Contract of Guarantee

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Contract of Guarantee:

A contract of guarantee is a contract to perform the promise or discharge the liability, of a third person in case of his default. The person who gives the guarantee is called the “Surety”. The person in respect of whose default the guarantee is given is called the principal debtor, and the person to whom the guarantee is given is called the creditor. A guarantee may either written or oral.

Explanation:

There can be no contract of guarantee without a liability enforceable at law. [AIR 1918 Bom 197].

Guarantee contains the ingredients of dedicated commitment, “absolute undertaking” an unambiguous assurance, unconditional willingness, definite certainty compliance without objection, sacred obligation and defined responsibility. [PLD 2003 SC 191]. A contract of guarantee is a tripartite agreement between the creditor, the principal debtor and the surety. Surety at the request of principal debtor, agree to answer the default of the debtor and undertakes performance of the debtor toward the creditor.

The primary idea of surety ship is an undertaking to indemnity if some other person does not fulfill his promise [AIR 1936 all 327]. Guarantee is accessory contract, whereby promisor undertakes to be answerable to promise for the debt, default or miscarriage of another person, whose primary liability of the promise must exist or be contemplated. [PLD 2003 SC 191]. Where the husband deposits the fixed deposit receipt of his wife in the bank as security of his overdraft account, the wife would be a surety within meaning of S. 126. [PLD 1968 Sc. 83.].

A mere recommendation by C that A should buy goods of B will not entail one C the consequences that might flow from his guarantee that A will not suffer any loss if he takes up B’s offer of sale. [AIR 1927 mad. 62].

Consideration for Guarantee:

Anything done, or any promise made, for the benefit or principal debtor may be a sufficient consideration to the surety for giving the guarantee.

Oral or written guarantee:

A contract of guarantee need not necessarily be in writing. It may be expressed by words of mouth or it may be tacit or implied and may be inferred from the course of conduct of the parties. Chapter VIII is not exhaustive on the subject [2003 CLD 363].

Right of surety:

Surety has certain rights under the contract of guarantee against the creditor, the principal debtor and co-sureties to a contract, if any.

Right against creditor:

Surety has a right against creditor to.

  1. Receive securities.
  2. To claim set off;

1.    To receive securities:

A surety is entitled to the benefit of every security which the creditor has against the principal debtor at the time when the contract of suretyship is entered into whether the surety knows of the existence of such security or not; and if the creditor loses, or without the consent of the surety parts with such security the surety is discharged to the extent of the value of the security.

Scope:

Section 141, prima facie, has reference to the simple case of a surety for a single debt for which the creditor hold a security or securities [AIR 1944 mad. 195].

Explanation:

The surety is entitled to demand all the securities held by the principal debtor, creditor at the time of payment whether they had been received simultaneously with the loan advanced or subsequently. The section does not enable the creditor to withhold from the surety any security actually held by him at the time when the debt is paid or in any other way to detract from the rights of the creditor as declared by s. 140.

Release of security:

Where the creditor holds property in attachment and he releases some of the property, the surety for the judgment debtor is released to the extent of the property released.

[AIR 1934 All.616].

Right to claim set off:

The surety is also entitled to the benefits of any set-off or counter claim, which the principal debtor has against the creditor, in respect of the same transaction.

“Set off signifies the substraction or taking away of one demand from another opposite or cross demand, so as to distinguish the smaller demand and reduce the greater by the amount of the less if the opposite demands are equal, to extinguish both. It was also formerly sometimes called stoppage, because the amount to be set off was stopped or deducted from the cross demands”. [A treatise on the law of set-off, Recoupment and counter claim (2nd ed.) 1872 by Thomas w. Waterman]

Surety’s rights against the principal debtor:

Surety has following rights against the principal debtor.

  1. Right to be indemnified.
  2. Right of subrogation.
  3. Right to be indemnified:
  4. 145 states that “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 sum which he has paid wrongfully. ”

Scope and applicability:

Apart from S.140 of the Contract Act, a surety has a right under s.145 to be indemnified by the debtor and the surety’s rights under this section are not limited to the rights of the creditor against the debtor. [AIR 1932 All. 610]. Where a person stands surety for another there is always an implied warranty by the latter, that he would indemnify such person in case he is indemnified owing to a default made by him in the performance of any of the conditions imposed upon him under the security bond. [1996 CLC 106.].

Right of subrogation:

Section 140 states that “where a guaranteed debt has become due or default of the principal debtor to perform a guaranteed has taken place, the surety upon payment or performance of all that he is liable for, is invested with all the rights which the creditor has against the principal debtor”

Explanation:

A surety paying off a debt is entitled to all the right and securities of the creditor as against the principal debt [AIR 1919 All 56]. Therefore, he is subrogated to all the remedies and right which the creditor has not only against the principal debtor but against the other and to all the securities and rights of action generally which the creditor has in respect of debt.

[AIR 1936 Mad. 342]

Against Co-Sureties:

Surety has following rights against co-sureties, in the contract of guarantee.

  1. To contribute equally.
  2. Subject to limitation (According to their liability)

To contribute Equally:

Section 146 states that where two or more persons are co-sureties for the same debt or duty either jointly or severally, and whether under the same contract or different contracts, and whether with or without the knowledge of each other, the co-sureties in the absence of any contract to the contrary are liable, as between themselves, to pay each an equal share of the whole debt, or of that part of it which remains unpaid by the principal debtor.

Subject to limitation:

147 co-sureties who are bound in different sums are liable to pay equally as far as limits of their respective obligations permits.

Discharge of Surety:

The following are the various circumstances in which a surety is discharged from his liability.

Notice of revocation:

Section 130 states that “A continuing guarantee may at any time be revoked by the surety, as to future transactions, by notice to the creditor”.

A specific guarantee can only be revoked, if the liability under the contract has not been incurred. Thus where the surety guaranteed the payment of the entire rent for the period of the lease he could not revoke it [1983 CLC 356].

By death of surety:

Section 131 states that the death of surety operates in the absence of any contract to the contrary, as revocation of continuing guarantee so far as regards future transaction.

By Act or Omission:

Discharge of the debtor without the consent of the surety destroys the liability of the surety though he had signed as a co-executant, where the creditor knew he was a surety.

[AIR 1924 Rang 360].

By extension of time:

Where the creditor extends time for the payment of a debt, without the surety’s consent, the surety is discharged. [1981 CLC 847]. Where creditors grant time to the debtor and allows payment by installment without the surety’s consent, the surety is discharged from his liability.

Loss of securities:

Section 141 states “— if the creditor loses, or, without the consent of the surety, parts with such security. The surety is discharged to the extent of the value of the security”.

By invalidation of contract of Guarantee:

A surety is also discharge from liability when the contract of guarantee is invalid. A contract of guarantee is invalid in the following cases.

  1. Guarantee obtained by fraud or misrepresentation S. 142
  2. Guarantee obtained by concealment 143
  3. By failure of consideration. 144

Impairing surety’s remedy:

Section 139 provides that if the creditor does any act which is in consistent with the rights of the surety, or omits to do any act, the surety requires him to do, and the eventual remedy of the surety against the principal of the surety against the principal debtor is thereby impaired, the surety is discharged.

Leasing corporation V. National Fiber ltd:

Where a variance in terms of contract is made without the consent of surety, u/s 133 of the contract act, such variance discharges the surety in respect of transaction subsequent to the date of variance. Surety is discharged u/s 139 of the contract Act, 1872 from the contract between the creditor and the principal debtor by which the principal debtor is released or by any act or omission of creditor, the legal consequences of which is the discharge of principal debtor where creditor and the principal creditor makes a composition with or where promises to give time to the principal debtor, the surety is discharged. 2002 CLD 643

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