Contract of Guarantee

 Contract of Guarantee

Guarantee can be defined as an agreement by which one person undertakes to discharge the liability in case another person makes default. Section 126 defines 'Contract of Guarantee', 'Surety', 'Principal Debtor and 'Creditor. According to Section 126 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'. The person to whom the guarantee is given is called the creditor

For example, 'A' asks 'B' to lend Rs 1 lac to C and undertakes a guarantee that if C fails to pay the amount 'A' will pay. This is a contract of guarantee in which 'A' is the surety, 'B' is the creditor and 'C is the principle debtor.

Essential features of contract of guarantee:

Following are the essential features of the contract of guarantee:

1. Tripartite contract
2. Consideration
3. Conditional promise
4. Writing not necessary

1. Tripartite contract: In contract of guarantee there are three parties i.e. creditor, principal debtor and surety. Contracts between the parties are:-

• As between Principal Debtor and Creditor (Main Contract, express)
• As between Surety and Creditor (Contract of guarantee, express)
• As between Surety and Principal Debtor (Implied contract, Section 145)

The contract between principal debtor and creditor constitutes principal debt. The purpose of guarantee is to secure payment of this principal debt. If there is no principal debt there is no guarantee. In the first set of contract the principal debtor makes a contract with creditor to pay the debt. In second set of contract surety contracts with creditor and undertakes to pay the creditor if principal debtor defaults. In third set of contract there is an implied promise by the principal debtor in favour of surety that in case the surety has to discharge the liability of the principal debtor, the principal debtor shall reimburse the same to the surety.

2. Consideration: Contract of guarantee should also be supported by some consideration. Section 127 provides that anything done, or any promise made for the benefit of principal debtor may be sufficient consideration to the surety for giving the guarantee. A guarantee without consideration is void. Benefit to the principal debtor is sufficient consideration. 

3. Conditional promise: There must be a conditional promise to be liable on default of the principal debtor. Supreme Court in Punjab National Bank v. Sri Vikram Cotton Mills, (1970) 1 SCC 60 held that there must be a conditional promise to be liable on the default of the principal debtor. A liability which is incurred independently of a default is not within the definition of guarantee.

4. Writing not necessary: Section 126 expressly declares that a guarantee may be either oral or written.

Surety's liability: Fundamental principle of surety's liability is laid down in Section 128. It provides that surety's liability is co-extensive with that of the principal debtor, unless it is otherwise provided by the contract. The creditor can sue either the surety or the principal debtor or both. The expression 'co-extensive with that of principal debtor' denotes extent of the surety's liability. It means surety is liable for the whole amount for which principal debtor is liable and he is liable for no more. However, the extent of liability can be regulated by the contract between the parties. 

Supreme Court in Bank of Bihar v. Damodar Prasad, AIR 1969 SC 297 held that the liability of the principal debtor and the surety is joint and several. The creditor can sue both of them together or either of them individually. It cannot be held that surety should be made liable only when the creditor has exhausted his remedies against principal debtor. Similarly in Ram Kishan v. State of U.P., AIR 2012 SC 2288 Supreme Court held that surety has no right to restrain the execution of decree against him until the creditor has exhausted his remedies against the principal debtor.

Discharge of liability of surety: The surety may be discharged from his liability in the following conditions:-

1. By notice of revocation by the surety
2. By surety's death
3. By variance in terms of contract between the principal debtor and creditor
4. By release or discharge of principal debtor 
5. When creditor compounds with, gives time to or agree not to sue, principal debtor
6. By creditor's act or omission impairing surety's eventual remedy

(1) By notice of revocation by the surety: Section 130 provides that in case of continuing guarantee, it may be revoked by the surety, as to the future transactions, by notice to the creditor.

(2) By surety's death: Section 131 provides that in case of continuing guarantee the death of surety operates as revocation of the guarantee. However, this provision is subject to the contract to the contrary ie. if there is a contract between the parties that in case of death of surety the continuing guarantee will not be revoked then this section will not apply.

(3) By variance in terms of contract between the principal debtor and creditor: Section 133 provides that if there is any variance in the terms of the contract between the principal debtor and the creditor without the consent of surety then in such case surety gets discharged with respect to the transactions subsequent to the change. Surety will not be discharged by variation if he has consented to the same. Section 133 incorporates the principle that surety is entitled to stand by the original contract, which cannot be altered without his consent.

(4) By release or discharge of principal debtor: Section 134 provides that 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 principal debtor.

(5) When creditor compounds with, gives time to or agree not to sue, principal debtor: Section 135 provides that when the creditor makes composition with the principal debtor or creditor promises to give time to the principal debtor or the creditor promises not to sue the principal debtor, the surety is discharged thereby unless the surety assents to such contract.

(6) By creditor's act or omission impairing surety's eventual remedy: Section 139 provides that if the creditor does any act which is inconsistent with the rights of surety and it results in impairing the eventual remedy of the surety against the principal debtor then in such case surety is discharged.

Conditions when surety is not discharged:- 

Under following conditions surety is not discharged:-

1. When an agreement is made by creditor with third person to give time to principal debtor
2. Creditor's forbearance to sue
3. Release of one co-surety by the creditor

(1) When an agreement is made by creditor with third person to give time to principal debtor: Section 136 provides that where a contract to give time to the principal debtor is made by the creditor with the third person, and not with the principal debtor, the surety is not discharged.

(2) Creditor's forbearance to sue: Section 137 provides that 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. This however, subject to the contract between the parties.поддер

(3) Release of one co-surety by the creditor: Section 138 provides that where there are co-sureties, a release by creditor of one of them does not discharge the others, neither does it free the surety so released from his responsibility to the other sureties.

Rights of surety: 

Following are the rights of sureties under the Act:-

1. Right against principal debtor
2. Rights of surety
3. Right against creditor
4. Right of contribution against co-sureties

1. Right against principal debtor: Section 140 provides that when the principal debtor makes a default in performance of his duty and surety makes the necessary payments on behalf of the principal debtor then in that case he becomes invested with all the rights which the creditor had against the principal debtor. This is called right of subrogation. Furthermore, according to Section 145 in every contract of guarantee there is an implied promise by the principal debtor to indemnify the surety and the surety is entitled to recover from the principal debtor whatever sum he has rightfully paid under the guarantee.

2. Right against creditor: Section 141 provides that a surety is entitled to benefit of every security which the creditor has against the principal debtor at the time when the contract of suretyship is entered into. If the creditor loses the security or without the consent of the surety parts with the security the surety is discharged to the extent of the security. It is based on the rule of equity that the surety is entitled to every remedy which the creditor has against the principal debtor including security. Supreme Court in State of M.P. v. Kaluram, AIR 1967 SC 1105 held that the expression 'security' in Section 141 is not to be used in technical sense. It includes all rights which the creditor had against the property at the date of contract.

3. Right of contribution against co-sureties: Section 146 provides that in absence of any agreement to the contrary co-sureties are liable to contribute equally. 

Continuing Guarantee: Section 129 provides that a guarantee which extends to a series of transactions is called a continuing guarantee. 

A continuing guarantee, as to future transactions, may be revoked either by notice of revocation by surety Section 130) or by the death of the surety [Section 131].

Difference between contract of indemnity and contract of guarantee

Contract of indemnity

1.  There are two parties i.e. indemnifier and indemnified.
2.  There is only one contract between indemnifier and indemnified.
3.  The nature of contract is for reimbursement of loss.
4.  An indemnifier cannot sure a third party for loss in his own name. He can bring such suit in the name of indemnified only.
5.  The liability in case of an indemnity is contingent.

Contract of guarantee

1. There are three parties i.e. creditor, principal debtor and surety.
2. There are three contracts. One between creditor and principal debtor, one between creditor and surety and one between surety and principal debtor.
3. The nature of contract is for the security of the creditor.
4. Surety can proceed against principal debtor after discharging the debt due.
5. The liability is subsisting. The liability arises when the guarantee is acted upon, though it remains suspended until the principal debtor makes default.