GUARANTEE

Definition

A contract of guarantee is a contract to perform the promise, or discharge the liability, of a third person in case of his default. 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.

Parties involved in the contract of guarantee

1. Principal Debtor– The person in respect of whose default the guarantee is given is called the principal debtor. 
2. Creditor– The person to whom the guarantee is given is called the creditor.
3. Surety– The person who gives the guarantee is called the surety.

Essential features of Guarantee

I) Secondary Obligation: A guarantee is a secondary obligation, which means that it is a collateral or ancillary obligation to support the primary obligation of another person, called the principal debtor. The guarantor promises to fulfill the obligation of the principal debtor if the latter fails to do so.

II) Tripartite Relationship: A guarantee involves a tripartite relationship between the creditor, the principal debtor, and the guarantor. The creditor is the person to whom the principal debtor owes the primary obligation, and the guarantor promises to fulfill that obligation in case of default by the principal debtor.

III) Conditional Nature: The liability of the guarantor is conditional upon the default of the principal debtor. The guarantor is liable to pay only when the principal debtor fails to fulfill the primary obligation.

IV) Written Instrument: A guarantee must be in writing and signed by the guarantor. The written instrument must clearly state the terms and conditions of the guarantee, including the amount guaranteed, the time period of the guarantee, and the nature of the primary obligation.

V) Co-extensive Liability: The liability of the guarantor is co-extensive with that of the principal debtor, which means that the guarantor is liable to pay the full amount of the debt owed by the principal debtor.

VI) Continuing Nature: Unless otherwise specified in the guarantee, the liability of the guarantor is a continuing one, which means that it remains in force until the primary obligation is fulfilled or until the guarantee is revoked by the guarantor.

Kinds of guarantee

There are several kinds of guarantees recognized under the Indian Contract Act, 1872. The main types of guarantees are as follows:

i. Specific Guarantee: A specific guarantee is a guarantee that is given for a specific transaction or purpose. For example, a person may give a specific guarantee to a bank for a loan taken by his friend.

ii. Continuing Guarantee: A continuing guarantee is a guarantee that remains in force until it is revoked by the guarantor. For example, a person may give a continuing guarantee to a supplier for all future transactions with his company.

iii. Oral or written guarantee – Under the Indian Contract Act, 1872, a guarantee must generally be in writing to be enforceable. However, there are some exceptions to this rule. An oral guarantee may be enforceable in certain situations, but it can be difficult to prove the terms and conditions of the guarantee without written evidence.

In case of an oral guarantee, it is important to have some form of evidence to prove the existence and terms of the guarantee.

Nature of surety’s liability

• 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 primary, meaning that they are directly responsible for the debt or obligation. If the principal debtor defaults, the creditor can pursue the surety for payment without first attempting to collect from the principal debtor.
• In some cases, a surety’s liability may be limited by the terms of the agreement. For example, the surety may only be responsible for a portion of the debt or obligation, or for a limited period of time.
• A surety’s liability may be discharged in a variety of ways, such as by performance of the debt or obligation, by release or discharge of the principal debtor, or by the creditor’s release of the surety.

Rights of surety

(I) Right against the principal debtor– These rights are as follows:

i. Right to indemnity: A surety has a right to be indemnified by the principal debtor for any losses they incur as a result of having to pay the debt or obligation. This means that the principal debtor must reimburse the surety for any payments made to the creditor.

ii. Right of subrogation: When a surety pays off the debt or obligation of the principal debtor, they have the right of subrogation. This means that the surety can take over the rights and remedies of the creditor against the principal debtor to recover the amount paid.

iii. Right to demand security: A surety may have the right to demand security from the principal debtor to guarantee their obligation as a surety. If the principal debtor fails to provide security, the surety may be discharged from their obligation.

(II) Rights against the creditor–

i. Right to set-off: If the creditor owes the principal debtor any money, the surety may have the right to set off that debt against the amount owed to the creditor by the surety.

ii. Right to securities: A surety is entitled to the benefit of every security which the creditor has against the principal debtor at the time when the contract of suretyship is entered into, whether the surety knows of the existence of such security or not; and if the creditor loses, or,without the consent of the surety, parts with such security, the surety is discharged to the extent of the value of the security.

Discharge of surety

A surety is a person who agrees to be responsible for the debt or obligation of another person (the principal debtor) in the event that the debtor defaults on their obligation. Once the principal debtor has fulfilled their obligation, the surety’s obligation is discharged. 

Modes of discharge of surety

1) By revocation of guarantee–

• A continuing guarantee may at any time be revoked by the surety, as to future transactions, by notice to the creditor.
• 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.

2) By conduct of creditor

• Any variance, made without the surety consent, in the terms of the contract between the principal debtor and the creditor, discharges the surety as to transactions subsequent to the variance.
• Discharge of surety by release or discharge of principal debtor
• Discharge of surety when creditor compounds with, gives time to, or agrees not to sue,principal debtor
• Discharge of surety by creditor’s act or omission impairing surety’s eventual remedy.

3) By invalidation of contract

• Any guarantee which has been obtained by means of misrepresentation made by the creditor, or with his knowledge and assent, concerning a material part of the transaction, is invalid.
• Any guarantee which the creditor has obtained by means of keeping silence as to material circumstances, is invalid.
• Where a person gives a guarantee upon a contract that the creditor shall not act upon it until another person has joined in it as co-surety, the guarantee is not valid if that other person does not join.