Contract of Guarantee

What is a Contract of Guarantee?

Section 126 of the Indian Contract Act 1860 applies to the Contract of Guarantee. A three-party contract is referred to as a "contract of guarantee" under the Indian Contract Act 1860. The individual who extends the guarantee is referred to as the "surety," the recipient of the guarantee is referred to as the "creditor," and the major debtor is the one for whom the guarantee is provided.

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This Story also Contains

1. What is a Contract of Guarantee?
2. Essentials of Contract of Guarantee
3. Types of Contract of Guarantee
4. Revocation of a Contract of Guarantee
5. Rights of a Surety in Contract of Guarantee
6. When does a contract of Guarantee become void?
7. The difference between a Contract of Guarantee and a Contract of indemnity-
8. Conclusion

In essence, a guarantee is a legal agreement that, if the principal debtor the person initially responsible for the debt is unable to repay the creditor, the third party the surety will take over as the next accountable party and bear the burden of the obligation.

Illustration

Through Party C, Individuals A and B have reached an agreement regarding a guarantee. Party B is required under this agreement to give Individual A an amount of Rs. 1000; yet, Party B may still be required to fulfil this financial commitment for a variety of reasons. Party C will then reimburse Individual A for the Rs. 1000.

Essentials of Contract of Guarantee

1. A Valid agreement is important for a Contract

This agreement can only be formed with the unanimous permission of the three parties involved: the principal debtor, the lender, and the surety. Remember that only at the principal debtor's request does the surety assume responsibility for paying the principal debtor's obligation. Consequently, there must be open channels of communication between the principal debtor and the surety, whether through direct or indirect channels. This guarantee contract will not be enforceable if the surety discusses it with the lender while the principal debtor is not informed.

2. A Consideration is essential between two Parties-

Any action or promise made in support of the principal debtor is considered sufficient consideration for the surety to give the guarantee, as per section 127 of the relevant legislation. This consideration offered by the creditor must be something that was not previously owed. However, nothing needs to be given back to the guarantor; in some circumstances, the creditor's forbearance in the debtor's default can be seen as adequate recompense.

3. Liability between parties is essential

Under a guarantee arrangement, a surety's duty is viewed as secondary. This implies that the principal debtor bears the major duty of fulfilling the terms of the contract, as the original agreement was made between the debtor and the lender. Repayment responsibilities of the surety only become due when the principal debtor defaults on their debts.

4. Existence of debt is essential

A guarantee agreement's main goal is to make sure the borrower pays back the loan. On the other hand, the guarantor is not required to fulfil any obligations if there is no such loan. Consequently, the guarantor is released from liability if the loan is deemed illegitimate or terminated.

5. The Contract should be valid

A guarantee agreement must fulfil all requirements for a legally binding contract because that is the type of arrangement it is. Therefore, among other requirements, mutual consent, a reasonable offer of consideration, and the acknowledgement of purpose to form a legal bond are necessary for guarantee agreements to be legally binding.

6. Transparency of the facts is essential

Any information that could affect the guarantor's obligation must be disclosed by the debtor to the surety. Any guarantees obtained by concealing such information are deemed to be void. Therefore, if the debtor acquires a guarantee by omitting material information, the guarantee becomes invalid.

7. Misrepresentation of facts is not allowed

Falsifying information to the surety is not a suitable way to obtain the assurance. Although it is not a contract of uberrima fides or perfect honesty, the guarantee agreement does not need the debtor or creditor to completely disclose to the surety all material information before the arrangement. However, any information that may have an impact on the surety's liability level must be represented accurately.

Types of Contract of Guarantee

There are two types of contracts of guarantee. The two types of contract Guarantee are Specific Guarantee and Continuing Guarantee.

Specific guarantee

This guarantee relates to a specific loan or transaction. After the loan has been settled, it ends.

Continuing Guarantee

Section 129 of the Indian Contract Act, of 1872, specifies a continuous assurance. A series of transactions is connected to this kind of guarantee. As long as the principal debtor makes transactions and they are not cancelled by the guarantor, it covers all of those transactions. Therefore, bankers typically search for a continuous guarantee to ensure that the guarantor's duty extends beyond the primary loans and covers all future debts as well.

Illustration-

S, who runs a bookshop, lends P several books with the understanding that their friend X will pay for the items if P is unable to pay. A few guarantees are necessary for this arrangement to go through, and K's liability ends the moment S receives payment for the books.

Revocation of a Contract of Guarantee

Guarantees for current debts are irreversible once an agreement is reached since the terms of the arrangement are legally binding. However, promises for upcoming transactions are subject to change at any time. If this occurs, any already completed transactions will be covered by the surety. Nonetheless, a contract of guarantee may be withdrawn in one of two ways. They're

Section 130- By giving notification to the Creditor,

Continuing guarantees can be ended, although this will only have an impact on future transactions. A notice does not absolve the surety of its responsibilities; rather, the surety remains liable for all transactions made before the notice was received. If the guarantee agreement specifies that a certain amount of notice must pass before the arrangement can be terminated, the surety must comply with this obligation, as the Offord v. Davies (1862) case illustrates.

Section 131- By surety’s death

Since there is no contract in place, a surety's ongoing guarantee is cancelled for all upcoming transactions upon their death. In the absence of a contract to the contrary, the surety's assurance for transactions that occur after their death is void. Any transactions done before the surety's death are thereafter the responsibility of their legal representatives. But any transactions that happened during the surety's lifetime are the estate of the deceased surety's responsibility. The estate of the deceased guarantor will not be held accountable for any transactions that occurred after the surety's death, even if the creditor was not aware of the surety's passing.

Rights of a Surety in Contract of Guarantee

A person who makes a promise in a guarantee arrangement is known as a surety. This person takes on the responsibility of paying back a specific sum of money or fulfilling any duties on behalf of another person if the latter fails to complete the tasks that were agreed upon. A Contract of Guarantee heavily relies on the surety. With multiple rights against the principal debtor, creditor, and co-surety, a surety has been incurred. They are listed below:

Rights of a surety against a Principal debtor-

• Subrogation rights of the surety-

Section 140 of the Indian Contract Act 1872 states that the surety assumes responsibility and acts on behalf of the principal borrower if the principal debtor defaults on their commitments to the creditor. After that, all of the creditor's rights against the principal borrower are transferred to the surety. Consequently, the surety has the right of subrogation, which allows them to recover the whole amount of work they have completed on behalf of the principal debtor

• Indemnity rights against the principal debtor-

Section 145 of the Indian Contract Act 1872 states that if the principal debtor defaults on any of their responsibilities, the surety assumes responsibility for satisfying the creditor's demands, which the principal debtor is required to perform by the terms of the agreement. This agreement now contains an underlying promise that, if the surety acts on behalf of the primary debtor, the principal debtor will be responsible for paying the surety back for all money that it has lawfully paid to the creditor. All of the creditor's rights against the major debtor are held by him.

Rights of a surety against the creditor-

A surety is legally entitled to the benefit of any security held by the creditor against the principal debtor at the time the suretyship agreement is executed, even if the surety is not aware of this security, as per section 141 of the Indian Contract Act 1872. In addition, the guarantor is released from liability to the extent of the security's value if the creditor suffers a loss or the security is taken away without the surety's consent.

Rights of Surety against the Co-surety-

The exit of one co-surety does not affect other co-surety-

Section 138 of the Indian Contract Act states that many people are referred to as co-sureties when more than one person is securing the principal obligation of the main debtor. To settle the secured loan, they are required to make the prearranged contributions. No other co-surety is released from their obligations by the creditor, and the released surety is not relieved of his duty to the other sureties either.

Therefore, those guarantors who are involved in finishing the agreement are entitled to receive additional support from the other guarantors involved when the principal debtor fails to fulfil his obligations and the repayment of a loan or completion of a task is ensured by additional co-sureties, leaving the creditor needing only one or more of the guarantors to complete the agreement.

The Equal participation of Co-securities

The co-sureties shall equally divide the liability absent a written agreement to the contrary. This rule will apply regardless of the co-sureties' knowledge of each other's involvement, the type of contracts involved (same or different), or whether they are responsible jointly or severally. This provision is included in Section 146 of the Indian Contract Act of 1872.

Responsibility for co-sureties tied to various amounts-

Section 147 of the Indian Contract Act 1872 states that unless there is a cap on the total amount each party is ready to guarantee, co-sureties must contribute their shares equally when they want to back different amounts.

When does a contract of Guarantee become void?

Like any other agreement, a guarantee agreement may be revoked if it is shown to be void or if the surety chooses to do so. The following circumstances can render a guarantee contract void:

1. Consent assured through misrepresentation of facts-

The guarantee agreement is deemed void if any material fact is falsely stated by the creditor, either knowingly or unknowingly.

2. Consent obtained through concealment of facts-

An agreement is deemed void when a creditor obtains a commitment by keeping quiet about a material component of the circumstances surrounding the agreement.

3. Non-existence of a co-surety-

If a guarantee agreement specifies that a creditor cannot act on a guarantee until another person becomes a co-surety, the guarantee is nullified if the other person fails to do so.

4. Depending on the extension of the surety’s liability-

A surety's obligation is equivalent to that of the principal debtor absent a clear agreement to the contrary. This suggests that the surety bears the same level of liability as the principal debtor.

The difference between a Contract of Guarantee and a Contract of indemnity-

Conclusion

A specific type of agreement for which certain laws have been set under the Indian Contract Act 1872 is the guarantee agreement. As we've discussed, a guarantee agreement's main goals are to protect the debtor from monetary loss and reassure the creditor that the guarantor will uphold the terms of the arrangement. There are two types of guarantees in each guarantee agreement: particular guarantees and continuous guarantees. Each guarantee agreement involves three parties.