The contract of guarantee is one of the most prominent and important topics under the Indian Contract Act, 1872. This Article explores the meaning, functions, nature, kinds and several other aspects of the Contract of Guarantee by relating them with the provisions under the Act.
The contract of guarantee, also known as a contract of surety, can be defined as a specific contract entered into for the purpose of performing the promise or discharging the liability of the third person whenever he/she is at fault. Such contracts specifically iterate that a guarantee can be oral and need not to be in writing.
Contract of Guarantee has been defined under Section 126 of the Indian Contract Act, 1872 i.e. “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”.
The basic essentials of a Contract of Guarantee can be concluded as follows:
- The Contract of Guarantee is said to be a specific contract;
- A promise to perform promise and discharge the liability of a third party;
- The performance will arise in cases of default on behalf of the third party;
- A Guarantee can be oral as well as written;
- The parties involved in a Contract of Guarantee are “Surety”, “Principal Debtor” and “Creditor”.
For the purpose of distinguishing a guarantee from the one that is original or absolute, a contract of guarantee is often known as a collateral or conditional contract.
Nature of Contract of Guarantee
- A guarantee can be divided into two classes i.e. one in which a promise becomes effective if the debtor fails to perform his obligations and the second in which there is a promise that the debtor will perform his obligations.
- An agreement is said to be a guarantee only when there is an existence or contemplation of some other principal, some other principal obligator’s obligation for which the guarantee will be subsidiary or ancillary.
- In other words, in the absence of a principal debtor, there cannot be any suretyship and a man cannot guarantee the debt of somebody else unless there is a debt of another person which can be guaranteed. A guarantee can be used as an indemnification if a person doesn’t fulfill his promise.
- The liability under a contract of guarantee is not a “promise to pay” as it is conditional and a person becomes liable only on the default of the principal debtor.
Functions of Contract of Guarantee
The main purpose of a contract of guarantee involves enabling a person to get a loan and goods on credit or on employment. Repayment of loan, price of goods sold on credit and the good conduct or honesty of a person employed in a particular office are the purposes for which a guarantee can be given.
Kinds of Guarantee-
There are two types of Guarantee i.e. Specific Guarantee which is for a specific transaction and Continuing Guarantee which is for a series of transactions.
- Specific Guarantee: A guarantee which is given for only one transaction or debt, the guarantee is known as a Specific Guarantee. A specific guarantee is said to be discharged when the debt is repaid or the promise is performed.
- Continuing Guarantee: A guarantee which is given for a series of transactions is known as continuing guarantee. In the case of continuing guarantee, the guarantor’s liability is for all the transactions and it is not discharged until revoked.
Difference between a Contract of Guarantee and a Contract of Indemnity
|Contract of Guarantee||Contract of Indemnity|
|1) It is defined under Section 126 of Indian Contract Act, 1872.||1) It is defined under Section 124 of Indian Contract Act, 1872.|
|2) It is defined as “A contract to perform the promise, or discharge the liability of a third person in case of his defaults.”||2) It is defined as “A contract by which one party promises to save the other from loss caused to him by the conduct of the promisor himself, or by the conduct of any other person.”|
|3) Three parties are involved in a contract of guarantee i.e. surety, principal debtor and the creditor.
|3) Two parties are involved in a contract of indemnity i.e. a promisor (the person indemnified) and a promise (the indemnifier).|
|4) In a contract of guarantee, three contracts exist i.e. between the principal debtor and the creditor, the surety and the principal debtor & the creditor and the surety.||4) In a contract of indemnity, only one contract exists between the indemnifier and the indemnified.|
|5) The liability of the surety to the creditor is collateral or secondary and the principal debtor is primarily liable.||5) The liability of the promisor to the promisor is primary and independent.|
|6) The surety must give the guarantee at the request of the debtor.||6) The indemnifier need not to necessarily act at the request of the indemnified.|
|7) The indemnifier’s liability arises only at the time of occurrence of a contingency.||7) The surety has to give guarantee for the performance is an existing debt or duty.|
|8) An indemnifier can sue a third party only is there is a loss in his own name and there exists no privity assignment in his favor.||8) A surety steps into the shoes of the creditor as and when the due debt is discharged by the principal debtor. He can sue the principal debtor in his own right.|
The answer to the question whether there is a sole surety or co-sureties defines the nature and extent of surety’s liability. Section 128 of the Indian Contract Act, 1872 provides that a surety’s liability is co-extensive with the principal debtor’s liability unless it is provided otherwise by the contract. The general rule in case of co-surety is that they will be jointly and severally liable. The sureties are independently and jointly liable for the whole debt.
According to Section 146, “Where two or more persons are co-sureties for the same debt or duty, either jointly or severally, ad whether under the same or different contracts, and whether with or without the knowledge of each other, the co-sureties, in the absence of any contract to the contract, are liable, as between themselves, to pay each an equal share of the whole debt, or that part of it which remains unpaid by the principal debtor.” Thus, the co-sureties are liable to contribute equally for the repayment of the debt.
Section 147 provides that the liability of co-sureties which is bound in different sums shall be paid equally to the extent of their respective obligations.
Discharge of Surety
When the surety’s liability comes to an end, the surety is said to be discharged from his liabilities. Discharge of Surety is a process in which the surety’s liability becomes co-extensive when he promises that he will perform the promise of principal debtor if he fails to perform it.
The grounds under which the surety can be discharged are:
- Revocation: The surety can be discharged by:
- Notice: According to Section 130 of the Contract Act, if a liability has already accrued, the specific guarantee cannot be revoked but the surety can revoke a continuing guarantee as to future transactions by giving notice to the creditor. The surety will be still liable for transactions which have been already entered into.
- Death: As per Section 131 of the Act, the death of the surety operates as a revocation of continuing guarantee in regard to continuing transaction, except as otherwise provided in the contract. The estate of the deceased surety will not be liable for the transactions that had been entered into between the principal debtor and the creditors after the death of the surety, even if the creditor has not been given such death notice.
- Novation: The concept of Revocation by Novation means substituting an old contract of guarantee for a new one either between one of the old parties and a new party or between the same parties and the mutual discharge of the old contract becomes the consideration for the new contract.
- Conduct of the Creditor: The surety can also be discharged by:
- Variation in terms of the contract (Section 153): A surety is only liable to the extent to which he agreed to in the contract. Thus, if the principal debtor and creditor varies their terms and conditions of the contract without the surety’s consent, the surety is not liable as to transactions subsequent to such variation.
- Discharge or Release of principal debtor (Section 134): If a contract between the creditor and principal debtor releases the principal debtor from his liability, it automatically discharges a surety from his liability. Any act or omission of the creditor which leads to discharge of the principal debtor also releases the surety of his liability.
- Compounding by creditor with principal debtor (Section 135): When a creditor and the principal debtor enters into a contract by which the creditor compounds with the principal debtor for not suing the principal debtor, the surety stands discharged unless the surety agrees to such contract.
- Creditor’s act or omission impairing sureties eventual remedy (Section 139): Any act or omission by the creditor inconsistent with the rights of the surety which impairs the surety against the principal debtor, discharges the surety from his liability.
- Loss of Security (Section 141): When the creditor parts with or loses any security given to him at the time of the contract of guarantee without the surety’s consent, the surety stands discharged from the liability to the extent of security’s value. But, in case of two or more debts secured by separate securities, the surety for one of the debts does not stands discharged if the creditor parts with or loses the security/securities relating to other debts.
- Invalidation of Contract: The surety’s liability can also be discharged by:
- Guarantee obtained by misrepresentation (Section 142) and concealment (Section 143): Any guarantee obtained by means of misrepresentation made by the creditor or with his knowledge and assent, concerning a material part of the transaction or obtained by means to keeping silence as to material transactions is invalid as per the provisions of Indian Contract Act, 1872.
- Failure of Co-Surety to join a surety (Section 144): According to Section 144, “Where a person gives a guarantee upon a contract that a creditor shall not act upon it until another person has joined in it as co-surety, the guarantee is not valid if that other person does not join.” Thus, a surety shall not be liable if he agrees to be only one of several co-sureties, unless the others execute the guarantee.
- Failure of consideration (Section 25): Whenever there is a failure of consideration between the principal debtor and creditor, the surety stands discharged as the agreement without consideration is null and void under Section 25 of the Act.
Exceptions to the Discharge of Surety-
There are few cases in which a surety does not stand discharged:
- When a contract for giving time to the principal debtor is not made by the creditor is not made with the principal debtor but with a third person, the surety will not be discharged under section 136 of the Act.
- In the case of non-existence of any provision in the guarantee to the contrary, mere forbearance on the part of the creditor to sue the principal debtor or to enforce any other remedy against him does not discharge the surety under section 137 of the Act.
- In case of co-sureties, if the creditor release one of them, the others do not stand discharged and it does not free the surety released from his liability to other sureties under Section 138 of the Act.