Meaning of Contract of Guarantee

A Contract of Guarantee is defined under Section 126 of the Indian Contract Act, 1872. It is a contract where a person (called the surety) promises to discharge the liability of a third person (called the principal debtor) in case of default, to a creditor. The contract involves three parties: the surety, the principal debtor, and the creditor. The objective of this arrangement is to secure repayment of a debt or performance of a duty. This makes a guarantee a tripartite agreement that provides financial assurance and promotes commercial trust.

Essential Features

For a valid contract of guarantee, all the essentials of a contract under the Indian Contract Act must be fulfilled, including free consent, lawful consideration, and competence of parties. The consideration received by the principal debtor is sufficient for the surety as well. The liability of the surety is usually co-extensive with that of the principal debtor as per Section 128, unless otherwise stated in the contract. Guarantees may be oral or written, and they can be either specific (for a single transaction) or continuing (for a series of transactions).

Rights and Liabilities of Surety

A surety, once he pays the debt or performs the obligation on behalf of the debtor, acquires certain rights. These include the right of subrogation (Section 140), where the surety steps into the shoes of the creditor after making payment, and the right to be indemnified (Section 145) by the principal debtor for losses incurred. On the liability side, the surety becomes immediately liable if the principal debtor defaults, unless the contract specifies otherwise. Thus, while protecting the creditor, the law also balances the surety’s interests.

Real-Life Example

Suppose Rahul takes a loan of ₹5 lakhs from a bank, and Amit agrees to act as a surety by signing a contract of guarantee. If Rahul fails to repay the loan, the bank can legally demand the money from Amit. Once Amit repays the amount, he is entitled to recover it from Rahul. Here, the bank is the creditor, Rahul is the principal debtor, and Amit is the surety. This demonstrates the working of a contract of guarantee in everyday financial transactions.

Mnemonic to Remember – “C-L-R”

To easily recall the basics of a contract of guarantee, remember C-L-R:

• C = Creditor (the person to whom the guarantee is given)
• L = Liability (surety’s liability is co-extensive with debtor – Sec. 128)
• R = Rights of Surety (subrogation – Sec. 140, indemnity – Sec. 145)

Think of it as: “Contract of Guarantee = C-L-R (Creditor, Liability, Rights).”

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