Introduction

A guarantee can be many a things. It can be assurance of a particular outcome or that

something will be performed in a specified manner. A guarantee is a way of assuming
responsibility for paying another‟s debts or fulfilling another‟s responsibilities. It can be a
promise for the execution, completion, or existence of something. A guarantee can also be a
promise or an assurance attesting to the quality or durability of a product or service.

The English law defines a „guarantee‟ as a „promise to answer for the debt, default or
miscarriage of another‟.

Section 126 of the Indian Contract Act, 1872[1] says that a Contract of Guarantee is a contract to
perform the promise or discharge the liability or a third person in case of his default.

► Illustration: If A gives an undertaking stating that if ` 200 are lent to C by B and C does not
pay, A will pay back the money, it will be a contract of guarantee. Here, A is the surety, B is the
principal debtor and C is the creditor.

Contract to perform the promise, or discharge the liability, of a third person in case of his default
is called Contract of Guarantee. A guarantee may be either oral or written. Section 126 of the
Indian Contract Act says:

says that a Contract of Guarantee is a contract to perform the promise or discharge the liability or
a third person in case.

“A "contract of guarantee" is 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 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.
  The person who gives the guarantee is called the Surety
 The person on whose default the guarantee is given is called the Principal Debtor
 The person to whom the guarantee is given is called the Creditor

So, basically law of guarantee involves a promise by one party to assume responsibility for the
debt obligation of a borrower if that borrower defaults. The person or company providing this
promise is also known as a "surety" or as a "guarantor".

A surety most typically requires a guarantor when the ability of the primary obligor, or principal,
to perform its obligations to the obligee (counterparty) under a contract is in question, or when
there is some public or private interest which requires protection from the consequences of the
principal's default or delinquency. In most common-law jurisdictions, a contract of suretyship is
subject to the Statute of Frauds (or its equivalent local laws) and is only enforceable if recorded
in writing and signed by the surety and by the principal.

Key Points to Note

 There are three parties in every Contract of Guarantee

 The liability arises right from the beginning. The surety becomes liable when the principle

debtor commits default in meeting the liability.

 Surety has the right to sue the third party (Principle Debtor) directly. The Law puts him in

the position of Creditor. Where as in Contracts of Indemnity, the Indemnifier cannot sue

the third party in his name. He has to sue in the name of the Indemnity-holder or after

obtaining the rights from him.

  Anything done, or any promise made, for the benefit of the principal debtor, may be a

sufficient consideration to the surety for giving the guarantee. The guarantor need not

personally derive any benefit from the guarantee.

 The liability of the surety is co-extensive with that of the principal debtor, unless it is

otherwise provided by the contract.

 The creditor can straightway proceed against the guarantor without first proceeding

against the principal debtor.

 The liability of the surety can never be greater than that of the principal debtor. The surety

can however may restrict his liability to part of the Principal debtor's liability by contract.

 Surety's liability is distinct and separate

ESSENTIALS OF CONTRACT OF GUARANTEE

Essentials of a valid contract: Since Contract of Guarantee if a species of a contract, the

general principles governing contracts are applicable here. There must be free consent, a
legal objective to the contract, etc. Though all the parties must be capable of entering into
a contract, the principal debtor may be a party incompetent to contract, ie., a minor. This
scenario is discussed later in this chapter.

A principal debt must pre-exist: A contact of gurantee seeks to secure payment of a debt,
thus it is necessary there is a recoverable debt. There can not be a contract to guarantee a
time barred debt.

Consideration received by the principal debtor is sufficient for the surety. Anything done,
or any promise made for the benefit of the principal debtor can be taken as sufficient
consideration to the surety for giving guarantee.
 NATURE OF CONTRACT OF GUARANTEE

The contract of guarantee has to be clear. A letter clearly stating the intention to
guarantee a transaction will go on smoothly or one will behave appropriately conduct
himself at work place will suffice. But a promise to pay extra attention or to take care of
it does not constitute a guarantee.

In India, a contract of guarantee may be oral or written. It may even be inferred from the
course of conduct of the parties concerned. Under English Law, a guarantee is defined as
a promise made by one person to another to be collaterally answerable for the debt,
default or miscarriage of the third persons and has to be in writing.

There are three parties in a contract of guarantee; the creditor, the principal debtor and the
surety. In a contract of guarantee, there are two contracts; the Principal Contract between
the principal debtor and the creditor as well as the Secondary Contract between the
creditor and the surety. The contract of the surety is not contract collateral to the contract
of the principal debtor but is an independent contract. Liability of surety is secondary and
arises when principal debtor fails to fulfill his commitments. Even an acknowledgement
of debt by the principal debtor will bind the surety.

It is not essential that the Principal Contract must be in place/existence at the time of the
Contract of Guarantee being made. The original contract between the debtor and the
creditor may be about to come into existence. Similarly, in certain situations, a surety
may be called upon to pay though the principal debtor is not liable at all. For example, in
cases where the principal debtor is a minor, the surety will be liable though the minor will
not be personally liable.

A contract of guarantee is to be enforced according to the terms of the contract.

A guarantee is a contract of strictissima juris that means liability of surety is limited by

law; a surety is offered protection by law and is treated as a favored debtor in the eyes of
the law. A contract of guarantee is not a contract „uberrimae fidei‟ (requiring utmost good
faith). Still the suretyship relationship is one of trust and confidence and the validity of
the contract depends upon the good faith of the creditor. However, it is not a part of the
creditor‟s duty to inform the surety about all his previous dealings with the principal
debtor.

In WYTHES vs. LABON CHARE 1858, Lord Chelmsford held that the creditor is not
bound to inform the matters affecting the credit of the debtor or any circumstances
unconnected with the transaction in which he is about to engage which will render his
position more hazardous.

Since it is based on good faith, a contract of guarantee becomes invalid if the guarantee is
obtained from the surety by misrepresentation or concealment as given in Sections 142
and 143 of the ICA, 1872.

► Illustration: If a clerk in an office occasionally fails to account for some of the receipts
for money collected, he may be asked for surety. In case the person who steps up to be a
surety for the clerk in the office is not informed of the occasional lapses on part of the
clerk which lead to the requirement of a surety, any guarantee given by him is invalid as
something of importance and directly affecting his decision to act as a surety was
concealed from him.
 RIGHTS OF A SURETY

As against the Creditor

According to the Indian Contract Act, 1872,

Sec. 133 –“Any variance made without the surety's consent, in the terms of the contract

between the principal [debtor] and the creditor, discharges the surety as to transactions
subsequent to the variance”

The creditor shall not vary terms of the contract between the creditor and the principal
debtor without the surety's consent. Any such variance discharges the surety as to transactions
subsequent to the variance. However if the variance is for the benefit of the surety or does not
prejudice him or is of an insignificant character, it may not have the effect of discharging the
surety.

Sec. 134 – “The surety is discharged by any contract between the creditor and the principal

debtor, by which the principal debtor is released, or by any act or omission of the

creditor, the legal consequence of which is the discharge of the principal debtor.”

The creditor should not release the principal debtor from his liability under the contract. The
effect of the discharge of the principal debtor is to discharge the surety as well. Any act or
omission on the part of the creditor which in law has the effect of discharging the principal
debtor puts an end to the liability of the surety.

Sec. 135 – “A contract between the creditor and the principal debtor, by which the creditor make

a composition with, or promises to give time, or not to sue, the principal debtor,

discharges the surety, unless the surety assents to such contract.”

 If an agreement is made between the Creditor and Principal debtor for compounding the
later's liability or promising him extension of time for carrying out the obligations or promising
not to sure, discharges the surety unless he assents to such a contract.

Sec. 139 – “If the creditor does any act which is inconsistent with the right of the surety, or

omits to do any act which his duty to the surety requires him to do, and the eventual

remedy of the surety himself against the principal debtor is thereby impaired, the

surety is discharged”.

The surety is discharged if the creditor impairs the surety's eventual remedy against the
principal debtor.

As against the Principal Debtor:

Right of subrogation - The surety on payment of the debt acquires a right of subrogation.

Sec 140 – “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 invested with all the rights which the

creditor had against the principal debtor.”

The surety cannot claim the right of subrogation to the creditor's securities if he has signed
up as a security for a part of the agreement and security has been held by the creditor for the
whole debt.
 EXTENT OF SURETIES LIABILITIES

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” states the liability of the
surety. In Industrial Finance Corporation of India Ltd. v. Cannonore Spinning &
Weaving Mills Ltd, (12 April, 2002) states that contract of guarantee does not provide
any contra note regarding the liability of the surety which can create an exception within
the meaning of Section 128.

Section 141 of the Indian Contract Act states that when a contract of suretyship is
entered surety is entitled to benefit every security that the creditor has against the
principal debtor. Surety will be liable even though the principal‟s contract is void.
Liability of sureties and principal debtor is co-extensive. A continuing guarantee can be
revoked by the surety in relation to future transactions by notice to the creditor.
Revocation can also occur with the death of surety.

It is explained under Section 130, 131 of the Act. If there is any changes that
happens to the original contract between the principal debtor and creditor then surety is
automatically discharged. The surety is also discharged if the principal debtor is released.
If one co-surety is discharged it does not discharge/set free the other surety from his
responsibility. Surety is entitled to recover from principal debtor the sums that he has
rightfully paid under the guarantee but not entitled to sums that he has paid wrongly.
Although the liability of the surety is co-extensive with that of the principal debtor, he
may limit his liability.

He may expressly declare his guarantee to be limited to a fixed amount. In other words,
the liability of a surety can be made less by a special contract but his liability cannot be
made greater than that of the principal debtor.

Surety‟s liability is secondary and not primary. The surety‟s liability arises immediately
on default by the principal debtor. He cannot be called upon to pay unless the principal
debtor has committed the default.

But in case of default by the principal debtor the creditor is not required to give a notice
of default to the surety. Creditor is not bound to proceed first against the principal debtor
before suing the surety unless the contract so provides.

The contract between the surety

and the creditor is an independent contract. Thus, where the original contract between the
creditor and the principal debtor is void the surety will be liable as if he is the principal
debtor. Similarly, where the contract between the creditor and the principal debtor is
voidable, the surety may not be discharged from liability.
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