Contract of Guarantee

Sanjay Bang
Points to be covered
 1) What is guarantee?
 2) Why it is important?
 3) The persons who are being involved in the contract of
guarantee.
 4) The nature of the contract of guarantee.
 5) The relevant sections to be covered for Contract of
guarantee.
 6) Definition of Guarantee covered under sec 126 of the
Contract Act.
 7) Position of English Law for guarantee.
Introduction
 In our day to day activates, specially in business transactions,
we require money to carry its smooth operation.
 E.gWhen company needs some money for its business it
approaches to a financial institute, specially a bank.
 The bank requires that the Managing Director Mr M
promises to repay the loan personally should the company
default.
Continue
 When the directors of the company including M execute the
promissory note on behalf of the company, they sign as
officials of company.
 M, the managing director signs again as individual. The
relationship between M and the bank is called a “Guarantee”
or “suretyship”.
 It’s a contractual relationship resulting from the
unconditional promise of M.
 Here M, who promises to pay in default of company is
known as Guarantor or the surety.
Continued
 The institute who lends the money is known as the Creditor,
here it is bank.
 The company who takes loan is known s principal debtor.
 If company fails to repay the loan , the bank can approach M,
for the repayment as if he is the principal debtor.
 Sometimes the bank ( lenders) may ask for more security for
the loan in addition to the personal gurantee.
Continued
 The principal debtor may be asked to furnish collateral
security against the advanced loan.
 If the loan is not repaid, the lenders have three option
 1) To compel the principal debtor to pay.
 2) Demand of the payment from the surety.
 3) To obtain the court order either to claim or sell the
collateral.
 But the third option is obviously, the last one.
Provisions of Guarantee under the
Indian Contract Act
 A contract of guarantee is entered into with the object of
enabling a person to get a loan or goods on credit or an
employment.
 The law relating to guarantee is given in the Indian Contract
Act, from sections 126 to 147.
 Definition :- A contract of guarantee is a contract to perform
the promise, or discharge the liability, of a third person in
case of his default.
 E.g- A and B go into shop, A says to the shopkeeper ,” Let B
have the goods , I will see you being paid”. This is contract of
indemnity.
Continued
 Instead of that if he says , “ If B doesn't pay you , I will pay”.
This is contract of guarantee.
 Contract of guarantee has following 3 purposes
 1) To secure the loans. Thus its guarantee for creditor.
 2) The contract of guarantee sometimes called as contract of
performance.
 E.g A employer often demands fidelity bond for the
employee who handles the cash or for good conduct, builders
in case of construction of project
Continued
 Bail bonds used in the criminal law, are a form of contract of
guarantee. It is a device which ensures , that a criminal
defendant will appear for trial.
 But in this topic, our primary concern is with the contracts
of guarantee which are used for securing loan.
 Thus, it is said that a contract of guarantee is an agreement
involving triangular contractual relationship wherein the
surety guarantees the creditor to pay the debt in case of
default of the principal debtor.
Continued
 In Contract of guarantee 3 contracts are being involved
 1) Contract between the principal debtor and the creditor
out of which the guaranteed debt arises.
 2) Contract between the surety and the creditor by which the
surety guarantees to pay the debt if principal debtor fails.
 3) Contract between the surety and the principal debtor by
which the principal debtor undertakes to indemnify the
surety if surety is required to pay.
Position of guarantee under English
Law
 In English Law, Guarantee is defined as a promise made by
one person to another be collaterally answerable for the debt,
default or miscarriage of a third person and must be
evidenced in writing.
 Thus, under English Law, Guarantee must be in written
format only.
 Whereas in India, guarantee may be oral or in written
format.
 Guarantee may be implied from the course of the conduct of
the parties.
Enforcement
 A contract of guarantee is to be enforced according to the
terms of the contract.
 In contract of liability the surety is considered as favored
debtor in the eye of law.
 A question is always arisen, whether the contract of
guarantee is a contract of uberrimae fide, which means
contract of utmost good faith.
 Sec 17 (2) of the Indian Contract Act talks about that, where
your silence also amounts to fraud.
 Insurance Contract is the best example of that.
Continued
 Unlike, the Insurance contract, the contract of guarantee is
not a contract of utmost good faith.
 Still the suretyship relationship is one of trust and confidence
and the validity of the contract depends upon the good faith
of the creditor.
 However, it is not a part of the creditors duty to inform the
surety about all the previous dealings with the principal
debtor.
 Law doesn’t compel to do so, for the surety cant initiate any
action against the creditor for non disclosure.
Judicial approach
 Wythes vs Labon Chare (1858), Lord Chelmsford held that
the creditor is not bound to inform the matters affecting the
credit of the debtor or any circumstances unconnected with
the transaction in which he is about to engage which will
render his position more hazardous. Since it is based on good
faith, a contract of guarantee becomes invalid if the guarantee
is obtained from the surety by misrepresentation or
concealment as given in section 142 and 143 of the Indian
Contract Act-1872.
Essentials of Contract of Guarantee
 1) A contract of guarantee must satisfy all the essential
elements of a valid contract under sec 10 of the Act.
 2) There must be Three parties in the contract. a) Surety b)
Principal debtor c) Creditor.
 3) A contract of guarantee pre-supposes the existence of a
liability enforceable at law. It is of the essence of a contract of
guarantee that there should be a liability , existing or future ,
enforceable at law.
Continued
 X took a loan on 1st Jan 2015 for 50000 and paid nothing,
neither interest nor the principle. On 10th January 2018,Y
promised to pay the amount due with X to the bank. Is this
valid contract of guarantee?
 4) A contract of guarantee may be oral or in the written
format. May be expressed or implied. Under the English
Contract, only written and expressed contract of guarantee is
a valid contract.
Continued
 5) There are two types of liabilities under the contract of
guarantee a) Primary liability. b) Secondary liability. The
primary liability is with the with the principal debtor and the
secondary liability is with the guarantor.
 State of Maharashtra vs. M.N Kaul:-The cardinal rule is that
the guarantor must not be made liable beyond the terms of
his engagement. Therefore, his liability is secondary and
conditional and that of principal debtor is primary. In case,
the principal debtor is not liable, the surety is also not liable.
Continued
 6) A contract of guarantee has to satisfy all the essential of a
valid contract, but for consideration and for the capacity,
special feature have to be applied.
 E.g- If principal debtor is not competent to contract, the
primary liability rests with the surety.
 Necessity was supplied to minor for which he didn’t pay and
Mr A took the guarantee to pay, in case of default? Can we
ask the surety to pay on the competency ground?
Points to be covered
 Effect of capacity on the contract of guarantee.
 Effect of consideration on the contract of guarantee.
 The circumstances which makes the guarantee invalid.
 The difference between Guarantee and indemnity.
 Types of guarantee.
Continued
 A minor pretended himself to be a major person and entered
in a contract with a person. Later on it was found that he was
minor and wanted to take undue advantage from the
privilege to minor. The surety on behalf of the minor refused
to continue with his liability. Decide the case n two
parameters.
 1) Status of contract under sec 11 of the Contract Act..
 2) Status of contract under Guarantee?
Continued
 The incapacity of the principal debtor doesn’t affect the validity of
a contract of guarantee. The creditor and the surety must be
competent to enter into the contract.
 In case, the principal debtor is minor, the surety is regarded as a
principal debtor and is personally liable to pay the debt, though
the principal is not liable.
 In Kashiba vs Sripat, (1894) I.L.R 19 Bom 697 it was observed
that the contract between the surety and the creditor is not
collateral but independent and the surety is held liable as principal
debtor.
Continued
 What would be the situation if the principal debtor has
become insolvent? Can we ask the surety to pay?
 It’s a general rue, that without consideration no contract is
possible. But in contract of guarantee, it is not necessary that
there must be some consideration present between the
Principal debtor and the Surety.
 Sec 127 says anything done , or any promise made, for the
benefit for the principal debtor may be sufficient
consideration to the surety for giving the guarantee.
Invalid guarantee
 1) According to section 142 of the Act, any guarantee which
has been obtained by means of misrepresentation made by
the creditor, or with his knowledge and assent, concerning a
material part of the transactions is invalid.
 E.gWythes vs Labon Chare (1858),
 2) Concealment , it is given in section 143 of the Act. It is
like fraud. Where the surety is intentionally kept away from
the reality and asked to provide his surety.
Continued
 3) Not joining by co-surety. According to section 144 of the
Act, where a person gives a guarantee upon a contract that a
creditor shall not act upon it until another person has joined
in it as co-securety, the guarantee is not valid if that other
person doesn’t join.
 It means if the liability is joint, it will be on both and no one
can be asked independently to perform his role under the
contract of guarantee.
Comparison between Guarantee
between indemnity
Guarantee
 1) There are 3 parties, the
Creditor, Principal debtor
and the surety.
 2) The liability of
indemnifier is primary.
Indemnity
 1) There are 2 parties,
indemnifier and the
indemnity holder.
 2) The liability of the
principal debtor is primary
and the surety is secondary. It
means if the principal debtor
fails then only the liability of
surety arises
Continued
Guarantee Indemnity
 3) There is only one  3) There are 3 contracts,
contract between the between the Principal
indemnified and the debtor and the creditor,
indemnifier. Creditor and the surety
and the Principal debtor
and the surety.
Continued
Guarantee
 4) The liability of the
indemnifier arises on the
happening of a contingent
event.
 5) It is for reimbursement
of loss.
Indemnity
 4) There is an existing debt
or duty, the performance
of which is guaranteed by
the surety.
 5) It is for the security of
the creditor for ensuring
his payment.
Continued
Guarantee Indemnity
 6) An indemnifier cannot  6) A surety on discharging
sue a third party for loss in the debt due by the
his own name because thee principal debtor for his
is no privity of the own recovery.
contract. He can do so only
if some assignment is in his
favour.
Continued
Guarantee Indemnity
 7) Indemnifier need not act  7) The surety gives the
on the request of the guarantee on the request of
indemnified. the principal debtor.
Types of guarantee
 Already we discussed the guarantee is given for 3 purposes
normally.
 Guarantee may be either retrospective or prospective.
 The former is obviously given for an existing debt while the
latter is given for some future agreement.
 Mainly there are two types of guarantee.
 1) Simple ( specific) guarantee. 2) Continuing guarantee
Continued
 Simple guarantee is one in which guarantee is given for a
single specific debt or transaction.
 It comes to an end as soon as the liability under that
transaction ends.
 A specific guarantee is once given , it is irrevocable.
 Continuing guarantee is defined in section 129 of the Act. It
is “ a guarantee which extends to a series of transactions is
called a continuing guarantee.
Continued
 It is not confined to single transaction.
 It is like standing offer which is accepted by the creditor every
time a subsequent transaction takes place.
 Whether a guarantee, is continuous or not it depends on the
language of the guarantee, the subject mater and the surrounding
circumstances.
 On the recommendation of Mr S, C employed P for collection of
rent from his tenants. S promised to make good any default made
by P. This is a contract of continuing guarantee
Continued
 A guarantees payment to B of the price of Five sacks of flour,
to be delivered by B to C and to be paid in a month. B
delivers Five sacks to C. C pays for them. Afterwards B
delivers Four sacks to C which C does not pay for. The
guarantee given by A was not a continuing guarantee and
accordingly, he is not liable for the price of the Four sacks.
 Any example from your side?
Revocation of continuing guarantee
 We all know, simple or specific guarantee cannot be revoked
at all. But continuous guarantee can be revoked as regards
future transactions under the following circumstances.
 1) By Notice-(130)- Notice will terminate the liability of the
surety as to future transactions. The liability of the surety will
come to end, as soon as the notice is served upon the
creditor. The notice must reach to the creditor.
Continued
 “A” the surety sends a notice to the Creditor “B” for revoking
the notice of continuous guarantee of “C” on 28th November
by letter. The letter reached to the Creditor by 2nd
December. But a transaction of contract took pace between B
and C on 1st December in limit of continuous guarantee.
What is the liability of “A” in the present case?
 Can C deny the liability? Give reasons
Continued
 The surety will remain liable for the transactions entered into
by him before giving the notice.
 2) By death of surety:-The death of the surety operates in the
absence of any contract, as revocation of continuous
guarantee.( So far as regards future transactions).
 I) Notice of death of surety will operate as a sufficient
revocation of continuing guarantee provided the guarantor or
his representatives have not contracted otherwise.
Continued
 E.g. The Guarantor or his representatives expressly
mentioned that the guarantee can be revoked only by serving
the notice, then automatically death of guarantor doesn’t
revoke the liability.
 II) In that case surety's heirs can be sued for liability already
incurred.
 III) The estate of the surety is liable for al transactions entered
into prior to death of the surety unless there was a contrary
to it.
Continued
 IV) However, his estate will not be liable or the transactions
entered into after his death, even if the creditor has no notice
of death.
 3)By discharge of surety:- Discharge of surety is one of the
ground to revoke the continuous guarantee in the following
circumstances.
 A) By variance in the terms o the original contract.
 B) By misrepresentation (142)
 C) By concealment.
Continued
 D) Failure of co-security to join.