Overview
The law of contract forms the foundation of commercial and personal agreements, ensuring that promises made between parties are legally enforceable. Among various forms of contracts, a Contract of Guarantee plays a vital role in maintaining financial security and trust, particularly in commercial transactions, loans, and credit dealings. It acts as a safeguard for creditors by providing a third-party assurance that debts or obligations will be fulfilled if the principal debtor defaults.
Under the Indian Contract Act, 1872, the concept of guarantee is dealt with under Sections 126 to 147. This essay discusses the meaning, nature, rights, and liabilities of a surety — the person who provides the guarantee — supported by real-life examples and a mnemonic to remember key points.
Meaning and Definition of Contract of Guarantee (Section 126)
According to Section 126 of the Indian Contract Act, 1872, a Contract of Guarantee is defined as:
“A contract to perform the promise or discharge the liability of a third person in case of his default.”
This means that in a guarantee, one person (the surety) promises to take responsibility if another person (the principal debtor) fails to perform his duty or repay the debt owed to a creditor.
Parties to a Contract of Guarantee
There are three parties involved:
- Principal Debtor – the person whose liability is guaranteed.
- Creditor – the person to whom the guarantee is given.
- Surety – the person who gives the guarantee.
Essentials of a Valid Contract of Guarantee
- Consideration – There must be some consideration for the surety’s promise (Sec. 127).
- Existence of a Debt or Obligation – There must be a principal liability to be guaranteed.
- Consent and Knowledge – The surety must give consent knowingly.
- Written or Oral – A guarantee may be oral or written.
Example:
A borrows ₹1,00,000 from B. C agrees to repay the amount if A fails to do so. This forms a Contract of Guarantee, where A is the principal debtor, B is the creditor, and C is the surety.
Nature and Scope of Contract of Guarantee
The Contract of Guarantee is a tripartite agreement based on mutual trust. The surety’s liability arises only when the principal debtor defaults. It is a collateral contract, meaning it depends on the existence of a primary liability.
A guarantee can be of two types:
- Specific Guarantee – given for a single transaction and ends once that transaction is completed.
- Continuing Guarantee (Section 129) – extends to a series of transactions and can be revoked at any time for future transactions by giving notice to the creditor.
Rights of Surety under the Indian Contract Act
Once the surety fulfills his obligation by paying the creditor, the law gives him several rights to recover his loss and to protect his interest. These rights are discussed below:
1. Rights Against the Principal Debtor
(a) Right of Indemnity (Section 145)
The surety is entitled to recover from the principal debtor all sums he has rightfully paid under the guarantee.
Example:
If C, the surety, pays ₹1,00,000 on behalf of A to B, C can recover the same amount from A.
(b) Right of Subrogation (Section 140)
After payment, the surety is subrogated to the rights of the creditor. He steps into the shoes of the creditor and can use all remedies available to the creditor against the debtor, such as securities or mortgage rights.
(c) Right to Securities (Section 141)
The surety is entitled to every security that the creditor held against the principal debtor, whether the surety knew of it or not. If the creditor loses or parts with such security, the surety’s liability is proportionately reduced.
2. Rights Against the Creditor
(a) Right to be Discharged from Liability
If the creditor varies the terms of the contract without the surety’s consent, or if he releases the principal debtor, or acts negligently with securities, the surety is discharged from liability (Sections 133–139).
(b) Right to Require Creditor to Sue Debtor
The surety can, before payment, call upon the creditor to sue the principal debtor if the debt is due and payable.
3. Rights Against Co-Sureties
When there are multiple sureties for the same debt, they share the liability equally unless there is a contract stating otherwise (Section 146).
If one surety pays more than his share, he can recover the excess from the co-sureties (Section 147).
Example:
A, B, and C are co-sureties for ₹60,000. If A pays the whole amount, he can recover ₹20,000 each from B and C.
Liabilities of Surety under the Indian Contract Act
The liability of a surety is comprehensive and begins immediately upon the debtor’s default.
1. Co-Extensive Liability (Section 128)
The surety’s liability is co-extensive with that of the principal debtor unless otherwise provided by contract. This means the surety is liable for the same amount and in the same manner as the debtor.
Example:
If A owes ₹50,000 to B and C is the surety, C’s liability is for the full ₹50,000, not just a part of it.
2. Conditional Liability
The surety’s obligation arises only when the principal debtor defaults. If the debtor performs his obligation, the surety is discharged.
3. Continuing Liability
In a continuing guarantee, the surety remains liable for all transactions until he revokes the guarantee for future dealings.
4. Discharge of Surety
The surety may be discharged by:
- Revocation of guarantee (Sec. 130–131)
- Variance in terms of contract without consent (Sec. 133)
- Release of debtor by creditor (Sec. 134)
- Loss of security by creditor (Sec. 141)
Real-Life Example: Bank Guarantee Case
In State Bank of India v. Premco Saw Mill (1984), the court held that when a bank gives a guarantee for a customer, it becomes liable to pay the guaranteed amount upon default by the customer, regardless of disputes between the bank’s client and the beneficiary.
This judgment reaffirmed the co-extensive liability of surety and established that a guarantee is a separate, independent contract that ensures trust and financial integrity in business dealings.
Distinction Between Contract of Indemnity and Guarantee
| Basis | Indemnity | Guarantee |
|---|---|---|
| Number of Parties | Two parties (indemnifier & indemnified) | Three parties (creditor, debtor, surety) |
| Number of Contracts | One | Three (between all parties) |
| Nature of Liability | Primary | Secondary |
| Purpose | Protect from loss | Ensure performance of obligation |
Mnemonic to Remember Rights and Liabilities of Surety – “I SURE PAY”
Use the mnemonic “I SURE PAY” to recall the core rights and liabilities of a surety:
- I – Indemnity (Sec. 145)
- S – Subrogation (Sec. 140)
- U – Use of Securities (Sec. 141)
- R – Rights against Creditor & Co-Sureties (Sec. 133–147)
- E – Equal Contribution by Co-Sureties (Sec. 146–147)
- P – Principal Debtor’s Liability Co-Extensive (Sec. 128)
- A – After Default, Surety’s Liability Arises
- Y – Yield of Discharge by Variance or Release (Sec. 133–134)
Mnemonic Sentence:
“I SURE PAY when the debtor fails to stay!”
This catchy phrase helps recall that the surety’s liability arises only upon default, but the law gives him strong rights to recover and protect his interests.
About lawgnan:
Enhance your understanding of the Contract of Guarantee and the Rights and Liabilities of a Surety under the Indian Contract Act, 1872 with detailed notes, examples, and easy mnemonics at Lawgnan.in. Lawgnan simplifies complex legal principles like indemnity, subrogation, and co-extensive liability into exam-ready explanations for LLB students and aspirants. Learn how Sections 126–147 establish fairness and protection for creditors and sureties in business and financial transactions. Visit Lawgnan.in today to explore structured study materials, case laws, and revision tools that make mastering contract law efficient and effective!
