Contract of Guarantee

Contract of Guarantee means a contract to perform the promises made or discharge the liabilities of the third person in case of his failure to discharge such liabilities.

Contract of Guarantee

As per section 126 of Indian Contract Act, 1872, a contract of guarantee has three parties: –

Surety: A surety is a person giving a guarantee in a contract of guarantee. A person who takes responsibility to pay a sum of money, perform any duty for another person in case that person fails to perform such work.

Learn more about Discharge and Rights of Surety here.

Principal Debtor: A principal debtor is a person for whom the guarantee is given in a contract of guarantee.

Creditor: The person to whom the guarantee is given is known as the creditor.

For example, Mr. X advances a loan of 25000 to Mr. Y and Mr. Z promise that in case Mr. Y fails to repay the loan, then he will repay the same. In this case of a contract of guarantee, Mr. X is a Creditor, Mr. Y is a principal debtor and Mr. Z is a Surety.

Contract of Indemnity

It is a contract in which one party promises to save the other from the loss caused to him by the acts of promisor or by any other person.

In a contract of indemnity, there are two parties namely indemnifier (promisor) and indemnified (promisee).

Source: freepik.com

Differentiation between contract of indemnity and contract of guarantee

There is a difference between the two special types of contracts, contract of indemnity and contract of guarantee which is as follows: –

1. In a contract of guarantee, there are three parties to a contract namely surety, principal debtor and creditor whereas in case of indemnity there are only two parties to a contract, promisor, and promisee.
2. In case of the contract of guarantee, the liability of the surety is secondary whereas in a contract of indemnity the liability of promisor is primary.
3. Surety provides guarantee only when requested by the principal debtor in a contract of guarantee. Indemnifier is not required to act at the request of the debtor,  in a contract of indemnity.
4. In a contract of guarantee, there is an existing liability for debt or duty, surety guarantees the performance of such liability.  In a contract of indemnity, the possibility of incurring a loss is contingent against which indemnifier undertakes to indemnify.
5. Surety is eligible to proceed against the principal debtor on payment of debt, in case principal debtor fails to pay the debt. Indemnifier cannot sue third parties in his own name.

Surety’s Liability

According to section 128 of Indian Contract Act, 1872, the liability of a surety is co-extensive with that of principal debtor’s unless the contract provides.

Liability of surety is same as that of the principal debtor. A creditor can directly proceed against the surety. A creditor can sue the surety directly without sueing principal debtor. Surety becomes liable to make payment immediately when the principal debtor makes default in such payment.

However, primary liability to make payment is of the principal debtor, surety’s liability is secondary. Also, where the principal debtor cannot be held liable for any payment due to any defect in documents, then surety is also not responsible for such payment.

Kinds of Guarantees

A contract of guarantee may be for an existing liability or for future liability. A contract of guarantee can be a specific guarantee (for any specific transaction only) or continuing guarantee.

Specific Guarantee: A specific guarantee is for a single debt or any specified transaction. It comes to an end when such debt has been paid.

Continuing Guarantee: A continuing guarantee is a type of guarantee which applies to a series of transactions.

A continuing guarantee applies to all the transactions entered into by the principal debtor until it is revoked by the surety. A continuing guarantee can be revoked anytime by surety for future transactions by giving notice to the creditors. However, the liability of a surety is not reduced for transactions entered into before such revocation of guarantee.

Revocation of Guarantee

1. By surety by giving a notice of revocation for future transactions.
2. On the death of surety. A continuing guarantee is revoked for all the future transactions due to the absence of a contract. However, his legal representatives will continue to be liable for transactions entered into before his death.

Discharge of a surety

• By giving notice of revocation for future transactions (section 130).
• In case of death of surety, the guarantee is revoked for all the future transactions (section 131).
• When there is a change in terms and condition of the contract between the creditor and principal debtor without obtaining the consent of surety. The surety will be discharged of all the transactions taking place after such change in terms and condition (section 133). For example – Q rents his house to R at a fixed rent, P becomes surety for rent payable by R to Q. R and Q agree on a higher rent for which they do not obtain P’s consent. In such a case P will be discharged as a surety after such change in contract.
• In case the creditor releases the debtor or makes any omission due to which results in the discharge of principal debtor’s liability (section 134).
• When the principal debtor makes payment of debt.
• When the creditor enters into an arrangement with the principal debtor for not to sue him or to provide extra time for payment of debt, the surety will be discharged (section 135).
• The surety will be discharged when the creditor does any act which is inconsistent with the rights of surety.

Solved Example for you

Write the circumstances when the contract of guarantee is invalid.

Answer: – Circumstances, when the contract of guarantee is invalid, are as follows:-

• The guarantee is obtained by misrepresentation of facts
• When the creditor obtains guarantee without disclosure of material facts or with the intention of committing fraud.
• When the contract is made on a condition that creditor shall not act upon until there enters a co-surety to a contract of guarantee and the other party fails to join.