Contract of Guarantee

 

DEFINITION AND MEANING

Guarantee is an undertaking to answer for another’s liability and collateral thereto. It is a collateral undertaking to pay the debt of another in case he does not pay it.

It is a provision to answer for the payment of some debt, or the performance of some duty in the case of failure of some person who, in the first instance, is liable for such payment or performance.

Guarantee is an undertaking to be collaterally responsible for the debt, default or miscarriage of another. A guarantee is a promise by one person, who is called the “guarantor” or “surety” to answer for the present or future debt of another person who is called the “principal debtor”, such promise being made to the party to whom the principal debtor is, or will become, liable.

In India, Contract of Guarantee is included in the Indian Contract Act, 1872 and is defined under section 126 as follows:

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.

Under Section 126 of the Contract Act, a contract of guarantee need not necessarily be in writing, it may be express by words of mouth, or it may be tacit or implied and may be inferred from the course of the conduct of the parties concerned.

A contract of guarantee should be entered into freely and voluntarily by the guarantor. In Davis vLondon and Provincial Marine Insurance Co said “Everything like pressure used by the intending creditor will have a very serious effect on the validity of the contract.”

ESSENTIALS OF CONTRACT OF GUARANTEE

  1. 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, etc. though all the parties must be capable of entering into a contract, the principal debtor may be a party incompetent to contract, and the principal debtor may be a party incompetent to contract, i.e. minor.
  1. A principal debt must pre- exist : A contract of guarantee seeks to secure payment of debt, thus it is necessary there is a recoverable debt. There cannot be a contract to guarantee a time barred debt.
  1. 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 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.

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 wull bund 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.

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

IMPORTANT FACTS

  1. There are three parties in every Contract of Guarantee.
  2. The liability arises right from the beginning. The surety becomes liable when the principle debtor commits default in meeting the liability.
  3. Surety has the right to sue the third party (Principal Debtor) directly. The law puts him in the position of Creditor. When 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.
  4. Anything done, or any promise made for the benefit if 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.
  5. The liability of the surety is co- extensive with that of the principal debtor, unless it is otherwise provided by the contract.
  6. The creditor can straightway proceed against the guarantor without first proceeding against the principal debtor.
  7. 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.
  8. Surety’s liability is distinct and separate.

CONTINUING GUARANTEE

A guarantee which extends to a series of transactions is called a continuing guarantee.

  • A continuing guarantee may at any time be revoked by the surety, as to future transactions, by notice to the creditor.
  • Any variance, made without the surety’s consent, in terms of the contract between the principal debtor and the creditor, discharges the surety as to transactions subsequent to the variance.

Rights of a surety

As against the creditor

According to the Indian Contract Act, 1872,

Section 133- 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.

Section 134- 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 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.

Section 135- 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.

Section 139 – 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.

Section 140 – The surety cannot claim the right of subrogation to the creditor 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.

 

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