What Is a Contract of Guarantee in Contract Act

Contract of Guarantee – Introduction

Let us understand this concept with the help of an example.

Raj agrees to contract to sell 10 kg of rice at Rs 500 on credit to Savita. Vishal, a friend of Savita, promises Raj to pay the amount in case Savita fails to pay the amount. Here, as Vishal had promised or guaranteed Raj to pay, he is bound by this promise.

Such types of contractual arrangement in which one party promises or guarantees to stand for another party to perform or discharge the liability of another in case of his default is called the contract of guarantee. The main aim of a contract of guarantee is to protect the other party from any loss.

Now, let us look at what the Indian Contract Act, 1872 says about the contract of guarantee.

Contract of Guarantee – Introduction
Contract of Guarantee
Essentials of Contract of Guarantee
Consideration for Guarantee
The Concept of Continuing Guarantee
Revocation of Guarantee
Rights of Surety
The Extent of Surety’s Liability
Discharge of Surety’s Liability

Contract of Guarantee

Section 126 of the Indian Contract Act deals with the contract of guarantee. A contract of guarantee is a contract where a third person promises (or guarantees) to perform the contract or to discharge the party’s liability to the contract in case of his default.

Number of Parties Involved

In a contract of guarantee, there are three parties involved, namely surety, principal debtor and creditor, as defined under section 126 of the Contract Act.

Surety: The person who gives the guarantee is known as surety.
Principal debtor: The person in respect of whose default the guarantee is given is known as the principal debtor.
Creditor: The person to whom the guarantee is given is known as the creditor.

For example: X contracts to sell 10 kg of rice for rupees 5,000 to Y on credit. Z, a friend of Y, promises X to pay rupees 5,000 in case Y does not pay or fails to pay rupees 5,000. Here, X is the creditor, Y is the principal debtor, and Z is the surety.

Tripartite Contract

Tripartite means involving three parties. In a contract of guarantee, due to the involvement of three parties, there are three different contracts among the parties themselves. These contracts are:

Between principal debtor and creditor (Which is the main contract that is expressed)
Between surety and creditor (Express contract of guarantee)
Between surety and principal debtor (It can be express or implied)

Essentials of Contract of Guarantee

The following are the essentials of the contract of guarantee:

There must be a valid contract between three parties, which are: principal debtor, creditor, and surety.
That the surety promises to perform the contract or discharge the liability of the principal debtor in case of his default.
That such liability is voluntarily taken by the surety.
It may be either oral or written.

Consideration for Guarantee

Section 127 of the Indian Contract Act mentions the consideration for guarantee. It provides that following consideration can be considered as sufficient consideration to the surety for giving the guarantee, and that are:
(a) anything done, or
(b) any promise made for the benefit of the principal debtor.

The Concept of Continuing Guarantee

As per section 129 of the Indian Contract Act, a guarantee which extends to a series of transactions is known as a continuing guarantee.

It means that once a guarantee is given, then it extends to the series of transactions.

For example: X, a milkman, contracts with Y to supply 1 litre of milk every day at Rs 50 for a month. But on a condition that Z shall pay the amount as a guarantor of Y. Here the amount of Rs 50 shall be paid by Z for a month. Every transaction of Rs 50 for each day is a series of transactions.

Revocation of Guarantee

Revocation of guarantee means to cancel or end the contract. The following modes can revoke a normal contract of guarantee or a contract of continuing guarantee:

1. That if the surety produces a notice of revocation to the creditor in relation to future transactions, which is provided under section 130 of the Indian Contract Act.

2. The death of the surety means automatic revocation of future transactions, which is provided under section 131 of the Indian Contract Act.

Rights of Surety

In a contract of guarantee, the rights of surety extend against the principal debtor and the creditor. Let us discuss them one by one.

Rights of Surety Against a Principal Debtor

Right of subrogation under section 140 of the Indian Contract Act.
An implied right or promise to indemnify the surety after the surety has done his responsibility under section 145 of the Indian Contract Act.

Rights of Surety Against Creditor

Right to the benefit of creditors securities under section 141 of the Indian Contract Act.
Right to set off the debts which the debtor has against the creditor.
Right to recover financial loss which resulted due to any fraud or misrepresentation practised by the creditor.

The Extent of Surety’s Liability

As per section 128 of the Indian Contract Act, the liability of the surety is co-extensive to that of the principal debtor. Thus, the liability of the surety is of secondary nature while of the principal debtor it is primary.

Discharge of Surety’s Liability

The liability of the surety, that is, to repay the debt of his principal debtor in case he doesn’t pay, is discharged by the following provisions of the Act.

1. If there are any changes made in terms of the contract without informing the surety about the same, the surety is discharged. Provided under section 133 of the Indian Contract Act.

2. If the principal debtor is released or discharged by the creditor, the surety is discharged. Provided under section 134 of the Indian Contract Act.

3. If the creditor himself compromises or extends the time to pay the debt or promises not to sue the principal debtor, the surety is discharged. Provided under section 135 of the Indian Contract Act.

4. If the creditor acts in such a manner or omits the conditions of the contract, the surety is discharged. Provided under section 139 of the Indian Contract Act.

Note: A surety is also discharged under the provisions of sections 130 and 131 of the Indian Contract Act, discussed before.

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Ankita Soni

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Ankita has written this article. She is pursuing B.A.LL.B from Amity University, Madhya Pradesh. She is a passionate law student and explores every opportunity. Ankita is good at legal research and manages her time efficiently.