractual responsibility of one party to pay the loss incurred to the other party
due to the acts of any other party. It is a contract, where there is a high probability
of risk and chance, in case if the original person does not honor his duty, then the
other person will be responsible to honor the same. In case of Guarantee contract,
third party comes into action as surety, if the Principal debtor fails to repay the
money to the creditor.
• A guarantee, which extends to a series of transactions, is called a 'continuing
guarantee.'
• In a contract of indemnity, there are only two parties namely the indemnifier
[promisor] and the indemnified [promisee]. In a contract of guarantee there are
three parties: creditor, principal debtor, and surety
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• The Contract of Bailment is where one party the Bailor transfers the possession of
goods to the Bailee other than as security, while the Contract of Pledge involves
transfer of goods to the other party as a security to recover debt or for any
performance.
• The popular forms of bailment are Delivery of goods by one person to another to
be held for the bailor's use, Goods given to a friend for his own use without any
charge, Hiring of goods, Delivering goods to a creditor to serve as security for a
loan, Delivering goods for repair with or without remuneration, Delivering
goods for carriage.
• Pledge is a variety or specie of bailment. It is bailment of goods as security for
payment of debt or performance of a promise. The person who pledges [or bails]
is known as pledgor or also as pawnor, the bailee is known as pledgee or also as
pawnee. In pledge, there is no change in ownership of the property
• In Contract of Agency, there is a person named agent, who works on behalf of
someone else named as Principal. The Agent works as per the instructions of the
Principal and on behalf and representing the Principal.
'
• Agency' is a comprehensive word used to describe the relationship between one
person and another, where the first mentioned person brings the second
mentioned person into legal relation with others.
• There are five general methods of creating an agency. (i) agency by actual
authority (ii) agency by ratification (iii) agency of ostensible authority (iv) agency
by necessity (v) agency by actual authority and apparent authority