A contract where one person promises to discharge the liability of another person in case of the latter’s default. Section 126 of the Indian Contract Act, 1872 defines the Contract of Guarantee.
A contract of guarantee is between three parties, namely:
Creditor- The person to whom the guarantee is given.
Principal Debtor- One against whose default the guarantee is given. The debtor has the primary liability.
Surety- One who gives the guarantee. His liability kicks in right at the moment the debtor makes a default. This means the surety holds secondary liability.
Section 128 of the Indian Contract Act states that the liability of the surety is co-extensive with the liability of the principal debtor. For instance, the surety is liable for the same amount as is the debtor.
Essential Features of a Contract of Guarantee
Following are the essential features of a contract of guarantee.
- Can be Oral or Written: According to the provisions of Sec. 126 of the learned act, a guarantee may either be oral or written. English law demands a written contract with the signature of the parties, but it is not necessary for India.
- Consideration: A contract of guarantee must fulfil every essential of a valid contract, as every contract does. There must be some consideration between the parties. However, it is not essential for the creditor to have direct consideration with the surety and vice-versa. Section 127 says the consideration by the principal debtor is enough for the surety.
- Misrepresentation and Concealment: Any guarantee obtained by the creditor through misrepresentation and concealment of facts of the transaction is void. Section 142 of the Act deals with misrepresentation and Section 143 with the concealment of facts.
- Three-party Contract: It is an agreement between three different parties; surety, debtor and creditor. Three separate contracts exist among the parties.
- A contract between Principal Debtor and Creditor
- Between Surety and Creditor and
- Between Surety and Principal Debtor.
Rights of the Surety
Since a contract of guarantee is like any other contract, it can be discharged as well. Here is a list of circumstances under which the surety is no longer liable for the guarantee.
Against the Creditor
Section 133: The creditor cannot make changes to the contract between him and the debtor without the agreement of the surety. Any such changes will lead to the discharge of surety from his liability.
Section 134: Principal Debtor cannot be released of his liabilities by the creditor. If the latter does so, the surety will be released of his liabilities as well.
Section 135: An agreement between the creditor and principal debtor compounding the latter’s liability or promising time extension, discharges surety of his liability if he does not assent to such an agreement.
Section 139: Any act of the creditor which impairs surety’s remedy will discharge the latter of his liability.
Illustration- B contracts to build some cars for C in return for a given sum. The sum has to be paid in instalments as the work makes progress from one stage to the next. A becomes surety to C for B’s due performance of the contract. C, without letting A know, prepays the last three instalments to B. This prepayment discharges A (surety) of his liability.
Against Principal Debtor
Following are the rights of surety against the principal debtor in a contract of guarantee.
Section 140: The surety will step into the shoes of creditor after the payment to the earlier creditor in case the debtor makes a default. The surety will now have all the rights against the principal debtor which the creditor had. This is known as Right of Subrogation.
Section 145: The surety is entitled to recover from the principal debtor whatever sum he has legally paid to the creditor under the guarantee. This implied promise
Against the Co-Surities
Section 146: According to the provisions of the said section of the Indian Contract Act, if there’s any co-surety in the contract, it is equally liable to the contract. A co-surety is also entitled to recover from other surities if he has paid the amount which was beyond his share of the debt.
Section 147: It deals with the liability of co-surities bound in different sums. The co-surities who are bound in different sums are liable to pay equally as far as the limits of their respective obligation limits.