Contract of Guarantee : Indian Contrect Act, 1872

This article is written by Krishnaraj Choudhary, Student of Dr. Anushka Law College Udaipur. The author in this article has discussed the concept of Guarantee

Contract of Guarantee :

Definition :

According to Section 126 of Indian Contract Act, 1872 A "Contract of guarantee" is a contract to perform the promise, or discharge the liability, of 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.

Parties to Contract :

The are mainly three parties to contract i.e. :

The person who gives guarantee is called the "Surety".
The person in respect of whose default the guarantee is given is called "principal debtor".
The person to whom the guarantee is given is called the "creditor"

Illustration :

'A' takes a loan from a bank. 'A' promises to the bank to repay the loan. 'B' also makes a promise to the bank saying that if 'A' does not repay the loan "then I will pay". In this case 'A' is a principal debtor, who undertakes to repay the loan, 'B' is the surety, whose liability is secondary because he promises to perform the same duty in case there is default on the part of 'A' the bank in whose favour the promise has been made is the creditor.

Essentials of Contract of Guarantee :

The following are the essentials of a contract of guarantee :

Must be made with the agreement of all three parties : All the three parties to the contract i.e. the principal debtor, the creditor, and the surety must agree to make such a contract with the agreement of each other. here it is important to note the surety take his responsibility to be liable for the debt of the principal debtor only on the request of the principal debtor.
Consideration : According to section 127 of the act, anything is done or any promise made for the benefit of the principal debtor is sufficient consideration to the surety for giving the guarantee. The consideration must be a fresh consideration given by the creditor and not a past consideration.
Liability : In a contract of guarantee, the liability of a surety is secondary. This means that since the primary contract was between the creditor and principal debtor, the liability to fulfill the terms of the contract lies primarily with the principal debtor. It is only on the default of the principal debtor that the surety is liable to repay.
Debt : The main function of a contract of guarantee is to secure the payment of the debt taken by the principal debtor. If no such debt exists then there is nothing left for the surety to secure. Hence in cases when the debt is time-barred or void, no liability of the surety arises.
Must Contain all the essential of a valid contract : Since a contract of guarantee is a type of contract, all the essential of a valid contract will apply in contracts of guarantee as well. Thus, all the essential requirement of a valid contract such as free consent, valid consideration, offer and acceptance, intention create a legal relationship etc are required to be fulfilled.
Consent of the surety should not have been obtained by misrepresentation or concealment : The creditor should not obtain guarantee either by any misrepresentation or concealment of any material facts concerning the transactions. If the guarantee has been obtained that way, the guarantee is invalid.

Section 142 : Guarantee obtained by misrepresentation invalid - Any guarantee which has been obtained by means of misrepresentation made by the creditor, or with the knowledge and assent, concerning a material part of the transaction is invalid.

Section 143 : Guarantee obtained by concealment invalid - Any guarantee which the creditor has obtained by means of keeping silence as to material circumstance is invalid.

Kinds of Guarantee :

Specific or simple Guarantee : When a guarantee is given in respect to a single debt or specific transaction is to come to an end when the guarantee debt is paid or the promise is duty performed. It is called specific or simple guarantee.
Continuing Guarantee : Section129, of the Indian Contract Act Defines a guarantee which towards to a series of transaction, is called a continuing guarantee. Thus, a continuing guarantee is not confined to a single transaction but keeps on moving to several transaction continuously.

Illustration : 'A' in consideration that 'B' will employ 'C' in collecting the rent of 'B' "gamidari" promises 'B' to be responsible to the amount of 5000Rs for the due collection and payment by 'C' of those rents.

Revocation of Continuing Guarantee :

Section 130 By Giving a notice : A continuing guarantee may at any time be revoked by the surety, as to future transaction by notice to the creditor. Illustration : 'A' guarantee to 'B' to the extent of Rs 10000 that 'C' shall pay for all the goods bought by him during the next 3 months. 'B' sues goods worth Rs 6000 to 'C' , 'A' gives notice of revocation, 'C' is liable for Rs 6000. If only goods are sold to 'C' after the notice of revocation, 'A' shall not be liable for that.
Section 131 By death of surety : The death of the surety operates in the absence of any contract to the contrary, as a revocation of a continuing guarantee so for as regards future transaction.

Right Of Surety :

Right against the Principal Debtor :

Right of surety on payment of debt or the right of subrogation :- The right of subrogation means that since the surety had given a guarantee to the creditor and the creditor after getting the payment is out of the scene, the surety will now deal with the debtor as if he is a creditor. Hence the surety has the right to recover the amount which he has paid to the creditor which may include the principal amount, costs and the interest.
The right of indemnity : In every contract of guarantee there is an implied promise by the P.D. (Principal Debtor) to indemnity the surety, and the surety is entitled to recover from the P.D. whatever sum he has rightfully paid under the guarantee.

Right against The Creditor :

Right to securities given by the P.D. : On the default of payment by the P.D. when the surety pays off the debt of the P.D. be becomes entitled claim all the securities which were given by the P.D. to the creditor. The Surety has the right to all security whether received before or after the creation of the guarantee and it is also immaterial whether the surety has knowledge of there security or not.
Right to Set-Off : When the creditor sues the surety for the payment of P.D. 's Liability, the security can claim set off, or counter claim if any, which the P.D. had against the creditor.

Right Against the Co-Sureties :

Release of one co-surety does not discharge other : Where there are co-surety, a release by the creditor of one of them does not discharge the others neither does it free the surety so released from his responsibility to the other securities.
Co-Surety to contribute equally : In the absence of any contract to the contrary, the co-sureties are liable to contribute equally. This principle will apply even when the liability of co-surety is joint or several, and whether under the same or different contracts and whether with or without the knowledge of each other. Illustration : 'A' , 'B' , 'C' and 'D' are co-sureties for a debt of Rs 20000 lent by 'Z' to 'R'. 'R' defaults in repaying the loan. 'A' , 'B' , 'C' and 'D' are liable to contribute Rs 5000 each.
Liability of co-surety bound in different sum : Co-surety who are bound in different sums are liable to pay equally as the limits of their respective obligations permit.

Discharge of surety from liability :

By Revocation ( Section 130 ) : Ordinary a guarantee is not revocable when once it is acted upon by Section 130 provide for revocation of continuing guarantee. A continuing guarantee may any time we revoke by the surety as to future transaction by notice to the creditor. Revocation become effective for future transaction while the surety remains liable for transaction already entered into.
By death of surety ( Section 131 ) : The continuing guarantee is also determined by the death of surety unless there is a contract to the contrary. The termination become effective only for the future transaction. The surety heir can be sued for liability already incurred. Section 131 says the liability of the deceased surety can be imposed against his legal heir by only to the extent of property inheritated by them.
By variance ( Section 133) : Discharge of surety by variance in terms of contract. Any variance made without the surety's consent in the terms of the consent in the terms of the contract between the P.D. and the creditor, Discharge the surety as to transactions subsequently to the variance.
Release or discharge of P.D. : The surety is discharge by any contract between the creditor and the P.D. , by which the P.D. is released or by any act or omission of the creditor the legal consequences of which is the discharge of P.D. The Section provide for two kinds of discharge from liability in first place if the creditor has any contract with a P.D. by which the later is released the surety is discharged and the second ground of discharge provided in Section 134 is that when the creditor does any act or omission the legal consequences of which is the discharge of the P.D. , the surety would also be discharge from his liability.
Composition, Extension of time & promise not to sue ( Section 135 ) : A contract between the creditor and P.D. by which the creditor makes a composition will of promises to give time to or not to sue the P.D. discharge the surety unless the surety assent to such contract. The Section provide the 3 modes of discharge from liability.
Surety not Discharged when agreement mode with third person to give time to P.D. ( Section 136 ) : Where a contract to give time to the P.D. is made by the creditor with a third person and discharged. If P.D. promises not to sue him the surety is discharged.
Creditor's forbeareance merely to sue does not discharged surety (Section 137) : Mere forbeareance on the part of the creditor to sue the P.D. or to enforce any other remedy against him does not in the guarantee to the contrary discharge the Surety.
Discharge of surety by creditor's act or omission impairing surety's eventual remedy ( Section 139 ) : If the creditor does any act which is inconsistent with the right of surety or omits to do any act which is duty to the surety require him to do and eventual remedy of the surety himself against the P.D. is thereby Impaired the surety is Discharged.

Nature of Surety's liability ( section 128 ) :

👉 The liability of the surety is co - extensive with that of the P.D. unless it is otherwise provided by the contract.

The term " Co - extensive with that of P.D." means that the surety is liable for what the P.D. is liable.
The liability of a surety arises only on default by the P.D. but as soon as the P.D. defaults, the liability of the surety begins and runs co - extensive with the liability of the P.D. , in the sense that the surety will be liable for all those sums for which the P.D. is liable.
Where a debtor cannot be held liable on account of any defect in the document, the liability of the surety ceases.
Surety's liability continues even if the P.D. has not been sued or is omitted from being sued. In other words, a creditor may chose against a surety first, unless there is an agreement to the contrary.

Written By - KR Choudhary