The Tripartite Shield: Decoding the Law of Guarantee in Modern Commerce

This Blog is Written by Rishika Singhal, 2nd Year, B.B.A. LL.B., Symbiosis Law School, Noida.

Blog 01 | Edition IX

Introduction

When we talk about the concept of Guarantee it is codified under “The Indian Contract Act” and it is as old as the concept of Debt itself. The Act helps in providing frameworks that govern the agreements as well as their enforceability. The contract of Guarantee is contained and governed under the “sections 126 to 147 of the Indian Contract Act”. Guarantee is a “tripartite agreement” and has a unique arrangement as it not only involves three different parties but also the three interrelated contracts. This form of contract has a very important role in the ‘commercial transaction of the modern world’, especially in the fields of banking and financial landings, projects based on infrastructure and the trade credit systems. The contract of guarantee helps in the smooth working of all these transactions by providing an extra or additional assurance in which the third party also known as the surety undertakes the liability of the ‘principal debtor’ in case any defaults that occurs in the transaction. This projects deals with the various statutory boundaries and evolution that have occurred in these contracts in India also focusing on how law maintains a balance between the rights of the surety and the protection of the creditor.

Research Objectives

To examine the effect of legal nature of the ‘contract of guarantee of the Indian Contract Act’. To explore the various situations under which the surety is lawfully discharged from his/her obligations as well as to explore the scope, rights, obligations related to the guarantee contract in India.

Research Question

What is nature, scope and the structure of contract of guarantee in the law of contracts? What are the various rights, remedies and the liabilities of surety, and under what all circumstances the surety can discharge the liabilities of the principal debtor?

Main Body:

The Framework and Definition:

The “contract of guarantee” is defined under the section-126 of the Indian contract act as a “contract to perform the promise, or discharge the liability, of the third person in case of default”. When we talk about the English Law such a contract should be in writing but the Indian position is not that rigid and is flexible in “P.J. Rajappan v. Associated Industries [AIR 1990 Ker 1]” the court held that the oral guarantee is not only valid not also enforceable in India conditioned to clear evidence of the agreement is present. This contract involves three parties namely –the surety, the ‘principal debtor’ and the ‘creditor’. Although the debtor is considered as the central to the agreement, the core or the main guarantee relationship is between the surety and the creditor. Thus, ‘unlike ordinary contracts that involve two parties, a contract of guarantee necessarily involves three parties.’

Essentials of Valid Guarantee:

In order to be a ‘valid contract’ all the requirements of the general contracts should be fulfilled for example there should be the free consent of the parties and the object of the contract should be lawful contract, apart from these there are a few more essentials to the ‘contract of guarantee’ as follows: Debt: in order for a contract to be valid there must be existence of a primary debt as well as a promise to be performed, if the debt is not enforceable it can’t be considered as a valid guarantee. Consideration: section 127 defines the consideration in guarantee as ‘anything done, or any promise made, for the benefit of the principal debtor, may be sufficient consideration to the surety for giving the guarantee’. In “State Bank of India v. Premco Saw Mill [AIR 1984 Guj 93]” also the court held that the creditor’s ‘forbearance to sue the debtor is considered to be a valid consideration for the surety.’ Consent: section 142 and 143 defines no misrepresentation and concealment it states that if a guarantee is obtained through misrepresentation or keeping silence on a material part of the transaction, it is invalid.

Guarantee v. Indemnity

The contract of indemnity is defined under section 124, and in which there are only two parties to the contract and the indemnifier’s liability is primary as well as independent. Whereas when we talk about the guarantee contract the surety’s liability is secondary in nature and arises only when default is being done on the part of the principal debtor. In “Gajanan Moreshwar v. Moreshwar Madan [AIR 1942 Bom 302]” it was observed that the indemnifier is the one who acts as a primary risk barrier while when we talk about surety, he is the one who act as a secondary risk barrier.

Co-extensive Liability

Section 128 describes that the ‘liability of the surety is co-extensive with that of the principal debtor, unless otherwise provided by the contract.’ In “Bank of Bihar Ltd v. Damodar Prasad [AIR 1969 SC 297]” it was held that it is not necessary that the creditor should always first sue the debtor for the amount and claim the remedies from him after a default is occured. The creditor has the right to directly sue the creditor first as soon as the default has occurred on the part of the principal debtor. 

Continuation and Revocation in Guarantee:

When we talk about guarantee it can be specific as well as continuing. ‘Section 129’ defines ‘continuing guarantee’ as a one that extends to a ‘series of transactions.’ The perfect example of such type is guarantee is the one in banking agreements in which a person guarantee a ‘fluctuating overdraft account’.

Revocation:

• By Notice: it is laid down under the section 130 of ‘the Indian Contract Act’ which states that “a continuing guarantee may at any time be revoked by the surety, as to future transactions, by notice to the creditor.”
• By Death: it is defined under ‘section 131’ of the ‘Indian Contract Act’ stating that “the death of the surety operates as a revocation of a continuing guarantee regarding future transactions, unless the contract states otherwise.”

Rights of Surety:

• Subrogation Right: when we talk about the ‘right of subrogation’ of surety it is described under section 140 “the surety is invested with all the rights of the creditor against the ‘principal debtor’ after payment.” Basically under this the surety “steps in the shoes” of the creditor.
• Right to Securities: Defined under ‘section 141’ the surety has the right to every surety some as to what the creditor has over the principal debtor at the time at which the agreement of surety ship was formed. In case the creditor decides or use these sureties the surety is then discharged of the value to the extent of the value of that security.
• Indemnity Right: Under ‘section 145’ it is the right of the surety to claim the money back from the ‘principal debtor’ which he has rightfully paid on his behalf due to the default under the ‘contract of guarantee’.

Surety’s Discharge:

The Indian law provides a number of ways in order to safeguard the surety from being held liable for the risks he had not agreed to a few of them are as follows:

• By Variance: Section 133 tells that when the ‘variance’ in the terms of the contract is done without the knowledge and the consent of the surety and is done between the debtor and the creditor, the surety is discharged from the transactions that are related to the variance.  
• By Release: Section 134 states that “the surety is discharged by any contract between the creditor and the principal debtor, by which the principal debtor is released”.

Conclusion

In India, nature and scope in consideration to the contract of guarantee represents a smooth balance between the necessity in the commercial world and protection of the people. Although section 128 tells and defines the powerful rights of the creditor in order to pursue surety co-extensively, the succeeding sections present in the “Indian Contract Act” makes sure that the surety is not exploited by the unauthorized changes done by the ‘principal debtor’ and the ‘creditor’ to the debt as well as from the loss of securities. Therefore, to conclude it is clear from the judicial interpretations that although guarantee is a secondary contract but when we talk about surety’s liability, it becomes immediate as soon as the default occurs on the part of the debtor. Moreover, the legal structure in India makes sure that the credit remains accessible throughout the market in India by providing a strong and powerful framework for the ones who provide security under such arrangements in “contract of guarantee”.

(Write to the author at rishika.singhal@symlaw.edu.in.)