What is Contract of Guarantee?
Sec. 126 of the Indian Contract Act 1872, which deals with the contract of guarantee, has defined it as “A contract to perform the promise, or discharge the liability of a third person in case of his defaults”.
Example: A advances a loan of Rs.10,000 to B, and C promises A that if B does not repay the loan, I will repay it. This is a contract of guarantee. It involves three parties namely,
- Surety, who gives the guarantee.
- Principal Debtor, in respect of whose default the guarantee is given.
- Creditor, to whom the guarantee is given.
Example: A supplies goods to B on C’s guaranteeing payment by B to A. This means that if B does not pay, C would be liable to pay. This is a “Contract of Guarantee”.
Here B is the principal debtor, C is the surety and A is the creditor.
A guarantee may be either “oral” or “written“. Just like any other contract, it should also fulfill all the essentials of a valid contract. As stated already, three parties are involved in a contract of guarantee. At the same time, there are three collateral contracts also namely,
1. As between A and B [A supplies goods to B on credit who promises that he would pay].
2. As between A and C [C gives guarantee the price of goods, I will pay].
3. As between C and B [B indemnifies C in case of B’s default in paying the amount to A).
Essentials of a Contract of Guarantee
1. Concurrence of All the Parties
All the three parties namely, the principal debtor, the creditor and the surety must agree to make such a contract.
In a contract of guarantee, liability of the surety is secondary i.e., the creditor must first proceed against the debtor and if the latter does not perform his promise, then only he can proceed against the surety.
3. Existence of a Debt
A contract of guarantee pre-supposes the existence of a liability, which is enforceable at law. If no such liability exists, there can be no contract of guarantee. Thus, where the debt, which is sought to be guaranteed is already time barred or void, the surety is not liable.
There must be consideration between the creditor and the surety so as to make the contract enforceable. The consideration must also be lawful. In a contract of guarantee, the consideration received by the principal debtor is taken to be the sufficient consideration for the surety.
Anything done, or any promise made, for the benefit of the principal debtor may be sufficient consideration to the surety for giving the guarantee
Thus, any benefit received by the debtor is adequate consideration to bind the surety. But past consideration is no consideration for a contract of guarantee. There must be a fresh consideration moving from the creditor.
5. Writing not Necessary
A contract of guarantee may either be oral or written. It may be express or implied from the conduct of parties.
Note: A Contract of Guarantee must always be in writing under English Law.
6. Essentials of a Valid Contract
It must have all the essentials of a valid contract such as offer and acceptance, intention to create a legal relationship, capacity to contract, genuine and free consent, lawful object, lawful consideration, certainty and possibility of performance and legal formalities.
7. No Concealment of Facts
The 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.
8. No Misrepresentation
The guarantee should not be obtained by misrepresenting the facts to the surety. Though the contract of guarantee is not a contract of uberrimae fidei 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