Contract of Guarantee

Contract of guarantee has been defined under section 126 of the Indian Contract Act, 1872. Provisions relating to the contract of the guarantee are provided in Chapter VIII and under sections 126 to 147 of the Indian Contract Act, 1872.

Table of Contents

Contract of Guarantee

Meaning and Definition of a Contract of Guarantee

Meaning and definition of a contract of guarantee have been given under section 126 of the Indian Contract Act, 1872. A contract of guarantee is defined as a contract to perform the promise or discharge the liability of the defaulting party in case he fails to fulfil his promise.

What is a contract of guarantee? As per the definition of a contract of guarantee, there are three parties involved in the contract of guarantee and they are;

1. Principal Debtor: – The principal debtor is one who borrows or is liable to pay and on whose default the guarantee is given.

2. Creditor: – The creditor is the party to the contract 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.

3. Surety/Guarantor: – Surety is the party to the guarantee contract who gives the guarantee to pay in case of default of the principal debtor.

In the contract of guarantee, 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.

Thus, there is a contract between the creditor and principal debtor and another contract between the creditor and surety for default of payment by the principal debtor.

Illustration: – Suraj advances a loan of Rs. 10,000/- to Niraj and Niraj agreed to return the loan within a reasonable time. Akash who is the boss of Niraj promises Suraj that in case Niraj fails to repay the load within a reasonable time then he will reimburse the said loan amount to Suraj. This is the contract of guarantee. In this example, Suraj is the creditor, Niraj is the principal debtor and Akash is the surety.

Moreover, the guarantee contract can be in the form of either oral or written. It may be express or implied from the conduct of the parties to the contract of guarantee.

Essential Elements of Contract of Guarantee

Agreement Between Three Parties

In the contract of guarantee, all the three contracting parties must be involved i.e. the principal debtor, the creditor and the surety.

In between, these contracting parties there should be three contracts i.e. primary contract between the creditor and principal debtor and the contract between the creditor and surety and the third contract between the principal debtor and surety. Here, it is essential that the surety takes his responsibility to be liable for the debt which is taken by the principal debtor only at the request of the principal debtor.

But, the communication of the surety with the creditor to enter into a contract of guarantee without the knowledge of the principal debtor, then there is no valid contract of guarantee.

Illustration: – A lends a loan to B of Rs. 10,000/-. Here, A is the creditor and B is the principal debtor. A approaches C to act as a surety for B without any information given to B who is the principal debtor. Therefore, this does not constitute a valid contract of guarantee.

Valid Consideration

According to section 127 of the Indian Contract Act, 1872, Anything done or any promise given for the benefit of the principal debtor is a valid consideration to the surety for giving the guarantee.

The consideration in the contract of a guarantee must be a fresh consideration given by the creditor and not a past consideration. Further, it is not necessary that the surety must receive any consideration out of the contract of guarantee and sometimes even tolerance on the part of the creditor in case of default is also enough consideration.

In the case of State Bank of India v/s Premco Saw Mill, 1983, it was held that the State Bank has given notice to the debtor and also threatened legal action against her if the debt amount is not repaid within some days. But, her husband agreed to become surety and undertook to pay the liability of the debtor and also executed the promissory note for the same in favour of the State Bank.

It was held by the court that such patience and acceptance on the side of the State Bank constituted a good consideration for the surety.

Liability

In the contract of guarantee, the liability lies on the principal debtor as there is the primary contract between the principal debtor and the creditor. And, the liability of the surety is a secondary one, because the surety is made liable only on the default of the principal debtor to repay the loan amount.

Existence of Debt

The main purpose of the contract of guarantee is to secure the payment of a debt which is taken by the principal debtor. Therefore, if there is no existence of debt then there is nothing left for the security to secure by the surety.

Hence, in the cases where the debt taken by the principal debtor is time-barred or void then no liability of the surety arises. And, their contract of guarantee could not be constituted.

Must be a Valid Contract

As we have already seen, the contract of guarantee is the type of contract and all the essential elements of a valid contract will apply in the contract of guarantee.

Therefore, all the essentials of a valid contract such as offer and acceptance, free consent, competency of parties, valid consideration, and intention to create a legal relationship etc. are required to be fully filled in the contract of guarantee.

No Concealment of Facts

In the contract of guarantee, the creditor or principal debtor should disclose all the reasonable material facts to the surety, that due to such concealment of facts are likely to affect the liability of surety. Therefore, if the creditor/principal debtor obtains the surety by the concealment of such facts is invalid.

No Misrepresentation

In a contract of guarantee, the guarantee should not be obtained by misrepresenting the facts to the surety. Though it is not necessary to disclose all the material facts but the facts that are likely to affect the liability of the surety then such facts must be represented truly.

FAQ

What are the elements of a contract of guarantee?

All the essentials of a valid contract such as offer and acceptance, free consent, competency of parties, valid consideration, and intention to create a legal relationship etc. are required to be fully filled in the contract of guarantee.

What are the three parties in guarantee?

In the contract of guarantee, all the three contracting parties must be involved i.e. the principal debtor, the creditor and the surety.

How many contracts are there in a contract of guarantee?

For these contracting parties, there should be three contracts i.e. primary contract between the creditor and principal debtor and the contract between the creditor and surety and the third contract between the principal debtor and surety.

What is the purpose of a guarantee?

Conclusion

Referred Books:

Contract of Guarantee

Contract of Guarantee

Meaning and Definition of a Contract of Guarantee