Quiz: Contracts of Indemnity and Guarantee — 28 questions

1. Which situation falls within the statutory definition of a contract of indemnity?

A. A party agrees to transfer ownership after receiving payment

B. A party promises to insure a person against every accidental event

C. A party promises to pay a debt if a third person defaults

D. A party promises to compensate another for loss caused by a person’s conduct

Answer: (D)

Explanation

A contract of indemnity involves a promise to save another from loss caused by the promisor or another person’s conduct. It is distinct from a guarantee, which responds to a third person’s default.

2. In a contract of indemnity, who is responsible for promising compensation, and who receives protection against the loss?

A. The indemnifier promises compensation, and the indemnity-holder receives protection

B. The indemnity-holder promises compensation, and the indemnifier receives protection

C. The surety promises compensation, and the principal debtor receives protection

D. The creditor promises compensation, and the surety receives protection

Answer: (A)

Explanation

The indemnifier is the party who promises to compensate for the loss, while the indemnity-holder is the party whose loss is to be made good.

3. Which loss is excluded from coverage under the statutory definition of indemnity?

A. Loss caused by a person acting within the promisor’s authority

B. Loss caused by an accident without human conduct

C. Loss caused by another person’s wrongful conduct

D. Loss caused by the promisor’s breach of duty

Answer: (B)

Explanation

The statutory definition does not cover loss caused by an accident without human conduct or by an act of God. Indemnity under this definition concerns loss connected with human conduct.

4. An indemnity-holder acting within the scope of authority is compelled to pay damages in a lawsuit. What may the holder recover from the indemnifier?

A. The damages the holder was compelled to pay

B. Only damages voluntarily paid before the lawsuit

C. Only unrelated expenses incurred after the lawsuit

D. No damages until the indemnifier is sued separately

Answer: (A)

Explanation

An indemnity-holder acting within the scope of authority may recover all damages that the holder is compelled to pay in the suit. Amounts outside that authorized context are not covered by this rule.

5. Which litigation expense may an indemnity-holder recover under the rules governing indemnity?

A. Costs of a separate transaction with no connection to the suit

B. Costs compelled in bringing or defending the suit

C. Voluntary expenses unrelated to the dispute

D. Personal expenses incurred before the indemnity arose

Answer: (B)

Explanation

The indemnity-holder may recover costs the holder is compelled to pay in bringing or defending the suit. Voluntary and unrelated expenses do not fall within this rule.

6. When does the indemnifier’s liability commence under the stated rule?

A. When the indemnity-holder’s liability becomes absolute and certain

B. When the indemnity-holder voluntarily incurs an unrelated expense

C. When the indemnity-holder first suspects that a loss may occur

D. When the indemnifier receives notice of any possible dispute

Answer: (A)

Explanation

The indemnifier’s liability commences when the indemnity-holder’s liability becomes absolute and certain, although the Act does not expressly specify the commencement time.

7. What event activates a contract of guarantee under Section 126 of the Indian Contract Act, 1872?

A. Any accidental loss suffered by the creditor

B. The principal debtor’s default in performing a promise or discharging liability

C. The surety’s decision to withdraw from the agreement

D. The creditor’s transfer of property to the principal debtor

Answer: (B)

Explanation

A guarantee is a promise to perform or discharge a third person’s liability if that person defaults. This differs from indemnity, which directly protects against specified loss.

8. In a contract of guarantee, which party gives the guarantee and which party receives it?

A. The principal debtor gives it, and the creditor receives it

B. The surety gives it, and the creditor receives it

C. The surety gives it, and the principal debtor receives it

D. The creditor gives it, and the surety receives it

Answer: (B)

Explanation

The surety gives the guarantee, the principal debtor is the person whose default is guaranteed, and the creditor is the person to whom the guarantee is given.

9. Which description correctly identifies the structure of a contract of guarantee?

A. It contains a single contract between the principal debtor and the creditor

B. It contains only a direct contract between the creditor and the surety

C. It contains an indemnity contract between the creditor and the principal debtor, without a surety contract

D. It contains a principal debtor-creditor contract, a creditor-surety contract, and an implied surety-debtor indemnity

Answer: (D)

Explanation

A guarantee is tripartite: it includes the principal contract between debtor and creditor, the secondary contract between creditor and surety, and an implied indemnity contract between surety and debtor.

10. Which underlying obligation can support a valid guarantee?

A. A purely moral obligation with no legal remedy

B. A debt barred by the limitation period

C. A future obligation that cannot be legally enforced

D. A recoverable debt or enforceable promise

Answer: (D)

Explanation

A guarantee requires a recoverable principal debt or an enforceable promise. A time-barred liability is not legally enforceable and therefore cannot support the guarantee.

11. Under Section 127, what may serve as sufficient consideration for the surety’s promise?

A. A benefit received by an unrelated third party

B. Past consideration provided before the guarantee

C. Consideration received by the principal debtor

D. Only a payment made directly to the surety

Answer: (C)

Explanation

Consideration received by the principal debtor is sufficient consideration for the surety’s promise. The consideration need not be given directly to the surety.

12. Which statement correctly describes the effect of incompetence to contract on a guarantee?

A. The guarantee remains valid whenever either party is incompetent

B. The guarantee is valid only when both the debtor and surety are competent

C. The guarantee may remain valid if the principal debtor is incompetent, but is void if the surety is incompetent

D. The guarantee is void whenever either the principal debtor or surety is incompetent

Answer: (C)

Explanation

A principal debtor’s incompetence does not necessarily invalidate the guarantee, but a surety who is incompetent to contract cannot give a valid guarantee.

13. How does a specific guarantee differ from a continuing guarantee?

A. A specific guarantee applies to future debts, while a continuing guarantee applies only to past debts

B. A specific guarantee is oral, while a continuing guarantee must be written

C. A specific guarantee covers repeated transactions, while a continuing guarantee covers one transaction only

D. A specific guarantee covers one transaction, while a continuing guarantee covers a series of transactions until revoked

Answer: (D)

Explanation

A specific guarantee ends when the single debt is discharged or the promise is performed. A continuing guarantee extends to a series of transactions until revoked.

14. Which parties are involved in a guarantee but not in the basic bilateral structure of an indemnity?

A. A creditor, principal debtor, and surety

B. A creditor and an indemnifier

C. A principal debtor and an indemnity-holder

D. An indemnifier and an indemnity-holder

Answer: (A)

Explanation

A guarantee is tripartite, involving the creditor, principal debtor, and surety. An indemnity is generally bilateral, involving the indemnifier and indemnity-holder.

15. A principal debtor defaults, and the creditor seeks payment from the surety. Which characterization best describes the surety’s liability?

A. Secondary in origin and ordinarily triggered by the principal debtor’s default

B. Limited to reimbursement after the creditor has recovered from the debtor

C. Primary and unconditional from the moment the contract is formed

D. Independent of any default by the principal debtor

Answer: (A)

Explanation

The surety’s liability is secondary because it ordinarily arises upon the principal debtor’s default. By contrast, an indemnifier’s liability is primary and unconditional.

16. What does a guarantee primarily protect the creditor against?

A. The principal debtor’s non-performance or non-payment

B. A third party’s unauthorized transfer of property

C. The indemnifier’s inability to reimburse the claimant

D. Any loss suffered without reference to another party’s obligation

Answer: (A)

Explanation

A guarantee secures the creditor against non-performance or non-payment by the principal debtor. Indemnity, in contrast, is directed toward reimbursement of loss.

17. Unless the contract provides otherwise, what does the surety’s co-extensive liability mean under Section 128?

A. The surety is liable for a fixed amount regardless of the debtor’s liability

B. The surety’s liability generally matches the principal debtor’s liability

C. The surety’s liability is always less than the principal debtor’s liability

D. The surety becomes liable only after obtaining the creditor’s rights by assignment

Answer: (B)

Explanation

Section 128 makes the surety’s liability co-extensive with that of the principal debtor by default. The parties may, however, contractually limit the surety’s liability.

18. Which statement best explains the relationship between the secondary nature of surety liability and the creditor’s remedies?

A. The liability is secondary because the creditor must exhaust all remedies against the principal debtor first

B. The liability is independent because the creditor may proceed only against the surety

C. The liability is primary because the creditor must sue the surety before the principal debtor

D. The liability is secondary because it ordinarily follows default, but the creditor may proceed against the surety first

Answer: (D)

Explanation

Surety liability is secondary in origin because it ordinarily arises after the principal debtor defaults. Nevertheless, the creditor may proceed directly against the surety first unless the parties agreed otherwise.

19. What is the effect of a surety’s notice revoking a continuing guarantee?

A. It invalidates the original guarantee from the date it was created

B. It ends the surety’s liability for all transactions, including earlier ones

C. It transfers liability for future transactions to the principal debtor

D. It ends the surety’s liability for future transactions but preserves liability for earlier ones

Answer: (D)

Explanation

Notice revokes a continuing guarantee only for future transactions. The surety remains liable for transactions entered into before the notice.

20. What is the usual effect of a surety’s death on a continuing guarantee?

A. It leaves the guarantee fully effective for all future transactions

B. It ends future coverage, while the estate remains liable for prior transactions

C. It transfers all future guarantee obligations directly to the creditor

D. It cancels liability for both past and future transactions

Answer: (B)

Explanation

Unless the contract provides otherwise, death revokes a continuing guarantee for future transactions. The surety’s estate remains liable for transactions entered into before death.

21. A creditor and principal debtor change the contract terms without the surety’s consent. For which transactions is the surety discharged?

A. No transactions, because contract changes do not affect a surety

B. All transactions under the original and changed contracts

C. Transactions entered into after the change only

D. Transactions completed before the change only

Answer: (C)

Explanation

An unauthorized variance in the contract discharges the surety for transactions subsequent to the variance. It does not release liability for transactions already completed.

22. Which creditor action discharges the surety from liability?

A. Remaining inactive while the principal debtor delays payment

B. Requesting payment from the principal debtor without changing the contract

C. Releasing the principal debtor through a new contract or legally effective act

D. Giving the principal debtor a routine reminder to perform

Answer: (C)

Explanation

The surety is discharged when the creditor releases or discharges the principal debtor through a new contract or an act or omission with that legal consequence. Mere inaction does not have that effect.

23. A creditor agrees with the principal debtor to give additional time for payment without obtaining the surety’s assent. What is the effect on the surety?

A. The surety remains liable because additional time strengthens the guarantee

B. The surety is discharged only if the principal debtor becomes insolvent

C. The guarantee becomes automatically enforceable against the co-sureties alone

D. The surety is discharged because the creditor promised to give time

Answer: (D)

Explanation

A creditor’s composition with, promise to give time to, or promise not to sue the principal debtor discharges the surety unless the surety assents. This differs from mere forbearance to sue.

24. When can a creditor’s conduct discharge a surety to an affected extent?

A. When the creditor preserves every remedy available against the principal debtor

B. When the creditor makes any demand for payment from the surety

C. When the principal debtor voluntarily requests more time to pay

D. When the creditor’s act or omission impairs the surety’s eventual remedy against the principal debtor

Answer: (D)

Explanation

A creditor’s act or omission that impairs the surety’s eventual remedy against the principal debtor discharges the surety to the extent affected.

25. When does a surety acquire the creditor’s rights against the principal debtor through subrogation?

A. When the guarantee is first executed

B. When the creditor first threatens legal action

C. After the surety pays all amounts for which the surety is liable

D. When the principal debtor requests an extension of time

Answer: (C)

Explanation

Subrogation arises after the surety has paid all that the surety is liable for. It does not arise merely when the guarantee is created or before performance.

26. Which payment may a surety recover from the principal debtor under the implied promise of indemnity?

A. Any payment made by the surety, including one made wrongfully

B. A payment exceeding the surety’s lawful obligation

C. A payment made without any liability under the guarantee

D. A payment rightfully made under the guarantee

Answer: (D)

Explanation

The principal debtor’s implied promise to indemnify permits recovery of sums rightfully paid under the guarantee. Wrongful payments are not recoverable under this promise.

27. What is the general contribution rule for co-sureties who guarantee the same debt?

A. The co-surety with the smallest maximum obligation contributes the largest share

B. Each co-surety contributes according to personal wealth rather than contractual limits

C. The creditor chooses which co-surety bears the entire unpaid debt

D. Each co-surety contributes equally, subject to agreed maximum limits where their obligations differ

Answer: (D)

Explanation

Co-sureties generally contribute equally toward the whole debt or unpaid part. If they are bound in different sums, each contributes equally within the applicable maximum limit.

28. Which persons are co-sureties?

A. Persons who borrow money together without guaranteeing repayment

B. Persons who guarantee the same debt or duty

C. Persons who guarantee different debts owed to the same creditor

D. Persons who receive security from the principal debtor

Answer: (B)

Explanation

Co-sureties are two or more persons who guarantee the same debt or duty. Their shared guarantee distinguishes them from persons connected only by the same creditor or debtor.