Contract of Guarantee

INTRODUCTION

Contract of Guarantee is a contract to perform the promise or to discharge the liability of the third person in case his default. Contract of guarantee involves three parties: Principal Debtor, Surety and Creditor. There are three types of contracts. Contract of indemnity, contract of guarantee and loan agreement. Contract of indemnity is between Surety and Principal Debtor; loan agreement is between Principal Debtor and Creditor and Contract of guarantee is between Surety and Creditor. This type of contract is also known as the Tripartite Contract.

NATURE AND ESSENCE

Contract of guarantee enables a person to get goods on credit. Guarantee is usually provided to give the creditor a second pocket to claim the money if one fails to pay. Independent liability different from guarantee – The liability which is incurred independently of a default is not within the definition of Guarantee.

ESSENTIALS FEATURES OF GUARANTEE

  1. All the essential features of a valid contract.
  2. Consent of the parties.
  3. Consideration (Section-127 of Indian Contract Act, 1872).
  4. No misrepresentation or concealment of facts.
  5. There should be a debt.
  6. Contract may be oral or written.

KINDS OF GUARANTEE

  • Specific/Simple Guarantee A Specific Guarantee pertains to a single debt or a single transaction.
  • Continuing Guarantee Guarantee is for a series of transactions. Liability extends till the revocation of guarantee.
  • Retrospective Guarantee Guarantee is for an existing debt or obligation.
  • Prospective Guarantee – Guarantee is for a future debt or obligation.
  • Fidelity GuaranteeGuarantee is on the good conduct or honesty of a person employed in a particular organization.

INVALID GUARANTEE

Following are a few of those cases when the guarantee given by the surety will be invalid and cannot be enforced against him:

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Guarantee obtained by misrepresentation (Sec. 142): Any type of guarantee which has been obtained by means of misrepresentation or concealment of facts made by the creditor, or with his knowledge and assent, concerning a material part of the transaction, is invalid.

Guarantee obtained by concealment (Sec. 143): Any contract of guarantee which the creditor has obtained from surety by means of keeping silence as to material circumstances or facts, is invalid.

In case co-surety does not join (Sec. 144): Where a surety gives a guarantee upon a contract that the creditor shall not act upon until another person has joined as co-surety in the contract, the guarantee will be invalid if that other person does not join.

SURETY’S LIABILITY

  • Surety’s liability is co-extensive with that of the principal debtor

Surety is liable for all the debts payable by the principal debtor to the creditor. Accordingly, interest, damages, costs etc. may also be recovered from the surety.

  • Commencement of surety’s liability

The liability of surety arises immediately on default by the principal debtor. There is no need of the creditor to first sue the principal debtor or first give a notice to the principal debtor about the default payment.

  • Surety’s liability may be limited

The surety may fix a limit on his liability up to which the guarantee shall remain effective.

  • Surety’s liability may be conditional (Section-144 of Indian Contract Act, 1872)

The surety may impose certain conditions in the contract of guarantee. Until those conditions are met, the surety shall not be liable.

Surety’s liability may be continuous

The surety may agree to become liable for a series of transactions of continuous nature. However, the surety may fix-

  1. a limit on his liability upto which the guarantee shall remain effective;
  2. a time period during which the guarantee shall remain effective.

DISCHARGE OF SURETY FROM LIABILITY

  1. Variance in terms of contract (Section-133)
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Any variation in terms and conditions must be approved by the parties concerned. If any changes take place without the consent of the surety, he will be discharged from his liability after such changes are made. In a continuing guarantee the surety need not perform his duties subsequent to the variance in the contract as it will discharge him from his liabilities.

  1. Release of Principal Debtor (Section-134)

If the principal debtor is released in a contract by the creditor or by any act or omission of the creditor which has the effect of discharging the principal debtor from his debt, then the surety is automatically released from his liabilities.

  1. Compounding by Creditor with Principal Debtor (Section-135)

The section provides for 3 modes of discharge from liability: Composition, promise to give time (Read Section-136) and promise not to sue the principal debtor (Read Section-137).

  1. Act or Omission Impairing Surety’s Eventual Remedy (Section-139)

The surety’s liability is discharged when the creditor acts or fails to act in a certain way. This action or its omission becomes inconsistent with the rights of the surety impairing his eventual remedy against the principal debtor. Also, if the creditor does not do his duty required towards the surety in the contract of guarantee, the surety can be discharged from his liability.

  1. Loss of creditor’s security (Section-141)

The surety is discharged from his liability if the creditor loses the security given to him by the principal debtor. The surety will be also discharged if the creditor parts with his security without his consent. However, he will not be discharged if the security of the creditor is lost due to natural calamities, or an act of an enemy of the country.

DIFFERENCE BETWEEN INDEMNITY AND GUARANTEE

S.No. INDEMNITY GUARANTEE
Meaning & Definition A contract by which one party promises to save the other from loss caused to him is called as a contract of indemnity. A contract of guarantee is a contract to perform the promise, or discharge the liability of a third person in case of his default.
Parties There are only two parties There are three parties.
Nature of Liability The liability of the indemnifier is independent & has primary liability. The liability of the surety is collateral & has secondary liability.
Purpose of Contract The contract of indemnity provide security against losses. The contract of guarantee provide security to creditors against default of the principal debtor.
Number of Contract In a contract of indemnity there is only one contract. In the contract of guarantee, there are three contracts.
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CONCLUSION

The contract of guarantee is a specific contract for which the Indian Contract Act has laid some rules. As we have discussed, the basic function of a contract of guarantee is to protect the creditor from loss and to give him confidence that the contract will be enforced with the promise of the surety. Every contract of guarantee has three parties and there exist two types of guarantees i.e specific guarantee and continuing guarantee. The type of Guarantee used depends on the situation and the terms of the contract. The surety has some rights against the other parties and liability of the surety is considered to be co-extensive with that of the principal debtor unless it is otherwise provided by the contract. In case the contracts are entered into by misrepresentation made by the creditor regarding material circumstances or by concealment of material facts by the creditor, the contract will be considered invalid.

Author: Shivam Bansal,
Symbiosis law School, Noida - 2nd Year

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