Black laws dictionary defines the term guarantee as the assurance that a legal
contract will be duly enforced. A contract of guarantee is governed by
the Indian Contract Act,1872 and includes 3 parties in which one of the parties
acts as the surety in case the defaulting party fails to fulfill his
Contracts of guarantee are mostly required in cases when a party
requires a loan, goods or employment. The guarantor in such contracts assures
the creditor that the person in need may be trusted and in case of any default,
he shall undertake the responsibility to pay. Thus we can say contract of
guarantee is invisible security given to the creditor and shall be discussed
Section 126 in The Indian Contract Act, 1872
126. Contract of guarantee, surety, principal debtor and creditor
'contract of guarantee' is a contract to perform the promise, or discharge the
liability, of a third person in case of his default. The person who gives the
guarantee is called the 'surety'; the person in respect of whose default the
guarantee is given is called the 'principal debtor', and the person to whom the
guarantee is given is called the 'creditor'. A guarantee may be either oral or
A contract of guarantee
is a contract to perform the promise, or
discharge the liability, of a third person in case of his default. The person
who gives the guarantee is called the 'surety'; the person in respect of whose
default the guarantee is given is called the 'principal debtor', and the person
to whom the guarantee is given is called the 'creditor'. A guarantee may be
either oral or written."
Thus Here We Can Infer That There The 3 Parties To The Contract:
The one who borrows or is liable to pay and on whose default
the guarantee is given.
The party 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.
The person who gives the guarantee to pay in case of default
of the principal debtor
Also, we can understand that a contract of guarantee is a secondary contract
that emerges from a primary contract between the creditor and the principal
Ankita advances a loan of INR 70000 to Pallav. Srishti who is the boss of Pallav
promises that in case Pallav fails to repay the loan, then she will repay the
same. In this case of a contract of guarantee, Ankita is the Creditor, Pallav
the principal debtor and Srishti is the Surety.
A contract of guarantee may either be oral or written. It may be express or
implied from the conduct of parties.
In P.J. Rajappan v Associated Industries(1983) the guarantor, having not signed
the contract of guarantee, wanted to wriggle out of the situation. He said that
he did not stand as a surety for the performance of the contract. Evidence
showed the involvement of the guarantor in the deal and had promised to sign the
The Kerala High Court held that a contract of guarantee is a
tripartite agreement, involving the principal debtor, surety and the creditor.
In a case where there is evidence of the involvement of the guarantor, the mere
failure on his part in not signing the agreement is not sufficient to demolish
otherwise acceptable evidence of his involvement in the transaction leading to
the conclusion that he guaranteed the due performance of the contract by the
principal debtor. When a court has to decide whether a person has actually
guaranteed the due performance of the contract by the principal debtor all the
circumstances concerning the transactions will have to be necessarily
Essentials of a Contract of Guarantee
Must be made with the agreement of all three partiesAll the three parties to the contract i.e the principal debtor, the creditor,
and the surety must agree to make such a contract with the agreement of each
other. Here it is important to note that the surety takes his responsibility to
be liable for the debt of the principal debtor only on the request of the
principal debtor. Hence communication either express or implied by the principal
debtor to the surety is necessary. The communication of the surety with the
creditor to enter into a contract of guarantee without the knowledge of the
principal debtor will not constitute a contract of guarantee.
Sam lends money to Akash. Sam is the creditor and Akash is the principal debtor.
Sam approaches Raghav to act as the surety without any information to Akash.
Raghav agrees. This is not valid.
ConsiderationAccording to section 127 of the act, anything is done or any promise made for
the benefit of the principal debtor is sufficient consideration to the surety
for giving the guarantee. The consideration must be a fresh consideration given
by the creditor and not a past consideration. It is not necessary that the
guarantor must receive any consideration and sometimes even tolerance on the
part of the creditor in case of default is also enough consideration.
In State Bank of India v Premco Saw Mill(1983), the State Bank gave notice to
the debtor-defendant and also threatened legal action against her, but her
husband agreed to become surety and undertook to pay the liability and also
executed a promissory note in favor of the State Bank and the Bank refrained
from threatened action. It was held that such patience and acceptance on the
bank's part constituted good consideration for the surety.
LiabilityIn a contract of guarantee, the liability of a surety is secondary. This means
that since the primary contract was between the creditor and principal debtor,
the liability to fulfill the terms of the contract lies primarily with the
principal debtor. It is only on the default of the principal debtor that the
surety is liable to repay.
Presupposes the existence of a DebtThe main function of a contract of guarantee is to secure the payment of the
debt taken by the principal debtor. If no such debt exists then there is nothing
left for the surety to secure. Hence in cases when the debt is time-barred or
void, no liability of the surety arises. The House of Lords in the Scottish case
of Swan vs. Bank of Scotland (1836) held that if there is no principal debt, no
valid guarantee can exist.
Must contain all the essentials of a valid contractSince a contract of guarantee is a type of contract, all the essentials of a
valid contract will apply in contracts of guarantee as well. Thus, all the
essential requirements of a valid contract such as free consent, valid
consideration offer, and acceptance, intention to create a legal relationship
etc are required to be fulfilled.
No Concealment of FactsThe creditor should disclose to the surety the facts that are likely to affect
the surety's liability. The guarantee obtained by the concealment of such facts
is invalid. Thus, the guarantee is invalid if the creditor obtains it by the
concealment of material facts.
No MisrepresentationThe guarantee should not be obtained by misrepresenting the facts to the surety.
Though the contract of guarantee is not a contract of Uberrima fides i.e., of
absolute good faith, and thus, does not require complete disclosure of all the
material facts by the principal debtor or creditor to the surety before he
enters into a contract. But the facts, that are likely to affect the extent of
surety's responsibility, must be truly represented
Kinds of Guarantee
Contracts of guarantees may be classified into two types:
Specific guarantee and
continuing guarantee. When a guarantee is given in respect of a single debt or
specific transaction and is to come to an end when the guaranteed debt is paid
or the promise is duly performed, it is called a specific or simple guarantee.
However, a guarantee which extends to a series of transactions is called a
continuing guarantee . The surety's liability, in this case, would continue till
all the transactions are completed or till the guarantor revokes the guarantee
as to the future transactions.
- S is a bookseller who supplies a set of books to P, under the contract
that if P does not pay for the books, his friend K would make the payment.
This is a contract of specific guarantee and K's liability would come to an end, the
moment the price of the books is paid to S.
- On M's recommendation S, a wealthy landlord employs P as his estate
manager. It was the duty of P to collect rent every month from the tenants
of S and remit the same to S before the 15th of each month. M, guarantee
this arrangement and promises to make good any default made by P. This is a
contract of continuing guarantee.
A continuing guarantee is defined under of the Indian Contract Act,1872. A
continuing guarantee is a type of guarantee which applies to a series of
transactions. It applies to all the transactions entered into by the principal
debtor until it is revoked by the surety. Therefore Bankers always prefer to
have a continuing guarantee so that the guarantor's liability is not limited to
the original advances and would also extend to all subsequent debts.
The most important feature of a continuing guarantee is that it applies to a
series of separable, distinct transactions. Therefore, when a guarantee is given
for an entire consideration, it cannot be termed as a continuing guarantee.
K gave his house to S on a lease for ten years on a specified lease rent. P
guaranteed that S, would fulfill his obligations. After seven years S stopped
paying the lease rent. 'K sued him for the payment of rent. P then gave a notice
revoking his guarantee for the remaining three years. P would not be able to
revoke the guarantee because the lease for ten years is an entire indivisible
consideration and cannot be classified as a series of transactions and hence is
not a continuing guarantee.
Revocation of Continuing Guarantee
So far as a guarantee given for an existing debt is concerned, it cannot be
revoked, as once an offer is accepted it becomes final. However, a continuing
guarantee can be revoked for future transactions. In that case, the surety shall
be liable for those transactions which have already taken place.
A contract of guarantee can be revoked in the following two ways:
- By giving a Notice
Continuing guarantees can be revoked by giving notice to the Creditor but this
applies only to future transactions. Just by giving a notice the surety cannot
waive off his responsibility and still remains liable for all the transactions
that have been placed before the notice was given by him. If the contract of
guarantee includes a clause that a notice of a certain period of time is
required before the contract can be revoked, then the surety must comply with
the same as said in Offord v Davies (1862).
A guarantees to B to the extent of Rs. 10,000, that C shall pay for all the
goods bought by him during the next three months. B sells goods worth Rs. 6,000
to C. A gives notice of revocation, C is liable for Rs. 6,000. If any goods are
sold to C after the notice of revocation, A shall not be, liable for that.
By Death of SuretyUnless there is a contract to the contrary, the death of surety operates as a
revocation of the continuing guarantee in respect to the transactions taking
place after the death of surety due to the absence of a contract. However, his
legal representatives will continue to be liable for transactions entered into
before his death.
The estate of deceased surety is, however, liable for those
transactions which had already taken place during the lifetime of the deceased.
Surety's estate will not be liable for the transactions taking after the death
of surety'even if the creditor had no knowledge of surety's death.
Period of Limitation
The period of limitation of enforcing a guarantee is 3 years from the date on
which the letter of guarantee was executed. In State Bank Of India vs Nagesh
Hariyappa Nayak And Ors
, against the advancement of a loan to a company, the
guarantee deed was executed by its directors and subsequently a letter
acknowledging the load was issued by same directors on behalf of the company. It
was held that the letter did not have the effect of extending the period of
limitation. Recovery proceedings instituted after three years from the date of
the deed of guarantee were liable to be quashed.
Rights of a Surety
After making a payment and discharging the liability of the principal debtor,
the surety gets various rights. These rights can be studied under three heads:
- Rights against the, principal debtors.
The right of surety on payment of debt or the Right of subrogationThe right of subrogation means that since the surety had given a guarantee to
the creditor and the creditor after getting the payment is out of the scene, the
surety will now deal with the debtor as if he is a creditor. Hence the surety
has the right to recover the amount which he has paid to the creditor which may
include the principal amount, costs and the interest.
The right of IndemnityIn every contract of guarantee, there is an implied promise by the principal
debtor to indemnify the surety, and the surety is entitled to recover from the
principal debtor whatever sum he has rightfully paid under the guarantee. This
is because the surety has suffered a loss due to the non-fullfillment of promise
by the principal debtor and therefore the surety has a right to be compensated
by the debtor
Luthra and co has taken a loan from Khaitan and co where Amarchand acts as
security on behalf of Luthra. Khaitan demands payment from Amarchand and on his
refusal sues him for the amount, Amarchand defends the suit having reasonable
grounds for doing so, but he is compelled to pay the amount of the debt with
costs. He can recover from Luthra the amount paid by him for costs, as well as
the principal debt.
Rights against the creditor
- Right to securities given by the principal debtor
On the default of payment by the principal debtor, when the surety pays off the
debt of the principal debtor he becomes entitled to claim all the securities
which were given by the principal debtor to the creditor. The Surety has the
right to all securities whether received before or after the creation of the
guarantee and it is also immaterial whether the surety has knowledge of those
securities or not.
On the guarantee of Priya, Anita lent rs 100000 to Sita. This debt is also
secured by security for the debt which is the lease of Sita's house. Sita
defaults in paying the debt and Priya has to pay the debt. On paying off Sita's
liabilities Priya is entitled to receive the lease deed in her favor.
Right to set offWhen the creditor sues the surety for the payment of principal debtor's
liabilities, the surety can claim set off, or counterclaim if any, which the
principal debtor had against the creditor.
Rights against the co-sureties
- Release of one co-surety does not discharge others
When the repayment of debt of the principal debtor is guaranteed by more than
one person they are called Co-sureties and they are liable to contribute as
agreed towards the payment of guaranteed debt. The release by the creditor of
one of the co-sureties does not discharge the others, nor does it free the
released surety from his responsibility to the other sureties.
Thus when the
payment of a debt or performance of duty is guaranteed by co-sureties and the
principal debtor has defaulted in fulfilling his obligation and thus the
creditor compels only one or more of the co-sureties to perform the whole
contract, the co-surety sureties performing the contract are entitled to claim
contribution from the remaining co-sureties.
Co-sureties to contribute equallyAccording to Section 146, in the absence of any contract to the contrary, the
co-sureties are liable to contribute equally. This principle will apply even
when the liability of co-sureties is joint or several, and whether under the
same or different contracts, and whether with or without the knowledge of each
A, B, C, and D are co-sureties for a debt of Rs. 2,0000 lent by Z to R. R
defaults in repaying the loan. A, B, C, and D are liable to contribute Rs. 5000
Liability of co-sureties bound in different sumsWhen the co-sureties have agreed to guarantee different sums, they have to
contribute equally subject to the maximum of the amount guaranteed by each one.
A, B and C, sureties for D, enter into three separate bonds, each in a different
penalty, A for Rs. 10,000, B for Rs. 20,000 and C for Rs. 40,000. D makes
default to the extent of Rs. 30,000. A B and C are liable to pay Rs. 10,000
each. Suppose this default was to the extent of Rs. 40,000. Then A would be
liable for Rs. 10,000 and B and C Rs. 15,000 each.
Discharge of Surety from LiabilityUnder any of the following circumstances a surety is discharged from his
- by the revocation of the contract of guarantee,
- by the conduct of the creditor, or
- by the invalidation of the contract of guarantee
We have already discussed above the first circumstance in which how a surety can
be discharged i.e by Revocation of the Contract of Guarantee. This includes by
giving notice or death or the surety.
Conduct of the Creditor
- Variance in terms of the contract
When a contract of guarantee has been materially altered through an agreement
between the creditor and principal debtor, the surety is discharged from his
liability. This is because a surety is liable only for what he has undertaken in
the guarantee and any alteration made without the surety's consent will
discharge the surety as to transactions subsequent to the variation.
A becomes surety to C for B's conduct as a manager in C's bank. Afterward, B and
C contract, without A' s consent, that B' s salary shall be raised, and that he
shall become liable for one-fourth of the losses on overdrafts. B allows a
customer to over-draw, and the bank loses a sum of money. A is discharged from
his suretyship by the variance made without his consent and is not liable to
make good this loss.
Release or discharge of the principal debtorA surety is discharged if the creditor makes a contract with the principal
debtor by which the principal debtor is released, or by any act or omission of
the creditor, which results in the discharge of the principal debtor.
A supplies goods to B on the guarantee of C. Afterwards B becomes unable to pay
and contracts with A to assign some property to A in consideration of his
releasing him from his demands on the goods supplied. Here, B is released from
his debt, and C is also discharged
from his suretyship. But, where the principal debtor is discharged of his debt
by operation of law,
say, on insolvency, this will not operate as a discharge of the surety.
Arrangement between principal debtor and creditor
According to section 135 when the creditor, without the consent of the surety,
makes an arrangement with the principal debtor for composition, or promise to
give him time to, or not to sue him, the surety will be discharged.
However, when the contract to allow more time to the principal debtor is made
between the creditor and a third party, and not with the principal debtor, the
surety is not discharged.
C, the holder of an overdue bill of exchange drawn by A as surety for B, and
accepted by B, contracts with M to give time to B, A is not discharged.
Loss of securityIf the creditor parts with or loses any security given to him at the time of the
guarantee, without the consent of the surety, the surety is discharged from
liability to the extent of the value of the security.
A, as surety for B, makes a bond jointly with 3 to C to secure a loan from C to
B. Later on, C obtains from B further security for the same debt. Subsequently,
C gives up further security. A is not discharged.
By Invalidation of the Contract
A contract of guarantee, like any other contract, may be avoided if it becomes
void or voidable at the option of the surety. A surety may be discharged from
liability in the following cases:
- Guarantee obtained by misrepresentation
When a misrepresentation is made by the creditor or with his knowledge or
consent, relating to a material fact in the contract of guarantee, the contract
Guarantee obtained by concealmentWhen a guarantee is obtained by the creditor by means of keeping silence
regarding some material part of circumstances relating to the contracts, the
contract is invalid
Failure of co-surety to join a suretyWhen a contract of guarantee provides that a creditor shall not act on it until
another person has joined in it as a co-surety, the guarantee is not valid if
that other person does not join.
Extent of a surety's liabilityIn the absence of a contract to the contrary, the liability of a surety is
co-extensive with that of the liability of the principal debtor. It means that
the surety is liable to the same extent to which the principal debtor is liable.
A guarantees to B the payment of a bill of exchange by C, the acceptor. On the
due date, 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.
The contract of guarantee is a specific contract for which the Indian Contract
Acy has laid some rules. As we have discussed, the basic function of a contract
of guarantee is to protect the creditor from loss and to give him confidence
that the contract will be enforced with the promise of the surety. Every
contract of guarantee has three parties and there exist two types of guarantees
i.e specific guarantee and continuing guarantee.
The type of Guarantee used
depends on the situation and the terms of the contract. The surety has some
rights against the other parties and liability of the surety is considered to be
co-extensive with that of the principal debtor unless it is otherwise provided
by the contract. In case the contracts are entered into by misrepresentation
made by the creditor regarding material circumstances or by concealment of
material facts by the creditor, the contract will be considered invalid.