In financial and contractual transactions, the role of a guarantor is critical in enhancing the confidence of lenders and enforcing obligations. Under Indian law, a guarantor provides a legal assurance to fulfill the obligations of a debtor in case of default. The concept is governed by the Indian Contract Act, 1872, and is commonly used in banking, lending, tenancy, and commercial contracts.
Who is a Guarantor?
A guarantor is a person who agrees to repay a debt or fulfill an obligation on behalf of another person (the principal debtor), in case that person fails to do so. The relationship is legally known as a contract of guarantee.
Definition under Indian Contract Act, 1872
- As per Section 126 of the Indian Contract Act: “A contract of guarantee is a contract to perform the promise or discharge the liability of a third person in case of his default.”
Key Terms in a Contract of Guarantee
- Principal Debtor: The person who is primarily liable to pay.
- Creditor: The person to whom the obligation is owed.
- Guarantor (Surety): The person who gives the guarantee and undertakes liability in case of default.
Essential Elements of a Valid Guarantee
To be legally enforceable, a contract of guarantee must include:
- Three Parties: Principal debtor, creditor, and guarantor.
- Consideration: The benefit given to the principal debtor is sufficient consideration for the guarantor.
- Consent and Free Will: The guarantor must give consent without coercion or fraud.
- Written or Oral: A guarantee can be either written or oral unless required to be in writing by a specific statute (e.g., in banking transactions).
Types of Guarantees
- Specific Guarantee
- Applies to a particular transaction or debt.
- Ends once the obligation is fulfilled.
- Continuing Guarantee
- Extends to a series of transactions.
- Can be revoked by notice to the creditor for future transactions.
Legal Rights of a Guarantor
1. Right to Subrogation (Section 140)
- Once the guarantor pays the debt, they step into the shoes of the creditor and can recover the amount from the principal debtor.
2. Right to Indemnity (Section 145)
- The guarantor has a right to be indemnified by the principal debtor for all payments lawfully made.
3. Right to Securities (Section 141)
- If the creditor had secured assets from the debtor, the guarantor can claim those securities after settling the debt.
Liabilities of a Guarantor
- Co-extensive Liability (Section 128)
The guarantor’s liability is equal to that of the principal debtor, unless specified otherwise. - Liability Arises on Default
The guarantor becomes liable only when the principal debtor defaults. - No Need to Exhaust Remedies Against Debtor
The creditor is not required to first sue the debtor before proceeding against the guarantor.
Discharge of Guarantor from Liability
A guarantor can be discharged from liability under the following circumstances:
- Revocation of Guarantee in case of continuing guarantees.
- Variation in Contract without guarantor’s consent.
- Discharge of Principal Debtor by the creditor’s act.
- Impairment of Securities by the creditor.
Important Case Laws on Guarantor in India
- State Bank of India v. Premco Saw Mill (1983)
Established that a guarantor’s liability is not deferred until all remedies against the debtor are exhausted. - Punjab National Bank v. Bikram Cotton Mills (1970)
Affirmed that the guarantor has the right to be indemnified by the debtor once payment is made.
Guarantor in Banking and Finance
In financial institutions, guarantors are frequently required for:
- Personal loans
- Home loans
- Business credit facilities
Banks assess the creditworthiness of guarantors as stringently as borrowers.