Contract of Guarantee
Section 126 of the Indian Contracts Act defines a contract of guarantee as A contract of guarantee is a contract to perform the promise or discharge the liability, of a third person in case of his default.
Furthermore, the section adds:
The person who gives the guarantee is called the surety, the person in respect of those defaults the guarantee is given called principal debtor, and the person to whom guarantee is given is called the creditor.
There are three parties in each guarantee contract, the principal creditor, the surety and the principal debtor.
A Contract of Guarantee consists 3 contracts:
- First, the principal debtor himself makes a commitment to fulfill a contract in favor of the creditor.
- Second, if the principal debtor makes a default, the surety undertakes to be liable to the creditor.
- Thirdly, the principal debtor’s implicit promise in support of the assurance that, in the event that the protection is obliged to discharge the responsibility of the principal debtor’s default, the principal debtor shall indemnify the protection for it.
Main features of contract of guarantee
- The contract can be either oral or in writing. Nevertheless, the assurance contract can only be in writing in English law.
- The guarantee contract presumes a principal liability or a discharge duty on the part of the principal debtor. Even if there is no such principal liability, one party agrees to pay another under such situations, and the enforcement of this obligation is not contingent on anyone else’s default, it is an indemnity contract.
- Sufficient consideration is to support the principal debtor. It is not necessary to have clear consideration between the creditor and the assurance that it is appropriate that the creditor has done anything for the good of the principle debtor.
- Assurance consent cannot be obtained by misrepresentation or cover of any material information relating to the transaction.
Differentiation between contract of indemnity and contract of guarantee
There is a difference between the two special types of contracts, contract of indemnity and contract of guarantee which is as follows: –
- In a contract of guarantee, there are three parties to a contract namely surety, principal debtor and creditor whereas in case of indemnity there are only two parties to a contract, promisor, and promisee.
- In case of the contract of guarantee, the liability of the surety is secondary whereas in a contract of indemnity the liability of promisor is primary.
- Surety provides guarantee only when requested by the principal debtor in a contract of guarantee. Indemnifier is not required to act at the request of the debtor, in a contract of indemnity.
- In a contract of guarantee, there is an existing liability for debt or duty, surety guarantees the performance of such liability. In a contract of indemnity, the possibility of incurring a loss is contingent against which indemnifier undertakes to indemnify.
- Surety is eligible to proceed against the principal debtor on payment of debt, in case principal debtor fails to pay the debt. Indemnifier cannot sue third parties in his own name.
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.
Revocation of Guarantee
- By surety by giving a notice of revocation for future transactions.
- On the death of surety. A continuing guarantee is revoked for all the future transactions due to the absence of a contract. However, his legal representatives will continue to be liable for transactions entered into before his death.
Solved Example for you
Write the circumstances when the contract of guarantee is invalid.
Answer: – Circumstances, when the contract of guarantee is invalid, are as follows:-
- The guarantee is obtained by misrepresentation of facts
- When the creditor obtains guarantee without disclosure of material facts or with the intention of committing fraud.
- When the contract is made on a condition that creditor shall not act upon until there enters a co-surety to a contract of guarantee and the other party fails to join.