This article is written by Suryash Kumar, graduated from Bangalore Institute of legal studies. The article talks about the Contract of Guarantee.
Table of Contents
Contract of Guarantee is a specific performance contract. It is called specific performance because it is an equitable relief. This is not the usual legal remedy where compensation for damages is adequate. Damages and specific performance are both remedies available upon breach of obligations by a party to the contract; the former is a ‘substitutional remedy’, and the latter a ‘specific remedy’.
The law prescribes that in an event where the actual damage for not performing the contract cannot be measured or monetary compensation is not adequate, one party can ask the court to direct the other party to fulfil the requirements of the contract.
It is also a discretionary relief, that is, it is left to the court to decide whether specific performance should be given to a party asking for it.
Why Contract of Guarantee is Specific performance?
Contract of Guarantee is Specific performance because the remedy is not the damages awarded by the court. The party has to fulfil its obligation under the contract i.e. perform a certain action he promised to do, instead of just paying money for his failure to fulfil obligations under the contract. It is the guarantor who commits to pay in case of default by the person for whom he has guaranteed. The nature of relief is of specific nature since guarantor has to perform the specific obligation, which he had undertaken under the agreement i.e. pay the assured.
Contract of Guarantee
Section 126 defines the Contract of Guarantee– A contract of guarantee involves three parties. It relates to the performance of contract on behalf of the third person whereby fulfilling his obligation under the contract by the guarantor
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.
Purpose of Contract of Guarantee
It enables a person to get a loan, or goods on credit or employment. Some person comes forward and ensures the lender or the supplier or the employer that he may be trusted and in case of any untoward incident, “I undertake to be responsible”.
In the old case of Birkmyr v Darnell the court said: Where a collateral guarantee arises when two persons come to shop, one of them to buy, the other to give credit, thereby promising the seller stating if he doesn’t pay I will’’. This is a collateral guarantee.
In English law, a guarantee is defined as ‘’a promise to pay for the debt, default or failure of another’’. “Guarantees are a backup when the principal fails the guarantee act as second pockets’’.
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.
Independent liability different from guarantee
There must be a conditional promise to be liable on the default of the principal debtor. A liability which is incurred independently of a default is not within the definition of guarantee.
This principle was applied in Taylor v Lee where a landlord and his tenant went to the plaintiff’s store. The landlord said to the plaintiff: Mr Parker will be on our land this year, and you will sell him anything he wants, and I will see it paid.
This was held to be an original promise and not a collateral promise to be liable for the default of another and, therefore, not a guarantee.
Essential Features of Guarantee
- Principal debt: “A contract of guarantee is a tripartite agreement which contemplates the principal debtor, the creditor and the surety’’. There should exist an independent debt. It is critical that there should be a principal debtor who has taken debt from the creditor. There can’t be a surety without a principal debtor.
- Consideration: One of the essential elements of contract is consideration which should be present in a contract of guarantee. It can be in any form which largely benefits the principal debtor.
Illustration: A sells and delivers goods to B. C afterwards requests A to forbear to sue B for the debt for a year, and promise that, if he does so, C will pay for them in default of payment by B. A agrees to forbear as requested. This is a sufficient consideration for C’s promise.
- Misrepresentation and concealment: A contract of guarantee is not a contract uberrimae fides or one of complete good faith.. Where a customer had a precarious credit position. The surety wasn’t aware of this and acted as a guarantor of the customer. It was held that the bank is under no obligation to disclose this fact to the surety. However, it is the duty of a party taking guarantee to provide the surety with important facts so that he can make an informed decision. Facts which will affect his responsibility under the contract of guarantee.
- Writing not necessary: Section 126 says that a guarantee may be either oral or written. In England, guarantee is not enforceable unless it is “In writing and signed by the party to be charged”.
The extent of the Surety’s Liability
Section 128 speaks about one of the cardinal principles relating to the contract of guarantee. It states that the liability of the surety is co-extensive with that of the principal debtor. The surety may, however, by an agreement place a limit upon his liability.
Section 128- The liability of the surety is co-extensive with that of the principal debtor unless it is otherwise provided by the contract.
Illustration- A guarantees to B the payment of a bill of exchange by C, the acceptor. The bill is dishonoured 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.
- Co-extensive: The first principle governing surety’s liability is that it is co-extensive or common with that of the principal debtor. He is liable for the whole amount for which the principal debtor is liable and he is liable for no more. 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.
- Condition precedent: Where there is a condition precedent to the surety’s liability, he will not be liable unless that condition is first fulfilled. Section 144 to an extent is based on this principle: Where a person gives a guarantee upon a contract that creditor shall not act upon it until another person has joined it as co-surety, the guarantee is not valid if that other person does not join.
An illustration in point is National Provincial Bank of England v Brackenbury: The defendant signed a guarantee which was intended to be a joint and several guarantees of three other persons with him. One of them did not sign. There is no agreement between the bank and the co-guarantors to dispense with his signature, the defendant was held not liable.
Proceeding against surety without exhausting remedies against the debtor
The defendant guaranteed a bank’s loan. A default had taken place, the defendant was sued. The trial court decreed that the bank shall enforce the guarantee in question only after having exhausted its remedies against the principal debtor. The Supreme Court overruled it stating that the very object of the guarantee is defeated if the creditor is asked to postpone his remedies against the surety. Solvency of the principal is not a sufficient ground for restraining execution of the decree against the surety.
Suit against surety alone
A suit against the surety without even prosecuting the principal debtor has been held to be maintainable. In this case, the creditor, in his affidavit, had shown sufficient reasons for not proceeding against the principal debtor.
Death of Principal debtor
A suit was filed against the principal debtor and surety. The suit against the principal debtor was found to be void ab initio because of his death even before the institution of the suit. The surety was held to be not discharged.
- Surety’s right to limit his liability or make it conditional
The surety may restrict his liability in the agreement. He can do this by expressly declaring his guarantee to be limited to a fixed amount. In such a case the surety cannot be liable for any amount beyond what is stated in the agreement. There might be a possibility that the principal debtor owes a greater amount but the surety will not be responsible for the amount exceeding what is stated in the agreement.
Impossibility of main contract
A loan for development and maintenance of bee culture was guaranteed. The surety undertook to be liable jointly and severally to pay off his instalments in case of failure on the part of the debtor. The bees died in consequence of a viral infection. There was a total failure of business. The debtor became disabled from paying instalments. The surety could not escape liability under the doctrine of impossibility of performance.
The creditor’s right to recover money from the guarantor doesn’t depend on the possibility of guarantor able to recover the amount from the principal debtor.
Continuing Guarantee- A guarantee which operates on a number of transactions within a particular period, is called a ‘’Continuing Guarantee’’.
This type of guarantee includes a number of transactions over a period of time. A creditor can hold the surety responsible for the default of the principal debtor for transactions that happen within a period of time.
Illustration- A guarantees payment to B, a mobile dealer, to the amount of $100, for any mobile he may supply to C as required by C over a period of time. B supplies C with mobile above the value of $100, and C pays B for it. Afterwards B supplies C with mobile to the value of $200 . C fails to pay. The guarantee given by A was a continuing guarantee, and he is accordingly liable to B to the extent of $100.
The essential feature of a continuing guarantee is that it doesn’t restrict to a specific number of transactions, but to any number of them and makes the surety liable for the unpaid balance at the end of the guarantee.
In Chorley & Tucker the distinction is explained: “A specific guarantee provides for securing of a specific advance or for advances up to a fixed sum, and ceases to be effective on the repayment thereof, while a continuing guarantee covers a fluctuating account such as ordinary current account at a bank, and secures the balance owing at any time within the limits of the guarantee…’’
A guarantee for the conduct of a servant appointed to collect rents has been held by the Calcutta High Court to be a continuing guarantee.
Joint -Debtors and suretyship
Section 132- This Section speaks about a situation when there are two guarantors who are liable to the creditor as joint-debtors. It says that the liability of the creditor is not affected by any private arrangement (Order of their liability) between the two debtors regarding one being the surety of the other even if the creditor knows of this arrangement. The creditor is not concerned with their mutual agreement that on would be a principal and the other surety.
Discharge of Surety From Liability
When the surety is no longer liable under the agreement the surety is said to be discharged from liability.
The Act recognises the following modes of discharge:
- By Revocation (Section-130)Revocation of continuing guarantee: The surety can revoke continuing guarantee by notifying the creditor with respect to the future transactions.
Revocation becomes effective for the future transactions while the surety remains liable for transactions already entered into.
Illustration- A guarantees for B making purchases from C to an extent of 10000rupees. After one month A revokes guarantee by giving notice to C. A will be liable for the supplies till the point he revoked his guarantee. Let’s say until revocation C supplied B with goods worth 6000rupees. A is under obligation to pay 6000 to C.
- By death of surety (Section 131): A continuing guarantee is also terminated by the death of the surety unless parties have expressed contrary intention.The termination is only with respect to the future transactions and the heirs of surety are liable for transactions that have already taken place.
- By variance (Section 133)- The contract of guarantee once formed becomes a contract of utmost good faith. This duty is imposed on the creditor. The surety is held discharged when, without his consent, the creditor makes any charge in the nature or terms of his contract with the principal debtor. ‘’The surety is discharged as soon as the original contract is altered without his consent’’.
- Discharge of surety by release or discharge of principal debtor (Section 134) – A surety can be discharged if there is any contract between principal debtor and the creditor, which releases the principal debtor. Any act or failure on creditor’s part which has the legal effect of discharging the principal debtor also absolves surety.
Illustration- A contracts with B for a fixed price to build a house for B within a given time, B supplying the necessary timber, C guarantees A’s performance of the contract. B omits to supply the timber. C is discharged from his suretyship.
- Release of principal debtor: The Section provides for two kinds of discharge from liability. The first one where creditor enters into an agreement with the principal debtor by which the latter is released, the surety is discharged. Where the creditor arrives at a compromise and releases the principal debtor, the surety is likewise released.
- Act or omission: The second scenario envisaged by the Section is when the creditor does ‘’any act or failure the legal effect of which is the absolve the principal debtor,’’ the surety would also be released from his liability. For example, Where the payment of rent due under a lease is guaranteed and the creditor terminates the lease, the effect would be the release of the surety also.
Discharge: (Section 135) Discharge of surety when creditor compounds with, gives time to or agrees not to sue principal debtor-. A contract where the creditor and principal debtor arrive at an arrangement which results in creditor making a composition with grants principal debtor with more time or undertakes not to sue the principal debtor absolves the surety. For this to operate the surety shouldn’t have assented to this arrangement between creditor and principal debtor.
The Section provides for three modes of discharge from liability:
- Promise to give time, and
- Promise not to sue the principal debtor
If the creditor makes a composition with the principal debtor, without consulting the surety, the latter is discharged. Composition results in altering the original contract, and, therefore, the surety is discharged.
For Example- A settlement was entered into between the principal borrower and bank for one-time settlement without reference to the guarantor. The court said that this resulted to novation of the contract between the creditor and principal debtor to the exclusion of guarantor. The liability of the guarantor ceased to exist.
Promise to give time- Promise to give time: when there is a fixed time, according to the agreement for the repayment of the debt. It is one of the duties of the creditor towards the surety not to allow the principal debtor more time for payment. Although, giving time to the principal will benefit the surety but it will be against the spirit of the contract of guarantee, without the consent of the surety.
Thus, where the principal debtor was to make payment for gas supplied within fourteen days and on one occasion he having failed to pay, the supplier took a promissory note from him, this amounted to extension of time and thereupon the surety was discharged.
By impairing surety’s remedy (Section 139): The creditor shouldn’t act in a way which is prejudice to surety’s interest. The remedy of the surety shouldn’t be affected by creditor’s action otherwise surety may be discharged.
It is one of the fundamental duties of the creditor not to do anything inconsistent with the rights of the surety. A surety after paying off the creditor, to secure his payment from the principal debtor.
This responsibility also directs the creditor to preserve the securities, if any, which he has against the principal debtor.
In Darwen&Pearce, The principal debtor was a shareholder in a company. His shares were partly paid and the payment of the unpaid balance was guaranteed by the surety. The shareholder defaulted in the payment of calls and the company forfeited his shares.
By reason of the forfeiture, the shares became the property of the company. If they had not been forfeited they would have belonged to the surety on payment of the outstanding calls. Thus, the forfeiture deprived the surety of his right to the shares and he was accordingly discharged.
Rights of Surety
Rights against the principal debtor
Rights of surety on payment or performance- The surety after paying the creditor or fulfilling his obligation under the contract takes the place of the creditor. He has all rights vested in him which the creditor had against the principal debtor.
When the surety has carried out all his obligations under the contract, he is conferred with all the rights which the creditor had against the principal debtor. The surety steps into the shoes of the creditor.
In Babu Rao Ramchandra Rao v Babu Manaklal Nehmal: “If the liability of the surety is coextensive with that of the principal debtor, his right is not less coextensive with that of the creditor after he satisfies the creditor’s debt’’.
Rights before payment
The surety may possess certain rights even before payment. We have a case where the Calcutta High Court decided on similar lines. The surety found that the amount had become due, the principal debtor was disposing of his personal properties one after the other lest the surety, after paying, may seize them and sought a temporary injunction to prevent the principal debtor from doing so. The court granted the injunction.
- Right to indemnity:
Section (145) Implied promise to indemnify surety- In every contract of guarantee, there is an implicit promise by the principal debtor to save the surety from harm. The surety is entitled to claim from the principal debtor whatever sum he had agreed to pay under the guarantee, but no sums which he wasn’t obligated to pay under the contract.
Illustration: A guarantees to C, to the extent of 2000 rupees, payment for the rice to be supplied by C to B. C supplies to B rice to a less amount than 2000 rupees, but obtains from A payment of the sum of 2000 rupees in respect of the rice supplied. A cannot recover from B more than the price of the rice actually supplied.
Rights Against creditor
- Right to securities- Surety’s right to benefit of creditor’s securities(Section 141): Surety has a right over the security which the creditor has in his possession at the time when the contract of guarantee was constructed. It doesn’t matter whether surety was aware of the security or not. The creditor, if without the consent of the surety gets rid of the security, the surety’s obligation is reduced to the extent of the value of the security disposed of.
The Section identifies the general rule of equity as observed in a case that the surety is entitled to redress which the creditor has against the principal debtor, including enforcement of every security.
On paying off the creditor the surety is exactly in the same positions as the creditor was against the principal debtor. The right exists irrespective of the fact whether the surety knows of the existence of such security or not.
The plaintiffs lent to B and P, who were traders, $300 for the payment of which the defendant became surety. At the time of the loan B and P assigned by deed as security for the debt, the lease of their business premises and plant, fixtures and things thereon. The plaintiff had the right to sell on default by giving a month’s notice. The default took place, but the defendant did not enter into possession. He received notice of the debtor’s insolvency but allowed them to continue in possession. Consequently, the assets were seized and sold by the receiver. It was held that the plaintiffs, by their omission to seize the property assigned on default, had deprived themselves of the power to assign the security to the surety. He was, therefore, discharged to the amount that the goods were worth.
- Right of set-off: If the creditor owes anything to the principal debtor, the amount owed can be adjusted in the creditor’s claim against the surety. The surety can charge from the amount to be given to the creditor if the creditor has to pay the principal debtor back.
- Right to share reduction:Reduction here refers to insolvency. A gives loan to B, C is the guarantor. Subsequently, B becomes insolvent. The property of B is attached to recover the loan he had taken. The official receiver in this particular case will create a list of creditors and pay them proportionate to the sum lent by them. The surety can ask the receiver about the amount given to A. The amount received by A through this process can be deducted by the surety.
For example, B was given the loan by the A of rupees 10,000/-, C, who is a surety in this contract gave a guarantee. A, became insolvent and when his property and assets was realised, when it was distributed by the official receiver and assignee, A got 1,000/- rupees. Now surety who is C in this case when he will make a payment to the A of rupees 10,000/-will ask the A to deduct the rupees 1,000/- which he has received from the official receiver and assignee. This right is the right available with the surety and it is known as a right to share reduction.
Right against Co-sureties
Where a debt has been guaranteed by more than one person, they are called co-sureties.
- Effect of releasing a Surety( Section 138): Release of one co-surety does not discharge others– If there are co-sureties involved and one of them is released by the creditor, the others are still liable and the surety so released is responsible to other co-sureties in the event of default.
The released co-surety will remain liable to others for contribution in the event of default.
- Right to contribution( Section 146): Co-sureties liable to contribute equally-.This Section says when there are two or more co-sureties then each has to contribute equally to the debt or a part of the debt. If there is no inconsistent agreement between the co-sureties.
Illustration: A and B are co-sureties for the sum of 2000 rupees which has been given to D by the bank. D defaults, A and B are liable 1000 rupees each among themselves.
- Liability of co-sureties bound in different sums: Co-sureties who have different obligations with respect to the amount is liable to pay equally as long as it isn’t beyond their respective obligation.
Illustration: A, B and C as sureties for D, enter into three several Bonds each in a different penalty, namely, A in the penalty of 10,000 rupees, B in that of 20,000 rupees, C in that of 40,000 rupees, conditioned for D’s duly accounting to E. D makes default to the extent of 30,000 rupees. A, B and C are liable to pay 10, 000 rupees.
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