What is Contract of guarantee? According to section 126 of The Contract Act, a contract of guarantee has been defined as follows:
“A contract of guarantee is a contract to perform the promise, or discharge the liability of the third person in case of his default the guarantee may be oral or written.”
A contract of guarantee is a contract where one owes guarantee to another party that if the contract is not preferred party or payment is not paid by the third party, he will perform the contract or will make payment on his behalf.
See Also: What is Acceptance of Proposal
Example of Contract of Guarantee
A request B to advance $5000 to C on the condition that if C will not pay the amount, A will pay for it.
B agrees to do so. It will be a contract of guarantee A Will be surety, C will be a principal debater and B will be a creditor.
Parties to the Contract of Guarantee
There are three parties in a contract of guarantee and they are as follows
Surety
The person who gives a guarantee is called surety. In the above illustration, A stands as surety in the contract
Principal Debtor
The person in respect of whose default the guarantee is given is called principal debtor. In the above illustration, C stands as principal debtor.
Creditor
The person to whom the guarantee is given is called the creditor in the above illustration, B stands as a creditor.
Continuing Guarantee
According to section 129, a guarantee, which extends to a series of transaction, is called a continuing guarantee.
A continuing guarantee is not only for one transaction but it covers a series of transactions.
The amount for which guarantee is given is fixed and it is not exhausted by the first transaction if it is less than the amount guaranteed.
See Also: What is Revocation of Proposal
Example: A requests B to employ C for the collection of monthly rent of B’s 10 shops which has been let out for $1000 each.
On the condition that A will be responsible for the due collection and payment of this rent by C to B. It is a continuing guarantee which covers a series of transactions until A withdraw his responsibility.
Modes of Termination of Contract
The modes of termination of guarantee are as under
Termination by notice
The surety can revoke guarantee as to a future transaction at any time by giving a notice to the creditor for the withdrawal of his guarantee sec 130.
Example: A agrees to deliver goods of the value of $10000 to B after 10 days and C gives guarantee for the payment of the amount before the delivery of the goods C withdraws his guarantee by giving notice to A. Now Cs guarantee will be terminated
Termination by changes in the terms of contract
Any variance (change) made without the surety’s consent in the terms of the contract between the principal debtor and the creditor, discharges the surety as to transactions, subsequent to the variance (sec 133).
Example: A agrees to End to B after one month and C gives a guarantee to A for repayment A pays $100000 to B. after 10 days.
Now C Will be discharged from guarantee due to changes in the terms of the contract.
Termination be death
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 (sec. 131).
Example: A request B to employ C for the collection of monthly rent of B’s 10 shops which have been let out for $1000 each, on the condition that A will be responsible for the due collection and payment by C to B.
After two months A dies, Now A’s property not be liable for any collection of rent after his death.
Termination by Creditors Act, or Omission of terms
The surety is discharged by any contract between the creditor and Principal debtor, by which the principal debtor is released, or by any act or omission of creditor, the legal consequence of which is the discharge of principal debtor, (section 134).
Example: A promises to send 1000 units of his product to B on advance payment after 10 days C gives a guarantee of B’S payment.
A sends the gods after 5 days without receiving an advance payment. Now C will be discharged to A’s act of delivering the goods without advance payment.
Termination by change of firm’s constitution
When the continuing guarantee is given to any firm or to a third party in respect of the transactions of the firm.
Such guarantee is terminated in the absence of any contract to the contrary, from the date of any change in the constitution of the firm
By Extension of time without surety’s consent
A contract between the creditor and the principal debtor (without the consent of the surety) by which the creditor make composition with, or promises to give time to, or not to sue the principal debtor, discharges the surety unless the surety assents to such contact (see 135).
See Also: What is Cancellation of Proposal
Example: A lends $5000 to B for two months and C gives guarantee for the repayment of this loan to A.
A extends the time for payment up to six months without the consent of C. Now C will be discharged ‘from guarantee.
By Creditors act which is against the rights of surety
If the creditor does any act, which is inconsistent with the rights of the surety, or omits to do any act, which was in his duty to do and by this, the surety loses his eventual remedy against the principal debtor discharges the surety (sec 139)
Example: A promises to build B’s house and B agrees to make payment in installments. When work reaches certain stages and last installment will be payable at the completion of the work C gives guarantee of A for the performance of work with in due time B makes payment of whole sum before the completion of work without the knowledge of C, now C Will be discharged from guarantee.
By losing security
Where under a contract, the principal debtor gives any type of security to the creditor with or without the knowledge of the surety, the surety has a right to benefit from all such securities.
If the creditor loses such security without the consent of surety, the surety is discharged to the extent of the value of the security,
Example: A gets loan from B for $500000 and gives him pearls of the value of $100000 as security.
C also gives a guarantee, to B for the repayment of loan. B returns the pearls to A without the consent of C. Now C will be discharged up to the value of pearls.
Legal deficiencies
The contract of guarantee is invalid and surety gets discharged due to the following legal deficiencies.
By misrepresentation: When any guarantee is obtained by means of misrepresentation made by the creditor or with his knowledge about the material part of the transaction, the contract is invalid and surety gets a discharge. (Sec .142).
By Keeping silence: When the creditor obtains guarantee by means of keeping silence as to material circumstances, the contract is once again invalid and surety gets a discharge. (Sec. 143).
Failure of Co-surety to join: 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 as co-surety.
See Also: What is Discharge of Contract
Essential conditions not fulfilled: Where the essential conditions of a valid contract are not fulfilled, the surety gets a discharge.
For example, parties are not competent to contract or consideration is illegal or contract is impossible to perform.
Rights of the Surety
A surety under a contract of guarantee has the rights against the following persons:
Principal Debtor: The surety has the following two rights against the principal debtor.
Right as Creditor: According to section 140, when on 127the default of principal debtor, the surety has made payment of the amount for which he is liable, is invested with all the rights which the creditor has against the principal debtor.
When the surety seeks to enforce his remedy, he shall be in the same position as if he was the original creditor still unpaid
Right to Indemnify
In 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, but no sums which he has paid wrongfully. (sec. 145)
Right Against Creditor
If principal debtor gives any security to the creditor at the time of contract, whether it is in the knowledge of the surety or not, the surety is entitled to the benefits of every such security.
If the creditor loses any such security without the consent of the surety, the surety is discharged from liability to the extent of the value of the security.
Rights Against Co-securities
When debt is guaranteed by two or more persons, they are said to be co-sureties and are equally liable for the amount of debt in the absence of any contract to contrary.
If one of them has paid all the debt can recovery from the others the amount paid in excess of his share.
Where co-sureties have given guarantee for different sums, they are bound to contribute equally up to the maximum of their obligation
Illustration: A has taken a loan of $20000 from B, C, and D have given a guarantee to B for the repayment of this loan by A. C has given guarantee for $10000 and D have given guarantee for $20,000.
In case of A’s default D pays the full amount to B. Now B will have right to get $5000 from C an equal amount up to the maximum of his amount of guarantee.
See Also: Contract of Indemnity
Liabilities of the Surety
The liability of the surety is co-extensive with that of the principal debtor unless it is otherwise provided by the contract (section 128).
The surety is only liable when the principal debtor fails or refuses to perform the contract. When the debtor will not make payment to the creditor, the surety will have to make payment.
But according to section 147, parties who are bound in different sums, are liable to pay equally as for as the limits of their respective obligations permit.
