CONTRACT OF GUARANTEE UNDER INDIAN CONTRACT ACT, 1872

This article will be discussing about the Contract of Guarantee with its object, main features, parties to it, kinds of guarantee, liability of surety, and distinction between Contract of Indemnity and Contract of Guarantee

1. CONTRACT OF GUARANTEE:

 

Section 126 of Indian Contract Act defines Contract of guarantee. It defines a ‘contract of guarantees’ a contract to perform the promise or discharge the liability of a third person in case of his default. The person who gives the guarantee is called ‘surety’. The person of whose default the guarantee is given is called the ‘Principal debtor’. The person to whom the guarantee is given is called the ‘creditor’.

 

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

 

2. OBJECT OF A CONTRACT OF GUARANTEE:

 

The object of a contract of guarantee is to provide additional security to the creditor in the form of a promise by the surety to fulfil a certain obligation, in case the principal debtor fails to do that.

 

3. PARTIES TO A CONTRACT OF GUARANTEE:

 

In every contract of guarantee, there are three parties, such as,

 

                     i.        Creditor,

                   ii.        Principal Debtor, and

                  iii.       Surety.

 

A surety is someone who offers to cover the debt in the event that the borrower is unable to do so. In the event of a decree in the creditor's favor against the principal borrower, the sureties may also be subject to the decree because of their joint and several liability with the principal debtor. However, the surety's liability automatically ends when a lawsuit against the principal debtor was dismissed for default and the ruling became final, leaving no liability remaining against the debtor.

 

4. MAIN FEATURES OF CONTRACT OF GUARANTEE:

 

i. The contract may be either oral or in writing.

 

A guarantee may be either oral or written, as per section 126. The position in India is different from the position in England on this issue. According to English law, a contract of guarantee must be in writing and signed by the parties involved in order to be legally binding.

 

ii. There should be a principal debt

 

A principal debt or obligation to be discharged by the principal debtor is a prerequisite for a contract of guarantee. The surety undertakes to be liable only if the principal debtor fails to discharge his obligation. A contract of indemnity exists when there is no such principal debt, but there is a promise by one party to compensate another in a specific circumstance, and the performance of this promise is not dependent upon the default of another party. Thus, when X and Z go to a shop, X purchases goods and Z tells the seller ‘If X does not pay you, I will’, it is a Contract of Guarantee. On the other hand, if X is not a principal debtor, but only Z makes a promise to the shopkeeper to pay, for instances, Z tells the shopkeeper ‘Let him (X) have the goods, I will be your paymaster’, it is a contract of indemnity, (Birkmyr vs. Darnell, 1704).

 

iii. Benefit to the principal debtor is sufficient consideration

 

A Contract of Guarantee requires consideration just like any other contract does.  For the surety’s promise, it is not necessary that there should be direct consideration between the creditor and the surety, it is enough that the creditor had done something for the benefit of the principal debtor. A benefit to the principal debtor is sufficient payment to the surety in exchange for providing the guarantee. This is clear from section 127, which read as under:

 

“Anything done, or any promise made for the benefit of the principal debtor may be sufficient consideration to the surety for giving the guarantee”.   

 

iv. Consent of the surety should not have been obtained by misrepresentation or concealment:

 

The creditor shouldn't obtain a guarantee by making any misrepresentation or concealment of any material facts about the transaction. If the guarantee was acquired in this manner, it is invalid. The position is explained by section 142 and 143 of the Indian Contract Act, 1872.

 

For example, X engages Z as a clerk to collect money for him. Z fails to account for some of his receipts and X in consequence calls upon him to furnish security for his duty accounting. Y gives his guarantee for X’s duly accounting. X does not acquaint Y with Z’s previous conduct. Z afterwards makes default. The guarantee is invalid.

 

5. KINDS OF GUARANTEES:

 

Guarantees can be of two types as summed up below;

 

                        i.        Specific Guarantee, and 

                       ii.        Continuing Guarantee. 

 

A specific guarantee is for a single debt or any specified transaction. It comes to an end when such debt has been paid.

 

A continuing guarantee is a type of guarantee which applies to a series of transactions.

 

A continuing guarantee applies to all the transactions entered into by the principal debtor until it is revoked by the surety. A continuing guarantee can be revoked anytime by surety for future transactions by giving notice to the creditors. However, the liability of a surety is not reduced for transactions entered into before such revocation of guarantee.

 

6. LIABILITY OF SURETY:

 

The liability of a surety is co-extensive with that of principal debtors unless the contract specifies otherwise, according to section 128 of the Indian Contract Act, 1872.

The provision that the surety’s liability is coextensive with that of the principal debtor means that his liability is exactly the same as that of the principal debtor. It means that on a default having been made by the principal debtor, the creditor can recover from the surety all what he could have recovered from the principal debtor. For instances, the principal debtor makes a default in the payment of a debt of Rs. 5,000/-. The creditor may recover from the surety the sum of Rs. 5,000/- plus interest becoming due thereon as well as the amount spent by him in recovering that amount. This may be further explained by the following example. A guaranteed to B the payment of exchange by C, the acceptor. The bill is dishonored by C, the acceptor. A is liable not only for the amount of the bill but also for any interest and charges which may have become due on it.

  

7. DISTINCTION BETWEEN A CONTRACT OF INDEMNITY AND A CONTRACT OF GUARANTEE:

 

Distinction between a Contract of indemnity and a contract of guarantee are as follows;

 

i. A Contract of indemnity is a contract by which one party promises to save the other from the loss caused to him by the conduct of the promisor or another person.

 

Whereas A contract of guarantee is a contract to perform the promise or discharge the liability of a third person in case of his default.

 

ii. In the Contract of indemnity, the liability of the promisor is primary. There is no secondary liability.

 

 On the other hand, in case of contract of guarantee, the primary liability is of principal debtor and the liability of the surety is secondary.

 

iii. In a Contract of indemnity the contract between the promisor (indemnifier) and the promisee (indemnity-holder) is express and specific.

On the other hand, in a contract of guarantee, the contract between surety and principal-debtor is implied and between creditor and principal debtor express.

 

iv. In the Contract of indemnity, there are two parties, indemnifier and indemnity holder.

 

Whereas, in the Contract of guarantee there are three parties, viz. creditor, the principal debtor and the surety.

 

v. In the Contract of indemnity, there is only one agreement i.e., the agreement between the indemnifier and indemnity holder.

 

While, in the contract of guarantee there are three agreements viz. an agreement between (1) the creditor and the principal debtor, (2) the creditor and the surety; and (3) the surety and the principal debtor.

 

vi. The Contract of indemnity protects the promise from the loss.

While the contract of guarantee is for the surety of the creditor.

 

vii. In the case of the Contract of indemnity, the promisor cannot file the suit against third person until and unless the promisee subrogates his rights in favour of the promisor.

 

On the other hand, in the case of contract of guarantee, the surety does not require any subrogation for filling of suit. He gets the right to file suit against the principal debtor as and when the surety pays the debt.

 

viii. In England, a contract of guarantee should be in writing whereas, a contract of indemnity may be either oral or in writing. There is no such distinction in India, whether it is a contract of indemnity of guarantee, the same may be either oral or in writing.

 

8. CONCLUSION:

 

At last, it can be concluded by stating that, a contract of guarantee which is also known as a contract of suretyship is a contract to perform the promise or discharge the liability of a third person in case the third person makes a default. The contract of guarantee may either be oral or in writing. For example, if X says to Y “lent money at interest to B and if B be unable to pay, I shall pay” then it is known as contract of guarantee.

It is well settled that bank guarantee is an autonomous contract. it’s common parlance that the issuance of guarantee is what a guarantor creates to discharge liability when the principal fails in his duty and guarantee is in nature of collateral agreement to answer for debt; (Syndicate Bank vs. Vijay Kumar, 1992).