Section 126 of Indian Contract Act defines Contract of guarantee. It defines a contract of guarantees 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 “surety”. The person of whose default the guarantee is given is called the “Principal debtor”. The person to whom the guarantee is given is called the creditor.
Contract of guarantee can be of two types. It can be oral or written. However, for a contract to form in between the parties there should be meeting of minds that means all three parties should be privy to the contract. Contract of guarantee is a promise to answer for the payment of the debt that the principal debtor takes from the creditor or the performance of some duty. IN case the principal debtor fails who is in the first instance liable to pay or perform. Therefore, the primary liability to pay is of the principal debtor. Whereas, the secondary liability is of the Surety i.e. when the principal debtor fails to pay, the surety comes into role.
Therefore, the contract of guarantee is to indemnify if principal debtor fails to fulfill his promise. In this indemnify is not equal to the contract of indemnify in Section 124 of ICA.
Difference between contract of guarantee and contract of indemnity
In contract of indemnity parties involved are 2 i.e. indemnifier and indemnity holder whereas in contract of guarantee there are 3 parties involved i.e. principal debtor, surety and creditor. In contract of guarantee there are 3 contracts, first is between principal debtor and creditor, second is between creditor and surety and third one is between surety and principal debtor.
However, there is no need to have three separate agreements between 3 parties. A single agreement can also make them parties to a contract of guarantee.
The nature of liability in the contract of indemnity is of the indemnifier i.e. The primary liability is of indemnifier. Whereas, the primary liability in a contract of guarantee is of the principal debtor and secondary liability is of surety.
Section 127 of Indian Contract Act
This section basically talks about the consideration in a contract of guarantee. The consideration for the surety’s promise may move from either the creditor or the Principal Debtor. The consideration may benefit the surety but it is not necessary that surety should receive any benefit from the consideration in contract of guarantee. This section speaks of the consideration i.e any benefit that is received by the principal debtor or creditor at the surety’s request.
Under section 128 of ICA, the liability of surety is co-extensive that of the principal debtor that means the surety is liable to the same extent as the principal debtor. For example if the principal debtor is not liable for debt for some reason, then surety is also not liable for the same. Also, the principal debtor is discharged from his debt by the creditor for some reason then surety will be discharged too. This section depends on the contract as well. Therefore, the surety’s liability depends on the terms of the contract and is not liable to pay more than the principal debtor has taken.
Example:-“A guarantees to B the payment of a bill of exchange by C, the acceptor. The bill is dishonored by C. A is liable, not only for the amount of the bill, but also for any interest and charges which may have become due on it. A guarantees to B the payment of a bill of exchange by C, the acceptor. The bill is dishonored by C. A is liable, not only for the amount of the bill, but also for any interest and charges which may have become due on it.”
The liability of the surety is joint and connected with the principal debtor. It is the choice of the creditor to recover the amount either from the principal debtor after his default or from surety. He may file a suit against both the principal debtor and the surety or may file a suit against the surety only or the principal debtor only.
In Bank of Bihar vs Damodar Prasad it was held that the creditor do not have exhaust all the remedies against principal debtor before suing the surety. It is the duty of the surety to pay the debt if principal debtor does not pay. The purpose of contract of guarantee is defeated if the creditor is asked to postpone his remedies against the surety. The liability of surety is immediate.
Section 129 of ICA defines continuing guarantee. A guarantee which extends to a series of transactions is called continuing guarantee. It is not confined to a single transaction. In this guarantee, surety is liable to pay the creditor for all the transactions. However, it is very important to find out if the guarantee is a continuing one or not.
Difference between continuing guarantee and simple guarantee
- A continuing guarantee can be revoked by the surety any time either by the notice to the creditor or until the surety’s death. Whereas, simple guarantee can not be revoked in any circumstances.
- In continuing guarantee, the transaction can go for long period of time therefore the surety will be held liable for long time as well whereas in simple guarantee the surety liability is over when the debt is paid or the performance is done.
To understand the nature of a guarantee, you must look at:
- The intention of the parties as expressed by the language in the contract.
- surrounding circumstances to see what was the subject matter which the parties examine.
Example of a continuing guarantee: A in consideration that B will employ C in collecting the rents of B’s zamindari, promises B to be responsible to the amount of Rs 5000 for the due collection and payment by C of those rents. This is a continuing guarantee.
Section 130 of ICA explains the revocation by notice. A continuing guarantee may be revoked anytime by the surety for the future transactions only by notice to the creditor.
The main ingredients of the section are as follows:-
- As to future transactions
- Notice to the creditor
Continuing guarantee extends to a series of transactions, surety has a right to withdraw such guarantee. As soon as the surety sends the notice of revocation to the creditor, the surety does not remain liable for any transaction that happens after he has given notice, However, the surety continues to remain liable for any transactions that has already taken place. if the mode of revocation by notice is mentioned in the contract, then notice must be given in that mode only and if no mode is given in the contract then the notice may be given in any form.
Section 131 of ICA explains the revocation by death of surety.The liability for any transactions that took place prior to the death of the surety will be borne by his heirs. This contract could be implied from the circumstances.
Discharge of Surety
Section 133 -139 explains all the circumstances in which surety is discharged. All these section can be called the rights of the surety as the surety will not be liable on the guarantee any more.
Contract of guarantee is a contract and can be discharged as a normal contract.
This sec of ICA explains discharge of surety by variance.
“Discharge of surety by variance in terms of contract.—Any variance, made without the surety’s consent, in the terms of the contract between the principal 1[debtor] and the creditor, discharges the surety as to transactions subsequent to the variance. —Any variance, made without the surety’s consent, in the terms of the contract between the principal 1[debtor] and the creditor, discharges the surety as to transactions subsequent to the variance.”
This section essentially the outcome of the general rule that is all the parties should be privy to the contract. It stated that when a amendment takes place in the contract without taking surety, the surety is discharged. Surety cannot be bound to something for which he has not contracted.
Illustration: A becomes surety to C for B’s conduct as a manager in C’s bank. Afterwards B and C contract without surety’s consent, that B’s salary sell be raised. In this Surety that is A is discharged as A did not know about the contract between B and C.
Exception of this Section:
In this if the alteration is made in the agreement without the surety’s consent that is beneficial to the surety, the surety is not discharged. The alteration should be unsubstantial/immaterial, then surety is not discharged. In Anirudhan vs The Thomco’s Bank Ltd it was held that the surety is not discharged as the contract between the principal debtor and creditor is beneficial to the surety.
This sec. states the, discharge of surety by release of Principal Debtor
In this section states that if the principal debtor is release because of any contract between creditor and principal debtor or by any act or omission of the creditor, then the surety is released. This section is connected with the section 128 of ICA which says that the liability of the surety is co-extensive with that of principal debtor. The reason for the discharge of surety is with the principal debtor that this release of the principal debtor extinguishes the principal obligation, to begin with.
In this section 2 types of release are mentioned.
1. Express release: This is a situation in where an express contract between the credit and the principal debtor results in discharge/release
2. Implied release: In the section the words “by any act or commission of the creditor, the legal consequence of which is the discharge of the principal debtor” refers to an implied release/discharge.
The acts or omissions by this section are referred to in section 39, 53, 54, 55, 67 of ICA.
1. Section 39– when a party to a contract has refused to perform or disabled himself from performing his promise.
2. Section 53– when a contract contains reciprocal promises and one party to the contract prevents the other from performing his promise.
3. Section 54– when a contract contain reciprocal promises such that one of them cannot be performed till the other has been performed.
4. Section 55– When a party to a contract promises to do certain things at or before a specific time and fails to do any such thing within that time
5. Section 67– If a promisee neglects to afford the promisor, reasonable facilities for the performance of his promise.
A contract between the creditor and the principal debtor without surety assent to
- to make a composition/compromise with
- promise to give time to
- not to sue the principal debtor
- discharges the surety
“To make composition with”- This essentially mean if the creditor makes any sort of compromise with the principal debtor with respect to the debt them surety will be discharged.
“Promise to give time to”- where the creditor extends time for the payment of debt without the consent of surety, then surety will be discharged.
“Not to sue the principal debtor”- If the creditor agrees with the principal debtor to not to ever sue against him, the surety will be discharged.
Where a contract to give time to the principal debtor is made by the creditor with a third person and not with the principal debtor, then the surety is not discharged.
Illustration– A agrees with B to supply 500 tons of steel in consideration of Rs 5 Lakhs. C stands surety to A . A agrees with D (B’s father) to extends the delivery date. C is not discharged as D is the third party and not the principal debtor.
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.
Mere forbearance means own its own. When creditor does not sue the principal debtor on its own then the surety is not discharged.
In this section consists of the following elements:
- The creditor either does something which is inconsistent with the rights of the surety or omits to do his duty towards the surety
- And because of this the eventual remedy of the surety that he had against the principal debtor is impaired(weakened) , the surety is discharged.
The meaning of this section is that the surety steps into the shoes of the creditor after he has paid the guaranteed debt or performed whatever he was liable for. This right of the surety to step into the shoes of the creditor is known as the surety’s right of subrogation.
A surety is entitled to every security which the creditor has against the principal debtor at the time when the surety ship is entered into. Or if the creditor loses or parts with such security the surety is discharged to the extent of the value of the security. This section is applied even when the surety’s consent is not there. The words “if the creditor loses security” refer to deliberate action by the creditor and not a mistaken situation beyond the control of the creditor.
Extent of discharge: if the value of the security is less than the liability undertaken by the surety, then the surety must be held to be discharged to the extend of the value of the security and that he will still be required to discharged the liability which exceeds the value of security. However, if the value of the security given is in far excess of the liability, the surety must be held to be discharged wholly.
Guarantee obtained by misrepresentation. Any guarantee obtained by misrepresentation made by the creditor is invalid.
Guarantee on contract that creditor shall not act on it until co-surety joins. Where a person gives a guarantee upon a contract that the 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. Where a person gives a guarantee upon a contract that the 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.
In every contract of guarantee there is an implied contract of indemnity in between the surety and principal debtor. Principal debtor has to indemnify the surety later with the rightfully sum. The surety can sue the principal debtor for the guarantee amount as soon as his liability becomes absolute. The surety may recover all damages, all costs and all sums in accordance with section 125 of ICA.
When one co-surety is released does not discharge other co-surety. A release by the 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.
This section defines co-sureties. Where 2 or more persons are co-sureties for the same debt or duty 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. contribution of all the co-sureties should be equal, if not mentioned in the contract. It should be according to the contract if the proportion is mentioned in the contract.
Co-sureties are bond in different sums are liable to pay equally as far s the limits of their respective obligations permit. For e.g.. – A, B and C are sureties for D enter into 3 several bonds. A in the penalty of Rs.10,000, B in that of Rs. 20,000 and C in Rs 40,000. D makes a default to the extent of Rs. 40,000. So, the liability of A will be 10,000, B’s liability will be 15,000 and C’s liability will be 15,000 as well.
Edited by Soma Sarkar
Approved & Published – Sakshi Raje