Guarantee under Contract Law

This article is written by Nazar Nawaz Abbasi pursuing LLB from Faculty of Law, University of Delhi.

INTRODUCTION

GUARANTEE AS PER DEFINED IN INDIAN CONTRACT ACT,1872

Contract of Guarantee is defined in Indian Contract Act in Section 126 which says-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,(a person who takes responsibility for another’s performance of an undertaking, for example, their appearing in court or paying a debt) 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 be in oral or written.

In Mathura Das v Secretary of State (AIR 1930 All 848) and in Nandlal Chanandas v Firm Kishinchand (AIR 1937 Sindh 50), it was observed by the SC that contract of guarantee can be created either by oral or by a written instrument and that it may be express or implied and may be inferred from the course of the conduct of the parties concerned. There is overwhelming evidence in this case that the second defendant had guaranteed the due performance of the contract by the first defendant, a principal debtor. Hence mere omission on his part to sign the agreement cannot absolve him from his liability as the guarantor.

Let us understand more.

WHAT GUARANTEE ACTUALLY MEAN

A guarantee is a promise to answer for the payment of some debt, or the performance of some duty, in case of the non-performance (failure) of another party, who is in the first moment is liable to such payment or performance. Security, in the form of a right of action against a third party, is known as a guarantee.

A guarantee is an associate contract by which the promisor undertakes to be answerable to the promisee for the debt, default or miscarriage of another person, whose primary liability to the promisee must exist or be contemplated. The words “debt, default or miscarriage” is descriptive of failure to perform legal obligations, existing or future, arising from any source, not only from contractual promises, but in any other factual situations capable of giving rise to legal obligations, such as those resulting from bailment, tort, or unsatisfied judgments. A letter of comfort is a recommendatory letter, and may not be a guarantee unless there is a specific undertaking to discharge liability in case of default.

A contract of guarantee is not a primary transaction but it is an independent transaction containing independent and reciprocal obligations. A contract of guarantee is a complete and separate contract by itself and enforcement as per its terms cannot be restrained by considering the terms of the underlying contract.

Lord Selborne observed that “there can be no surety-ship unless there be a principal debtor, who of course may be constituted in the course of the transaction by matters ex post facto, and need not be so at the time, but until there is a principal debtor there can be no surety-ship”.

A guarantee is an undertaking to compensate (indemnify) if some other person does not fulfil his promise. The liability under a contract of guarantee is conditional on the default of the principal debtor, and hence does not amount to a “promise to pay”; and a guarantee would not attract the provisions of the Bengal Money Lenders Act. A contract of guarantee is not one uberrimae fidei, but a contract of strictissimi Juris.

The creditor’s rights under the contract of the guarantee are transferable. In an assignment of the reversion of a lease, the benefit of a covenant by a surety guaranteed performance by the tenant would also pass, even though the benefit of such a covenant is not expressly assigned. The liability of a surety cannot form the subject of trust. The legal representatives of a surety continue to be responsible (liable) for the amount to the creditor, after the death of the surety, but their liability is limited to the extent of the estate inherited by them from the surety. The question of whether the representatives hold any estate of the deceased, surety can be raised and decided in the very case in which the liability of the surety is in question.

Value of the Guarantee

A guarantee is the simplest form of banking security, more easily obtained than any other and yet frequently most difficult to aware. It is intangible security which may or may not be of adequate value when it is most needed. Some guarantors expect to be called upon to honour their contract and therefore it is imperative that the lending banker should exercise the greatest care in obtaining the guarantee and thereafter ensure that it is at all times worth what is required from it. The advice from experience is, perhaps, not to lend relying solely on a guarantee unless the bank is completely satisfied that the guarantor is really undoubted for the amount required and that he is unquestionable.

Liability

A ‘liability’ in Section 126 of the Indian Contract Act, 1872, means a liability which is enforceable by law, and if that liability doesn’t exist, there can’t be a contract of guarantee. A surety is not liable on a guarantee for payment of a debt which is a statute.

The SC in Chattanatha Karayalar v Central Bank of India Ltd laid down that if a transaction is contained in more than one document between the same parties, they must be read and interpreted together. Although a guarantor may together with the principal debtor in executing the promissory note he will not be a co obligant where the primary transaction and the conduct of the parties shows that he is a surety under Section 126 of the Contract Act,1872.

Essentials of a Guarantee

Should be a valid Contract
There must be a concurrence of three parties namely-the principal debtor, the creditor and surety.
Contact of Guarantee be either written or oral.
In a contract of Guarantee liability of the surety is secondary i.e., the creditor must proceed against the debtor and if the latter doesn’t perform his promise, then only he can proceed against the surety.
The guarantee should not be obtained by misrepresenting the facts to the surety.
The Creditor should disclose the surety the facts that are likely to affect the surety’s liability.

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