Contract of Guarantee

Contract of Guarantee
• SECTION-126 – A ‘contract of guarantee’ is a contract to perform the promise, or discharge the
liability, of a third person in case of his default.
• Enable a person to get:
1. Loan
2. Goods on credit
3. Employment
• 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’,
the person to whom the guarantee is given is called the ‘creditor’.
Object- To provide additional security to the creditor - promise to pay if Principal Debtor defaults.
 Contract of
Indemnity
Principal Debtor Surety

Contract- Contract of
goods/services Guarantee

Creditor

Contract of guarantee is a “tripartite contract”- 3 contracts

Principal debtor promise to repay to creditor.
Surety takes liability if principal debtor defaults
Principal debtor indemnify the surety if surety pays to creditor
 Essential features of Guarantee

Principal
Misrepresentation/ Oral/writing
Debt Consideration
Concealment
Principal Debt
• Purpose of guarantee- secure payment of debt (existence of recoverable
debt necessary)
• No Principal debt – No valid guarantee
• Birkmyr v Darnell (1704)
• Swan v Bank of Scotland (1836)
The payment of overdraft of banker’s customer was guaranteed by the
defendant. Overdraft were contrary to the statute and void – Surety not liable
• Guarantee of Minor’s debt-India?
• Minor debt knowingly guaranteed - Kashiba v Sripat (1895)
Consideration
• Contract of guarantee should have a consideration. Guarantee
without consideration is void.
• S 127- Anything done or any promise made for the benefit of principal
debtor – sufficient consideration for surety.
Principal Debtor Surety

Creditor

In this case Creditor promise to deliver goods is sufficient consideration for surety’s promise.
• Guarantee for past debts:
• A sells and delivers goods to B. C afterwards, without consideration
agrees to pay in default of B.
• Agreement void
Misrepresentation and concealment
• Creditor not obtain guarantee by misrepresentation or concealment of
material facts- guarantee invalid.
• S142- Guarantee obtained by misrepresentation invalid- Guarantee by
misrepresentation made by creditor or with his knowledge and assent,
concerning a material part of transaction is invalid.
• S 143- Guarantee obtained by concealment invalid – guarantee which
creditor obtained by keeping silent to material circumstances is invalid.
• A engages B (Clerk) to collect money for him. B fails and A asks for
security. C gives guarantee. A does not acquaint C of B previous
conduct. B makes default – Guarantee invalid
• A guarantees C for iron supplied to B upto 2000 tons. B & C agree that
B pay 5 Rs per ton beyond market price, such excess to be applied for
old debt. Agreement concealed from A – A not liable as surety.
• London General Omnibus Co. v Hollowan (1912)
Defendant invited to give guarantee for fidelity of servant. Employer
earlier dismissed him for dishonesty- did not disclose to surety. –
Servant embezzled – Surety not liable
Oral/Writing
• Guarantee may be either oral or in writing – S 126
• England only in writing and signed by party to be charged.
Difference
Indemnity Guarantee
1. Two Parties 1. Three Parties
2. Only one contract 2. Three Contracts
3. Object – to protect promisee 3. Object- security of the
against some loss creditor
4. Liability of indemnifier is 4. Liability of surety is
primary (A and B secondary
5. After surety paid, he steps in
5. After indemnifier paid the
the shoes of creditor and
holder, he cannot recover
can realize payments from
amount from anybody
Principal Debtor
Liability of Surety
• S 128- Liability of surety is coextensive with that of Principal debtor,
unless otherwise provided by contract.
• The liability is exactly the same as that of Principal Debtor. – creditor
can recover from surety all that he could recover from PD.
• Ex. A guaranteed to B payment of Bill of exchange by C. The bill is
dishonored by C. A is liable for dishonor amount as well as any other
interest or charges due.
• If liability of PD reduced – liability of surety reduces.
• Liability of PD not enforceable (illegal contract) – No liability of surety
1) Can creditor sue surety without exhausting remedies against PD?
• S 128- Liability of PD and surety coextensive.
• If PD defaults – creditor can sue either PD or Surety or Both.
• Creditor can sue surety even though not exhausted remedies against
PD.
• Unless the contract otherwise provides for.
• Bank of Bihar v Damodar Prasad AIR 1969
Plaintiff bank lent money to Damodar Prasad on guarantee of Paras
Nath Sinha. Loan neither paid by PD nor Surety.
Bank filed suit against them.
Decree passed in favour of bank- condition that bank enforce dues
against surety only after exhausting all remedies against PD.
SC overruled
• State Bank of India v Indexport Registered (1992) 3 SCC
Creditor must proceed against mortgaged property first and then only
against surety for balance.
Action against PD alone- Allowed
Suit against Surety alone – Allowed (Pradip D Kothari v Ceat Financial
Services Ltd
2) Condition Precedent
• Where condition precedent to surety liability – not liable unless condition
fulfilled.
• Co-surety- Where a debt has been guaranteed by more than one person
• S 144 – where a person gives guarantee upon a contract that creditor shall
not act until another person has joined as co-surety
• Guarantee not valid – if not joined
• National Provincial Bank of England v Brackenbury (1906)
Defendant signed guarantee intended to be joint with 3 persons. One did not
sign – No guarantee- Defendant not liable
• James Graham & Co. v Southgate Sands (1985)
• Signature of co-surety forged – surety not liable
 Rights of Surety

Principal Co-
Creditor
Debtor Surety

Subrogation (S-140) Securities (S-141) Effect of releasing surety (S-138)

Indemnity (S-145) Set off Right to contribution (S 146-147)

Right against Principal Debtor
1. Right of Subrogation (S-140)
• When principal debtor (PD) makes a default in payment, surety makes
payment.
• Surety becomes invested with all rights which creditor has against
Principal Debtor (PD)
• Surety steps into the shoes of the creditor – creditor has right to sue
the principal debtor.
• In subrogation surety may get some rights even before payment.
• Mamata Ghose v United Industrial Bank, AIR 1987
In a suit if defendant threatens or is about to dispose/remove his
property with intent to defraud creditors.
- Court may grant temporary injunction to restrain from removal.
• Babu Rao Ramchandra Rao V. Babu Manaklal Nehmal ,AIR 1939
• If the liability of the surety is coextensive with that of the principal
debtor, his right is not less coextensive with that of the creditor after
he satisfies the creditor’s debt.
• The surety may sue the PD in the rights of the C.
• Amritlal Goverdhan Lalan V. State Bank of Travancore, AIR 1968
• S.C – The S will be entitled to every remedy which the creditor had
against the P.D.
• Enforce every security- stand in the place of C , transfer the securities
to Him.
• The rights of the S are not merely upon the contract , but upon
natural justice.
2. Right to indemnity
• When principal debtor defaults & surety makes payment- implied
promise that debtor will pay back.
• Only sum that is rightfully paid but not for one paid wrongfully.
• Ex- a) B indebted to C. A is surety. C demand payment from A and A
refuses. C files suit. A defend suit having reasonable grounds but
compelled to pay debt.- can recover Cost + Principal Debt
• b) A not having reasonable grounds defends suit – can recover only
Debt, No Cost
• c) A guarantees to C, to extent of Rs 2000 payment for rice to be supplied to B. C
supplies less amount then Rs 2000 but obtains from A payment of sum of Rs 2000.
• A cannot recover from B more price.
• CK Aboobacker v KP Ayishu AIR (2000)
Kerala HC- guarantor liable for payment only to extent Principal Debtor has
defaulted. If substantial portion of loan has been paid – guarantor pay only balance
due.
• Supreme Leasing V. Low Chaun Heny, 1989
• Every contract of guarantee there is an implied promise by the PD to indemnify
the S.
• This right enables S to recover from PD sum rightfully paid.
Right against Creditor
1. Right to securities (S141)
Surety entitled to benefit of every security which creditor has against principal debtor.
Whether surety knows of the existence of security or not.
If creditor loses or without consent of surety parts with security – surety is discharged to the
extent of value of security.
Ex. A) C advances B, 2000 Rs on guarantee of A. C also has further security for Rs 2000 by
mortgage of ‘s furniture. C cancel mortgage. B becomes insolvent and C sues A on his guarantee.
A discharged from liability upto value of furniture
• Craythorne V. Swinburne, 1807
• This section incorporates the general rule of equity.
• S is entitled to every remedy which the C has against the PD, including enforcement of every
security.
• MP v Kaluram AIR 1967 SC 1105
• Surety has no right to securities which creditor obtained from Principal debtor after making
contract of guarantee.
• English law different- Surety entitle to benefit

• 2) Right of set-off
• If creditor sues surety, surety has benefit of set-off that PD had against creditor.
• Surety – counter claim
• Bechervaise V. Lewis , 1872
• C has in his hand something belonging to the PD , For which C could have counter claimed.
• Surety – counter claim
Right against co-surety
1) Right to contribution (S146 & S147)
S 146 Co-sureties liable to contribute equally where 2 or more persons
are co sureties for same debt – under same or different contracts- with
or without knowledge of each other.
Co-sureties in absence of contract to contrary – pay equal for debt

A B C D

Surety for Rs 3000 – Equally liable (Rs 1000/surety)

Right against co-surety

A B C D

Surety for Rs 1000

Contract – A=1/4, B=1/4, C=1/2
A= 1000 (1/4)- 250
B = 1000 (1/4)- 250
C = 1000 (1/2) - 500
• S 147 Co-sureties – bound to different sums liable to pay equally as far as limits
of their respective obligation permit
1) A, B, C surety
A-10,000 B-20,000 C- 40,000.
PD defaults – 30,000
A,B,C liable 10,000 each
2) PD defaults – 40,000
A-
B-
C-
3) PD defaults – 70,000
A-
B-
C-
• SBI V. Prem Dass ,AIR 1998
• Where there are several sureties for the same debt, PD defaults.
• Each S is liable to contribute equally to the extent of the default.
• Shirley V. Burdett, 1911
• If one co- surety has been compelled to pay more than his share, he can recover contribution
from his co – surety so as to equalize the loss as between all of them.
• An action for contribution will lie when one co- surety has paid more than his share of the
common liability.
2) Effect of releasing surety
S 138 Where there are co-sureties,
release by creditor of one does not discharge others,
Discharged surety responsible to other surety
Released surety liable to others for contribution in case of default.
Sri Chand V. Jagdish Parshad Kishan Chand , AIR 1966
• The released co- surety will remain liable to the others for
contribution in the event of default.
Continuing Guarantee
• S 129 A guarantee which extends to a series of transactions –
continuing guarantee
• Intended to cover number of transactions
• A) A, in consideration that B will employ C in collecting the rent of B ,
promises to be responsible upto 5000 Rs. For due collection and
payment of those rents.- Continuing guarantee
• B) A guarantee payment to B of five sacks of flour to be delivered by B
to C and to be paid for in a month. B delivers and C pays off.
Afterwards again delivers and C does not pay. A not liable – Not
continuing guarantee.
 Discharge of Surety

Variance in Creditor
Revocation compounds/
terms
give time to PD

Release/ Creditor
Death
Discharge Act/Omission
Discharge of surety
• Discharge – When liability of surety comes to an end or extinguishes.
• Modes of discharge:
1) Revocation by surety
S 130- A continuing guarantee may at any time be revoked by surety--
as to future transactions – by notice to the creditor.
• Surety liability continues to exist for transactions already made but is
revoked for ‘future transactions’.
• Future transactions- all transactions made subsequent to the notice.
2) By surety’s death (S131)
Death of surety operates, in absence of any contract to the contrary- as
a revocation of a continuing guarantee – with regards to the future
transactions.
Death of surety- automatic revocation – unless otherwise provided.
RK Dewan v State of U.P (2005)
Liability of legal heir only limited to the extent of property inherited.
3) By variance in terms of contract (S133)
Surety is discharged- without consent – creditor makes changes in
nature and the terms of contract.
When surety undertook liability on certain terms- expected remain
unchanged during whole period of guarantee.
Surety discharged as regards to the transactions subsequent to such a
change.
Not liable for altered contract.
• S - 133 Any variance made without surety’s consent in terms of the contract
between principal debtor and creditor, discharges surety as to transactions
subsequent to variance.
• Examples-
Bonar v Macdonald (1850)
• Defendant guaranteed conduct of a manager of a bank
• Bank raised salary – liability 1/4 of the losses
• No communication to the surety.
• Surety not liable.
Khatun bibi v Abdullah
• Payment of rent guaranteed and rent increased without consent of
the surety.
• Will the surety be discharged if no substantial or material variation or
is beneficial to the surety?
• MS Anirudhan v Thomco’s bank ltd. (1963)
• Defendant guaranteed repayment of loan of Rs 20,000 given by
plaintiff bank to Principal Debtor.
• Guarantee paper showed loan to be Rs 25,000.
• Bank refused to accept
• Principal the reduced the amount to Rs 20,000- without intimation to surety gave it to
the bank.
• PD- defaulted
• Whether alteration discharged him?
• Charan Singh v Security Finance Pvt Ltd (AIR 1988)
Effect of decree against surety.
Creditor obtained decree against PD and Surety- liable to pay
Creditor settlement with PD- accept less amount and not enforce decree against him for
balance.
Does not discharge Surety
S 133-139 apply where no decree passed.
4) By release or discharge of principal debtor ( S134)
• S 134 – The surety is discharged by any contract between the creditor
and principal debtor, by which PD is released or by any act or
omission of creditor – legal consequence is discharge of PD.
• Ex 1) A gives a guarantee to C for goods to be supplied by C to B. C
supplies goods to B and afterwards B becomes embarrassed and
contracts with the creditors to assign his property in consideration of
his releasing. Here B is released- Surety A is discharged.
• 2) A contracts with B to grow a crop of indigo on A land and to deliver
it to B at a fixed rate and C guarantees A performance of contract.
• B diverts stream of water which is necessary for irrigation of A’s land. And prevents
him from raising indigo. C not liable.
3) A contracts with B for fixed price to build a house for B within a stipulated time, B
supplying timber. C guarantee’s A performance. B omits to supply the timber – C
discharged.
S128 liability of surety is coextensive with the PD.
Hence if PD released surety will be discharged.
1) Release of PD
• Aypunni Mani v Devassy Kochouseph (AIR 1966)
Where liability of PD is reduced under the provisions of a statute- liability of surety
also diminishes.
• Maharashtra SEB v official liquidator (1982)
A discharge which the principal debtor may secure by operation of law
in bankruptcy (or in liquidation proceedings in the case of a company)
does not absolve the surety of his liability.
2) Act or Omission
Unity Finance Ltd v Woodcock (1963)
Where payment of rent due under a lease is guaranteed and creditor
terminates the lease – surety discharged.
5)When creditor compounds with, gives time to or agrees not to sue
the PD
• S 135- A contract between creditor and PD by which creditor makes a
composition with or promises to give time to, or not to sue, PD –
discharges the surety – unless surety assents to contract.
• 3 circumstances
1. Composition with PD
2. Promises to give time to PD
3. Promises not to sue PD
1. Composition with PD
• Means variation in original contract- discharge of surety
• A borrows 10,000 from B. C is surety. Thereafter A and B agree that A
may repay Rs 5000 instead of 10,000- Surety discharged.
2. Creditor promising to give time to PD
• Means extending period of payment – not contemplated in contract.
• Surety expects creditor take performance without delay.
• If time is given to PD- and later surety asked to repay- delay in his
reimbursement- prejudice surety
• Mahanth Singh U Ba Yi (AIR 1939)
Surety right to sue PD is interfered with.
• Kurian v the alleppey CCMS Society (AIR 1975)
• Amrit Lal v State Bank of Travancore (AIR 1968)
Agreement by creditor with PD to take payment in installments instead of
lumpsum amounts to giving time to PD- results in discharge
Agreement made with third person to give time to PD – not discharge surety
3. Creditor promising not to sue the PD-
Discharge of surety
Forbearance to sue- no discharge
The right to sue not extinguished in forbearance.
S 137 – Forbearance to sue does not discharge surety
Ex.
Until end of Limitation period?
English law – Carter v White (1883) (Not Discharged)
Mahanth Singh v U Ba YI AIR 1939
6) By creditor act or omission impairing surety eventual remedy
S139- If the creditor does any act which is inconsistent with the right of the
surety or omits to do any act which his duty to surety requires him to do,
and the eventual remedy of the surety is impaired – surety is discharged.
Ex. 1) A puts M as apprentice to B and gives a guarantee to B for M’s
fidelity. B promises on his part that he will M once a month.
B omits- M embezzles. A not liable.
2) B contracts to build ship for C – to be paid by installments. A becomes
surety for B’s performance. C without knowledge of A prepays to B last 2
installments. - A discharged.
3) C lends money to B. A becomes surety. B give power to C to sell furniture and
apply proceeds for discharge. C sells furniture – due to misconduct and willful
negligence – small price realized. – A not liable.
State Bank of India v Praveen Tanneries (1992)
• Surety discharged – bank couldn’t give security in the same condition as they
formerly stood.
Darwen & Pearce, Re (1927)
PD shareholder in a Company. Shares partly paid and payment of unpaid was
guaranteed by surety. PD defaulted-company forfeited shares.
Shares became property of Co.- deprived surety right to shares.
Surety discharged.
Bhumiputra Merchant Banker Berhad v Melewar Corpn (1990)
• Creditor owes to surety the duty of realizing proper value of securities
in case if he sells the same.
State Bank of Saurashtra v Chitranjan Rangnath Raja (1980)
• Bank granted loan on the security of stock in godown. Loan
guaranteed by surety. Goods lost from godown due negligence of
bank officials. Surety discharged to the extent of value of the stock
lost.
• Waiver of Rights
• T Raju Shetty v Bank of Baroda (Karnataka HC)
• UOI v Pearl Hosiery Mills AIR (1961) S133