DEPARTMENT OF LAWS

PANJAB UNIVERSITY REGIONAL CENTRE,LUDHIANA

CONTRACT – II

TOPIC :

CONTRACT OF GUARANTEE

(SECTION-126-147)

SUBMITTED TO : SUBMITTED BY :

PROF.NEELAM BATRA HARPREET SINGH , 78

L.L.B 2nd SEM

 ACKNOWLEDGEMENT
It gives me immense pleasure to present this assignment for the partial fulfillment of the
course. I would like to take the opportunity of this platform to thank various individuals ,
without he support of whom, this assignment would not have been successful.

I am highly grateful to PROF. NEELAM BATRA for her selfless guidance throughout the
completion of our project. her teaching has not only helped us in managing this subject but
also in completion of this project.

I thankful her for making me understand this topic and cooperating in the making of this
project .
INDEX
 INTRODUCTION

The Contract of Guarantee, indisputably one of the most important topics under Contract Law
is also known as a contract of surety. The Indian Contracts Act, 1872 contains several
provisions which explain the nature and scope of a contract of guarantee in detail.

Contract of Guarantee is a contract to perform the promise or to discharge the liability of the
third person in case his default. Contract of guarantee involves three parties: Principal
Debtor, Surety and Creditor. There are three types of contracts. Contract of indemnity,
contract of guarantee and loan agreement. Contract of indemnity is between Surety and
Principal Debtor; loan agreement is between Principal Debtor and Creditor and Contract of
guarantee is between Surety and Creditor. This type of contract is also known as the
Tripartite Contract.

.
What is a contract of guarantee?

Section 126 of the Indian contract act defines a contract of guarantee as a contract to perform
the promise or discharge the liability of the defaulting party in case he fails to fulfill his
promise.

Thus here we can infer that there the 3 parties to the contract

Principal Debtor – The one who borrows or is liable to pay and on whose default the
guarantee is given

Creditor – The party who has given something of value to borrow and stands to receive the
payment for such a thing and to whom the guarantee is given

Surety/Guarantor – The person who gives the guarantee to pay in case of default of the
principal debtor

Also, we can understand that a contract of guarantee is a secondary contract that emerges
from a primary contract between the creditor and the principal debtor.

Illustration

Ankita advances a loan of INR 70000 to Pallav. Srishti who is the boss of Pallav promises
that in case Pallav fails to repay the loan, then she will repay the same. In this case of a
contract of guarantee, Ankita is the Creditor, Pallav the principal debtor and Srishti is the
Surety.

A contract of guarantee may either be oral or written. It may be express or implied from the
conduct of parties.

Case Law - In P.J. Rajappan v Associated Industries(1983)

The guarantor, having not signed the contract of guarantee, wanted to wriggle out of the
situation. He said that he did not stand as a surety for the performance of the contract.
Evidence showed the involvement of the guarantor in the deal and had promised to sign the
contract later. The Kerala High Court held that a contract of guarantee is a tripartite
agreement, involving the principal debtor, surety and the creditor. In a case where there is
evidence of the involvement of the guarantor, the mere failure on his part in not signing the
agreement is not sufficient to demolish otherwise acceptable evidence of his involvement in
the transaction leading to the conclusion that he guaranteed the due performance of the
contract by the principal debtor. When a court has to decide whether a person has actually
guaranteed the due performance of the contract by the principal debtor all the circumstances
concerning the transactions will have to be necessarily considered.

Essentials of a Contract of Guarantee

1) Must be made with the agreement of all three parties

All the three parties to the contract i.e the principal debtor, the creditor, and the surety must
agree to make such a contract with the agreement of each other. Here it is important to note
that the surety takes his responsibility to be liable for the debt of the principal debtor only on
the request of the principal debtor. Hence communication either express or implied by the
principal debtor to the surety is necessary. The communication of the surety with the creditor
to enter into a contract of guarantee without the knowledge of the principal debtor will not
constitute a contract of guarantee.

Illustration

Sam lends money to Akash. Sam is the creditor and Akash is the principal debtor. Sam
approaches Raghav to act as the surety without any information to Akash. Raghav agrees.
This is not valid.

2) Consideration

According to section 127 of the act, anything is done or any promise made for the benefit of
the principal debtor is sufficient consideration to the surety for giving the guarantee. The
consideration must be a fresh consideration given by the creditor and not a past consideration.
It is not necessary that the guarantor must receive any consideration and sometimes even
tolerance on the part of the creditor in case of default is also enough consideration.

Case Law - In State Bank of India v Premco Saw Mill(1983)

The State Bank gave notice to the debtor-defendant and also threatened legal action against
her, but her husband agreed to become surety and undertook to pay the liability and also
executed a promissory note in favor of the State Bank and the Bank refrained from threatened
action. It was held that such patience and acceptance on the bank’s part constituted good
consideration for the surety.

3) Liability

In a contract of guarantee, the liability of a surety is secondary. This means that since the
primary contract was between the creditor and principal debtor, the liability to fulfill the
terms of the contract lies primarily with the principal debtor. It is only on the default of the
principal debtor that the surety is liable to repay.

4) Presupposes the existence of a Debt

The main function of a contract of guarantee is to secure the payment of the debt taken by the
principal debtor. If no such debt exists then there is nothing left for the surety to secure.
Hence in cases when the debt is time-barred or void, no liability of the surety arises. The
House of Lords in the Scottish case of Swan vs. Bank of Scotland (1836) held that if there is
no principal debt, no valid guarantee can exist.

5) Must contain all the essentials of a valid contract

Since a contract of guarantee is a type of contract, all the essentials of a valid contract will
apply in contracts of guarantee as well. Thus, all the essential requirements of a valid contract
such as free consent, valid consideration offer, and acceptance, intention to create a legal
relationship etc are required to be fulfilled.

6) No Concealment of Facts

The creditor should disclose to the surety the facts that are likely to affect the surety’s
liability. The guarantee obtained by the concealment of such facts is invalid. Thus, the
guarantee is invalid if the creditor obtains it by the concealment of material facts.

7) No Misrepresentation

The guarantee should not be obtained by misrepresenting the facts to the surety. Though the
contract of guarantee is not a contract of Uberrima fides i.e., of absolute good faith, and thus,
does not require complete disclosure of all the material facts by the principal debtor or
creditor to the surety before he enters into a contract. But the facts, that are likely to affect the
extent of surety’s responsibility, must be truly represented
Illustrations

a) S is a bookseller who supplies a set of books to P, under the contract that if P does not pay
for the books, his friend K would make the payment. This is a contract of specific guarantee
and K’s liability would come to an end, the moment the price of the books is paid to S.

b) On M’s recommendation S, a wealthy landlord employs P as his estate manager. It was the
duty of P to collect rent every month from the tenants of S and remit the same to S before the
15th of each month. M, guarantee this arrangement and promises to make good any default
made by P. This is a contract of continuing guarantee.

The creditor should disclose to the surety the facts that are likely to affect the surety’s
liability. The guarantee obtained by the concealment of such facts is inv

KINDS OF GUARANTEE

Specific/Simple Guarantee – A Specific Guarantee pertains to a single debt or a single

transaction.

Continuing Guarantee – Guarantee is for a series of transactions. Liability extends till the
revocation of guarantee.

Retrospective Guarantee – Guarantee is for an existing debt or obligation.

Prospective Guarantee – Guarantee is for a future debt or obligation.

Fidelity Guarantee – Guarantee is on the good conduct or honesty of a person employed in a

particular organization

INVALID GUARANTEE

Following are a few of those cases when the guarantee given by the surety will be invalid and
cannot be enforced against him:

Guarantee obtained by misrepresentation (Sec. 142): Any type of guarantee which has
been obtained by means of misrepresentation or concealment of facts made by the creditor, or
with his knowledge and assent, concerning a material part of the transaction, is invalid.
Guarantee obtained by concealment (Sec. 143): Any contract of guarantee which the
creditor has obtained from surety by means of keeping silence as to material circumstances or
facts, is invalid.

In case co-surety does not join (Sec. 144): Where a surety gives a guarantee upon a contract
that the creditor shall not act upon until another person has joined as co-surety in the contract,
the guarantee will be invalid if that other person does not join

Continuing guarantee

A continuing guarantee is defined under section 129 of the Indian Contract Act,1872. A
continuing guarantee is a type of guarantee which applies to a series of transactions. It applies
to all the transactions entered into by the principal debtor until it is revoked by the surety.
Therefore Bankers always prefer to have a continuing guarantee so that the guarantor’s
liability is not limited to the original advances and would also extend to all subsequent debts.

The most important feature of a continuing guarantee is that it applies to a series of separable,
distinct transactions. Therefore, when a guarantee is given for an entire consideration, it
cannot be termed as a continuing guarantee.

Illustration

K gave his house to S on a lease for ten years on a specified lease rent. P guaranteed that S,
would fulfill his obligations. After seven years S stopped paying the lease rent. ‘K sued him
for the payment of rent. P then gave a notice revoking his guarantee for the remaining three
years. P would not be able to revoke the guarantee because the lease for ten years is an entire
indivisible consideration and cannot be classified as a series of transactions and hence is not a
continuing guarantee.

Revocation of Continuing Guarantee

So far as a guarantee given for an existing debt is concerned, it cannot be revoked, as once an
offer is accepted it becomes final. However, a continuing guarantee can be revoked for future
transactions. In that case, the surety shall be liable for those transactions which have already
taken place.
A contract of guarantee can be revoked in the following two ways-

1) By giving a notice (Section 130)

Continuing guarantees can be revoked by giving notice to the Creditor but this applies only to
future transactions. Just by giving a notice the surety cannot waive off his responsibility and
still remains liable for all the transactions that have been placed before the notice was given
by him. If the contract of guarantee includes a clause that a notice of a certain period of time
is required before the contract can be revoked, then the surety must comply with the same as
said in Offord v Davies (1862).

Illustration

A guarantees to B to the extent of Rs. 10,000, that C shall pay for all the goods bought by
him during the next three months. B sells goods worth Rs. 6,000 to C. A gives notice of
revocation, C is liable for Rs. 6,000. If any goods are sold to C after the notice of revocation,
A shall not be, liable for that.

2) By Death of Surety(Section 131)

Unless there is a contract to the contrary, the death of surety operates as a revocation of the
continuing guarantee in respect to the transactions taking place after the death of surety due
to the absence of a contract. However, his legal representatives will continue to be liable for
transactions entered into before his death. The estate of deceased surety is, however, liable
for those transactions which had already taken place during the lifetime of the deceased.
Surety’s estate will not be liable for the transactions taking after the death of surety’even if
the creditor had no knowledge of surety’s death.

Period of Limitation

The period of limitation of enforcing a guarantee is 3 years from the date on which the letter
of guarantee was executed. In State Bank Of India vs Nagesh Hariyappa Nayak And Ors,
against the advancement of a loan to a company, the guarantee deed was executed by its
directors and subsequently a letter acknowledging the load was issued by same directors on
behalf of the company. It was held that the letter did not have the effect of extending the
period of limitation. Recovery proceedings instituted after three years from the date of the
deed of guarantee were liable to be quashed.

Rights of a Surety
After making a payment and discharging the liability of the principal debtor, the surety gets
various rights. These rights can be studied under three heads:

(i) rights against the, principal debtors.

(ii) rights against the creditor, and

(iii) rights against the co-sureties.

(i) Rights against the Principal Debtor

1) The right of surety on payment of debt or the Right of subrogation(Section 140)

The right of subrogation means that since the surety had given a guarantee to the creditor and
the creditor after getting the payment is out of the scene, the surety will now deal with the
debtor as if he is a creditor. Hence the surety has the right to recover the amount which he has
paid to the creditor which may include the principal amount, costs and the interest.

2) The right of Indemnity(Section 145)

In every contract of guarantee, there is an implied promise by the principal debtor to

indemnify the surety, and the surety is entitled to recover from the principal debtor whatever
sum he has rightfully paid under the guarantee. This is because the surety has suffered a loss
due to the non-fullfillment of promise by the principal debtor and therefore the surety has a
right to be compensated by the debtor

Illustration

Luthra and co has taken a loan from Khaitan and co where Amarchand acts as security on
behalf of Luthra. Khaitan demands payment from Amarchand and on his refusal sues him for
the amount, Amarchand defends the suit having reasonable grounds for doing so, but he is
compelled to pay the amount of the debt with costs. He can recover from Luthra the amount
paid by him for costs, as well as the principal debt.

(ii) Rights against the Creditor

1) Right to securities given by the principal debtor(section 141)

On the default of payment by the principal debtor, when the surety pays off the debt of the
principal debtor he becomes entitled to claim all the securities which were given by the
principal debtor to the creditor. The Surety has the right to all securities whether received
before or after the creation of the guarantee and it is also immaterial whether the surety has
knowledge of those securities or not.

Illustration

On the guarantee of Priya, Anita lent rs 100000 to Sita. This debt is also secured by security
for the debt which is the lease of Sita’s house. Sita defaults in paying the debt and Priya has
to pay the debt. On paying off Sita’s liabilities Priya is entitled to receive the lease deed in
her favor.

2) Right to set off

When the creditor sues the surety for the payment of principal debtor’s liabilities, the surety
can claim set off, or counterclaim if any, which the principal debtor had against the creditor.

(iii) Rights against the Co-sureties

1) Release of one co-surety does not discharge others (Section 138)

When the repayment of debt of the principal debtor is guaranteed by more than one person
they are called Co-sureties and they are liable to contribute as agreed towards the payment of
guaranteed debt. The release by the creditor of one of the co-sureties does not discharge the
others, nor does it free the released surety from his responsibility to the other sureties. Thus
when the payment of a debt or performance of duty is guaranteed by co-sureties and the
principal debtor has defaulted in fulfilling his obligation and thus the creditor compels only
one or more of the co-sureties to perform the whole contract, the co-surety sureties
performing the contract are entitled to claim contribution from the remaining co-sureties.

2) Co-sureties to contribute equally (Section 146)

According to Section 146, in the absence of any contract to the contrary, the co-sureties are
liable to contribute equally. This principle will apply even when the liability of co-sureties is
joint or several, and whether under the same or different contracts, and whether with or
without the knowledge of each other.

Illustration

A, B, C, and D are co-sureties for a debt of Rs. 2,0000 lent by Z to R. R defaults in repaying
the loan. A, B, C, and D are liable to contribute Rs. 5000 each.
3) Liability of co-sureties bound in different sums(Section 147)

When the co-sureties have agreed to guarantee different sums, they have to contribute equally
subject to the maximum of the amount guaranteed by each one.

Illustration

A, B and C, sureties for D, enter into three separate bonds, each in a different penalty, A for
Rs. 10,000, B for Rs. 20,000 and C for Rs. 40,000. D makes default to the extent of Rs.
30,000. A B and C are liable to pay Rs. 10,000 each. Suppose this default was to the extent of
Rs. 40,000. Then A would be liable for Rs. 10,000 and B and C Rs. 15,000 each.

Discharge of Surety from Liability

Under any of the following circumstances a surety is discharged from his liability:

i) by the revocation of the contract of guarantee,

ii) by the conduct of the creditor, or

iii) by the invalidation of the contract of guarantee

We have already discussed above the first circumstance in which how a surety can be
discharged i.e by Revocation of the Contract of Guarantee. This includes by giving notice or
death or the surety.

(ii) Conduct of the Creditor

1) Variance in terms of the contract(Section 133)

When a contract of guarantee has been materially altered through an agreement between the
creditor and principal debtor, the surety is discharged from his liability. This is because a
surety is liable only for what he has undertaken in the guarantee and any alteration made
without the surety’s consent will discharge the surety as to transactions subsequent to the
variation.

Illustration

A becomes surety to C for B’s conduct as a manager in C’s bank. Afterward, B and C
contract, without A’ s consent, that B’ s salary shall be raised, and that he shall become liable
for one-fourth of the losses on overdrafts. B allows a customer to over-draw, and the bank
loses a sum of money. A is discharged from his suretyship by the variance made without his
consent and is not liable to make good this loss.

2) Release or discharge of the principal debtor(Section 134)

A surety is discharged if the creditor makes a contract with the principal debtor by which the
principal debtor is released, or by any act or omission of the creditor, which results in the
discharge of the principal debtor.

Illustration

A supplies goods to B on the guarantee of C. Afterwards B becomes unable to pay and

contracts with A to assign some property to A in consideration of his releasing him from his
demands on the goods supplied. Here, B is released from his debt, and C is also discharged

from his suretyship. But, where the principal debtor is discharged of his debt by operation of
law,

say, on insolvency, this will not operate as a discharge of the surety.

3) Arrangement between principal debtor and creditor

According to section 135 when the creditor, without the consent of the surety, makes an
arrangement with the principal debtor for composition, or promise to give him time to, or not
to sue him, the surety will be discharged.

However, when the contract to allow more time to the principal debtor is made between the
creditor and a third party, and not with the principal debtor, the

surety is not discharged (Section 136).

Illustration

C, the holder of an overdue bill of exchange drawn by A as surety for B, and accepted by B,
contracts with M to give time to B, A is not discharged.

4) Loss of security(Section 141)

If the creditor parts with or loses any security given to him at the time of the guarantee,
without the consent of the surety, the surety is discharged from liability to the extent of the
value of the security.

Illustration
A, as surety for B, makes a bond jointly with 3 to C to secure a loan from C to B. Later on, C
obtains from B further security for the same debt. Subsequently, C gives up further security.
A is not discharged.

(iii) By Invalidation of the Contract

A contract of guarantee, like any other contract, may be avoided if it becomes void or
voidable at the option of the surety. A surety may be discharged from liability in the
following cases:

1) Guarantee obtained by misrepresentation(Section 142)

When a misrepresentation is made by the creditor or with his knowledge or consent, relating
to a material fact in the contract of guarantee, the contract is invalid

2) Guarantee obtained by concealment(Section 143)

When a guarantee is obtained by the creditor by means of keeping silence regarding some
material part of circumstances relating to the contracts, the contract is invalid

3) Failure of co-surety to join a surety(Section 144)

When a contract of guarantee provides that a creditor shall not act on it until another person
has joined in it as a co-surety, the guarantee is not valid if that other person does not join.E

Extent of a surety’s liability

In the absence of a contract to the contrary, the liability of a surety is co-extensive with that
of the liability of the principal debtor. It means that the surety is liable to the same extent to
which the principal debtor is liable.

Illustration

A guarantees to B the payment of a bill of exchange by C, the acceptor. On the due date, the
bill is dishonored 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.

DIFFERENCE BETWEEN INDEMNITY AND GUARANTEE

S.No. INDEMNITY GUARANTEE

Meaning & A contract by which one party A contract of guarantee is a contract to

 promises to save the other from perform the promise, or discharge the
Definition loss caused to him is called as a liability of a third person in case of his
contract of indemnity. default.

Parties There are only two parties There are three parties.

The liability of the indemnifier is

Nature of The liability of the surety is collateral &
independent & has primary
Liability has secondary liability.
liability.

The contract of guarantee provide security

Purpose of The contract of indemnity provide
to creditors against default of the principal
Contract security against losses.
debtor.

Number of In a contract of indemnity there is In the contract of guarantee, there are

Contract only one contract. three contracts.

CONCLUSION

The contract of guarantee is a specific contract for which the Indian Contract Act has laid
some rules. As we have discussed, the basic function of a contract of guarantee is to protect
the creditor from loss and to give him confidence that the contract will be enforced with the
promise of the surety. Every contract of guarantee has three parties and there exist two types
of guarantees i.e specific guarantee and continuing guarantee. The type of Guarantee used
depends on the situation and the terms of the contract. The surety has some rights against the
other parties and liability of the surety is considered to be co-extensive with that of the
principal debtor unless it is otherwise provided by the contract. In case the contracts are
entered into by misrepresentation made by the creditor regarding material circumstances or
by concealment of material facts by the creditor, the contract will be considered invalid.