Guarantee Contract

This article is written by Soma Mohanty of KIIT School of Law, Bhubaneswar. In this article she has mentioned about the essentials, conditions,revocation process in the guarantee contract.

Table of Contents

Contract of Guarantee

• A “contract of guarantee” in Section 126 of Indian Contract Act, 1872 is defined as a contract, in which a person promises to perform an act or discharge the liability of a third person in case of his default.
• Contract of guarantee involves three parties.

1. Surety
2. Principal Debtor
3. Creditor

• The guarantee may be in written form or oral form.

Surety

• A person who gives a guarantee in a contract is called surety according to Section 126 of the Indian Contract Act, 1872.
• The surety is the person who is responsible to pay when the person.
• Example: “A” takes a loan from “B”, and “C” promises to pay back the amount if “A” fails to pay it on time. In this case, “C” is said to be a surety.

Principal Debtor

• A person for whom the guarantee to pay back the amount on his default is given in a contract of guarantee is said to be the principal debtor according to Section 126 of the Indian Contract Act, 1872.
• Example: “A” takes a loan from “B”, and “C” promises to pay back the amount if “A” fails to pay it on time. In this case, “A” is said to be the principal debtor.

Creditor

• The creditor is the person to whom the guarantee is given by the surety to pay the amount back on default of the principal debtor according to Section 126 of the Indian Contract Act, 1872.
• Example: “A” takes a loan from “B”, and “C” promises to pay back the amount if “A” fails to pay it on time. In this case, “B” is said to be the creditor.

Contract of Indemnity

• According to Section 124 of the Indian Contract Act, 1872, when a party contracts with the other party and promises to bear the loss suffered by the other party, while executing the duty.
• Example: “A” enters into a contract with “B”. “A” promises to indemnify “B” if it enters into a deal with “C”. Then “B” entered into a deal with “C” and suffered loss. In this case, “A” is liable to pay for the loss suffered by “B”.

Essentials

• There should be a valid contract.
• The loss should be suffered by the indemnity holder.
• The loss suffered should be the consequence of the conduct of the indemnifier.

Differentiation between contract of indemnity and contract of guarantee

Contract of Indemnity

Contract of Guarantee

In this type of contract, one party promises the other party to pay for the losses suffered to him due to the conduct of the promisor or another person.

In this type of contract, one party promises the other party to be liable for the default of a third party.

Two parties are involved in this contract.

1. Indemnifier
2. Indemnity holder

Three parties are involved in this contract:

The promisor is the person who is primarily liable.

In this case, the principal debtor is primarily liable and the surety is secondarily liable.

The promisee is to be liable for loss suffered.

The promisee is to be liable in the case of default.

There is only one agreement existing between the indemnifier and indemnity holder.

There exist three agreements;

1. Between surety and principal debtor.
2. Between surety and creditor.
3. Between creditor and principal debtor.

Surety’s Liability

• Surety’s liability is coextensive to the liability of debtors according to the Section 128 of the Indian Contract Act, 1872
• Example – “B” the principal debtor is not paying back the sum of money borrowed and also the interest to “c” who is the creditor. In this case, “A” who is the surety would be liable to pay on the default of “B”.

• In the above illustration, the surety has the right to recover the sum of money from the debtor.
• The surety has the right to limited liability.
• Example – “B” has taken a loan of amount rs 20,000 form “C”. Here “A” who is the surety, state that he would be liable on default of Rs 10,000. So in this case, “A” acted to be the surety for the limited amount as stated.

• Surety’s liability towards the creditor comes to play as soon as the debtor is found in the state of default.
• If the contract between the creditor and the debtor is found to be void then the surety would be considered to be primarily liable.
• Example – “B” is a minor who enters into the contract. “B” took a loan of a certain amount from “C”. in this case, “A” who is the surety would be primarily liable as he has given a guarantee to the contract.

Kinds of Guarantees

There are two types of Guarantee:

When a guarantee is given only for a specific/ particular transaction is called a specific guarantee.

When a guarantee is given on a series of the transaction then it is called continuing transaction.

“A” guarantees the payment to be made by “B” to “C”, on the transfer of goods for july month. After the end of the july month, “C” again send goods to “B”. in this case “A” would be liable for the default by “B” incurred in the month of july only.

“A” guarantees payment to “B”, for selling pens of Rs.1000 at the end of every month to “C”. so “B” started supplying pens to “C” on payment at Rs. 1000. But after somedays “B” started supplying the pens at Rs. 2000 to “C”. it was seen that “C” was not able to pay for it. In this case, “A” would be liable for the payment of Rs. 1000 as per the contract.

Revocation of Guarantee

In the case of a continuing guarantee, revocation can be made under certain circumstances.

1. According to Section 130 Indian Contract Act, 1872, a continuing guarantee can be revoked any time but there should be a notice given to the creditor by the surety.

• Illustration: “A” guarantees payment of Rs. 10000 to “B” on purchase of coal to be made by “C”. Then “B” supplied the coal of Rs. 5000 to “C”, “A” gives a notice to “B” coal dealer not to supply coals to “B” further. In this case, A is liable for the payment of supply of coal worth Rs. 5000. But “A” won’t be liable for any further supply made after the notice of revocation.

1. According to Section 131 Indian Contract Act, 1872, revocation of continuing contract takes place on the death of the surety. There is no requirement of notice under these circumstances.

Discharge of a surety

Sections

Provision

Revocation by notice.

Revocation on surety’s death.

A surety can be discharged when there is variation in the contract between the debtor and creditor, and he was not made aware of it.

A surety can be discharged, when the debtor is discharged by the creditor.

• A surety can be discharged, when a debtor enters into a contract with the creditor without the consent of the surety.
• When the contract is to extend the time for the debtor to pay a debt or a promise not to sue the debtor.

A surety can be discharged, when the creditor enters into a contract to extend the time for payment of the debt by the principal debtor with a third party.

A surety can be discharged, when the creditor fails to take any legal action on the principal debtor against the default.

When a creditor omits to do an act, which infringes his duty towards the surety, then surety would be discharged.

When a surety pays the default amount of the debtor, he is liable to get all the securities of the debtor that the creditor has against the debt.

Surety has the right to get benefit from the creditor’s securities.

What is the Contract of Guaranteee?

• A “contract of guarantee” in Section 126 of the Indian Contract Act, 1872 is defined as a contract, in which a person promises to perform an act or discharge the liability of a third person in case of his default.
• There are three parties in Contract of Guarantee:

1. Surety
2. Principal debtor
3. Creditor

• There are two kinds of guarantee:

1. Specific guarantee
2. Continuing guarantee

Essentials of a Contract of Guarantee

• There should be an agreement between all the parties in the contract. i.e,

1. Between surety and principal debtor.
2. Between surety and creditor.
3. Between creditor and principal debtor.

• In this, the principal debtor is primarily liable and surety is secondarily liable.
• The contract made can be in written or oral form.
• It should be a valid contract with free consent.
• The creditor should not hide any facts that would affect the surety’s liability.

Period of Limitation

• The limitation period for enforcing a guarantee is 3 years from the date of issue of the letter of guarantee.

Rights of a Surety

Against the Creditor

• According to Section 141 of the Indian Contract Act, 1872, the surety has the right over the security of the debtor, which was kept in the form of security by the creditor against the debt.
• Exception: Even if the surety is not aware of the security which the creditors have kept, he would be liable to get it after the discharge of his obligation.

Against the Principal Debtor

• According to Section 140 of the Indian Contract Act, 1872, when a surety discharges his obligation towards the creditor on default, then the principal debtor is liable to pay the amount back to the surety. Thus he holds the status of the creditor in this case. This is known as the right of subrogation.
• According to Section 145 of the Indian Contract Act, 1872, the principal debtor promises to indemnify the surety. In this situation, the surety has the right to recover the sum of money he has paid under the guarantee.

Against co-sureties

• When a surety discharges his obligation towards the creditor and pays more on behalf of co-sureties then, he would be liable for the payment of extra sum from the co-sureties.

Rights of a Surety

• Surety’s liability is coextensive to that of the debtor’s liability. It means that in the case of default of the debtor, the degree of liability of the debtor towards the creditor is the same as the liability of surety towards the creditor.
• Example – When “B” borrowed money from “C”, with “A” as the surety, then it was found that “B” was in default. In this case, “A” is bound to pay for the principal amount as well as the interest to be paid.

Short Notes on Continuing Guarantee

• Continuing guarantee under Section 129 of the Indian Contract Act, 1872, is defined as a guarantee which is given on a series of transactions.
• Illustration – “A” guarantees payment to “B”, for selling pens of Rs.1000 at the end of every month to “C”. so “B” started supplying pens to “C” on payment at Rs. 1000. But after somedays “B” started supplying the pens at Rs. 2000 to “C”. it was seen that “C” was not able to pay for it. In this case, “A” would be liable for the payment of Rs. 1000 as per the contract.

Features of continuing guarantee

• The guarantee must be ancillary and subsidiary.
• A contract of guarantee is not one uberrimae fidei (insurance contracts) but a contract of strictissima (strictest letter of the law).
• The continuing guarantee can be revoked under certain circumstances.

Revocation of Continuing Guarantee

Revocation by Notice

• According to Section 130 Indian Contract Act, 1872, a continuing guarantee can be revoked any time but there should be a notice to the creditor by the surety.
• Illustration: “A” guarantees payment of Rs. 10000 to “B” on purchase of coal to be made by “C”. Then “B” supplied the coal of Rs. 5000 to “C”, “A” gives a notice to “B” coal dealer not to supply coals to “B” further. In this case, A is liable for the payment of supply of coal worth Rs. 5000. But “A” won’t be liable for any further supply made after the notice of revocation.

Death

According to Section 131 Indian Contract Act, 1872, revocation of continuing contract takes place on the death of the surety. There is no requirement of notice under these circumstances.

• TAGS
• Contract of Guarantee
• Contract of Indemnity
• Creditor
• Discharge of a surety
• Essentials
• features
• Kinds of Guarantees
• Principal Debtor
• Revocation
• rights
• Surety
• Surety’s Liability