Contract of Guarantee by Sesa Gill

Sec. 126 of the Contract Act 1872, which deals with the contract of guarantee, has defined it
as “A contract to perform the promise, or discharge the liability of a third person in case of
his defaults”.

Example: A advances a loan of Rs. 10,000 to B, and C promises A that if B does not repay
the loan, I will repay it. This is a contract of guarantee. It involves three parties namely,

1. Surety, who gives the guarantee.

2. Principal Debtor, in respect of whose default the guarantee is given.

3. Creditor, to whom the guarantee is given.

Example: A supplies goods to B on C’s guaranteeing payment by B to A. This means that if

B does not pay, C would be liable to pay. This is a “Contract of Guarantee”.

Here B is the principal debtor, C is the surety and A is the creditor.

There are three contracts in contract of guarantee:

1. Between creditor and Principal debtor

2. Between surety and creditor
3. Between surety and Principal debtor

Essentials of a Contract of Guarantee

1. Concurrence of All the Parties

All the three parties namely, the principal debtor, the creditor and the surety must agree to
make such a contract.

2. Liability

In a contract of guarantee, liability of the surety is secondary i.e., the creditor must first
proceed against the debtor and if the latter does not perform his promise, then only he can
proceed against the surety.

3. Existence of a Debt

A contract of guarantee pre-supposes the existence of a liability, which is enforceable at law.

If no such liability exists, there can be no contract of guarantee.

4. Consideration
There must be consideration between the creditor and the surety so as to make the contract
enforceable. The consideration must also be lawful.  In a contract of guarantee, the
consideration received by the principal debtor is taken to be the sufficient consideration for
the surety.

Thus, any benefit received by the debtor is adequate consideration to bind the surety. But past
consideration is no consideration for a contract of guarantee. There must be a fresh
consideration moving from the creditor.

5. Writing not Necessary

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

6. Essentials of a Valid Contract

It must have all the essentials of a valid contract such as offer and acceptance, intention to
create a legal relationship, capacity to contract, genuine and free consent, lawful
object, lawful consideration, certainty and possibility of performance and legal formalities.

7. 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.

8. 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 uberrimae fidei 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.

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.

Discharge of a Surety (Sec.130 – 141)

1. Death of surety-The death of a surety as regards future transactions in case of a

continuing guarantee in the absence of a contract to the contrary.

2. Notice of revocation -Notice of revocation as regards future transactions in case of a

continuing guarantee. For example, A gives a guarantee to B to the extent of RS50000,
that C will pay all the bills that B will draw upon her. B draws bills on C and she accepts
the bill. A gives notice of revocation. C dishonours the bill at maturity. A is liable as it
was a transaction before the notice of revocation.
Rights of a Surety
1. Rights against the Creditor

As per section 141, a surety is eligible to the benefit of every security which the creditor has
against the principal debtor. This holds true even if at the time of entering into the contract of
guarantee the surety was unaware of the existence of such a security.

Also, when the creditor losses or parts with such security without the consent of the surety, this
discharges the surety to the extent of the value of such security.

2. Rights against the Principal Debtor

Once the surety discharges the debt, he obtains the rights of a creditor against the principal
debtor. He can now sue the principal debtor for the amount of debt paid by him to the creditor
due to the default of the principal debtor.

In a case where the principal debtor on discovering that the debt has become due, starts
disposing of his properties in order to prevent seizure by the surety, the surety can compel the
debtor to pay the debt and discharge him from his liability to pay.

3. Surety’s rights against the co-sureties

When a surety pays more than his share to the creditor, he has a right of contribution from the
co-sureties, who are equally liable to pay. For example, A, B, and C are the co-sureties to David
for a sum of RS30000 lent to Erwin who made default in payment. Thus, A, B, and C are liable
to pay RS10000 each as between them. So, in this case, if anyone of them pays more than
RS10000, he can claim the excess from the other two co-sureties so as to reduce his payment to
RS10000 only. However, if one of the co-sureties becomes insolvent, the other co-sureties shall
contribute his share equally. Right to share benefit of the security