Introduction:
Section 126 of the Indian Contract Act states that contract of guarantee is “a contract to perform the promise, or to discharge the liabilities if a third person in case of his default.”
- The person who gives the guarantee is called Surety.
- The person in respect of whose default guarantee is given is called Principal Debtor.
- The person to whom the guarantee is given is called Creditor.
A guarantee maybe oral or written.
For example, Sam lends Rs.1500 to Leena on the guarantee by Tina that if Leena does not re-pay money to Sam, Tina will do so. Here, Tina is the surety, Leena is the principal debtor, Sam is the creditor.
Essential Conditions of a Contract of Guarantee
1. Co-existence of Creditor, Principal Debtor and Surety
There must exist a principal debtor for a recoverable debt for which the surety is liable.
In the case of Swan vs. Bank of Scotland [1]1863, it was held that contract of guarantee was a tri-party contract i.e. it contained 3 contracts-
- Between creditor and principal debtor
- Between principal debtor and surety
- Between surety and creditor
2. Consideration
According to Section 127 of the Act, the contract must have a valid consideration i.e. a promise which benefits the principal debtor in some way.
Illustration
Rohit sells goods to Payal. Afterwards, Priya requests Rohit to withhold to sue Payal for a year and promises that if Rohit does so, she will take guarantee of providing the payment in case Payal does not pay. Rohit agrees to withhold to sue Payal for a year. This is sufficient consideration for Priya’s guarantee.
However, there is no uniformity on the issue of past consideration and transactions. In the case of Allahabad Bank vs S M Engineering Industries 1992[2], it was held that the surety cannot be sued when there is no payment made of the date of the guarantee. But in the case of Union Bank of India vs A P Bhonsle 1991[3], past debts were also held to be recoverable if the principal debtor gets another benefitted as a result of the guarantee.
3. Liability must be Legally Enforceable
The surety can be held liable only when the liability of the principal debtor is legally enforceable. Otherwise, he cannot be held liable. For example, for a debt which is already time-barred, the surety cannot be held liable.
4. It should be Without Misrepresentation or Concealment
Under section 242, a contract made by misrepresentation of facts is invalid and under section 143, a contract made by concealment of facts is invalid.
In the case of London General Omnibus vs Holloway 1912[4], the surety guaranteed the employment of a person who was in the past let go for dishonesty by the same employer. This fact wasn’t disclosed to the surety. When later there was embezzlement of funds by the employee from the employer, the person (surety) was not held liable.
Kinds of Guarantee
1. Specific Guarantee
When guarantee extends to a single transaction or is given for a single debt, it is called a specific guarantee or simple guarantee.
For example, Sam guaranteed payment to Leena of the price of 3 pairs of trousers to be delivered by Leena to Tina and to be paid in a week. Leena delivers them to Tina who pays for them. Afterwards, Leena delivers 2 trousers to Tina for which she does not pay. The guarantee given by Sam was a specific guarantee and therefore he is not liable for the payment of the 2 trousers delivered afterwards.
2. Continuing Guarantee
As per section 129, “a guarantee which extends to a series of transactions is called a continuing guarantee.” It is not confined to a single transaction. The surety can fix up a limit on this liability as to time or amount of guarantee when the guarantee is a continuing one. The fact that the guarantee is continuing can also be ascertained from the intentions of the parties and the surrounding circumstances.
Illustration- Sam guarantees payment to Leena for any purchasing done by Tina in two months with the amount of Rs.3000. Afterwards, Leena supplies Tine with goods worth Rs. 4000 and Tina fails to pay. Hence, Sam is liable for Rs.3000 as it was a continuing guarantee.
Thus, a continuing guarantee allows a person to make multiple transactions without having to create a new guarantee for each transaction. In the case of Nottingham Hide Co vs Bottrill 1873, it was held that in order to decide whether a case is of continuing guarantee or not, the facts, circumstances, and intention of each case must be considered.
Revocation of Continuing Guarantee
1. By Notice
Section 130 – A continuing guarantee can be revoked at any time by the surety by giving a distinct notice to the creditor.
Once the guarantee is revoked, the surety is not liable for any further transactions.
In the case of Lloyd’s vs Harper 1880[5], it was held that the employment of a servant is only one transaction. The employment of the servant is not a continuing guarantee.
2. By Death
Section 131 – The death of the surety itself leads to the revocation of a continuing guarantee for any future transactions unless the contrary is provided in the contract of guarantee.
In the case of Durga Priya vs Durga Pada AIR 1928[6], Calcutta High Court held that in each case of a continuing guarantee, the contract needs to be referred to find whether revocation is due to death or surety or not. If the contract contains a clause that says the contract is valid even after the death of surety, then the contract stays alive.
Also, no notice of death of surety needs to be given to the creditor. Heirs of the surety will not be liable for any fresh transactions, entered by the creditor with the principal debtor, after the death of the surety without knowledge of such death.
This is based on the principle that personal action lies with the deceased.
Rights of the Surety
Being a contract, certain rights are made available to all the parties. Following are the rights specific to the surety:
1. Right against Principal Debtor
This right included the right of subrogation (section 140) and right to indemnity (section 145).
Right of subrogation- When a debt owed by a principal debtor has been fulfilled by the surety, he is entrusted with all the rights a creditor has against the principal debtor. This also gives the right to the surety to sue a principal debtor. However, it is up to the surety to waive this right or keep it with him.
Right to Indemnity- This right allows the surety to recover the payment in the contract from the principal debtor.
2. Right against Principal Creditor
Before payment of the debt- The surety may before the payment of the debt require the creditor to extract the same from the principal debtor.
After payment of the debt- After the payment of the debt, the surety is entrusted with the rights of the creditor against the principal debtor (section 140).
Right to Security (section 141)- The surety is benefited with any securities the creditor has against the principal debtor when the contract was entered. Though it may not be necessary that the surety is informed at the time of entering the contract. It is the responsibility of the creditor not to part with any security without the permission of the creditor after the contract has been enforced.
In the case of State of MP vs Kaluram AIR 1967[7], the state sold felled trees for a fixed price in four equal instalments, the payment of which was guaranteed by the defendant. The contract further provided that if a default was made in the payment of an instalment, the State would get the right to prevent further removal of timber and would sell the timber for the realization of the price. The buyer defaulted but the State still did not stop him from removing further timber. The surety was then sued for the loss but he was not held liable.
Right to Set-off- If the creditor sues the surety, the surety has the right to set off i.e. use any counterclaims the principal debtor may have against the creditor.
Rights of Co-Sureties
When the debt is guaranteed by 2 or more people, they are known as co-sureties.
If one of the sureties pays the debt on behalf of other sureties, he has the right to recover the payment from the same. All the sureties are required to pay equal divided amounts of the total sum unless mentioned in the contract.
DIFFERENCE BETWEEN CONTRACT OF INDEMNITY AND GAURANTEE
| Contract of Indemnity (Section 124) | Contract of Guarantee (Section 126) |
| 1. It is a bipartite agreement between the indemnifier and indemnity-holder. | 1. It is a tripartite agreement between the Creditor, Principal Debtor, and Surety. |
| 2. Liability of the indemnifier is contingent upon the loss. | The surety provides a guarantee for a debt to the principal debtor. |
| 3. Liability of the indemnifier is primary to the contract. | 3. Liability of the surety is secondary ie. the surety is liable only if the principal debtor fails. The liability of the principal debtor is primary. |
| 4. The undertaking in indemnity is original. | 4. The undertaking in a contract of guarantee is collateral with reference to the original contract made between the principal debtor and the creditor. |
| 6. The reason for a contract of indemnity is to make good on a loss if there is any. | 6. The reason for a contract of guarantee is to enable a third person to get credit. |
| 7. Once the indemnifier fulfils his liability, he does not get any right over any third party. He can only sue the indemnity-holder in his own name. Indemnifier cannot sue a third party for the loss suffered. | 7. Once the guarantor fulfils his liability by paying any debt to the creditor, he steps into the shoes of the creditor and gets all the rights that the creditor had over the principal debtor. The surety can sue the principal debtor. |
Conclusion
Contract of guarantee is a specific type of contract that helps a person with no credit to secure employment or a loan. There are two types of these contracts- specific and continuous. There is also provision for the revocation of a continuous contract of guarantee. A surety can also be discharged of guarantee by variation in terms of the contract. The contract of guarantee consists of three contracts- between principal debtor and creditor, between creditor and the surety, and an indemnity contract between the principal debtor and the surety. There are certain rights present with the surety against the principal debtor and the creditor. These include rights of subrogation, right to indemnity, right against creditor before the payment of debt and after the payment of the debt. Various rights are also present with co-sureties.
References:
[1] John Swan and other vs. the Bank of Scotland, 1863, https://www.casemine.com/judgement/uk/5a8ff8c660d03e7f57ecd142#
[2] Allahabad Bank vs S.M. Engg. Industries And Ors. on 30 January, 1992, https://indiankanoon.org/doc/106835/
[3] Union Bank Of India vs Avinash P. Bhonsle on 24 April, 1991, https://indiankanoon.org/doc/1399287/
[4] London General Omnibus Co Ltd v Holloway: 1912, https://swarb.co.uk/london-general-omnibus-co-ltd-v-holloway-1912/
[5] All Answers Ltd. (November 2018). Lloyd’s v Harper – Case Summary. Retrieved from https://www.lawteacher.net/cases/lloyds-v-harper.php?vref=1
[6] Durga Priya Chowdhury vs Durga Pada Roy And Ors. on 24 March, 1927, https://indiankanoon.org/doc/834485/
[7] State Of Madhya Pradesh vs Kaluram on 5 September, 1966, https://indiankanoon.org/doc/845556/
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