This article is written by Samriddhi Tripathi, LLM student from Christ University, Lavasa Campus. In this article, the author has explained about the contract of guarantee under the Indian Contract Act with other related provisions in detail. 

It has been published by Rachit Garg.

Table of Contents

Introduction

An agreement which is enforceable by law is called a contract. A contract is an agreement where certain terms and conditions are agreed by the parties in exchange of consideration and a guarantee means an assurance which is being given by a party to someone in respect to an act. Hence, the contract of guarantee is a contract between three parties in respect to any default done by a person then another party assures to recover that loss. 

In this article you will further read about the contract of guarantee between the specific parties of  the contract of guarantee. How the contract of guarantee is different from other forms of contract and provisions under which they are enforced with judicial interpretations.

What is a contract of guarantee

Section 126 of the Indian Contract Act, 1872 has defined the contract of guarantee. The word contract of guarantee in simplified form means a contract which is an agreement forcible in the eye of law and  guarantee which means the assurance. 

The Contract of Guarantee is a contract where there are 3 people involved. In a sense, a person lends money who is said to be a creditor to another person who is in need of money, called the principal debtor along with a person who gives the guarantee that the money will be repaid to the creditor either by the principal debtor or if he makes a default in paying then the guarantor or surety will make the payment. 

Essentials of a contract of guarantee

Parties to be involved in a contract 

In a contract of guarantee there must be a contract between three parties. The three parties include the creditor, the principal debtor and the surety. In respect to a loan which is taken by the principal debtor from a creditor having a surety.

Role of surety

The surety is bought in the contract just as a person who gives a guarantee that the principal debtor will pay the amount but if in any circumstances the principal debtor fails to pay the amount the creditor may ask the surety to pay the debt amount. The important point to be noted here is that only if the principal debtor does not pay the debt then only the creditor can ask the surety to clear his debt. 

Consideration involved 

It is the established principle of contract law that a contract is valid only when the contract involves any kind of consideration in it. Section 127 of the Indian Contract Act, 1872 clarified in respect to the consideration as part of surety it says that if any benefit is being received by the principal debtor the same can be regarded to be for the surety to give the guarantee. 

Essentials for making a contract valid

There are certain points to be kept in mind while making a contract valid. There must be an offer, with a lawful consideration between the parties to enter into a contract and the age must be of at least 18 years, giving free consent to enter into a contract. 

All the facts must be communicated

All the facts to the surety should be communicated in respect to the contract which is being executed. The creditor or the principal debtor cannot conceal any facts in relation to the contract of guarantee. 

There must be a debt 

It is important that there must be any kind of debt in the contract. If the debt is not there then there cannot be a contract of guarantee. A promise for the repayment of the dues must be there on part of the principal debtor or the surety. 

Parties to a contract of guarantee

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In the contract of guarantee there are three parties involved. The parties in contract of guarantee are the following :

  1. Creditor – The creditor is the person who lends money to the principal debtor and is entitled to receive the loan back as the specified time period expires. 
  2. Principal debtor – The principal debtor is the person who receives the loan from the creditor and it is the primary liability of the principal debtor to return the money back. 
  3. Surety – The surety is a person who takes the guarantee that the principal debtor will return the money back. The surety is also called a guarantor. If the principal debtor fails to pay the loan amount then the creditor can ask the surety to repay the loan. 

Rights of a surety

Rights against the creditor

i) Right to securities with the creditor 

Section 141 of the Indian Contract Act,1872 has mentioned  the right of surety to get a share in the security which has been kept while entering into the contract of guarantee. The place of surety is the same as the place of the creditor in terms of security. It is a compulsion on a creditor to share the security with the surety; it is irrelevant whether the surety was aware of the security or not. If the principal debtor defaults in the payment and the surety has cleared the dues, it makes the surety entitled for a share. 

ii) Loss of securities without creditor’s negligence

Under this circumstance the creditor takes the security of the principal debtor in case of default of payment. The surety has the right to set-off the claim in respect to the value of security from the debt of the principal debtor. 

Illustration–  A being the creditor gave a loan to B of Rs 2,00,000 on the surety of C. While B has kept his house on security in respect to the loan borrowed from A. B was in default to pay the loan of A. If A files a case against C for the repayment of the due amount, then C can claim discharge of the amount from the security which was recovered

Rights against the principal debtor

i) Rights of subrogation

Section 140 of the Indian Contract Act, 1872 has stated the right of subrogation. The right of subrogation means forming a new contract to recover the debt from the parties. As the surety has paid the amount due in respect to default made by the principal debtor. Now the surety takes the place of the creditor and the principal debtor is entitled to pay the repaid loan amount which was paid on behalf of him to the creditor in the original contract of guarantee. 

ii) Rights of indemnity against the principal debtor

Under Section 145 of the Indian Contract Act, 1872 it is mentioned to indemnify the surety. ‘To indemnify’ means that a party will pay the damages which are caused to the party in respect of fulfilment of the act of the promisor. Under the Contract of Guarantee the principal debtor is obliged to indemnify the surety in respect to the default of payment at the time of discharging the loan amount. It is not compulsory that the indemnity clauses should be mentioned in the contract; it is an implied duty of the principal debtor in respect to default of payment. 

iii) Securities received by the creditor after the contract of guarantee

Section 141 of the Indian Contract Act, 1872 has mentioned the right of surety in the security which is mentioned in the contract of guarantee. If the principal debtor makes a default in payment of the loan amount and the payment is made by surety then in this case the surety can avail the benefit of security. If the amount is being deducted from security then in this case the surety can be discharged. 

Surety’s rights against the co-sureties

i)  Co-sureties right to get release from the contract 

Section 138 of the Indian Contract Act, 1872 has stated that if one surety is discharged from his liability it will not mean that all the sureties are also discharged from his obligation. Co-sureties here means that when more than one surety gives the guarantee or takes the obligation to pay the debt of the principal debtor. As per Section 138 when the principal debtor fails to pay the debt and if the creditor asks only one surety to fulfil his duty. In this case that surety can ask the other co-sureties to fulfil their responsibility. 

2.Co-sureties are entitled to contribute equally 

Section 146 of the Indian Contract Act, 1872 has mentioned that the liabilities of co-securities are joint. If the contract does not mention the liability of co-securities as joint, it must be implied that all the co-securities will share equally the debt not paid by the principal debtor. 

3.Co-sureties entitled to pay the amount as promised 

As per Section 147 if the co-securities have promised a particular amount to pay in the sum of debt then they are obligated to pay that sum if the principal debtor causes default in payment of the loan.

Illustrations: Ram, Shyam and Mohan are co-securities to Ramesh. Ramesh took a loan of Rs 9,000. If three of them have decided to pay Rs 3,000 each in case of default of payment of the loan by Ramesh. Then they are entitled to pay Rs 3,000 only

Conditions under which the surety can be discharged from his liability 

There are majorly three circumstances when a surety can be discharged from his liability. The circumstances are :- 

  1. Revocation of contract of guarantee; 
  2. Conduct of the creditor; and
  3. Invalidating contract of guarantee. 

i) Revocation of contract of guarantee 

By way of notice 

According to Section 130 of the Indian Contract Act, 1872 the surety can revoke the contract of  guarantee by way of notice to the creditor in advance. The surety is exempted from any responsibility after the surety gives notice to the creditor. It means that prior to the notice all contracts will be valid. 

Death of surety 

According to Section 131 of the Indian Contract Act, 1872 the death of the surety will cause a revocation of the contract of guarantee. But the legal heirs of surety will be obliged to perform the contract on behalf of surety. 

 ii) Conduct of the creditor 

Terms of contract being changed 

According to Section 133 of the Indian Contract Act, 1872 if the creditor makes any changes in the terms of contract with the consent of the principal debtor without the knowledge of the surety. The surety will be discharged from the contract of guarantee. The reason being the surety will be liable for the conduct only which he would have promised to do and not further. 

Performance of contract of guarantee 

According to Section 134 of the Indian Contract Act, 1872 the surety will be discharged from his promise if the principal debtor fulfils his promise or pays the loan and the contract of guarantee is executed.

Mere compromise

According to Section 135 of Indian Contract Act, 1872 the creditor gives extra time to the principal debtor for the payment of the loan amount and promises that he may not sue the debtor for this; in this case the surety is discharged from the contract. 

iii) Invalidating the contract of guarantee 

Contracts executed through misrepresentation 

According to Section 142 of the Indian Contract Act,1872 if the contract is made by a creditor by concealing material facts from the parties or he has misrepresented the terms of the contract,  then the contract is not valid. It will not be enforced under law.

Contract entered through concealing facts 

According to Section 143 of the Indian Contract Act,1872 if the contract was entered through concealing a material fact from the parties then the contract will not be valid. 

Unless co-sureties consent to a contract 

According to Section 144 of the Indian Contract Act,1872  the contract will not be forceable unless the other co-sureties enter into a contract of guarantee. 

Surety’s liability 

Section 128 of the Indian Contract Act, 1872 has stated the liability of surety. The liability of surety will be co-extensive which means that the extent to which the principal debtor is liable is the same as the surety is liable. The surety cannot be made liable to the extent in which the principal debtor is not. The contract of guarantee is primarily with the principal debtor and then with the surety.

Case laws with respect to contract of guarantee

State of Madhya Pradesh v. Kaluram 1967 SCR (1) 266 (1966)

Facts of the case

The auction was held by the forest officer in Madhya Pradesh for the sale of felled trees. The auction was in favour of Jagatram. The contract was executed between Jagtram and Government of Madhya Pradesh where the payments were decided to be made in instalments where Nathuram and Kaluram were made the surety if Jagatram made any default in payment of the dues. After the payment of the first instalment, Jagatram failed to pay the due amount from the second instalment and cleared all the trees. In respect to the non-payment of the due amount, the surety was asked to fulfil the promise. 

Issue involved in the case

 Whether the co-sureties are liable to pay the debt ?

Judgement of the Court

The Hon’ble Supreme Court relied his judgement on Section 141 of Indian Contract Act the department should not have allowed the Jagatram to clear the forest without the due payment of loan and it can be seen that the fault was on part of creditor hence, the surety cannot be made liable to pay the loan amount as this act made him discharge from his liability. 

Rajappan v. Associated Industries Private Ltd. (1990)

Facts of the case 

The agreement of guarantee was drafted by the plaintiff on the account of surety given by the second defendant in respect to a loan of Rs 10,000 to the first defendant. In this case the plaintiff was the creditor, the principal debtor was the first defendant and the surety was the second defendant.

The terms were already reciated to both the parties and both of them agreed to the terms. After relying on the terms the draft was made for the agreement but at the time of execution of signature, the second defendant contended to the Plaintiff that he was in hurry and would sign the agreement later due to some urgent work and left the place. Now when the time came to fulfil the promise of being a guarantor he refused the said terms and said that he had never signed the agreement, hence he is not entitled to pay the due amount. 

Issue involved in the case 

Whether the second defendant is entitled to pay the amount because he promised to be a guarantor? 

Judgement of the Court

The Hon’ble Kerala High Court mentioned there was certain evidence in favour of the second defendant which was produced by the plaintiff in respect to  performance of the agreement. The Hon’ble Court established that, as the second defendant on just the basis of not signing the agreement cannot be discharged from his duties. Hence, the contract of guarantee is an agreement where three parties are involved: the creditor, principal debtor and the surety. It should not be necessary that only the signature will be considered as entering into an agreement but implied acts can also be deemed as a consent.

Radha Kanta Pal v. United Bank of India Ltd. (1954)

Facts of the case

The case was in respect to the agreement. Rajanikant Pal (Deceased) came under a bond dated 8 August 1944 with Comilia Banking Corporation Limited (at the time of executing the bond) now known as United Bank of India after amalgamation in respect to appointing Nishikanta Pal as a cashier in the bank. The consideration of the bond was Rs 10,000.

When Nishikanta Pal was appointed as a cashier in the bank, the misrepresentation in cash of the bank was found twice. The bank instead of taking any disciplinary action against Nishikanata deducted the amount from Rajanikant promissory note without any prior consent or information given to the parties in view of adjusting their claims.

Judgement of the Court

The Court stated that the creditor was in the  employer’s position. He must have checked in regard to the work being done and he could have taken any action against the employee. The Hon’ble Court stated that Section 139 of the Indian Contract cannot be brought in this case. 

Ansal Engineering Projects Limited v. Tehri Hydro Development Corporation Limited and Another (1966)

Facts of the case

The petitioner entered into a contract with the respondent dated 30 March, 1991 in respect to the construction of a residential quarter in Tehri. The residential quarters were not completed within the time period. The respondent terminated the contract on his part and went to United Commercial Bank Ltd. (UCO) to collect the amount. As part of the conflict the plaintiff appointed an arbitrator for the resolution of the said dispute. 

Judgement of the Court

The Hon’ble Court stated that the respondent was not entitled to receive the amount from the bank guarantee. This will be regarded as revocation of contract through illegal means and will be termed as fraud on the part of the respondent. 

Difference between contract of indemnity and contract of guarantee

BasisContract of Indemnity Contract of Guarantee
Provision under Indian Contract Act Section 124 of Indian Contract Act defines Contract of IndemnitySection 126 of Indian Contract Act defines Contract of Guarantee
DefinitionIt is a contract of promise to save the person from loss which is caused by another person. It is a contract of a guarantee that the principal debtor will not make a default in payment of due by the surety.
Parties to a Contract There are two parties involved indemnifier and indemnity holder There are three parties involved in a contract, creditor, principal debtor and surety 
Liability of third party In this contract the promisor has primary liability in case of default In this contract the primary liability will be on the principal debtor if he is at default then it is the surety. 
Number of agreement between partiesThere is only one contract. That is between the indemnifier and the indemnity holder.There are three contracts.Firstly, between Creditor and Principal Debtor. Secondly with the Principal Debtor and Surety. Thirdly, between Creditor and Surety.

Conclusion

The contract of guarantee is different from the other forms of contract. In the contract of guarantee there are three parties involved instead of two parties and more specifically this contract is executed to protect the creditor from the default of the principal debtor, unusual to other contracts. In common forms of contract there must be a consideration in exchange for fulfilment of the act but here there is no major consideration involved; it is a promise to recover the loss caused to the creditor by the default of the principal debtor.

FAQs

The extent of liability of the surety under the contract of guarantee?

The surety’s liability is coextensive in the contract of guarantee; it means that the surety can only be made liable to the extent with which the principal debtor is liable. 

Can a contract of guarantee be enforceable only if it is in writing ?

No, the contract of guarantee can be either in oral or in writing to be enforced in India.

Can a surety be entitled to fulfil his promise even after the principal debtor paid the dues?

The agreement is said to be over on the date at which the principal debtor pays the loan amount and the creditor cannot enforce the surety to pay the amount promised; it is promised only if the principal debtor causes a default in payment to the creditor.

References


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