Contract of guarantee:- The Indian Contract Act 1872 Notes

Meaning of Certain Terms under Setion 126 of Indian Contract Act 

• Meaning of ‘contract of guarantee’
  A ‘contract of guarantee’ is a contract to –
  • Perform the promise; or
  • Discharge the liability, of a third person in case of his default.

• Meaning of ‘surety’
  The person who gives the guarantee is called as ‘surety’

• Meaning of ‘principal debtor’
  The person in respect of whose default the guarantee is given is called as ‘principal debtor’.

• Meaning of ‘creditor’
  The person to whom the guarantee is given is called as ‘creditor’.

What is a Contract of Guarantee?

A contract of guarantee is an agreement in which the surety promises to fulfill the obligation of the principal debtor if the latter defaults on a debt or fails to perform their obligation. The contract creates a legal obligation on the surety to pay or perform when the principal debtor fails.

• ON MONEY
  • Nature of payment
    • Specific/Simple Guarantee: Guarantee is for a      single transaction. It ends when debt is discharged or promise         is performed.
    • Continuing Guarantee: Guarantee is for a series of transactions. Liability extends till  the revocation of guarantee.
  • Effective time of payment
    • Retrospective Guarantee: Guarantee is for an existing debt or obligation
    • Prospective Guarantee: Guarantee is for a future debt or obligation
• ON PERSON
  • Fidelity Guarantee: Guarantee is on the good conduct or honesty of a person employed in a particular organizations.

Key Elements of a Contract of Guarantee:

• Must have all the essentials of a valid contract
  • All the essentials of a valid contract must be present in the contract of guarantee.
  • Exceptions:
    • Consideration received by the principal debtor is a sufficient consideration to the surety for giving the guarantee.
    • Even if principal debtor is incompetent to contract, the guarantee is valid. But, if surety is incompetent to contract, the guarantee is void.

• Primary liability of some person
  • The principal debtor must be primarily liable. However, even if the principal debtor is incompetent to contract the guarantee is valid.
  • The debt must be legally enforceable.
  • The debt must not be a time barred debt.

• The contract must be conditional
  • The liability of surety is secondary and conditional.
  • The liability of surety arises only if the principal debtor makes a default.

• No misrepresentation
  • The creditor should disclose all the facts which are likely to affect the surety’s liability.
  • There must not be any concealment of facts.

• Form of contract
  A contract of guarantee may be either oral or written.

• Joining of other co-sureties
  The guarantee by a surety is not valid if –
  • A condition is imposed by a surety that some other person must also join as a co- surety; but
  • Such other person does not join as a co-surety.

NATURE AND EXTENT OF SURETY’S LIABILITY

• Surety’s liability is coextensive with liability of principal debtor
  General rule –
  • Surety is liable for all the debts payable by the principal debtor to the creditor.
  • Accordingly, interest, damages, costs etc. may also be recovered from the surety.
• Exception:- The contract of guarantee may provide otherwise.

• Commencement of surety’s liability
  • The liability of surety arises immediately on default by the principal debtor.
  • The creditor is not required to –
    • first sue the principal debtor; or
    • first give a notice to the principal debtor.

• Surety’s liability may be limited
  • The surety may fix a limit on his liability up to which the guarantee shall remain effective.

• Surety’s liability may be continuous
  • The surety may agree to become liable for a series of transactions of continuous nature.
  • However, the surety may fix –
    • a limit on his liability upto which the guarantee shall remain effective;
    • a time period during which the guarantee shall remain effective.

• Surety’s liability may be conditional
  The surety may impose certain conditions in the contract of guarantee. Until those conditions are met, the surety shall not be liable.

Continuing Guarantee Under Indian Contract Law 

• Meaning
  A guarantee which extends to a series of transactions is called as continuing guarantee.

• Revocation (Sec.130)
  Continuing guarantee may be revoked, at anytime, by the surety by giving a notice to the creditor. However, revocations shall be effective only in respect of future transactions (i.e. the liability of the surety with regard to previous transactions remains unaffected)

• Death of surety (sec. 131)
  Death of the surety operates as a revocation of a continuing guarantee as to future transaction.

Types of Guarantees

The three types of guarantees are based on the nature and scope of the surety’s liability:

1. Specific Guarantee:
   A specific guarantee is given for a single, particular transaction or debt. The liability of the surety terminates once the guaranteed transaction is complete.

   Example: C guarantees A’s loan of ₹50,000. Once A repays the loan, C’s guarantee ends.

2. Continuing Guarantee (Section 129):
   A continuing guarantee extends to a series of transactions between the same parties. The surety’s liability continues until the guarantee is revoked.

   Example: C guarantees A’s credit line with B for multiple purchases. The guarantee covers each transaction until C revokes it.

3. Conditional Guarantee:
   A conditional guarantee becomes enforceable only upon the occurrence of a specific event or condition.

   Example: C guarantees A’s performance of a contract with B only if A is awarded a particular project.

Features of a Contract of Guarantee

The features of a contract of guarantee include:

1. Secondary Liability:
   The surety’s liability is secondary, arising only when the principal debtor defaults. If the debtor fulfills their obligation, the surety’s liability does not come into play.

2. Consent of All Parties:
   The contract must be entered into with the knowledge and consent of all three parties—creditor, principal debtor, and surety.

3. Consideration:
   No separate consideration is required for the surety, but the consideration between the principal debtor and creditor is sufficient for the contract of guarantee.

4. Obligation of Principal Debtor:
   The liability of the surety is based on the obligation of the principal debtor. If the principal debtor’s liability is void or invalid, the surety’s liability also ceases.

Nature of Surety’s Liability in a Guarantee Contract

The surety’s liability is contingent upon the default of the principal debtor. Once the principal debtor defaults, the surety becomes liable to fulfill the promise or discharge the debtor’s liability.

Extent of Surety’s Liability:

1. Co-Extensive with Principal Debtor:
   Under Section 128, the liability of the surety is co-extensive with that of the principal debtor. This means that the surety’s liability is equal to that of the debtor unless specifically limited by the contract.

   Example: If A defaults on a loan of ₹1,00,000, the surety, C, is liable for the same amount.

2. Liability in Case of Death:
   If the surety dies, the liability of the surety’s estate depends on the terms of the contract. In case of a continuing guarantee, the surety’s liability can extend to future transactions unless revoked.

Rights of Surety (Sec.140, 141, 145, 146 and 147)

1. Rights against principal debtor
   • Right of indemnity
     There is an implied promise by the principal debtor to indemnity the surety.The surety is entitled to claim from the principal debtor all the sums which he has rightfully paid.The surety cannot recover such sums, which the he has paid wrongfully.
   • Right of subrogation
     On payment of a debt, the surety shall be entitled to all the rights which the creditor could claim against the principal debtor.
     
     
2. Rights against the creditor
   • Right of subrogation
     The surety can claim all the securities which the creditor had at the time of giving of guaranteeIt is immaterial as to whether the surety had knowledge of such securities or not.If the securities are returned by the creditor to the principal debtor the surety is discharged to the extent of value of the securities so returned.
   • Right of set off
     • Any amount recoverable by the principal debtor may be claimed as deduction.
     • Any amount recoverable by the surety may be claimed as deduct
   • Rights to share reduction
     If the principal debtor becomes insolvent, the surety may claim proportionate reduction in his liability.
3. Rights against co-sureties
   • Rights to contribution General Rule
     All the co-sureties shall contribute equally

Exceptions

• Under the contract of guarantee, the co-sureties may fix limits on their respective liabilities. Even in such a case, the co-sureties shall contribute equally, subject to maximum limit fixed by the co-sureties.
• The contract of guarantee may provide that the co-sureties shall contribute in some other proportion.

• Right to share benefit of securities
  If one co-surety receives any security, all the other co-sureties are entitled to share the benefit of such security.

Distinction Between Indemnity and Guarantee

Discharge of Surety From Liability (Sec.130 To 144)

DISCHARGE OF SURETY

• Revocation of contract of guarantee               
• Invalidation of contract of guarantee   
• Conduct of Creditor                                        

Notice of revocation by surety

• Specific guarantee
  A specific guarantee can be revoked only if liability of principal debtor has not arisen.

• Continuing guarantee
  A continuing guarantee can be revoked only in respect of future transactions.

• Death of surety
  In case of death of surety, a continuing guarantee is automatically revoked in respect of future transactions.

• Variance in terms If –
  • Any variation is made subsequent to formation of contact of guarantee; and
  • Such variation is made without the consent of surety;

Then –

• The surety shall be released for such transactions as take place after such variation.

• Release or discharge of principal debtor If –
  • The creditor makes a fresh contract with the principal debtor whereby the principal debtor is relieved from his liability; or –
  • The creditor does any act or omission resulting in discharge of the principal debtor;

Then – The surety is discharged.

• Composition with principal debtor
  The surety is discharged if the creditor makes a composition with the principal debtor without obtaining the consent of surety.

• Giving extension of time to principal debtor
  The surety is discharged if the creditor extends the time for repayment of the debt by the principal debtor without obtaining the consent of the surety.

• Loss of security by a creditor
  The surety is discharged to the extent of security lost by the creditor.

Latest Case Law on Contract of Guarantee

• Bank of Baroda v. Tejraj Surana (2021)
  In this case, the court held that the surety’s liability is co-extensive with that of the principal debtor under Section 128 of the Indian Contract Act. The court emphasized that the surety is liable for the entire amount of the debt if the principal debtor defaults, even if the creditor has not exhausted remedies against the debtor.
• State Bank of India v. Ramakrishna (2020)
  This case dealt with the discharge of surety’s liability due to the variation of contract terms. The court ruled that when the terms of the agreement between the creditor and debtor were altered without the surety’s consent, the surety was discharged from liability.

Conclusion

The contract of guarantee under the Indian Contract Act, 1872, is a crucial mechanism for securing debts and obligations in commercial transactions. The surety plays an essential role by providing a secondary guarantee that ensures the creditor is protected if the principal debtor defaults. Understanding the nature of the surety’s liability, the rights of the surety, and the types of guarantees is fundamental for anyone involved in business, lending, or legal practice. With the growing reliance on guarantees in financial and contractual dealings, this area of law continues to evolve through judicial interpretations and legislative reforms.