CONTRACT OF GUARANTEE
GUARANTEE in Law of Contract
Introduction:
A person, who seeks to borrow money or to undertake some other obligation, may be required to pledge some property with the creditor as security.
But the creditor may be willing to lend money to a person if he can get some other person to assume personal liability as security for the payment of the loan or for the performance of the promised acts. In this case the creditor gives a loan to the debtor on the combined financial standing of the debtor and some third person, called the surety.
Definition of Contract of GUARANTEE:
According to Section 126 of Contract Act 1872:
“A contract of guarantee is a contract to perform the promise or
discharge the liability of a third person in case of his default”.
Parties:
There are three parties to a contract of guarantee:
1) Surety: The person who gives the guarantee.
2) Creditor: The person to whom the guarantee is given.
3) Principal Debtor: The person for whom the guarantee is
given.
Illustrations:
(a) A requests B to lend Rs. 5,000 to C and guarantees that C will repay
the amount within a stated time, and on C's failure to pay he will himself
pay to B, there is contract of guarantee,
(b) On the request of B, A promises to the employer of B that if B makes
a default he shall make good the same to him. There is a contract of
guarantee.
(c) If two come to a shop and one buys, and the other to give him credit,
promises the seller, “if he does not pay you, I will."
Essential Features of contract of guarantee:
The following are the essential features of contract of guarantee:
(1) Principal Contract:
The purpose of a guarantee is to secure a debt, the existence of a
recoverable debt is necessary. A contract of guarantee is an agreement
between the principal debtor, the creditor and the surety. The three
separate contracts exist between them. If the promise in the principal
contract is not fulfilled only then the liability of the guarantor arises.
In a contract of guarantee there should be someone liable as a principal
debtor and the surety should be liable on principal debtor’s default. It
is a Principal contract and not collateral.
Illustration:
X takes a loan of Rs. 5000 from Y on the guarantee of Z. The agreement
between X and Y is the principal contract and the contract between Y and Z
is a contract of a guarantee. The liability of Z to pay the amount will
arise only when X fails to repay the loan.
(2) Consideration:
A contract of guarantee, like every other contract must have essential
elements of a valid contract, e.g. free consent, legality of object,
competency of parties etc. It must also be supported by some
consideration. But there need not -be direct consideration between the
surety and the creditor and consideration received by the principal debtor
is sufficient for the surety. According to ‘section 127 of the Act,
Anything done, or any promise made, for the benefit of the principal
debtor, may be a sufficient consideration to the surety for giving the
guarantee.
Illustrations:
(a) B requests A to sell and deliver to him goods on credit. A
agrees to do so, provided C will guarantee the payment in consideration of
A’s promise to deliver the goods. This is a sufficient consideration for
C’s promise
(b) A sells and delivers goods to B. C afterwards requests A not to sue B
for the debt for a year, and promises that if he does so, C will pay for
them in default of payment by B. A agrees to forbear as requested. This is
a sufficient consideration for C’s promise.
(c) A Sells and delivers goods to B. C afterwards, without consideration,
agrees to pay for them in default of B. The agreement is void.
(3) No Misrepresentation:
According to Section 142, a guarantee obtained by means of
misrepresentation made by the creditor or with his knowledge and assent,
concerning a material part of the transaction, is invalid.
In a contract of guarantee, surety is entitled to know material facts of
the contract of guarantee. It is the duty of the creditor to disclose the
material facts about the contract and principal debtor, to the surety. If
the consent of surety will be obtained by misrepresentation, the surety
will be discharged from his liability.
Illustration: The defendant was invited to give a guarantee for the
honesty of a servant. The employer had already dismissed him for dishonesty,
but did not disclose this fact to the surety. The servant committed another
embezzlement. The surety was held not liable.
(4) Writing not necessary:
According to section 126, it is not necessary that contract of guarantee
must be in writing. It may be either oral or written.
Nature and Extent of Surety’s Liability:
Section 128 of the contract Act 1872 provides that the liability of the
surety is co-extensive with that of the principal debtor, unless it is
otherwise provided by the contract.
A surety’s liability is co-extensive with that of the principal debtor the
phrase co-extensive with that of principal debtor’ shows the quantum of the
surety’s liability, the quantum of obligation of a surety is the same as
that of a principal debtor, unless there is a contract to the contrary. In
general, it will be neither more nor less; the surety’s liability can be
made less than that of the principal debtor but never greater with special
contract.
Illustration: A guarantees to B the payment of a bill of exchange by
C, the acceptor. The bill is dishonored by C. A is liable not only for the
amount of the bill and interest thereon, but also for the notional charges
which may have been incurred for noting and protesting the bill.
Nature of Surety’s Liability:
The following are the rules regarding the nature of surety’s liability:
- The liability of a surety is secondary. It means that surety is liable only on default of the principal debtor.
- The liability of the surety arises immediately on the default of the principal debtor, unless there is an express provision in the contract that the creditor must file a suit against the principal debtor or must give notice of default to the surety. If the contract is the silent, the creditor may file a suit against the surety directly.
- Where a creditor holds securities from the principal debtor for his debt, the creditor need not first resort to these securities before suing the surety, unless otherwise agreed.
- The surety will not be liable where the creditor has obtained guarantee by misrepresentation.
- The law does not treat the principal debtor and surety as one person. It is not necessary that the surety will be liable only if the principal debtor is liable. One may be liable while the other may not be. For example:
- If some variation in the contract is done later on by the creditor and principal debtor, without surety’s consent, the surety is not liable while the principal debtor is liable.
- Any judgment obtained against the principal debtor will not be enforceable against the surety without any special agreement.
- A debt may become time-barred as against the principal debtor, but the surety may still be liable, if he stood surety at a later date.
- A discharge of the principal debtor by operation of Jaw e.g.; insolvency, does not discharge the surety.
- The surety is liable even if the contract between the creditor and the principal debtor is voidable at the option of the principal debtor and is avoided by him.
- The creditor cannot ask the surety to pay under the contract of guarantee unless the creditor has performed his part of the contract.
Kinds of Guarantee
A guarantee may be an “ordinary guarantee’ or a “continuing guarantee’ An
ordinary guarantee is different from a continuing guarantee.
(1) Ordinary Guarantee:
The guarantee which is given for a single specific debt or transaction is
called an “ordinary or specific guarantee’. It comes to an end as soon as
the liability under the transaction ends.
Illustrations:
(a) “I hereby agree to be answerable to K for the amount of 5 sacks of
flour to be delivered to T, payable in one month.” 5 sacks were supplied
and T paid for them. Further supply were made during the same month, for
which T failed to pay. The surety was then sued. The court held that it
was not a continuing guarantee there was no liability for parcels
delivered for various subsequent periods.
(b) I do hereby guarantee the payment of goods to be delivered in
umbrellas and parasols to J in the sum of pound 200.
(2) Continuity Guarantee:
According to section 129 A guarantee, which extends to a series of
transactions, is called continuing guarantee’. In other words-a guarantee
which covers a number of transactions over a period of time is called
continuing guarantee. It is just like a standing offer which is accepted
by the creditor every time a subsequent transaction takes
place.
Being a standing offer it may be revoked at any time by the surety as to
future transactions.
Illustration:
(1) A guarantees to C for B’s credit purchases with a running balance of
account not exceeding Rs. 5,000. This is a continuing
guarantee.
(2) A guarantees to C for B’s purchases from C for six months to the
extent of Rs. 5,000. This is a continuing guarantee.
Conclusion:
To conclude that a contract of guarantee is a contract to perform the
promise, to discharge the liability of a third person in case of his
default. The surety enjoys many
rights against principal debtor, creditor and co-sureties.