The provisions of the Contract of Guarantee are covered under The Indian Contract Act, 1872, and is defined under Section 126 as
Section 126 – ‘Contract of guarantee’, ‘surety’, ‘principal debtor’ and ‘creditor’—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.
In simple terms, it can be defined as the promise given by a person to pay off the debt, to a third person or perform a promise on the failure of the principal debtor.
Contract of guarantee is a trilateral contract, which means the contract is made between Surety + Principal Debtor and Creditor. Here, Surety (is the guarantor) Principle Debtor (the person for whom the guarantee is given), and Creditor ( to whom the guarantee is given).
Note- Here, the liability of the surety is Co-extensive. Covered under Section 128 of The Indian Contract Act, 1872.
Section 128 Surety’s liability- The liability of the surety is co-extensive with that of the principal debtor, unless it is otherwise provided by the contract.
Co-extensive liability means that surety is liable for the whole amount for which the principal debtor is liable and he, the surety is liable for no more.
But, if the payment of a loan bond is guaranteed, the surety is liable not only for the amount of the loan but also for any interest and charge which may have become due on it. Where the principal debtor acknowledges liability and this has the effect of extending the period of limitation against him the surety also becomes affected by it.
Let’s suppose Mr Harpreet Randhawa (Surety), Mr Ambani Group (Principal Debtor), and Punjab National Bank (Creditor).
Here, in this hypothetical situation, Mr Ambani Group takes a loan from, Punjab National Bank of Rs, 1,000 crores, which was guaranteed by Mr Harpreet Randhwa, because of the fact what if Mr Ambani Group fails to pay off the debt.
Note- Here, the primary liability to pay the debt will be of the Principal Debtor (Mr Ambani Group) and the Secondary liability will be of the Guarantor (Mr Harpreet Randhawa), on the failure of the principal Debtor to pay off the debt.
Concept of Co-Surety
The concept of co-surety is covered under Section 146 of The Indian Contract Act, 1872. It is defined as
Section 146 – Co-sureties liable to contribute equally– Where two or more persons are co-sureties for the same debt or duty, either jointly or severally, and 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 contrary, are liable, as between themselves, to pay each an equal share of the whole debt, or of that part of it which remains unpaid by the principal debtor.
Co-surety can be defined in simple terms as, when the guarantee to pay the loan is divided between people.
Let’s understand the concept with the help of an example: –
let’s suppose a hypothetical situation, wherein Principal Debtor (Mr C) taken a loan of Rs, 1,000 crores from the Creditor bank (Mr D). Now here, in this situation, the surety is not able to give the guarantee because of such a big amount.
So, here the solution is, the guarantee for the amount can be given by two people, Surety-1 (Mr A) and Surety-2 (Mr B).
The liability to pay the debt of the principal debtor will be divided, as each surety takes the liability mentioned in the contract.
Note– If in the contract the liability is not fixed between the sureties, the liability would be equal. Whereas, if it is fixed, it will be paid according to the ratio of shares mentioned in the contract.
For eg- In the discussed hypothetical situation, if the liability is not fixed between Surety-1 and Surety-2, then the liability would be divided equally of Rs, 500 Crore each. but if mentioned in the contract the ratio of 60:40 of Surety-1 and Surety-2 respectively then the liability would be Rs, 600 crore and Rs, 400 crores.
Types of Guarantee
A guarantee can be identified based on Transaction and Time.
Guarantee on the basis of Transaction can further be sub-divided into Specific Transaction and Continuing Guarantee, and guarantee based on time can be further be sub-divided into Retrospective Guarantee and Prospective Guarantee.
A guarantee is given for only one transaction or debt, the guarantee is known as a specific guarantee. It is said to be discharged when the debt is repaid or the promise is performed.
For. eg- If Mr A friend of Mr B comes from Mumbai to his home to meet him. Mr B directed his known shopkeeper, Mr C, to give his friend Mr A whatever product he wants and also made the statement that if he fails to pay the amount of the product, he will pay on his behalf.
here, it is noted that Mr B, gave the guarantee for the specific transaction for that particular product and not for anything else. So, it is a specific guarantee.
Continuing guarantee is covered under Section- 129 of The Indian Contract Act, 1872. It is defined as
Section 129 Continuing guarantee– A guarantee which extends to a series of transactions is called a “continuing guarantee”.
In simple terms, it can be said guarantee is made for more than one transaction or debt.
For eg- If Mr A friend of Mr B comes from Mumbai to his home to meet him. Mr B directed his known shopkeeper, Mr C, to give his friend Mr A whatever product he wants for a period of one year and also made the statement that if he fails to pay the amount of the product, he will pay on his behalf.
Here, it is stated that Mr B allowed his friend to purchase the goods for one year, and gives the guarantee that if he fails, I will pay the amount. This is a continuing guarantee because the transaction is covered for a period of one year.
Note- A Continuing guarantee can be revoked at any time before the transaction is made. If the transaction is made the surety is liable for the loss.
Revocation of Continuing guarantee by way of giving Notice or by the death of the surety is covered under Section 130 and 131 of The Indian Contract Act, 1872, respectively.
Section 130 Revocation of continuing guarantee– A continuing guarantee may at any time be revoked by the surety, as to future transactions, by notice to the creditor.
It is defined in this section, that revocation of continuing guarantee can be given only for the transaction which has not taken place, the surety is liable for those which is already been done.
For eg- If Mr A is the principal debtor and Mr B is the guarantor for his continuing transaction which he takes from Mr C the creditor. The surety has the power to revoke his guarantee, at any time before any transaction could take place. let’s say there will be 3 transactions in one year, the surety gives the notice after transaction 1.
So, he is liable for transaction 1 and not for the reaming one.
Section 131 Revocation of continuing guarantee by surety’s death– The death of the surety operates, in the absence of any contract to the contrary, as a revocation of a continuing guarantee, so far as regards future transactions.
The surety is not liable for any transaction which has taken place after his/her death. But, if it is written in the contract to the contrary that the surety legal representatives will be liable, then his/her legal representative will be held liable for the losses.
The legal representatives will be liable for all the transaction, which has taken place before the death of the surety.
A retrospective Guarantee is defined as the guarantee given for the debt which is already there outstanding at the time of guarantee.
for. eg- if there is a liability from Mr A’s side to pay of his debt to Mr.B. Here if Mr C gives the guarantee to pay off his debt, which is already there, it is known as Retrospective Guarantee.
A Prospective Guarantee is a guarantee which is given for future transactions.
Difference between Contract of Indemnity and Guarantee
|Contract of Indemnity||Contract of Guarantee|
|Contract of Indemnity is made between 2 parties. Indemnifier and indemnity holder.||Contract of Guarantee is made between 3 parties. Principal Debtor, Creditor, and Surety.|
|There will be only 1 Contract made between Indemnifier and Indemnity holder.||There will be 3 Contracts made individually between Principal Debtor, Creditor, and Surety.|
|Indemnifier will have the Primary liability to pay the debt.||Primary liability to pay the debt will be of the Principal Debtor and secondary would be of the Surety.|
It is said that Contract of Guarantee is a trilateral contract, what does it actually mean.
Contract-1, Contract is made between Principal Debtor+ Creditor.
In the above discussed hypothetical situation, Ambani Group takes a loan from Punjab National Bank, where the contract is made between them as the amount of loan given by the bank to Principal Debtor is enough consideration, and the promise given by the principal debtor to the bank is enough consideration.
Contract-2, Principal Debtor+ Surety.
The Promise made by the surety (Mr Harpreet Randhawa) to pay back the amount on the failure of the principal debtor is enough consideration from the surety side and there is a contract of indemnity between the principal debtor and surety, which means after paying the amount on behalf of principal debtor by the surety, the principal debtor is liable to return the amount to him later.
Contract-3, Surety+ Creditor.
The amount which the creditor gives to the principal debtor is enough consideration for surety. The amount which surety pay on the failure of the principal debtor is enough consideration from the surety side towards the creditor.
Essentials of a Valid Contract of Guarantee
- Existence of debt
There should be an existence of a debt for which a guarantee can be given by surety to the creditor. If there is no existence of the debt, the surety would not be able to give the guarantee for anything.
2. The contract should be tri-parted
The contract is made between the Principal debtor, Surety, and Creditor. Without them, the contract will not be a contract of guarantee.
The primary liability to pay off the debt is of the principal debtor and secondary liability is of the surety.
There is an implied contract of indemnity between surety and principal debtor.
3. A minor can also become a principal debtor
A person of minor age can also become the valid party for the contract of guarantee. His/her minority will not let the contract void.
A contract of guarantee, without consideration, is void. but it is not necessary to have a direct consideration for the contract of guarantee.
Consideration for guarantee is covered under Section- 127 of The Indian Contract Act, 1872.
Section 127 Consideration for guarantee- 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.
A promise made by the surety to pay the debt on behalf of the principal debtor is enough consideration. The creditor gives the amount of loan to the principal debtor on a promise to get it from either principal debtor or surety is enough consideration. The indemnity clause between the principal debtor and surety is enough consideration.
Rights of Surety
- Right of Surety, against Principal Debtor.
Rights of Surety, against Principal Debtor are covered under Section- 140 and 145 of The Indian Contract Act, 1872, as the right of Subrogation and right of indemnity, respectively.
Section-140 Rights of surety on payment or performance- 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 word Subrogation means substitution. When a Principal debtor fails to pay the liability, then surety on behalf of him pays the debt to the creditor. The creditor has the right against surety to acquire whatever Principal Debtor was required to pay, after the failure of the principal debtor.
After, paying the amount by the surety, the surety has all the power of the creditor and can now recover the debt from the principal debtor.
Section- 145 Implied promise to indemnify surety– 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, but no sums which he has paid wrongfully.
The surety is entitled to recover from the principal debtor whatever sum he has rightfully paid under the contract of guarantee.
Note- But the sum which he has paid wrongfully will not make the principal debtor liable for that amount.
For eg- If the surety is liable to pay the amount of 2 lakh to the creditor on behalf of the principal debtor. Here, what surety does is he made a payment of 1,50,000 via cheque, whereas the amount left of Rs. 50,000 was paid by him in black,
Here, Principal Debtor is liable only to pay the amount of Rs. 1,50,000. Because the amount left was made in black.
Note – The provision of indemnity is implied and no such statement would be acceptable that there is no contract of indemnity, in the contract.
2. Right of Surety, against Creditor.
Right of Surety, against Creditor, is covered under Section- 141 of The Indian Contract Act, 1872.
Section- 141 Surety’s right to benefit of creditor’s securities– A surety is entitled to the benefit of every security which the creditor has against the principal debtor at the time when the contract of suretyship is entered into, whether the surety knows of the existence of such security or not; and if the creditor loses, or without the consent of the surety, parts with such security, the surety is discharged to the extent of the value of the security.
If Mr A is the Creditor, Mr B is the Principal Debtor and Mr C is the Surety. Here, if the Principal debtor gives his car as security to Creditor, Surety has the right toward the car which is given is given as security.
3. Right of Surety, against Co-Surety.
The right of Surety, against Co-Surety, is elaborated above.
Therefore, the contract of guarantee can be understood as a form of protection available to the other party when entering into a contract with the first party. The three parties involved in the contract are -principal debtor, the creditor, and the surety. The contract should fulfil all the requirements to be valid and should include specific terms and conditions. The relief sought is provided on the non-fulfilment of the terms.