A contract of guarantee is a specific contract. It is a contract to perform the promise, or discharge the liability, of a third person in case of his default. A guarantee may be either oral or written. The contract of guarantee is also called as contract of surety. It specifically provides that a guarantee need not be in writing, it may be oral.
2) Definition of Contract of Guarantee :
Sec. 126 of the Indian Contract Act, 1872 provides the definition of Contract of Guarantee, surety, principle debtor and creditor 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.
- Surety - The person who gives the guarantee is called the "surety"
- Principle debtor - The person in respect of whose default the guarantee is given is called the "principal debtor".
- Creditor - The person to whom the guarantee is given is called the "creditor".
The English law defines a ‘guarantee’ as a ‘promise to answer for the debt, default or miscarriage of another’.
3) Essential Ingredients of Contract of Guarantee :
i) It is a contract comprising a promise to perform-a) Promise of third party
b) Discharge the liability of the third party
ii) Performance arises in case of the default of the third party
iii) Guarantee may be oral or written
iv) There must be three parties i.e. surety, principle, debtor, and creditor.
4) Function of Guarantee - The main function of a contract of guarantee is to enable a person to get a loan or goods on credit or on employment. The guarantee may be given for
i) The repayment of loan/debt, orii) The repayment of price of the goods sold on credit, or
iii) The good conduct or honesty of a person employed in a particular office.
5) Nature of Contract of Guarantee-
- The contract of guarantee has to be clear.
- A guarantee is an undertaking to indemnity if some other person does not fulfill his promise.
- The liability under the contract of guarantee is conditional on the default of the principle debtor and hence does not amount to a ‘promise to pay’.
- In India, a contract of guarantee may be oral or written. It may even be inferred from the course of conduct of the parties concerned.
- Under English Law, a guarantee is defined as a promise made by one person to another to be collaterally answerable for the debt, default or miscarriage of the third person and has to be in writing.
- There are three parties in a contract of guarantee; the creditor, the principal debtor, and the surety.
- In a contract of guarantee, there are two contracts; the Principal Contract between the principal debtor and the creditor as well as the Secondary Contract between the creditor and the surety.
- The contract of the surety is not contract collateral to the contract of the principal debtor but is an independent contract. Liability of surety is secondary and arises when the principal debtor fails to fulfill his commitments. Even an acknowledgment of debt by the principal debtor will bind the surety.
- A contract of guarantee is to be enforced according to the terms of the contract.
6) Kinds of Contract of Guarantee-
i) Specific or simple guarantee- when a guarantee is given for a single transaction or a debt, it is called as a specific or simple guarantee. Such guarantee stands discharged when the debt is duly rapid or the promise is duly performed.
ii) Continuing guarantee- when a guarantee extends to a series of transactions is called a continuing guarantee. Such a guarantee remains in existence until it is revoked.
7) Liability of surety-
The nature and extent of the liability of the surety is dependent on the number of sureties- a) a sole surety or b) co-sureties
a) Sureties liability (Sec.128) - The liability of the surety is co-extensive with that of the principle debtor, unless it is otherwise provided by the contract.
Illustration :
‘A’ guarantees to ‘B’ the payment of bill of exchange by ‘C’, the acceptor. 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.b) Co-sureties liable to contribute equally (Sec.146)-
Where two or more persons are co-sureties for the same debt or duty, either jointly or severally, and whether under the same or different contracts, and whether with or without the knowledge of each other, the co-sureties, in the absence of any contract to the contrary, are liable, as between themselves, to pay each an equal share of the whole debt, or of that part of it which remains unpaid by the principal debtor.
Illustration :
i) A, B and C, as sureties to D, for the sum of 3000 rupees lent to E. E makes default in payment. A, B and C are liable, as between themselves, to pay 1000 rupees each.
ii) B and C are sureties to D for the sum of 1000 rupees lent to E, and there is a contract between A, B and C that A is to be responsible to the extent of one-quarter, B to the extent of one-quarter, and C to the extent of one-half. E makes default in payment. As between the sureties, A is liable to pay 250 rupees, B 250 rupees and C 500 rupees.
c) Liability of co-sureties bound in different sums (Sec.147)- Co-sureties who are bound in different sums are liable to pay equally as far as the limits of their respective obligations permit.
Illustration :
i) A, B and C as sureties to D, enter into three several bonds, each in different penalty, namely A for 10000 Rs, B for 20000 Rs, and C for 30000 Rs with E. D makes a default on 30000 Rs. All of them are liable for 10000 Rs each.ii) A, B and C as sureties to D, enter into three several bonds, each in different penalty, namely A for 10000 Rs, B for 20000 Rs, and C for 40000 Rs with E. D makes a default on 70000Rs. A, B and C are liable for the full amount of their bonds.
8) Discharge of surety from liability - A surety is said to be discharged from liability when his liability comes to an end. Indian Contract Act 1872 specifies the following conditions in which a surety is discharged of his liability-
i) By a notice of revocation - Sec.130 of Revocation of continuing guarantee states that- A continuing guarantee may at any time be revoked by the surety, as to future transactions, by notice of the creditor.
Once the guarantee is revoked, the surety is not liable for any future transaction however he is liable for all the transactions that happened before the notice was given.
Illustrations :
a) ‘A’ in consideration of ‘B’s discounting, at A’s request, bills of exchange for ‘C’ guarantees to ‘B’, for twelve months, the due payment of all such bills to the extent of Rs. 5,000. ‘B’ discounts bills for ‘C’ to the extent of Rs. 2,000. Afterwards, at the end of three months, ‘A’ revokes the guarantee. This revocation discharges ‘A’ From all liability to ‘B’ for any subsequent discount. But ‘A’ is liable to ‘B’ for the Rs. 2,000, on default of ‘C’.
b) ‘A’ guarantees to ‘B’, to the extent of the Rs. 10,000, that ‘C’ shall pay all the bills that ‘B’ shall draw upon him. ‘B’ draws upon ‘C’. ‘C’ accepts the bill. ‘A’ gives notice of revocation. ‘C’ dishonors the bill at maturity. ‘A’ is liable upon his guarantee.
ii) By death of surety (Sec.131) - The death of the surety operates, in the absence of any contract to the contrary, as a revocation of a continuing guarantee, so far as regards future transactions.
The death of the surety acts as a revocation of a continuing guarantee with regards to future transactions, if there is no contract to the contrary.
iii) By variance in terms of contract (Sec.133) - Any variance, made without the surety's consent, in the terms of the contract between the principal [debtor] and the creditor, discharges the surety as to transactions subsequent to the variance.
A variance made without the consent of the surety in terms of the contract between the principal debtor and the creditor, discharges the surety as to the transactions after the variance.