Understanding the Concept of Guarantee
In commercial and financial transactions, trust is essential. However, when one party doubts another’s ability to fulfill obligations, a third person’s assurance can make the deal possible. This assurance forms the basis of a Contract of Guarantee.
A Contract of Guarantee is a vital component of modern credit systems, where banks, lenders, and businesspersons rely on guarantees to secure performance or repayment. This contract creates a tripartite relationship involving a creditor, a principal debtor, and a surety (guarantor).
The guarantee provides the creditor confidence to extend credit or perform certain actions, knowing that if the principal debtor fails, the surety will step in. Understanding the rights and obligations of a surety is essential to ensure fairness and legal compliance under the Indian Contract Act, 1872.
Definition and Essential Features of a Contract of Guarantee
Legal Definition (Section 126, Indian Contract Act, 1872)
According to Section 126 of the Indian Contract Act, 1872,
“A contract of guarantee is a contract to perform the promise, or discharge the liability, of a third person in case of his default.”
Here:
- The person who gives the guarantee is called the Surety.
- The person in respect of whose default the guarantee is given is called the Principal Debtor.
- The person to whom the guarantee is given is called the Creditor.
A contract of guarantee may be oral or written, as per Section 126.
Essential Elements of a Contract of Guarantee
- Three Parties — Creditor, Principal Debtor, and Surety must exist.
- Consideration — As per Section 127, anything done for the benefit of the principal debtor is sufficient consideration for the surety.
- Consent — There must be free consent without misrepresentation or concealment.
- Existence of Liability — There must be an existing or potential liability of the principal debtor.
- Legality — The purpose of the guarantee must be lawful.
Example:
If A lends ₹1,00,000 to B and C guarantees the repayment, it becomes a contract of guarantee. If B fails to pay, C (the surety) becomes liable.
Nature of the Surety’s Liability
The surety’s liability under a contract of guarantee is secondary and co-extensive with that of the principal debtor, unless otherwise stated in the contract.
- Section 128 of the Indian Contract Act provides: “The liability of the surety is co-extensive with that of the principal debtor, unless otherwise provided by the contract.”
This means the creditor can directly proceed against the surety without first suing the principal debtor. However, the surety’s liability ceases when the principal debt is satisfied, or the contract is discharged.
Example:
If B owes ₹50,000 to A, and C guarantees payment, A can demand full payment directly from C if B defaults, without first suing B.
Rights of a Surety
Once a surety fulfills his obligation or makes payment under a guarantee, he is entitled to certain legal rights to protect himself. These rights are provided under Sections 140–147 of the Indian Contract Act, 1872 and can be classified into three main categories:
1. Rights Against the Principal Debtor
(a) Right of Subrogation (Section 140)
When the surety pays the debt on behalf of the principal debtor, he steps into the shoes of the creditor and acquires all the rights the creditor had against the debtor.
This means the surety can recover the money paid and also claim securities or remedies held by the creditor.
Example:
If C pays the loan of ₹1,00,000 on behalf of B to A, C gets the same rights as A had — such as reclaiming any mortgaged property or collateral from B.
(b) Right to Indemnity (Section 145)
Under Section 145, the principal debtor must indemnify the surety for all payments and lawful actions done under the guarantee.
The law presumes an implied promise that the principal debtor will repay the surety.
Example:
If the surety pays ₹20,000 to the creditor due to the debtor’s default, he can recover ₹20,000 from the debtor under this right.
2. Rights Against the Creditor
(a) Right to Securities (Section 141)
When a creditor has securities from the principal debtor, the surety is entitled to the benefit of all those securities once he pays the debt. If the creditor loses or releases any security without the surety’s consent, the surety is discharged to that extent.
Example:
If A (creditor) holds B’s gold as security and C is the surety, but A releases the gold without C’s consent, C’s liability reduces accordingly.
(b) Right to Set-off
If the surety has any claim against the creditor (for instance, repayment of a previous loan), he can use it as a set-off when sued by the creditor.
(c) Right to Discharge
If the creditor alters the terms of the contract, releases the debtor, or acts in a way that prejudices the surety’s position, the surety is discharged from liability (Sections 133–139).
3. Rights Against Co-Sureties
When there are multiple sureties for the same debt, each surety is liable to contribute equally, unless otherwise agreed. These rights are recognized under Sections 146 and 147.
(a) Equal Contribution (Section 146)
If one surety pays more than his share, he can recover the excess from co-sureties.
Example:
A, B, and C are co-sureties for a debt of ₹30,000. If A pays ₹15,000, he can claim ₹5,000 each from B and C.
(b) Right of Contribution for Different Amounts (Section 147)
If co-sureties are bound in different sums, contribution is based on their maximum liability as stated in the contract.
Real-Life Example: Rights of Surety in Action
In State Bank of India v. Indexport Registered (1992), the Supreme Court of India held that a surety’s liability is co-extensive with that of the principal debtor. The bank was entitled to recover dues from both simultaneously.
However, in Bank of Bihar v. Damodar Prasad (1969), it was established that once the surety pays, he immediately gains the right of subrogation, allowing him to recover from the debtor. These cases highlight the balance between creditor’s protection and surety’s rights under the Act.
Mnemonic to Remember the Rights of a Surety — “S.I.C.”
Use the mnemonic “S.I.C.” to remember the three main categories of a surety’s rights:
- S – Rights against the Surety’s Principal Debtor (Subrogation, Indemnity)
- I – Rights against the Creditor (Securities, Set-off, Discharge)
- C – Rights against Co-sureties (Contribution, Reimbursement)
Mnemonic Sentence:
“A Surety is always S.I.C. about his rights — Sure, Indemnified, and Contributory.”
This easy trick helps law students and professionals recall the three pillars of a surety’s rights quickly during exams or practice.
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