CONTRACT OF GUARANTEE

RAJKUMAR
GUARANTEE

• In simple terms, a Guarantee means, the promise to pay another's

debt or fulfil another’s contractual obligations, if that party fails to
pay its debt or perform its obligations.
ECONOMIC FUNCTION OF GUARANTEE
• The function of a contract of guarantee is to enable a person to get a
loan or goods on credit or an employment. Some person comes
forward and tells the lender, or the supplier or the employer that he
may be trusted and in case of any default, “I undertake to be
responsible”.
OBJECT
• The object of a contract of guarantee is to provide additional security
to the creditor in the form of a promise by the surety to fulfil a certain
obligation, in case the principal debtor fails to do that.
• A contract tripartite agreement which contemplates the principal
debtor, the creditor, and the surety.
BIRKMYR V DARNELL
• In this case the court said “ If two come to a shop and one buys, and
the other to give him credit, promises the seller, ‘If he does not pay
you, I will”
• This type of collateral undertaking to be liable for the default of
another is called a “Contract of guarantee”. In English law a guarantee
is defined as “a promise to answer for the debt, default or miscarriage
of another”.
• “Guarantees are usually taken to provide a second pocket to pay if
the first should be empty”
EXAMPLE
• A takes a loan from a bank. A promises to the bank to repay the loan.
B also makes a promise to the bank saying that if A does not repay the
loan “then I will pay”. In this case, A is the principal debtor who
undertakes to repay the loan, B is the surety, whose liability is
secondary because he promises to perform the same duty in case
there is default on the part of A. The bank in whose favour the
promise has been made is the creditor.
THREE CONTRACTS
• There are three contracts in a contract of guarantee. .
• Firstly, the principal debtor himself makes a promise in favour of the
creditor to perform the promise.
• Secondly, the surety undertakes to be liable towards the creditor if
the principal debtor makes a default.
• Thirdly, an implied promise by the principal debtor in favour of the
surety in case the surety has to discharge the liability of the default of
the principal debtor the principal debtor shall indemnify the surety of
the same.
PARTIES
• The person who gives the guarantee is called the “Surety”. The
person in respect of whose default the guarantee is given is called the
“ principal debtor” and the person to whom the guarantee is given
called the “creditor”.
CONDITIONAL PROMISE
• There must be a conditional promise to be liable on the default of
the principal debtor. A liability which is incurred independently of a
default is not within the definition of guarantee.
• To refer again to Birkmyr v Darnell where referring to the buyer’s
companion, the Court said that if the companion had said “I will your
pay master” or ‘I will see you paid’ That would have been an
undertaking as for himself and is not guarantee”
TAYLOR V LEE
• A landlord and his tenant went to the plaintiff’s store. The landlord
said to the plaintiff: Mr Parker will be on our land this year, and you
will sell him anything he wants, and I will see it paid.
• This was held to be not a collateral promise to be liable for the
default of another and therefore not a guarantee.
SECTION 126
• Section 126 of the Contract Act defines a contract of guarantee as a
contract to perform the promise or discharge the liability of a third
person in case of his default. The person who gives the guarantee is
called the "surety", the person in respect of whose default the
guarantee is given is called the "principal debtor" and the person to
whom the guarantee is given is called the "creditor".
• The Contract Act uses the word ‘surety’ which is same as a
‘guarantor’.
ESSENTIAL FEATURES OF A GUARANTEE
• ORAL OR WRITING
• In India, as per section 126, a contract of guarantee may be oral or
written. It may even be inferred from the course of conduct of the
parties concerned.
• On this point, the position in India is different from that in England.
According to English law, for a valid contract of guarantee, it is
necessary that it should be in writing and signed by the party to be
charged herewith.
ESSENTIAL FEATURES OF A GUARANTEE
• PRINCIPAL DEBT
• The purpose of a guarantee being to secure the payment of a debt,
the existence of a recoverable debt is necessary.
• It is the essence of a guarantee that there should be someone liable
as principal debtor and the surety undertakes to be liable on his
default. If there is no principal debt there can be no valid guarantee.
ESSENTIAL FEATURES OF A GUARANTEE
• CONSIDERATION
• As in any other contract, the consideration is also needed for a
contract of guarantee. For the surety’s promise, it is not necessary
that there should be direct consideration between the creditor and
the surety, it is enough that the creditor had done something for the
benefit of the principal debtor.
• Benefit to the principal debtor constitutes a sufficient consideration
to the surety for giving the guarantee.
ESSENTIAL FEATURES OF A GUARANTEE
• MISREPRESENTATION AND CONCEALMENT

• The creditor should not obtain guarantee either by any

misrepresentation or concealment of any material facts concerning
the transaction. If the guarantee has been obtained that way, the
guarantee is invalid.
• It is the duty of a party taking a guarantee to put the surety in
possession of all the facts likely to affect the degree of his
responsibility and if he neglects to do so, it is at his peril. A surety
ought to be acquainted with the whole contract.
SECTION 142
• GUARANTEE OBTAINED BY MISREPRESENTATION INVALID

• Any guarantee obtained by means of misrepresentation made by the

creditor or with his knowledge and assent, concerning a material part
of the transaction, is invalid.
SECTION 143
• GUARANTEE OBTAINED BY CONCEALMENT, INVALID
• Any guarantee which the creditor has obtained by means of keeping
silence to material circumstances is invalid.
OMINIBUS V HOLLOWAY
• Guarantees for the good conduct of a servant have invited more
frequent application for this principle.
• In this case, the defendant was invited to give a guarantee for the
fidelity of a servant. The employer had earlier dismissed him for
dishonesty, but did not disclose the fact to the surety. The servant
committed another embezzlement. The surety was held not liable.
The surety believed that he was making himself answerable for a
presumably honest man.
EXTEND OF SURETY’S LIABILITY
• The fundamental principle about the surety’s liability, as laid down in
Section 128 is that the liability of the surety is co-extensive with that of the
principal debtor. The expression “co-extensive” with that of the principal
debtor” shows the maximum extent of the surety liability. He is liable for
the whole of the amount for which the principal debtor is liable and he is
liable for no more.
• It is a settled principle of law that the guarantor's liability is co-extensive
with that of the principal debtor.
• The surety may, however, by an agreement place a limit upon his liability.
• Where the principle debtor acknowledges liability and this has the effect
of extending the period of limitation against him the surety also becomes
affected by it.
SECTION 128
• The liability of the surety is co-extensive with that of the principal
debtor, unless it is otherwise provided by the contract.

• Illustration: A guarantees to B the payment of a bill of exchange by C,

the acceptor. The bill is dishonoured by C. A is liable not only for the
amount of the bill but also for any interest and charges which may
have become due on it.
SURETYSHIP AGREEMENT
• In almost all suretyship agreements, the creditor would want the
person signing surety to also bind themselves as co-principal debtors.
This results in the surety being liable in the same manner as the
principal debtor, which means the creditor is able to recover the debt
owing directly from the surety without first trying to recover from the
principal debtor.
PROCEEDING AGAINST SURETY
• The defendant guaranteed a bank’s loan. A default having taken
place, the defendant was sued. The trail court decreed that the bank
shall enforce the guarantee in question only after having exhausted
its remedies against the principal debtor.
• The Patna High Court confirmed the decree. But the Supreme Court
overruled it.
• In a subsequent case, the Supreme Court held that the creditor must
proceed against the mortgaged property first and then only against
the surety for the balance. [Bank of Bihar v Damodar Prasad and Anr]
SURETY’S RIGHT TO LIMIT HIS LIABILITY
• It is open to the surety to place a limit upon his liability. He may
expressly declare his guarantee to be limited to a fixed amount, for
example that “my liability under this guarantee shall not at any time
exceed the sum of Rs…..”
• In such a case, whatever may be owing from the principal debtor, the
liability of the surety cannot go beyond the sum so specified.
• A surety can attach any other condition to his liability.
ILLUSTRATION
• In the lease agreement example below, let us assume that the surety
had also bound themselves as a co-principal debtor, but their liability
was limited to R100 000, with rent payable by the tenant at R50 000 a
month. If the tenant defaults on their rent for January, February and
March, a total of R150 000, and the landlord, without cancelling the
lease agreement, calls on the surety to settle the amount then
outstanding, the landlord would only be able to recover R100 000
from the surety. The landlord would have to recover the outstanding
R50 000 from the principal debtor.
DISCHARGE OF SURETY
• A surety is said to be discharged from liability when his liability
comes to an end.
• Ordinarily a guarantee is not revocable when once it is acted upon.
BY DEATH OF SURETY
• A guarantee is also determined by the death of the surety unless
there is a contract to the contrary. Once again, the termination
becomes effective only for the future transactions. The surety’s heir
can be sued for liability already incurred.
BY VARIENCE
• The surety liability is discharged when the creditor without his
consent has altered the original contract.
• The surety is discharged as soon as the original contract is altered
without his consent.
SECTION 133
• Any variance, made without the surety’s consent, in the terms of the
contract between the principal debtor and the creditor, discharges
the surety as to transactions subsequent to the variance.
RELEASE OR DISCHARGE OF PRINCIPAL
DEBTOR-SECTION 134
• The surety is discharged by any contract between the creditor and the
principal debtor, by which the principal debtor is released.
ACT OR OMISSION
• The second ground of discharge provided in Section 134 is that when the
creditor does “ any act or omission the legal consequence of which is the
discharge of the principal debtor” the surety would also be discharged
from his liability.
• Where, for example, there is a contract for the construction of a building
the performance of which is guaranteed by a surety. Under the contract,
the creditor has to supply the building material An omission on his part to
do so would discharge the contractor and so would the surety be
discharged.
• Similarly, where the payment of rent due under a lease is guaranteed and
the creditor terminates the lease, the effect would be the release of the
surety also.
ILLUSTRATION
• A contracts with B to grow a crop of indigo on A's land and to deliver
to B at a fixed rate, and C guarantees A's performance of this contract.
B diverts a stream of water which is necessary for the irrigation of A's
land , and thereby prevents him from raising the indigo. C is no longer
liable on his guarantee.