Contract of Guarantee

11/03/2020 1 By indiafreenotes

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 fulfil his promise. In this indemnify is not equal to the contract of indemnify in Section 124 of ICA.

Continuing Guarantee

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 in this section is:

  • 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.

Essentials of a Contract of Guarantee

1. Concurrence of All the Parties

All the three parties namely, the principal debtor, the creditor and the surety must agree to make such a contract.

2. Liability

In a contract of guarantee, liability of the surety is secondary i.e., the creditor must first proceed against the debtor and if the latter does not perform his promise, then only he can proceed against the surety.

3. Existence of a Debt

A contract of guarantee pre-supposes the existence of a liability, which is enforceable at law. If no such liability exists, there can be no contract of guarantee. Thus, where the debt, which is sought to be guaranteed is already time barred or void, the surety is not liable.

4. Consideration

There must be consideration between the creditor and the surety so as to make the contract enforceable. The consideration must also be lawful.  In a contract of guarantee, the consideration received by the principal debtor is taken to be the sufficient consideration for the surety.

Anything done, or any promise made, for the benefit of the principal debtor may be sufficient consideration to the surety for giving the guarantee

– Sec. 127 of Indian Contract Act, 1872..

Thus, any benefit received by the debtor is adequate consideration to bind the surety. But past consideration is no consideration for a contract of guarantee. There must be a fresh consideration moving from the creditor.

  1. Writing not Necessary

A contract of guarantee may either be oral or written. It may be express or implied from the conduct of parties.

  1. Essentials of a Valid Contract

It must have all the essentials of a valid contract such as offer and acceptance, intention to create a legal relationship, capacity to contract, genuine and free consent, lawful object, lawful consideration, certainty and possibility of performance and legal formalities.

  1. No Concealment of Facts

The creditor should disclose to the surety the facts that are likely to affect the surety’s liability. The guarantee obtained by the concealment of such facts is invalid. Thus, the guarantee is invalid if the creditor obtains it by the concealment of material facts.

  1. No Misrepresentation

The guarantee should not be obtained by misrepresenting the facts to the surety. Though the contract of guarantee is not a contract of uberrimae fidei i.e., of absolute good faith, and thus, does not require complete disclosure of all the material facts by the principal debtor or creditor to the surety before he enters into a contract. But the facts, that are likely to affect the extent of surety’s responsibility, must be truly represented.