All about the Contract of Guarantee

The term ‘contract’ is an agreement enforceable by law, whereas a ‘guarantee’ is a contractual promise to ensure that a third party fulfils its spoken duties. The contract of guarantee states that a contract is made to achieve guarantees or release the person from liability if he/she fails to discharge duties.

A contract of guarantee is ruled by the Indian Contract Act (ICA) 1872 and involves three parties where one of the parties serves as the surety if the defaulting party cannot perform his/her responsibilities. The specific purpose of a Contract of Guarantee is to provide the security of a party from any loss.

This study investigates the contract of guarantee and presents different conditions.

Contract of Guarantee

Section 126 of the ICA deals with the contract of guarantee and is an agreement to fulfil a promise or perform a liability of a third person if he fails to do so. A guarantee may be written or verbal. It may be said or indicated from the behaviour of parties.

Legally, a guarantee is a commitment to pay for the debt, insolvency, or failure of another person. Guarantees are a backup for the creditor when the principal fails.

Parties Involved Under Contract of Guarantee

The three parties involved in such contracts are expressed through various names as follows:

• Principal Debtor – The individual who borrows money from the other party and is responsible for paying and on whose default the assurance is given.
• Creditor – The individual who has given something of worth to borrow, who stands to obtain the payment, and to whom the assurance is offered.
• Surety / Guarantor – The individual who gives the assurance to pay in case of default of the principal debtor.

Example

Ayush takes a loan of Rs. 800000 from Ratna. Tarun was the brother-in-law of Ayush, and he assured that if Ayush failed to repay the loan, he would compensate the same. In this case, Ratna manages to be the creditor, Ayush is the principal debtor, and Tarun is the guarantor.

Conditions of a Contract of Guarantee

1. A Triple Contract, Which Requires Agreement of all Three Parties

All three parties, the principal debtor, creditor, and guarantor, must conform to all the terms of the contract and should coordinate with each other. The guarantor takes up the obligation to be responsible for the debt of the principal debtor at the appeal of the principal debtor.

The communication of the guarantor to the creditor should be precise and with details of the principal debtor.

2. Consideration

Section 127 of the ICA states the consideration for guarantee. The consideration obtained by the principal debtor is sufficient for surety. Anything done or any assurance for the help of the principal debtor can be regarded as sufficient consideration to the surety for assurance.

3. Discharge of Liability

The liability on the guarantor is secondary. However, the burden for the discharge of liability lies on the principal debtor. The surety of repayment is given only on the default of the principal debtor.

4. Essentials of a Valid Contract

The contract of guarantee is a kind of contract. Therefore, it should satisfy the requirements of a proper agreement, that is, free consent, reasonable consideration proposal, and acceptance.

5. No Hiding of Facts

No facts shall be hidden from the guarantor to acquire wrong consent. The guarantee will be considered null if the creditor obtains it by hiding the material facts. The facts shall be adequately illustrated before surety.

6. Presupposes the Presence of a Debt

The surety occurs in case of a precondition for the happening of debt, which the surety will ultimately fulfil. However, when a debt is time-barred or invalid, then no penalty of surety emerges.

Types of Guarantee

Contract guarantees are of two types, namely continuing guarantee and specific guarantee.

Continuing Guarantee

Section 129 of the ICA expresses a different kind of guarantee known as a continuing guarantee. The Act presents a guarantee that expands to a sequence of transactions.

The Act contains several transactions over time. The guarantor can be held responsible for the non-payment of the principal debtor for that specific period.

Example

• K is a boss who acts as a guarantee for P for the collection of rent from the property of Z. P is responsible to collect rent from every renter every month and give it to Z. If P fails to fulfil his duty, it will be K who would be held responsible for the same till P has the job for the collection of rents. This kind of agreement is a continuing guarantee.

Specific Guarantee

A specific guarantee is provided in terms of a single debt or specific transaction, and it ends when the debt is completed or the contract is duly executed.

Illustration

K is a teacher who obtained a loan from a bank for the construction of his house. He made his friend F a guarantor if he failed to pay the amount. This is an agreement of a specific guarantee. The liability of F would end the instant the loan is refunded to the bank.

Rights of a Surety

The surety has different types of rights:

Rights against the Principal Debtor

1. Section 140: The surety has the right of subrogation against the principal debtor after the debt is paid. He has the right to retrieve the payment he/she paid to the creditor, including the principal amount, expenses, and interest.

2. Section 145: The surety has the right of indemnity. There is an implied assurance by the principal debtor to repay surety, and the surety has the right to get the amount from the principal debtor, the total he/she paid under the contract of guarantee. It is a right given to the surety before payment.

Right Against the Creditor

1. Section 141: The surety has the right to obtain help from the creditor’s security, which lies under the creditor’s control while signing the contracts of guarantee.

2. The surety has the right to set off, which means if he/she owes anything to the debtor, then that amount would be modified in the creditor’s share against surety. The surety can set the amount to be provided to the creditor if the creditor has to pay the principal debtor back.

Extent Of Surety’s Liability

Section 128 of the ICA states that the penalty of the surety is co-extensive to that of the principal debtor, which signifies that the extent of liability stays the same for both. Here, the liability of the surety is secondary, but that of the principal debtor is primary. The principal debtor must pay his/her debt and not the guarantor.

Release of Surety From Liability

The guarantor can back off from refunding the debt and its responsibility in the following circumstances cited in another section of the ICA.

• Section 133 – If any modifications are made to the agreement signed originally without notifying the guarantor, then the surety is released.
• Section 134 – If the creditor releases the principal debtor from the penalty, then the surety is also freed.
• Section 135 – If the creditor himself compromises or expands the period to pay the debt or decides not to sue the principal debtor, then the surety is released.
• Section 139 – If the creditor changes the requirements of the agreements and himself discards the requirements from it, then the surety has no liability.

Cancellation of Guarantee

This means to revoke or terminate the agreement.

• Section 130 of the ICA states that if the surety sets a statement before the creditor regarding the revocation of the guarantor to forthcoming transactions, then the person is released of their liability.
• Likewise, Section 131 of the ICA also cancels the guarantee on the demise of the surety. This suggests an automated cancellation of forthcoming transactions.

Case Laws

• In P.J Rajappan v. Associated Industries (1983), the guarantor had not signed the contracts of guarantee and desired to be released from the condition and stated that he did not stand as a surety for the implementation of the agreement. However, the proof established that the guarantor was involved in the contract and vowed to sign the contract later.

  The Kerala High Court stated that a contract of guarantee is a triple contract concerning the surety, creditor, and principal debtor. If there is adequate proof that the surety is involved, then the loss on his/her part in not signing the contract will not be sufficient to ruin. Otherwise, sufficient evidence of his involvement in the dealing directs to the decision that he/she insured the due enactment of the agreement by the principal debtor.

  When a court has to settle on the exact involvement of the guarantor in the agreement, all the events regarding the dealings should be considered.

• In Ram Narain v Lt. Col. Hari Singh, the Court stated that the case when the parties perform contracts of guarantee without concern is invalid. The contract is invalid if made after the agreement between the principal debtor and the creditor. The contracts of guarantee must be completed simultaneously with the original agreement.

Conclusion

The contract guarantees safety for the individual who loans money or an item of worth to a person (principal debtor). The contract involves a guarantor who bears the debt on insolvency from the debtor side, and it is an agreement that involves three parties. Thus, it is known as a triple contract.