Contract of Guarantee
A contract of guarantee, as defined in Section 126 of the Indian Contract Act, 1872, is a contract to perform the promise or discharge the liability of a third person in case of their default.
Essentials of a Contract of Guarantee:
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Three Parties: A contract of guarantee involves three parties:
- Surety: The person who gives the guarantee (also known as the guarantor).
- Principal Debtor: The person for whom the guarantee is given and whose default the surety guarantees.
- Creditor: The person to whom the guarantee is given (the lender or obligee).
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Primary Liability of the Principal Debtor: The primary liability to perform the contract or discharge the obligation rests with the principal debtor. The surety’s liability is secondary and arises only upon the principal debtor’s default.
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Existence of a Debt or Duty: There must be an existing debt or duty, the performance of which is guaranteed by the surety. A guarantee cannot exist without a principal debt.
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Consideration: There must be consideration for the surety’s promise. However, it is not necessary that there should be direct consideration between the creditor and the surety. Any benefit conferred upon the principal debtor is sufficient consideration for the surety to give the guarantee (Section 127).
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All Essentials of a Valid Contract: A contract of guarantee must also fulfill all the essential elements of a valid contract, such as offer, acceptance, free consent, capacity to contract, lawful object, etc.
Distinction between Contract of Indemnity and Guarantee:
| Feature | Contract of Indemnity | Contract of Guarantee |
|---|---|---|
| Number of Parties | Two (Indemnifier and Indemnity-holder) | Three (Surety, Principal Debtor, and Creditor) |
| Nature of Liability | Primary liability of the indemnifier | Secondary liability of the surety |
| Time of Liability | Liability arises when the indemnity-holder suffers a loss | Liability arises on the default of the principal debtor |
| Purpose | Protection against loss | Security for the performance of a duty or obligation |
| Request | May or may not be based on a request | Usually based on a request from the principal debtor |
Letters of Indemnity and Letters of Guarantee:
- Letters of Indemnity: These are written instruments embodying a contract of indemnity. They typically outline the specific events or circumstances under which the indemnifier will compensate the indemnity-holder for any losses.
- Letters of Guarantee: These are written instruments embodying a contract of guarantee. They clearly state the surety’s promise to answer for the debt or default of the principal debtor.
Continuing Guarantee:
Section 129 defines a continuing guarantee as “a guarantee which extends to a series of transactions.” It covers multiple transactions or a series of debts. The surety’s liability continues until the guarantee is revoked.
Revocation of Continuing Guarantee:
A continuing guarantee can be revoked:
- By Notice: The surety can revoke the guarantee by giving notice to the creditor for future transactions (Section 130).
- By Death of Surety: The death of the surety operates as a revocation of the continuing guarantee for future transactions (Section 131).
Invalid Guarantee:
A guarantee can be invalid under various circumstances, including:
- Misrepresentation or Concealment: If the guarantee is obtained by misrepresentation or concealment of material facts by the creditor (Sections 142 and 143).
- Failure of Consideration: If there is no valid consideration for the surety’s promise.
- Principal Debt is Void: If the principal debt itself is void (e.g., due to the incapacity of the principal debtor), the guarantee is also void.
- Variance in Contract: Any variance 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 (Section 133).
- Release of Principal Debtor: If the creditor releases the principal debtor, the surety is also discharged (Section 134).
Understanding the nuances of contracts of guarantee is crucial in various commercial and financial transactions, providing security and assurance to creditors.