Contract of Guarantee: Meaning & Features (Indian Contract Act)

What is Contract of Guarantee?

Section 126 of the Indian Contract Act 1872 establishes that a Contract of Guarantee is a type of contract where one party promises the other party to perform the promise or to discharge the liability which is incurred by the third party due to his default. Contract of Guarantee is governed under the Indian Contract Act 1872, where three parties come together to create a contract of guarantee. A contract of guarantee is mostly seen in the cases of loans, employment, etc. A surety is the person who shall undertake the responsibility to perform the contract in case the principal debtor fails to undertake his share of responsibility. It may be inferred that surety acts as a layer of security for the creditor.

Contract of Guarantee can be either an oral contract or a written contract. There are three parties in a contract of guarantee, namely the principal debtor, creditor, and surety. In a contract of guarantee, there exists three contracts, viz primary contract between the creditor and principal debtor, then a contract between surety and creditor comes into existence when the principal debtor has made a default in fulfilling his part of the responsibility. The third contract exists between the surety and the principal debtor, where the surety has the right to recover the consideration paid to the creditor.

Geeky Takeaways:

• A contract of guarantee is a legal promise that is made by a third party to pay off an obligation of another party in case the debtor fails to fulfill his part of the obligation.
• The purpose of a contract of guarantee is to get assurance regarding the performance of the contract to be executed.
• A guarantee is a secondary obligation that comes to light once the principal debtor has failed to acknowledge his part of the performance.
• Contract of guarantee is a tripartite agreement, there are three parties in a contract of guarantee, namely the surety, the principal debtor, and the creditor.

Example of Contract of Guarantee

Consider the following example under Contract of Guarantee:

• Ritesh obtains a loan from XYZ bank, and Sudhir promises the bank that if Ritesh fails to repay the loan amount, he will pay off the amount to the bank. This is a Contract of Guarantee.
• In any case, where Ritesh fails to pay off the loan amount, the bank can recover the amount from Sudhir and Sudhir will be liable to pay off the dues.
• Also, Sudhir will have the right to claim the amount he has paid to the bank from Ritesh.
• Here in this case, Ritesh is the Principal Debtor, and in his respect, Sudhir has given a guarantee to the bank.
• XYZ bank is the Creditor, Sudhir has given XYZ bank the guarantee, and the bank can recover the loan amount in case of default.
• Sudhir is the Surety, as he has given the guarantee to the bank in respect of Ritesh.

Section 126: Indian Contract Act 1872

1. Surety: A surety is a person who gives the guarantee in the contract of guarantee. Surety takes responsibility to pay an agreed sum of money, or he may also be required to perform any agreed duty for another person in case the principal debtor fails to perform such work as agreed to by the creditor.

2. Principal Debtor: The principal debtor is the person for whom the surety gives a guarantee to the creditor in a contract of guarantee. The primary contract exists between the creditor and the principal debtor.

3. Creditor: The creditor is the person to whom the guarantee is given by the surety in respect of any debt or performance that lies with the principal debtor. The creditor may demand performance from either the surety or the principal debtor.

Features of Contract of Guarantee

1. Principal Debt: The primary purpose of giving a guarantee is to secure the payment of a debt. The existence of recoverable debt is compulsory. If there is no existence of principal debt, there can be no valid contract of guarantee. It is a necessity of a contract to guarantee that there should be someone to be liable as a principal debtor, and the surety gives a guarantee in this regard.

2. Consideration: Consideration is an important element to exist in every contract to make it a valid contract. Even in the contract of guarantee, the contract should be supported by the consideration. A contract of guarantee made without the presence of consideration is considered null and void. However, it shall be noted that there is no requirement for the existence of any direct consideration between the surety and the creditor.

3. Existence of a Liability: Under the contract of guarantee there must be an existing liability or a promise whose performance is guaranteed by the surety. Furthermore, the liability or promise shall necessarily be enforceable by the law. The liability should not be time-barred by the limitation act.

4. No Misrepresentation or Concealment: Any guarantee obtained by the means of misrepresentation made by the creditor, or with his knowledge and assent, a material part of the transaction, is invalid. Any such guarantee that the creditor has obtained employing keeping silence as to material facts is considered invalid in the eyes of the law.

5. Writing Not Necessary: A contract of guarantee is not required to be in writing, the contract can either be oral or written and in both cases it will be valid and legally enforceable.

6. Joining of Other co-sureties: When a person gives a guarantee in regards to a contract, the creditor will not be required to act upon it until another surety joins the contract as co-surety, the guarantee will not be valid if the other person does not join along with other surety.

Conclusion

A guarantee is a legal assurance that a contract will be duly enforced. A contract of guarantee is governed under the Indian Contract Act 1872. A contract of guarantee is a legal promise that is made by a third party to pay off an obligation of another party in case the debtor fails to fulfill his part of the obligation. The purpose of a contract of guarantee is to get assurance regarding the performance of the contract to be executed. A guarantee is a secondary obligation that comes to light once the principal debtor has failed to acknowledge his part of the performance. Three parties come together to create a contract of guarantee. A contract of guarantee is mostly seen in the cases of loans, employment, etc. A surety is the person who shall undertake the responsibility to perform the contract in case the principal debtor fails to undertake his share of responsibility.

Contract of Guarantee- FAQs

Which section governs the Contract of Guarantee under the Indian Contract Act 1872?

Section 126 of the Indian Contract Act 1872 establishes that a Contract of Guarantee is a type of contract where one party promises the other party to perform the promise or to discharge the liability which is incurred by the third party due to his default. Contract of Guarantee can be either an Oral Contract or a Written Contract. The principal debtor, creditor and surety are the three parties in a contract of guarantee.

How many types of guarantee are there?

There are mainly two types of guarantee, which are-

• Specific Guarantee: A guarantee which extends only to a specific transaction.
• Continuing Guarantee: Continuing guarantee is one which extends to a series of transactions.

Highlight the difference between a Contract of Guarantee and a Contract of Indemnity?

Contract of indemnity is a contractual obligation where one party promises to pay for the loss or damages incurred by another party. Whereas, under the contract of guarantee, third party promises legally to pay off a debt or obligation of another party if the debtor fails to fulfill his obligation.

What is the nature of surety’s liability in the Contract of Guarantee?

• The liability of surety is secondary.
• Surety is liable only when the principal debtor makes a default.
• The creditor has the right to demand the performance from surety before demanding it from the principal debtor.

How can a Contract of Guarantee be discharged?

Contract of guarantee can be discharged by various modes:

• By revocation.
• By the conduct of the creditor.
• By the Invalidation of contract of guarantee.

Also refer to: Difference between Contract of Indemnity and Guarantee