Contract of Guarantee in indian contract law.pptx.pdf

Contract of Guarantee

1. Sanjay Bang
Contract of Guarantee

2. Points to be covered
⚫1) What is guarantee?
⚫2) Why it is important?
⚫3) The persons who are being involved in
the contract of guarantee.
⚫4) The nature of the contract of guarantee.
⚫5) The relevant sections to be covered for
Contract of guarantee.
⚫6) Definition of Guarantee covered under
sec 126 of the Contract Act.
⚫7) Position of English Law for guarantee.

3. Introduction
⚫In our day to day activates, specially in
business transactions, we require money to
carry its smooth operation.
⚫E.g When company needs some money
for its business it approaches to a financial
institute, specially a bank.
⚫The bank requires that the Managing
Director Mr M promises to repay the loan
personally should the company default.

4. Continue
⚫When the directors of the company
including M execute the promissory note
on behalf of the company, they sign as
officials of company.
⚫M, the managing director signs again as
individual. The relationship between M
and the bank is called a “Guarantee” or
“suretyship”.
⚫It’s a contractual relationship resulting
from the unconditional promise of M.
⚫Here M, who promises to pay in default of
company is known as Guarantor or the
surety.

5. Continued
⚫The institute who lends the money is
known as the Creditor, here it is bank.
⚫The company who takes loan is known s
principal debtor.
⚫If company fails to repay the loan , the
bank can approach M, for the repayment
as if he is the principal debtor.
⚫Sometimes the bank ( lenders) may ask for
more security for the loan in addition to
the personal gurantee.

6. Continued
⚫The principal debtor may be asked to
furnish collateral security against the
advanced loan.
⚫If the loan is not repaid, the lenders have
three option
⚫1) To compel the principal debtor to pay.
⚫2) Demand of the payment from the
surety.
⚫3) To obtain the court order either to claim
or sell the collateral.
⚫But the third option is obviously, the last
one.

7. Provisions of Guarantee under the
Indian Contract Act
⚫A contract of guarantee is entered into with
the object of enabling a person to get a
loan or goods on credit or an employment.
⚫The law relating to guarantee is given in
the Indian Contract Act, from sections 126
to 147.
⚫Definition :- A contract of guarantee is a
contract to perform the promise, or
discharge the liability, of a third person in
case of his default.
⚫E.g- A and B go into shop, A says to the
shopkeeper ,” Let B have the goods , I will
see you being paid”. This is contract of
indemnity.

8. Continued
⚫Instead of that if he says , “ If B doesn't pay
you , I will pay”. This is contract of
guarantee.
⚫Contract of guarantee has following 3
purposes
⚫1) To secure the loans. Thus its guarantee
for creditor.
⚫2) The contract of guarantee sometimes
called as contract of performance.
⚫ E.g A employer often demands fidelity
bond for the employee who handles the
cash or for good conduct, builders in case
of construction of project

9. Continued
⚫Bail bonds used in the criminal law, are a
form of contract of guarantee. It is a device
which ensures , that a criminal defendant
will appear for trial.
⚫But in this topic, our primary concern is
with the contracts of guarantee which are
used for securing loan.
⚫Thus, it is said that a contract of guarantee
is an agreement involving triangular
contractual relationship wherein the surety
guarantees the creditor to pay the debt in
case of default of the principal debtor.

10. Continued
⚫In Contract of guarantee 3 contracts are
being involved
⚫1) Contract between the principal debtor
and the creditor out of which the
guaranteed debt arises.
⚫2) Contract between the surety and the
creditor by which the surety guarantees to
pay the debt if principal debtor fails.
⚫3) Contract between the surety and the
principal debtor by which the principal
debtor undertakes to indemnify the surety
if surety is required to pay.

11. Position of guarantee under English
Law
⚫In English Law, Guarantee is defined as a
promise made by one person to another be
collaterally answerable for the debt, default
or miscarriage of a third person and must
be evidenced in writing.
⚫Thus, under English Law, Guarantee must
be in written format only.
⚫Whereas in India, guarantee may be oral or
in written format.
⚫Guarantee may be implied from the course
of the conduct of the parties.

12. Enforcement
⚫A contract of guarantee is to be enforced
according to the terms of the contract.
⚫In contract of liability the surety is
considered as favored debtor in the eye of
law.
⚫A question is always arisen, whether the
contract of guarantee is a contract of
uberrimae fide, which means contract of
utmost good faith.
⚫Sec 17 (2) of the Indian Contract Act talks
about that, where your silence also
amounts to fraud.
⚫Insurance Contract is the best example of
that.

13. Continued
⚫Unlike, the Insurance contract, the contract
of guarantee is not a contract of utmost
good faith.
⚫Still the suretyship relationship is one of
trust and confidence and the validity of the
contract depends upon the good faith of
the creditor.
⚫However, it is not a part of the creditors
duty to inform the surety about all the
previous dealings with the principal
debtor.
⚫Law doesn’t compel to do so, for the surety
cant initiate any action against the creditor
for non disclosure.

14. Judicial approach
⚫Wythes vs Labon Chare (1858), Lord
Chelmsford held that the creditor is not
bound to inform the matters affecting the
credit of the debtor or any circumstances
unconnected with the transaction in which
he is about to engage which will render his
position more hazardous. Since it is based
on good faith, a contract of guarantee
becomes invalid if the guarantee is
obtained from the surety by
misrepresentation or concealment as
given in section 142 and 143 of the Indian
Contract Act-1872.

15. Essentials of Contract of Guarantee
⚫1) A contract of guarantee must satisfy all
the essential elements of a valid contract
under sec 10 of the Act.
⚫2) There must be Three parties in the
contract. a) Surety b) Principal debtor c)
Creditor.
⚫3) A contract of guarantee pre-supposes the
existence of a liability enforceable at law. It
is of the essence of a contract of guarantee
that there should be a liability , existing or
future , enforceable at law.

16. Continued
⚫X took a loan on 1
st
Jan 2015 for 50000 and
paid nothing, neither interest nor the
principle. On 10
th
January 2018, Y
promised to pay the amount due with X to
the bank. Is this valid contract of
guarantee?
⚫4) A contract of guarantee may be oral or in
the written format. May be expressed or
implied. Under the English Contract, only
written and expressed contract of
guarantee is a valid contract.

17. Continued
⚫5) There are two types of liabilities under
the contract of guarantee a) Primary
liability. b) Secondary liability. The
primary liability is with the with the
principal debtor and the secondary liability
is with the guarantor.
⚫ State of Maharashtra vs. M.N Kaul:-The
cardinal rule is that the guarantor must not
be made liable beyond the terms of his
engagement. Therefore, his liability is
secondary and conditional and that of
principal debtor is primary. In case, the
principal debtor is not liable, the surety is
also not liable.

18. Continued
⚫6) A contract of guarantee has to satisfy all
the essential of a valid contract, but for
consideration and for the capacity, special
feature have to be applied.
⚫E.g- If principal debtor is not competent to
contract, the primary liability rests with
the surety.
⚫Necessity was supplied to minor for which
he didn’t pay and Mr A took the guarantee
to pay, in case of default? Can we ask the
surety to pay on the competency ground?

19. Points to be covered
⚫Effect of capacity on the contract of
guarantee.
⚫Effect of consideration on the contract of
guarantee.
⚫The circumstances which makes the
guarantee invalid.
⚫The difference between Guarantee and
indemnity.
⚫Types of guarantee.

20. Continued
⚫A minor pretended himself to be a major
person and entered in a contract with a
person. Later on it was found that he was
minor and wanted to take undue advantage
from the privilege to minor. The surety on
behalf of the minor refused to continue
with his liability. Decide the case n two
parameters.
⚫1) Status of contract under sec 11 of the
Contract Act..
⚫2) Status of contract under Guarantee?

21. Continued
⚫The incapacity of the principal debtor doesn’t
affect the validity of a contract of guarantee.
The creditor and the surety must be
competent to enter into the contract.
⚫In case, the principal debtor is minor, the
surety is regarded as a principal debtor and is
personally liable to pay the debt, though the
principal is not liable.
⚫In Kashiba vs Sripat, (1894) I.L.R 19 Bom 697 it
was observed that the contract between the
surety and the creditor is not collateral but
independent and the surety is held liable as
principal debtor.

22. Continued
⚫What would be the situation if the
principal debtor has become insolvent?
Can we ask the surety to pay?
⚫It’s a general rue, that without
consideration no contract is possible. But
in contract of guarantee, it is not necessary
that there must be some consideration
present between the Principal debtor and
the Surety.
⚫Sec 127 says anything done , or any
promise made, for the benefit for the
principal debtor may be sufficient
consideration to the surety for giving the
guarantee.

23. Invalid guarantee
⚫1) According to section 142 of the Act, any
guarantee which has been obtained by
means of misrepresentation made by the
creditor, or with his knowledge and assent,
concerning a material part of the
transactions is invalid.
⚫ E.g Wythes vs Labon Chare (1858),
⚫2) Concealment , it is given in section 143
of the Act. It is like fraud. Where the surety
is intentionally kept away from the reality
and asked to provide his surety.

24. Continued
⚫3) Not joining by co-surety. According to
section 144 of the Act, where a person gives
a guarantee upon a contract that a creditor
shall not act upon it until another person
has joined in it as co-securety, the
guarantee is not valid if that other person
doesn’t join.
⚫It means if the liability is joint, it will be on
both and no one can be asked
independently to perform his role under
the contract of guarantee.

25. Comparison between Guarantee
between indemnity
Guarantee
Indemnity
⚫1) There are 3
parties, the
Creditor, Principal
debtor and the
surety.
⚫2) The liability of
indemnifier is
primary.
⚫1) There are 2 parties,
indemnifier and the
indemnity holder.
⚫2) The liability of the
principal debtor is
primary and the
surety is secondary. It
means if the principal
debtor fails then only
the liability of surety
arises

26. Continued
Guarantee Indemnity
⚫3) There is only
one contract
between the
indemnified and
the indemnifier.
⚫3) There are 3
contracts, between
the Principal
debtor and the
creditor, Creditor
and the surety and
the Principal
debtor and the
surety.

27. Continued
Guarantee
Indemnity
⚫4) The liability of
the indemnifier
arises on the
happening of a
contingent event.
⚫5) It is for
reimbursement of
loss.
⚫4) There is an
existing debt or
duty, the
performance of
which is guaranteed
by the surety.
⚫5) It is for the
security of the
creditor for ensuring
his payment.

28. Continued
Guarantee Indemnity
⚫6) An indemnifier
cannot sue a third
party for loss in his
own name because
thee is no privity
of the contract. He
can do so only if
some assignment is
in his favour.
⚫6) A surety on
discharging the
debt due by the
principal debtor
for his own
recovery.

29. Continued
Guarantee Indemnity
⚫7) Indemnifier
need not act on the
request of the
indemnified.
⚫7) The surety gives
the guarantee on
the request of the
principal debtor.

30. Types of guarantee
⚫Already we discussed the guarantee is
given for 3 purposes normally.
⚫Guarantee may be either retrospective or
prospective.
⚫The former is obviously given for an
existing debt while the latter is given for
some future agreement.
⚫Mainly there are two types of guarantee.
⚫1) Simple ( specific) guarantee. 2)
Continuing guarantee

31. Continued
⚫Simple guarantee is one in which
guarantee is given for a single specific debt
or transaction.
⚫It comes to an end as soon as the liability
under that transaction ends.
⚫A specific guarantee is once given , it is
irrevocable.
⚫Continuing guarantee is defined in section
129 of the Act. It is “ a guarantee which
extends to a series of transactions is called
a continuing guarantee.

32. Continued
⚫It is not confined to single transaction.
⚫It is like standing offer which is accepted by
the creditor every time a subsequent
transaction takes place.
⚫Whether a guarantee, is continuous or not it
depends on the language of the guarantee, the
subject mater and the surrounding
circumstances.
⚫On the recommendation of Mr S, C employed
P for collection of rent from his tenants. S
promised to make good any default made by
P. This is a contract of continuing guarantee

33. Continued
⚫A guarantees payment to B of the price of
Five sacks of flour, to be delivered by B to
C and to be paid in a month. B delivers
Five sacks to C. C pays for them.
Afterwards B delivers Four sacks to C
which C does not pay for. The guarantee
given by A was not a continuing guarantee
and accordingly, he is not liable for the
price of the Four sacks.
⚫Any example from your side?

34. Revocation of continuing guarantee
⚫We all know, simple or specific guarantee
cannot be revoked at all. But continuous
guarantee can be revoked as regards future
transactions under the following
circumstances.
⚫1) By Notice-(130)- Notice will terminate
the liability of the surety as to future
transactions. The liability of the surety will
come to end, as soon as the notice is served
upon the creditor. The notice must reach
to the creditor.

35. Continued
⚫“A” the surety sends a notice to the
Creditor “B” for revoking the notice of
continuous guarantee of “C” on 28
th

November by letter. The letter reached to
the Creditor by 2
nd
December. But a
transaction of contract took pace between
B and C on 1
st
December in limit of
continuous guarantee. What is the liability
of “A” in the present case?
⚫Can C deny the liability? Give reasons

36. Continued
⚫The surety will remain liable for the
transactions entered into by him before
giving the notice.
⚫2) By death of surety:-The death of the
surety operates in the absence of any
contract, as revocation of continuous
guarantee.( So far as regards future
transactions).
⚫I) Notice of death of surety will operate as a
sufficient revocation of continuing
guarantee provided the guarantor or his
representatives have not contracted
otherwise.

37. Continued
⚫E.g. The Guarantor or his representatives
expressly mentioned that the guarantee
can be revoked only by serving the notice,
then automatically death of guarantor
doesn’t revoke the liability.
⚫II) In that case surety's heirs can be sued
for liability already incurred.
⚫III) The estate of the surety is liable for al
transactions entered into prior to death of
the surety unless there was a contrary to it.

38. Continued
⚫IV) However, his estate will not be liable or
the transactions entered into after his
death, even if the creditor has no notice of
death.
⚫3)By discharge of surety:- Discharge of
surety is one of the ground to revoke the
continuous guarantee in the following
circumstances.
⚫A) By variance in the terms o the original
contract.
⚫B) By misrepresentation (142)
⚫C) By concealment.

39. Continued
⚫D) Failure of co-security to join.