Contract of Guarantee is an integral part of the Law of Contracts as it deals with the basic premise of promise and surety guaranteed to the creditor in turn of loaning money to the debtor, or in the case, the principal debtor. This is one of the basic forms of contract and can be seen very commonly practised by moneylenders, businesses, firms and even banks.
In these types of contract, there is normally the involvement of three parties – the creditor, the (principal) debtor and the surety. The creditor is the one who lends the money, the principal debtor is the one who borrows the money while the surety acts as a guarantee for if the debtor defaults or fails to pay the money they borrowed from the creditor in due time.
The involvement of three parties causes there to be individual contracts between them as well – one contract between creditor and debtor, one between the debtor and surety and the last one being in between the creditor and surety. Each contract is interrelated and binds each party into a different liability with different rights; however, the terms of the contract should not vary from one to another or the contract will be held as void.
In the case when there is more than one surety in the contract, such persons are known as ‘co-surety’ – and they are considered one party altogether instead of each co-surety being considered a party individually. Each co-surety should be appointed from the beginning of the contract and should be contractually liable to the debtor and creditor rather than to each other. In no case shall a surety be added later into the contract as co-surety without the contract being altered or remade into a new one completely.
The only difference between surety and co-surety is that their liabilities are divided and cooperated the number of co-sureties while in case of a surety they have to pay and handle the liabilities alone when the debtor defaults – otherwise, both the role or surety and co-surety do not arise if the debtor manages to pay back in full.
Rights of Co-surety
The rights of a co-surety are very similar to that of a surety (covered under Section 140-147 of Indian Contract Act) and those rights are listed as below:
Against the principal debtor
- Each co-surety has the right to claim the money they have paid to the creditor in heed of the debtor. However, they do not have the right to claim any money other than what is mentioned in the contract for their portion.
- Each co-surety inherits the rights of the creditor once they pay off the debt for the principal debtor. The principal debtor has the liability to indemnify the co-sureties.
Against the creditor
- Each co-surety has the right to claim all the securities (materialistic guarantees) from the creditor once the principal debtor defaults and they pay off the debt – however, if the creditor has returned the securities back to the debtor, then all the co-sureties are discharged from their duties to the extent of the value of the security.
For example, if a debtor had given his gold jewellery (valued presumably 2 lakhs) as a security to the creditor on a loan of about 3 lakhs with two co-sureties and insolvents on the full amount, the co-sureties are liable to only pay for the 1 lakh that cannot be covered by the securities if the securities are returned to the debtor by the creditor.
- Any amount that is recoverable by the debtor or any of the co-sureties can be claimed and accounted as a deduction of the amount to be paid to the creditor.
- If a debtor defaults after paying a portion of their debt, then the co-sureties only owe the amount left to pay to the creditor as per the contract.
Against other co-sureties
- If any one of the co-sureties receives any security, all the co-sureties have the right to share the benefit of that surety amongst one another.
- All co-sureties are required to contribute equally until and unless specified otherwise in the contract.
The examples for the last right would go as follows:
If there are three co-sureties (X and Y and Z) of the principal debtor (D) who took the loan of 9 lakhs from the creditor (C), upon insolvency of D, the co-sureties X, Y and Z are to pay to the creditors C equally – that is, 3 lakhs each.
However, in the case if the contract specifies the amount each co-surety has to pay, each has to pay the minimum equal to their limit. For example, if the contract specifies for X to pay 2 lakhs, Y to pay 3 lakhs and Z to pay the rest of the 4 lakhs upon D’s insolvency, then:
- If D manages to pay 6 lakhs and the defaults for the rest, all three co-sureties are to pay 1 lakh each to the creditor for the debtor.
- If D pays 2 lakhs and defaults, then X has to pay the specified 2 lakhs in the contract while Y and Z will cover the rest equally – that is, 2.5 lakhs each.
- If D defaults completely, then each has to pay the specified amount in the contract for their own liability.
Liabilities of Co-surety
Just like the liabilities of surety, the liabilities of each co-surety are coextensive with that of the principal debtor. That is, since co-sureties, just as sureties, are liable for all the debts taken by the principal debtors up their default, any interest, damages or any kinds of costs payable by the debtor to the creditor also includes in this. However, any such extended pay must be mentioned in the contract or else the co-sureties will not be liable to pay – and if the fact is hidden from the co-sureties or if the facts are misinterpreted, then the co-surety will be automatically discharged from the contract.
In addition to this, a co-surety’s liability is as limited as mentioned in the contract – they may even fix their own limit up to which they have to pay in accordance with the other co-sureties. Some conditions can also be mentioned to limit the liability of the co-sureties or from when they are liable. That is, conditions can be laid down which, unless met, cannot make the co-sureties liable. However, all the sureties as well as the creditor and principal debtor should agree with these conditions and limits or else the contract would be void on the ground of misinterpretation and all the co-sureties would be discharged.
- Bare Act of Indian Contract Act, 1872
Author: Debapriya Biswas,
Amity Law School, Noida (2nd year)