INDIAN INSTITUTE OF LEGAL STUDIES

A STUDY OF THE CONTRACT OF

GUARANTEE AND ITS ESSENTIALS

PROJECT UNDERTAKEN BY:

NITISH KUMAR ROY
B.A LLB (HONS) SEM-3
ROLL NO: 34

UNDER THE GUIDANCE OF:

Mr. MINGMA D. SHERPA
ASSISTANT PROFESSOR OF LAW
INDIAN INSTITUTE OF LEGAL STUDIES
 ACKNOWLEDGEMENT
I would like to express my special thanks of gratitude to my teacher Ms. Mingma D. Sherpa,
who gave me the golden opportunity to do this wonderful assignment of Contract-2 on " A
STUDY OF THE CONTRACT OF GUARANTEE AND ITS ESSENTIALS”, who also
helped me in completing my assignment. I came to know about so many new things and I am
really thankful to them. Secondly, I would also like to thank my parents and friends who
helped me a lot in finalizing this project within the limited time frame.
 TABLE OF CONTENT

SL NO. CHAPTERIZATION PAGE NO.

1. SYNOPSIS 1

2. CONTRACT OF GUARANTEE 4

3. ESSENTIALS OF CONTRACT OF GUARANTEE 5

4. TYPE OF GUARANTEE 8

5. RIGHTS OF SURETY 10

6. CONCLUSION 12

7. BIBLIOGRAPHY 13
 SYNOPSIS
EVOLUTION OF THE PROBLEM
The evolution of the problem surrounding the contract of guarantee in India has been shaped
by legal interpretations, societal needs, and economic developments. Initially defined under
Section 126 of the Indian Contract Act, 1872, a contract of guarantee involves three parties:
the principal debtor, the creditor, and the surety. Over time, the complexities of this
relationship have become apparent, particularly regarding the rights and obligations of each
party. The distinction between contracts of guarantee and indemnity has also emerged as a
significant area of discussion, highlighting the differences in liability and the nature of
obligations. Challenges have arisen from issues such as misrepresentation, concealment of
facts, and the necessity for consideration, which have led to judicial scrutiny and evolving
case law. As economic activities expanded and financial transactions became more intricate,
the need for clarity in these contracts increased, prompting amendments and interpretations
aimed at safeguarding the interests of all parties involved. Consequently, understanding the
essentials of a contract of guarantee has become crucial for ensuring enforceability and
protecting against defaults in various financial contexts.

STATEMENT OF THE PROBLEM

The statement of the problem in studying the contract of guarantee and its essentials revolves
around the complexities and ambiguities that arise in its application and enforcement within
the legal framework. Despite being defined under Section 126 of the Indian Contract Act,
1872, the practical implications of a contract of guarantee often lead to disputes regarding the
rights and obligations of the parties involved—the principal debtor, creditor, and surety. Key
issues include the necessity for clear consideration, the impact of misrepresentation or
concealment of facts, and the distinction between a contract of guarantee and a contract of
indemnity. Additionally, there is a need to explore how varying interpretations by courts
affect the enforceability of such contracts and the protection offered to sureties. This study
aims to identify these challenges, analyze their implications on legal practice, and propose
solutions to enhance clarity and fairness in contracts of guarantee, thereby ensuring that all
parties are adequately informed and protected in their contractual relationships.

HYPOTHESIS
The hypothesis for the study on the contract of guarantee and its essentials posits that the
clarity and enforceability of contracts of guarantee in India are significantly influenced by the

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adherence to essential legal principles outlined in the Indian Contract Act, 1872. It is
hypothesized that when all parties—namely the principal debtor, creditor, and surety—fulfill
the necessary conditions, such as mutual agreement, valid consideration, and transparency
regarding material facts, the likelihood of disputes and invalidation of these contracts
decreases.

RESEARCH QUESTIONS
1. What are the essential elements required for a valid contract of guarantee under the
Indian Contract Act, 1872?

2. How does the tripartite relationship between the principal debtor, creditor, and surety
impact the enforceability of a guarantee contract?

3. What is the role of consideration in a contract of guarantee, and how does it differ
from other types of contracts?

4. When can a guarantee be considered invalid due to misrepresentation or concealment

of material facts by the creditor?

OBJECTIVE OF THE STUDY

The objective of this study on the contract of guarantee and its essentials is to provide a
thorough examination of the legal framework governing contracts of guarantee as outlined in
the Indian Contract Act, 1872. Specifically, the study aims to define and analyze the contract
of guarantee, clarifying its tripartite nature involving the principal debtor, creditor, and surety.
It will identify and elaborate on the essential elements required for a valid contract of
guarantee, including consideration, existence of a principal debt, and mutual agreement
among all parties. The study will investigate relevant legal provisions and case law that
influence the enforceability of contracts of guarantee, focusing on issues such as
misrepresentation, concealment of facts, and the duties of disclosure owed by creditors to
sureties.

SIGNIFICANCE OF THE STUDY

The significance of studying the contract of guarantee and its essentials lies in its critical role
in facilitating financial transactions and ensuring security for creditors. As defined under the
Indian Contract Act, 1872, a contract of guarantee involves three parties: the principal debtor,
the creditor, and the surety, where the surety provides a safety net for the creditor in case of
default by the debtor. This study is essential as it elucidates the legal framework governing

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such contracts, highlighting their practical implications in various contexts, including loans,
credit transactions, and employment.

SCOPE OF THE STUDY

The scope of the study on the contract of guarantee and its essentials encompasses a detailed
exploration of the legal framework and practical implications of guarantee contracts as
defined under the Indian Contract Act, 1872. This study aims to analyze the tripartite
relationship between the principal debtor, creditor, and surety, focusing on the roles and
responsibilities of each party involved. It will investigate the essential elements that
constitute a valid contract of guarantee, including consideration, mutual consent, and the
existence of a principal debt.

LIMITATION OF THE STUDY

The limitations of the study on the contract of guarantee and its essentials primarily stem
from the complexities and evolving nature of legal interpretations surrounding this area of
contract law. One significant limitation is the reliance on existing legal frameworks and case
law, which may not encompass all possible scenarios or adequately address emerging issues
in modern financial transactions. Additionally, the study may face challenges in obtaining
comprehensive data on real-world applications of guarantee contracts, as many disputes are
resolved privately or through informal agreements rather than formal litigation.

RESEARCH METHODOLOGY
The research methodology for the study on the contract of guarantee and its essentials will
adopt the doctrinal research method and a mixed-methods approach, combining both
qualitative and quantitative research techniques to provide a comprehensive analysis of this
legal concept. Initially, the study will involve an extensive review of secondary data sources,
including relevant statutes, legal textbooks, and scholarly articles that discuss the principles
and provisions of the Indian Contract Act, 1872, particularly Section 126, which defines the
contract of guarantee.

LITERATURE REVIEW
The existing literature on the topic of contracts of guarantee and their essentials provides a
comprehensive understanding of this legal concept. Scholars have delved into the historical
evolution of guarantee contracts, tracing their origins to ancient legal systems and their
subsequent development in modern contract law.

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 CONTRACT OF GUARANTEE
(SEC 126-147)

A Contract to perform the promise, or discharge the liability, of a third person in case of his
default is called Contract of Guarantee. A guarantee may be either oral or written.
1. The person who gives the guarantee is called the Surety
2. The person on whose default the guarantee is given is called the Principal Debtor
3. The person to whom the guarantee is given is called the Creditor.
Illustration: If A gives an undertaking stating that if ` 300 are lent to C by B and C does not
pay, A will pay back the money, it will be a contract of guarantee. Here, A is the surety, B is
the principal debtor and C is the creditor. Surety is the person gives the guarantee, the
Principal Debtor is one for whom the guarantee is given and the creditor is the person to
whom the guarantee is given.

Contract Act uses the word ‘surety’ which is same as ‘guarantor’ Prima facie, the surety is
not undertaking to perform should the principal debtor fail; the surety is undertaking to see
that the principal debtor does perform his part of the bargain.

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 ESSENTIALS OF CONTRACT OF GUARANTEE

1. Must be made with the agreement of all three parties

All the three parties to the contract i.e the principal debtor, the creditor, and the surety must
agree to make such a contract with the agreement of each other. Here it is important to note
that the surety takes his responsibility to be liable for the debt of the principal debtor only on
the request of the principal debtor. Hence communication either express or implied by the
principal debtor to the surety is necessary. The communication of the surety with the creditor
to enter into a contract of guarantee without the knowledge of the principal debtor will not
constitute a contract of guarantee.

Illustration:

Sam lends money to Akash. Sam is the creditor and Akash is the principal debtor. Sam
approaches Raghav to act as the surety without any information to Akash. Raghav agrees.
This is not valid.

2. Consideration

According to section 127 of the act, anything is done or any promise made for the benefit of
the principal debtor is sufficient consideration to the surety for giving the guarantee. The
consideration must be a fresh consideration given by the creditor and not a past consideration.
It is not necessary that the guarantor must receive any consideration and sometimes even
tolerance on the part of the creditor in case of default is also enough consideration.

In State Bank of India v Premco Saw Mill(1983), the State Bank gave notice to the debtor-
defendant and also threatened legal action against her, but her husband agreed to become
surety and undertook to pay the liability and also executed a promissory note in favor of the
State Bank and the Bank refrained from threatened action. It was held that such patience and
acceptance on the bank's part constituted good consideration for the surety.

3. Liability

In a contract of guarantee, the liability of a surety is secondary. This means that since the
primary contract was between the creditor and principal debtor, the liability to fulfill the
terms of the contract lies primarily with the principal debtor. It is only on the default of the
principal debtor that the surety is liable to repay.

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 4. Presupposes the existence of a Debt

The main function of a contract of guarantee is to secure the payment of the debt taken by the
principal debtor. If no such debt exists then there is nothing left for the surety to secure.
Hence in cases when the debt is time-barred or void, no liability of the surety arises. The
House of Lords in the Scottish case of Swan vs. Bank of Scotland (1836) held that if there is
no principal debt, no valid guarantee can exist.

5. Must contain all the essentials of a valid contract

Since a contract of guarantee is a type of contract, all the essentials of a valid contract will
apply in contracts of guarantee as well. Thus, all the essential requirements of a valid contract
such as free consent, valid consideration offer, and acceptance, intention to create a legal
relationship etc are required to be fulfilled.

6. No Concealment of Facts

The creditor should disclose to the surety the facts that are likely to affect the surety's
liability. The guarantee obtained by the concealment of such facts is invalid. Thus, the
guarantee is invalid if the creditor obtains it by the concealment of material facts.

7. No Misrepresentation

The guarantee should not be obtained by misrepresenting the facts to the surety. Though the
contract of guarantee is not a contract of Uberrima fides i.e., of absolute good faith, and thus,
does not require complete disclosure of all the material facts by the principal debtor or
creditor to the surety before he enters into a contract. But the facts, that are likely to affect the
extent of surety's responsibility, must be truly represented

Section 127 clarifies this as follows:

"Anything done or any promise made for the benefit of the principal debtor may be

sufficient consideration to the surety for giving the guarantee."

Illustrations:

1. A agrees to sell to B certain goods if C guarantees the payment of the price of the
goods.C promises to guarantee the payment in consideration of A's promise to deliver goods
to B. This is a sufficient consideration for C's promise.

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 2. A sells and delivers goods to B. C, afterwards, requests A to forbear to sue B for an
year and promises that if A does so, he will guarantee the payment if B does not pay. A
forbears to sue B for one year. This is sufficient consideration for C's guarantee.

3. A sells and delivers goods to B. Later on, C, without any consideration, promises to
pay A if B fails to pay. The agreement is void for lack of consideration.

It is pertinent to note that there is no uniformity on the issue of past consideration. In the case
of Allahabad Bank vs S M Engineering Industries 1992 Cal HC, the bank was not allowed
to sue the surety in absence of any advance payment made after the date of guarantee. But in
the case of Union Bank of India vs A P Bhonsle 1991Mah HC, past debts were also held to
be recoverable under the wide language of this section. In general, if the principal debtor is
benefitted as a result of the guarantee, it is sufficient consideration for the sustenance of the
guarantee. It should be without misrepresentation or concealment –

Section 142 specifies that a guarantee obtained by misrepresenting facts that are material to
the agreement is invalid, and section 143 specifies that a guarantee obtained by concealing a
material fact is invalid as well.
Illustrations: -

1. A appoints B for collecting bills. B fails to account for some of the bills. A asks B to
get aguarantor for further employment. C guarantees B's conduct but C is not made aware of
B previous mis-accounting by A. B, afterwards, defaults. C cannot be held liable.

2. A promises to sell Iron to B if C guarantees payment. C guarantees payment however,

C isnot made aware of the fact that A and B had contracted that B will pay 5 Rs higher that
the market prices. B defaults. C cannot be held liable.
In the case of London General Omnibus vs Holloway 1912, a person was invited to
guarantee an employee, who was previously dismissed for dishonesty by the same employer.
This fact was not told to the surety. Later on, the employee embezzled funds but the surety
was not held liable.

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 TYPE OF GUARANTEE

ON THE BASIS OF TRANSACTION ON THE BASIS OF TIME

SPECIFIC GUARANTEE CONTINUING GUARANTEE

RETROSPECTIVE PROSPECTIVE
GUARANTEE GUARANTEE

Continuing Guarantee:

As per section 129, a guarantee which extends to a series of transactions is called a

continuing guarantee.

Illustrations –

1. A, in consideration that B will employ C for the collection of rents of B's zamindari,
promises B to be responsible to the amount of 5000/- for due collection and payment by C of
those rents. This is a continuing guarantee.

2. A guarantees payment to B, a tea-dealer, for any tea that C may buy from him from
time to time to the amount of Rs 100. Afterwards, B supplies C tea for the amount of 200/-
and C fails to pay. A's guarantee is a continuing guarantee and so A is liable for Rs 100.

3. A guarantees payment to B for 5 sacks of rice to be delivered by B to C over the

period ofone month. B delivers 5 sacks to C and C pays for it. Later on B delivers 4 more
sacks but C fails to pay. A's guarantee is not a continuing guarantee and so he is not liable to
pay for the 4

sacks. Thus, it can be seen that a continuing guarantee is given to allow multiple transactions
without having to create a new guarantee for each transaction.

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In the case of Nottingham Hide Co vs Bottrill 1873, it was held that the facts,
circumstances, and intention of each case has to be looked into for determining if it is a case
of continuing guarantee or not.

Revocation of Continuing Guarantee:

As per section 130, a continuing guarantee can be revoked at any time by the surety by notice
to the creditor.

A contract of guarantee can be revoked in the following two ways:

 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. If the contract of guarantee includes a clause that a notice of a certain period of time
is required before the contract can be revoked, then the surety must comply with the same as
said in Offord v Davies (1862).

Illustration

A guarantees to B to the extent of Rs. 10,000, that C shall pay for all the goods bought by him
during the next three months. B sells goods worth Rs. 6,000 to C. A gives notice of
revocation, C is liable for Rs. 6,000. If any goods are sold to C after the notice of revocation,
A shall not be, liable for that.

 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. However, his legal representatives will continue to be liable for
transactions entered into before his death.

The estate of deceased surety is, however, liable for those transactions which had already
taken place during the lifetime of the deceased. Surety's estate will not be liable for the
transactions taking after the death of surety even if the creditor had no knowledge of surety's
death.

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 RIGHTS OF THE SURETY

A contract of guarantee being a contract, all rights that are available to the parties of a
contract are available to a surety as well. The following are the rights specific to a contract of
guarantee that are available to the surety.

Rights against principal debtor

Right of Subrogation Right to Indemnity: Rights against creditor

1. Right to securities: As per section 141, a surety is entitled to the benefit of every
securitywhich the creditor has against the principal debtor at the time when the contract of
suretyship is entered into whether the surety knows about the existence of such security or
not; and if the creditor loses or without the consent of the surety parts with such security,
the surety is discharged to the extent of the value of the security

The SC in the case of State of MP vs Kaluram AIR 1967. In this case, the state had sold a
lot of felled trees for a fixed price in four equal instalments, the payment of which was
guaranteed by the defendant. The contract further provided that if a default was made in the
payment of an instalment, the State would get the right to prevent further removal of timber
and the sell the timber for the realization of the price. The buyer defaulted but the State still
did not stop him from removing further timber. The surety was then sued for the loss but he
was not held liable. It is important to note that the right to securities arises only after the
creditor is paid in full. If the surety has guaranteed only part of the debt, he cannot claim a
proportional part of the securities after paying part of the debt. This was held in the case of
Goverdhan Das vs Bank of Bengal 1891.

2. Right of set off.

Rights against co-sureties.

1. Effect of releasing a surety (section 138)

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2. Right to contribution: (section 146)

As per section 147, co-sureties who are bound in different sums are liable to pay equally as
far as the limits of their respective obligations permit. Illustrations – 1. A, B and C as sureties
to D, enter into three several bonds, each in different penalty, namely A for 10000Rs, B for
20000 Rs, and C for 30000Rs with E. D makes a default on 30000Rs. All of them are liable
for 10000Rs each.

2. A, B and C as sureties to D, enter into three several bonds, each in different

penalty,namely A for 10000Rs, B for 20000 Rs, and C for 40000Rs with E. D makes a default
on 40000Rs. A is liable for 10000Rs while B and C are liable for 15000Rs each..

3. A, B and C as sureties to D, enter into three several bonds, each in different

penalty,namely A for 10000Rs, B for 20000 Rs, and C for 40000Rs with E. D makes a default
on 70000Rs. A, B and C are liable for the full amount of their bonds.

Discharge of Surety from Liability:

A surety is said to be discharged from liability when his liability comes to an end. Indian
Contract Act 1872 specifies the following conditions in which a surety is discharged of his
liability –

1. Section 130 - By a notice of revocation

2. Section 131 - By death of surety

3. Section 133 - By variance in terms of

4. Section 134 - By discharge of principal debtor

5. Section 135 - By composition, extension of time, or promise not to sue

Extent of Surety's Liability:

As per section 128, the liability of a surety is co-extensive with that of the principal debtor,
unless it is otherwise provided in the contract.

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 CONCLUSION
The contract of guarantee is a specific contract for which the Indian Contract Acy has laid
some rules. As we have discussed, the basic function of a contract of guarantee is to protect
the creditor from loss and to give him confidence that the contract will be enforced with the
promise of the surety. Every contract of guarantee has three parties and there exist two types
of guarantees i.e specific guarantee and continuing guarantee.

The type of Guarantee used depends on the situation and the terms of the contract. The surety
has some rights against the other parties and liability of the surety is considered to be co-
extensive with that of the principal debtor unless it is otherwise provided by the contract. In
case the contracts are entered into by misrepresentation made by the creditor regarding
material circumstances or by concealment of material facts by the creditor, the contract will
be considered invalid.

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 BIBLIOGRAPHY
1. https://www.legalserviceindia.com/legal/article-7706-essentials-of-a-contract-of-
guarantee.html
2. https://www.lkouniv.ac.in/site/writereaddata/siteContent/
202004061919580137anurag_sriv_law_Contract_of_Guarantee.pdf
3. https://www.scribd.com/document/521436286/contract-of-guarantee-and-its-
essentials

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