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De Jure
June 4, 2022

Contract of Guarantee
INTRODUCTION

A contract of guarantee is included in Chapter VIII of the Indian Contract Act. With a total of 22 sections dealing with the
various aspects of guarantee, it is the second-largest chapter after the chapter dealing with bailment under the Indian
Contract Act, which has more than 30 sections.

"The underlying function of a The contract of guarantee is a familiar and widely spoken, read and written topic. Some of the
contract of guarantee is to not just
answer for the payment of the debt commonly discussed topics are the parties to the guarantee, kinds of guarantee, types of
but also the performance of some guarantee, essentials of the contract of guarantee (which is partly covered under Chapter VIII
duty, in the case of failure of the
person who, in the first instance, is and the remaining under different sections of the Contract Act), invocation of guarantee, letter
obligated to fulfil such obligation". of comfort, and other evolving concepts like stand by letter of credit, letter of awareness, etc.

In this article, we are discussing some of the lesser-known provisions dealing with the contract of guarantee such as
nature of consideration, the rule of co-extensiveness, the doctrine of subrogation, and contracting-out provisions all of
which have a significant bearing on the contractual obligations assumed by the relevant parties to the contract of
guarantee.

NATURE OF CONSIDERATION

The presence of consideration is important for any contract.

Any contract without consideration is ex nudo pacto actio non oritur, i.e. it will be considered void. Simply put, an
agreement without consideration cannot be held to be binding on the contracting parties.
In the case of Dwarampudi Nagaratnamba v. Kunuku Ramayya and Another (1968 AIR 253 SC), the Supreme Court of
India held that the transfer made by the appellant without any consideration cannot be treated as a valid consideration.

The Contract Act provides that anything done or any promise made for the benefit of the principal debtor may be a
sufficient consideration to the guarantor or the surety for giving the guarantee.

"While the presence of

Here, it is important to note that the consideration to be given need not necessarily be in consideration is indispensable
monetary terms. Not taking disciplinary actions against the principal debtor, forbearance on for any contract, the
consideration to be given need
the bank’s part to initiate adverse action or not triggering an event of default also constitutes not necessarily be in monetary
good and valid consideration for the guarantee contract. Even not suing, actual suspension of terms."

legal proceedings against the principal debtor or an agreement to forbear for a reasonable time will also provide
pending
sufficient consideration to support a surety promise.

Also, the consideration flowing under the contract may or may not be adequate, however, that will essentially not aff ect
the validity of the contract. In other words, there is no 'consideration adequacy test' to be fulfilled. In some agreements,
one often comes across the qualifying legend where the parties are made to acknowledge the sufficiency of the
consideration under the contract. However, such redundancy can safely be avoided.

PRINCIPLES OF CO-EXTENSIVENESS

Another important and interesting but yet less considered provision is the rule of co-extensiveness.
In terms of the Indian Contract Act, the liability of the surety is co-extensive with that of the principal debtor. This means
that the creditor can choose to proceed to recover a debt against the surety independent of the principal debtor or from
the securities furnished by the principal debtor. Hence, although the contract of guarantee may originate from the same
transaction it is considered an independent contract which creates rights and liabilities separate and distinct from those
created by a contract between the principal debtor and the creditor.

A similar principle also holds good for the co-guarantors. A co-guarantor cannot insist that the creditor should proceed
against another guarantor before invoking the rights against him, since the liability of guarantors is joint and several .

"The liability of the guarantor cannot be It was decided in the case of Ram Sagar Singh v. Yogendra Narain Prasad Singh (AIR
deferred until the creditor has exhausted
1975 Pat. 239) by the Patna High Court that the liability of the surety is co-extensive
his remedies against the principal debtor
and the option to seek recourse either with that of the principal debtor and the surety is liable to pay the entire amount without
against the principal debtor or against the
the creditor having required to exhaust his other remedies. This was supported by a
guarantor or any of the guarantors (from
the group of co-guarantors) is completely decision of the Supreme Court in the case of The Bank of Bihar Limited v. Dr.
on the creditor."
Damodar Prasad (AIR 1969 SC 297).

As a general rule, the liability of the guarantor remains intact so long as the debt of the principal debtor is not
discharged. However, the fact that the obligation of the principal debtor is void or unenforceable will not necessarily
release the guarantor from his liability under the guarantee contract. Depending upon the facts and circumstances of the
matter, there are judicial pronouncements for and against this point.
DOCTRINE OF SUBROGATION

The right of subrogation is defined to mean the right of the guarantor to be placed in the position of the creditor once the
obligations of the principal debtor is discharged by the guarantor. In other words, the guarantor has the right to step into
the shoes of the creditor and enjoy all the rights that the creditor originally had against the principal debtor to recover the
amounts paid by the guarantor.
"All the rights of the creditor get vested in the
As an example, if the creditor has a charge over the securities of the principal guarantor after the guarantor has discharged the
debtor or if the creditor has the right to sue the principal debtor. The obligation of the principal debtor toward the creditor
which are the subject of his guarantee. Hence, the
guarantor can therefore have the right over the securities and to sue the fulfilment of the obligations by the guarantor for the
principal debtor is not without recourse but with
principal debtor after principal obligations are discharged by the guarantor.
recourse to the guarantor."

In Darbari Lal v. Mahbub Ali Mian (AIR 1927 All 538) it was held that a surety paying off the debt is entitled to all the
rights and securities of the creditor as against the principal debtor. In the case of Parvateneni Bhushayya v. Potluri
Suryanarayana And Ors. (AIR 1944 Mad 195), the Madras High Court held that the language of section 140 of the
Contract Act which employs the words "is invested with all the rights which the creditor had against the principal debtor"
makes it plain that even without the necessity of a transfer the law vests those rights in the surety.

A surety is entitled to the benefit of every security that the creditor has against the principal debtor, irrespective of
whether or not the surety knows of the existence of such security. If the creditor loses or without the consent of the
surety, parts with such security, the surety will be discharged to the extent of the value of the security.
CONCLUSION

While the Contract Act indicates the liability of the surety, it does not specify the manner of discharge of the debt of the
principal debtor. Further, although the liability of the guarantor is absolute and distinct, the provisions of Chapter VII I are
not immutable rules and can be contracted out at the drafting stage. At the time of settling the deed of guarantee, the
point under consideration will also be whether you are representing a guarantor, principal debtor, or creditor. Hence, one
cannot have a "one size fits all" approach. We will in our next rounds of articles separately discuss more on the
contracting out provisions, important points to be taken into consideration while settling the contract of guarantee, how
the negligence of a creditor or banker can seriously affect the liability of a guarantor, and some key differences between
indemnity and guarantee.

CONTRIBUTED BY:
Amish Shroff, Partner: amish@rajaniassociates.net
Ruchi Sethna, Associate: rsethna@rajaniassociates.net

DISCLAIMER:

This Article is meant for information purposes only and does not constitute any legal advice by Rajani Associates or by
the authors to the article. The contents of the Article cannot be intended to be comprehensive legal advice and would
require re-evaluation based on the facts and circumstances. We cannot assume any legal liability for any errors or
omissions. Should you have any queries on any aspect contained in this article, you may contact the author by way of
an e-mail or write to us at editorial@rajaniassociates.net
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