WHAT IS CONTRACT OF GUARANTEE?
Section 126 of the Indian contract act defines a contract of guarantee as a contract to perform the promise or discharge the liability of the defaulting party in case he fails to fulfill his promise.
It further states that, the person who gives the guarantee is called surety , the person in respect of whose default the guarantee is given is called principal debtor, and the person to whom the guarantee is given is called creditor.
And, the last part of the section states that guarantee may be either oral or written.
There are three parties in a contract
Principal Debtor – The one who borrows or is liable to pay and on whose default the guarantee is given.
Creditor – The party who has given something of value to borrow and stands to receive the payment for such a thing and to whom the guarantee is given.
Surety/Guarantor – The person who gives the guarantee to pay in case of default of the principal debtor.
Essentials of a Contract of Guarantee
1) Must be made with the agreement of all three parties
4)Presupposes the existence of a Debt
5)Must contain all the essentials of a valid contract
6) No Concealment of Facts
7) No Misrepresentation
Kinds of guarantee
There are two types
1)Specific Guarantee: When a guarantee is given in respect of a single debt or specific transaction and is to come to an end when the guaranteed debt is paid or the promise is duly performed, it is called a specific or simple guarantee.
2)Continuing Guarantee: a guarantee which extends to a series of transactions is called a continuing guarantee or A continuing guarantee is a type of guarantee which applies to a series of transactions. It applies to all the transactions entered into by the principal debtor until it is revoked by the surety. Therefore Bankers always prefer to have a continuing guarantee so that the guarantor’s liability is not limited to the original advances and would also extend to all subsequent debts.
How can continuing guarantee be revoked?
It can be revoked in two ways:
1) By giving a notice
Continuing guarantees can be revoked by giving notice to the Creditor but this applies only to future transactions. Just by giving a notice the surety cannot waive off his responsibility and still remains liable for all the transactions that have been placed before the notice was given by him. I
2) By Death of Surety
Unless there is a contract to the contrary, the death of surety operates as a revocation of the continuing guarantee in respect to the transactions taking place after the death of surety due to the absence of a contract.
There are some Rights of Surety to Contract
Rights against the Principal Debtor
1)The right of surety on payment of debt or the Right of subrogation:
The right of subrogation means that since the surety had given a guarantee to the creditor and the creditor after getting the payment is out of the scene, the surety will now deal with the debtor as if he is a creditor.
2) The right of Indemnity:
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.
Rights against the Creditor
1) Right to securities given by the principal debtor:
On the default of payment by the principal debtor, when the surety pays off the debt of the principal debtor he becomes entitled to claim all the securities which were given by the principal debtor to the creditor.
2) Right to set off
When the creditor sues the surety for the payment of principal debtor’s liabilities, the surety can claim set off, or counterclaim if any, which the principal debtor had against the creditor.
Rights against the Co-sureties
1) Release of one co-surety does not discharge others:
When the repayment of debt of the principal debtor is guaranteed by more than one person they are called Co-sureties and they are liable to contribute as agreed towards the payment of guaranteed debt.
2) Co-sureties to contribute equally:
This principle will apply even when the liability of co-sureties is joint or several, and whether under the same or different contracts, and whether with or without the knowledge of each other
3) Liability of co-sureties bound in different sums:
When the co-sureties have agreed to guarantee different sums, they have to contribute equally subject to the maximum of the amount guaranteed by each one.