law of guarantee and its kinds with case law | Lecture notes Contract Law

CONTRACT OF GUARANTEE

The term ‘guarantee’ may be defined as an undertaking by one person to pay

the amount due from another preson. And a contract to pay the amount due

from another preson, in case the latter fails to pay, is known as contract of

guarantee. The term ‘contract of guarantee’ is defined in Section 126 of the

Indian Contract Act, which reads as under:-

“A contract of guarantee is a contract to performs the promise, or discharge

the liability of a third person in case of his default."

The analysis of this section shows that, a contract of guarantee is a contract

in which a person promises to discharge the liability of a third person in case

the third person fails to discharge his own liability. It may be noted that the

following three parties are involved in a contract of guarantee :

1. Surety: The party who gives the guarantee is known as surety.

2. Principal debtor: The party on whose behalf the guarantee is given is known

as a principal debtor, i.c., the party in respect of whose default the guarantee

is given.

3. Creditor: The party to whom the guarantee is given is known as creditor.

Thus, a contract of guarantee is a tripartite agreement between the surety,

the principal debtor ..rid the creditor in which the surety promises to pay the

amount of debt to the creditor if the principal debtor fails to pay.

Example 18.10: A advanced a loan of Rs. 5000 to B at the request of C. And C

promised to A that if II does not repay the amount then he <C) will pay. This is

a contract of guarantee. In this case, A is ‘.lie creditor, II is the principal debtor

and C is the surety.

18.8. ESSENTIALS AND LEGAL RULES FOR A VALID CONTRACT OF GUARANTEE

The contract of guarantee must satisfy the requirements of a valid contract; A

contract of .-.dilutee is a special kind of contract. As such, it must have all the

essential elements of a valid . ntract such as consideration, free consent,

competence of the parties, legality of object and consideration.

Example - A requested B to give him a loan of Rs. 10,000. B agreed to give

the loan if C guarantees the repayment of the loan. C refused to give the

guarantee. However, the guarantee from C was obtained by practising coercion

upon him. This is not a valid guarantee as surety’s (C’s) consent is not free.

As regards the consideration and capacity of the parties, a contract of

guarantee has special features, which are discussed in the following two

essentials :

2. The contract of guarantee must be supported by consideration: It is,

however, not necessary that there should he direct consideration between the

surety and creditor. The law presumes that the consideration received by the

principal debtor is the sufficient consideration for the surety. Thus, something

done for the benefit of the principal debtor is the sufficient consideration for a

contract of guarantee. And it is not necessary that the surety himself must be

benefitted (Section 127).

Example 18.12: A requested B to sell and deliver to 'mm a tape recorder on

credit. B agreed to do so provided C will guarantee the payment of the price of

the tape recorder. C promised to guarantee the payment of the price in

consideration of fl’s promise to deliver the tape recorder to A. This is a

sufficient consideration for C's promise of guarantee.

Example 18.13: A sold and delivered goods to B. C afterwards requested A not

to tile a suit for the recovery of the price for six months. And C promised that if

he (.4) does so then he will pay the price in default of payment by B. A agreed

not to file a suit for six months. This is a sufficient consideration for C's promise

of guarantee.

It may, however, be. noted that there must be some consideration. If the

consideration is totally absent then the contract of guarantee is invalid.

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CONTRACT OF GUARANTEE

The term ‘guarantee’ may be defined as an undertaking by one person to pay the amount due from another preson. And a contract to pay the amount due from another preson, in case the latter fails to pay, is known as contract of guarantee. The term ‘contract of guarantee’ is defined in Section 126 of the Indian Contract Act, which reads as under:- “A contract of guarantee is a contract to performs the promise, or discharge the liability of a third person in case of his default." The analysis of this section shows that, a contract of guarantee is a contract in which a person promises to discharge the liability of a third person in case the third person fails to discharge his own liability. It may be noted that the following three parties are involved in a contract of guarantee :

Surety: The party who gives the guarantee is known as surety.
Principal debtor: The party on whose behalf the guarantee is given is known as a principal debtor, i.c., the party in respect of whose default the guarantee is given.
Creditor: The party to whom the guarantee is given is known as creditor. Thus, a contract of guarantee is a tripartite agreement between the surety, the principal debtor ..rid the creditor in which the surety promises to pay the amount of debt to the creditor if the principal debtor fails to pay. Example 18.10: A advanced a loan of Rs. 5000 to B at the request of C. And C promised to A that if II does not repay the amount then he <C) will pay. This is a contract of guarantee. In this case, A is ‘.lie creditor, II is the principal debtor and C is the surety. 18.8. ESSENTIALS AND LEGAL RULES FOR A VALID CONTRACT OF GUARANTEE The contract of guarantee must satisfy the requirements of a valid contract; A contract of .-.dilutee is a special kind of contract. As such, it must have all the essential elements of a valid. ntract such as consideration, free consent, competence of the parties, legality of object and consideration. Example - A requested B to give him a loan of Rs. 10,000. B agreed to give the loan if C guarantees the repayment of the loan. C refused to give the guarantee. However, the guarantee from C was obtained by practising coercion upon him. This is not a valid guarantee as surety’s (C’s) consent is not free. As regards the consideration and capacity of the parties, a contract of guarantee has special features, which are discussed in the following two essentials :
The contract of guarantee must be supported by consideration: It is, however, not necessary that there should he direct consideration between the surety and creditor. The law presumes that the consideration received by the principal debtor is the sufficient consideration for the surety. Thus, something done for the benefit of the principal debtor is the sufficient consideration for a contract of guarantee. And it is not necessary that the surety himself must be benefitted (Section 127). Example 18.12: A requested B to sell and deliver to 'mm a tape recorder on credit. B agreed to do so provided C will guarantee the payment of the price of the tape recorder. C promised to guarantee the payment of the price in consideration of fl’s promise to deliver the tape recorder to A. This is a sufficient consideration for C's promise of guarantee. Example 18.13: A sold and delivered goods to B. C afterwards requested A not to tile a suit for the recovery of the price for six months. And C promised that if he (.4) does so then he will pay the price in default of payment by B. A agreed not to file a suit for six months. This is a sufficient consideration for C's promise of guarantee. It may, however, be. noted that there must be some consideration. If the consideration is totally absent then the contract of guarantee is invalid.

204 Law of Contracts Example 18.14: A sold and delivered goods to B. Afterwards, C without any consideration, agreed to pay the price in default of B. The agreement is void as it is without any consideration. Simultaneous tripartite contract between surety, creditor and principal delator is not necessary. When once a contract between principal debtor and creditor is formed, a contract by which the surety guarantees the debt, can also take place. And the consideration may move either from the creditor or the principal debtor. Thus a guarantee can be given after the loan has been advanced. Moreover, the word ‘done’ in Section 127 shows that the past benefit to the principal debtor may be a good consideration for a bond of guarantee. In Parsanjit Mahlha v. U.C. Bank, AIR 1979 Pat. 151, the Patna High Court has held that a guarantee given after the execution of the loan document is valid. In another case, past debts were also held to be covered under the wide language of Section 127. | Union Bank of India v. A.P. Bhonslc (1991) Mah LJ 1004]. However, in M.N.A. Khan v. Commercial & Industrial Bank. AIR 1969 AP 294, the A.P. High Court has support the view that past consideration is not a good consideration. It is submitted that the position stated above appears to be correct. 7>. The contract of guarantee must be made by the parties competent to contract: We know that the competency of the parties is an important requirement of a valid contract. As such, the parties to a contract of guarantee, must also be competent to contract. However, the incapacity of the principal debtor docs not affect the validity of a contract of guaranatcc. Thus, the requirement is that the creditor and the surety must be competent to eater into a valid contract. A principal debtor may be a minor. In such cases, the surely is regarded as principal debtor and is personally liable to pay the debt, though the principal debtor is not liable. In such cases, the contract between the creditor and surety is treated as a primary and independent, and not a collateral. The surety is also liable if the guarantee is given knowing the minority of the debtor. ■ Kashi ha v. Shripat (1.895) J9 IL.R Bom. 697 )^4 Example 18.15: A requested 3 to lend Rs. 1000 to C, a minar. And A promised that if C failed to repay ilien lie i-.l p.iv .he amount In this cave, though the principal debtor (te.. O >x a minor, hut the contract •. 1..1 ft i< enforceable And ft can recover the amount Irom A

- m.u; be someone primarily liable: It is an essential requirement of a contract of _. "'ere must he someone primarily liable (/ e. liable as principal riehior) other than "e matter of fact, a contract of gitatmucc presupposes the existence of a liability ci-.tcrcc.v ■ .o'. If there is no such primary liability, there can be no vatic! coi iiaci of guuriiaiee. Howe'er. •. -rated above, the guarantee given for minor’s debt is enforceable Example lJt.U>: A owed Rs 10.000 to ft After the debts became time-barred by the l aw of Limiution. C a guarantee to ft for the repayment of the amount. This is not a valid contract of guarantee as ;:.e ?:.tr.ary lability between A and ft is not enforceable by law due to the expiry of limitation period. Example 18.17: A was enjoying overdraft facilities from a Bank, ft guaranteed the repayment of the i. mount of overdraft. However, the overdrafts were contrary to the law and therefore void. A defaulted in repayment of the overdraft. The bank filed a suit against ft (the surety) for the recovery of the amount. It was held that ft was not liable to pay. The court observed, “if there is nothing due. no balance, the obligation to make that nothing good amounts itself to 4

206 Law of Contracts 18.10, KINDS OF GUARANTEE Though there are many kinds of guarantee, yet the following two kinds are important from the subject point of view :

Specific or simple guarantee: It is a guarantee which is given for a specific transaction. In other words, a guarantee which extends to a single transaction or debt, is known as a specific or simple guarantee. Such gurantee comes to an end as soon as the transaction is duly performed or the debt is duly discharged. Example 18.21: A requested B to deliver five bags of wheat to C. The bags were to be delivered and paid for in a month. A promised that if C failed to pay the price within one month, then he (A) will pay the same. 8 delivered five bags of wheat to C and C paid the price. Afterwards. 8 delivered four more bags of wheat to C which C did not pay for. In this case, the guarantee given by A was a sepeific guarantee which came to an end on the performance of the guaranteed transaction. And thus, A is not liable for four bags of rice delivered after the performance of the first promise.
Continuing guarantee: It is a guarantee which is given for a series of transactions of continuing nature. The term ‘continuing guarantee’ is defined in Section 129 of the Indian Contract Act, which provides that a guarantee which extends to series of transactions or debts, is known as a continuing guarantee. Such guarantee does not come to an end on the performance of a single transaction or discharge of a single debt. It remains enforceable even for the subsequent debts or transactions also. However, the surety can fix up a limit on his liability for time or amount of the guarantee. Thus, a continuing gurantee can be for a fixed period. The reason for the same is that, the continuing guarantee speaks of continuing transactions and not the period of such transactions. [Estern Bank Ltd. v. Parts Sen-ices of India.. AIR 1986 Cal. 611. Example 18.22: AtA’s request, 8 employed Cfor collecting the rent of his (8 si zamindari. A promised B to be responsible up to Rs. 50,000 for the collection and payment by C of those rents. This is a continuing guarantee. Example 18.23: A guaranteed payment to B. a tea dealer, to the amount of Rs. 5 lakh for any tea that he may supply to C from time to time. 8 supplied some tea to C to the value of Rs. 5 lakh, and C paid for it. Afterwards, 8 supplied some more tea to C to the value of Rs. 1 lakh. Rut C failed to pay for it. In this case, the guarantee given by A was a continuing guarantee as it extended to any tea that may be supplied by 8 to C front time to time. And thus, A is liable to 8 to the extent of Rs. 5 lakh. Example 18.24: A, a fruit dealer, agreed to supply certain fruits to 8 on credit, at the request of C. And C gave a guarantee to A for the payment of the price for any fruits that he may supply to 8 from time to time within one year. A supplied some fruit to 8 to the value of Rs. 2 lakh and 8 paid for it. After the expiry of one year, A supplied some more fruits to 8 to the value of Rs, 50,000, But 8 failed to pay for it. In this case, the gururantec given by C was a continuing guarantee but it was valid for one year only. And thus, C is not liable to A for the price of the fruit supplied after the expiry of one year. Thus, the essence of a continuing guarantee is that it applies not to a specific number of transactions, but to any number of them. It makes the surety liable for unpaid balance at the end of the guarantee. Whether a guarantee, is a continuing guarantee or not, depends upon the language of the guarantee and the surrounding circumstances. Note: A guarantee may be ‘retrospecive’ or ‘prospective’ also. A guarantee given for an existing debt, is called a 'retrospective guarantee’. And the guarantee, given for a future debt, is called a ‘prospective guarantee’. A guarantee given for the good conduct or honesty of a person employed in a particular office, is callled a ‘fidelity guarantee’. The guarantee may also be ‘absolute' or ‘conditional’. An absolute guarantee means a guarantee where the surety unconditionally promises to pay in case of default of the principal

debtor. A conditional guarantee mean a guarantee where the surety promises to pay in case some event, in additon to. the default of (he principal debtor, happens. 18.11. REVOCATION OF CONTINUING GUARANTEE The revocation of a guarantee means the cancellation of the guarantee. On the revocation of a continuing guarantee, the liability of the surety comes to an end for the future transactions. However, the surety continues to be liable for the previous transactions. A continuing guarantee may be revoked in any of the following ways :

By notice of revocation by the surety (Section 130): A surety may revoke the continuing guarantee at any time, by giving a notice of revocation to the creditor. It may, however, be noted that it continuing guarantee can be revoked in respect of the future transactions only. Thus, the revocation is effective for the future transactions only. And the surety remains liable for the transactions already entered into before the revocation. Example 18.25: A. a shopkeeper, agreed to supply some goods to B on credit, at the request of C. And C gave a guarantee to A for the payment of the price up to Rs. 10,000. After three months, C revoked the guarantee by giving notice to A. But within these three months, A had already supplied goods to B worth Rs. 2,500. In this case, C is liable to pay Rs. 2,500 to A if B fails to pay the same. And he (C) will not be liable for the goods supplied after the revocation. Example 18.26: A, a factory owner, took an industrial shed on rent from B for a period of three years. C gave a guarantee to B for the payment of rent by A during this period. After one year. C revoked the guarantee by giving notice to B. In this case, C is liable to pay the rent of one year if A fails to pay the same. But he fC) will not be liable for any rent payable by A after the revocation.
By the death of the surety (Section J3I): A continuing guarantee is revoked on the death of the surety. However, the death of the surety revokes the eontinuing guarantee only if there is no contract to the contrary. It may be noted that the guarantee is automatically revoked on surety’s death and no notice of death is required to be given to the creditor. In this case also, the revocation is effective for future transactions only. And the surety’s legal heir remains liable for the transactions already entered into before the death of the surety. Example 18.27: At A s request, B employed C for collecting the rents of his (B's) house. A gave a guarantee to B to the extent of Rs. 5,000 for the due collections of rent by C. A collection of Rs. 1,000 was made by C and thereafter A died. On A's death, the guarantee gets revoked in respect of the collections made after A ’s death. However, A 's legal representatives are liable up to Rs. 1,000 if C fails to give this amount to B. Note: A continuing guarantee is also revoked when the surety is discharged from liability. The circumstances in which (he surety is discharged from his liability will he discussed in Art. 18.17. 18.12. NATURE AND EXTENT OF SURETY’S LIABILITY The nature and extent of surety’s liability may be discussed under the following heads:
Surety's liability is co-extensive: The liability of a surety is co-extensive with that of the principal debtor. This means that the surety is liable to the same extent to which the principal debtor is liable. In other words, the liability of the surety is the same as that of the principal debtor. The nature and extent of surety’s liability is explained in Section 128 of the Indian Contract Act, which reads as under : "The liability of the surety is co-extensive with that of the principal debtor, unless it is otherwise provided by the contract." Thus, the quantum of surety’s liability will be the same as that of the principal debtor. Whatever amount of money a creditor can legally realise from the principal debtor, including interest, damages, costs, etc., the same amount can

creditor to first recover the amount out of the mortgaged property, and the balance from him. Here, the court allowed the surety to proceed as he liked. In case of default by the principal debtor, the creditor can immediately demand the amount from the surety. He is not required tc give a notice of default to the surety. It may, however, be noted that where the contract of guarantee provides that the surety will not be liable unless some condition is fulfilled, then the surety is not liable until such condition is actually fulfilled. e.g., where it is provided in the guarantee that the surety shall be liable only after a notice of demand is served on him, then surety’s liability will arise only after the notice of demand is served on him.

Surety's liability where the original contract between creditor and principal debtor is void or voidable: The liability of the surety is not, necessarily, simultaneous with that of the principal debtor. Their liability is different arising from the different contracts. The contract between the surety and creditor in an independent contract and not a collateral one. Thus, it cannot be said that the surety will be liable only if the principal debtor is liable (though such restriction can be imposed by specific agreement to that effect). Therefore, when (he original contract between the principal debtor and creditor is void, e.g., where the principal debtor is a minor, the surety will remain liable, In such a case, the surety is liable as if he was the principal debtor.^5 6 Similarly, where the original contract is voidable at the option of principal debtor who has exercised his option and revoked the contract, the surety may not be discharged from his liability. Moreover, the surety is also not discharged where the creditor fails to sue the principal debtor within the period of limitation, if the limitation period is otherwise available against the surety. [Mahant Singh v. U. ha. Yi (1939) 66 l.A. 198]. Example 18.32: A gave a loan of Rs. 5,000 to 8. And C gave a guarantee to A for the repayment of the loan. On the due date. B failed to repay the loan. However, A waited for one year and thereafter issued a notice to C demanding the payment of the loan. C replied the notice and promised to make payment within six months. However, A did not take any legal action for two more years. By this time, A lost his remedy against the principal debtor (Zi) as the debt becomes time barred after the expiry of three years from the dare of default. A then filed a suit against the surety (C) for the recovery of tile amount of loan. In this case. C is liable to pay the amount of loan as die limitation peiiod for filing the suit is available against him." Thus, the surety continues to be liable even if the original debt becomes time- barred. It may, however, be noted that where an already time-barred debt is gauranteed then the surety will not be liable. Because in such cases, there will be no valid contract of guarantee. The existence of an enforceable debt is the essential requirement for a valid guarantee (minor’s debt is an exception to this rule). Whore the principal debtor is discharged by the operation of law', the surety remains liable [Dane v. Mortgage Insurance Corpn. (1894) 1 Q B 54). The surety also remains liable on the death of principal debtor. Note: There is also a contrary view that the surely is not liable if the original contract between the principal debtor and the creditor is void. In E.K. Namhiar v. V.K. Raman (AIR 1957 Mad. 164) it was observed that "the liability of the surety is only ancillary and can rest only on a valid obligation on the part of the party whose debt or obligation is guaranteed". Thus, according to Ibis view, the liability of the surety is secondary. If the original contract between principal debtor and creditor is void, the question of surety’s liability does not arise. It is submitted, this view appears to be correct as in case of void contract between principal debtor and creditor there is no enforceable principal debt. However, it is for the courts to decide keeping in view the facts and circumstances of each particular case.
Surety‘s liability under continuing guarantee: This has already been discussed in detail in Art. 18.10. 5 Kashiba v. Shripai. (1895) 19 ILR Bombay 697, Tikkt La! v. Kaina! Chand (1940) Nagpur 1632. 6 The limitation period against the surety starts from the date of notice of demand, if the agreement of guarantee so provides. In this case, such agreement is presumed.

210 Law of Contracts 18.13. RIGHTS OF THE SURETY The rights of the surety may be discussed under the following three heads :

Rightsagainst the principal debtor.
Rights againsl the creditor.
Rights against the co-sureties.

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CONTRACT OF GUARANTEE