A contract of guarantee is a contract to perform the promise, or discharge the liability, of a third person in case of his default (S.126, Indian Contract Act, 1872). The person who gives the guarantee is the surety; the person in respect of whose default the guarantee is given is the principal debtor; and the person to whom the guarantee is given is the creditor.
Legal Framework
| Provision | Subject | Key Rule |
|---|---|---|
| S.126 | Definition of guarantee | Contract to perform the promise or discharge the liability of a third person on default; may be oral or written |
| S.127 | Consideration for guarantee | Anything done, or any promise made, for the benefit of the principal debtor is sufficient consideration for the surety |
| S.128 | Surety's liability | Co-extensive with that of the principal debtor, unless the contract provides otherwise |
| S.129 | Continuing guarantee | A guarantee extending to a series of transactions |
| S.130 | Revocation of continuing guarantee | May be revoked as to future transactions by notice to the creditor |
| S.131 | Revocation by surety's death | Death of the surety operates as revocation as to future transactions, in the absence of contrary contract |
Essential Characteristics
| Element | Explanation |
|---|---|
| Three parties | Surety, principal debtor, and creditor, connected by three distinct agreements |
| Existing or future liability | There must be a recoverable debt or duty; if the principal debt is void, there is nothing to guarantee |
| Primary liability on the principal debtor | The surety's obligation arises only on default |
| Consideration | Benefit to the principal debtor suffices (S.127); the surety need not receive anything |
| Concurrence of all three parties | Each must consent to the arrangement, though not necessarily in one document |
| No misrepresentation or concealment | S.142 and S.143 make a guarantee invalid if obtained by misrepresentation or by keeping silence as to material circumstances |
Why consideration flowing to the principal debtor is enough: In ordinary contract law, consideration must move at the promisor's request and support the promise made. S.127 relaxes this by treating the benefit conferred on the principal debtor as the consideration for the surety's promise. Without this rule almost no guarantee would be enforceable, because sureties characteristically receive nothing themselves. The section recognises the commercial reality that a surety's motive is to enable the principal debtor to obtain credit.
Why a void principal debt destroys the guarantee: A guarantee is accessory to the principal obligation. If the principal debt is void, for example because the principal debtor is a minor and the contract is void under Mohori Bibee, there is no liability capable of being guaranteed, and the surety is not liable either. This follows from the definition in S.126 which requires the liability of a third person.
Facts: The defendant orally promised the plaintiff that if the plaintiff lent a horse to a third party, the defendant would see that the horse was returned or would answer for it. The horse was not returned.
Issue: Was the promise a guarantee (requiring the third party's liability to exist first) or an original independent undertaking?
Held: The court distinguished the two situations. Where the promisor says "I will see you paid" the third party remains liable and the promise is collateral, a guarantee. Where the promisor says "let him have the goods, I will be your paymaster" the promisor assumes primary liability and it is not a guarantee.
Relevance: The classical authority on distinguishing a guarantee from an original promise. Cite where the question is whether the promisor's liability is primary or secondary.
Facts: A surety guaranteed a bank loan. On the principal debtor's default the bank sued both. The trial court decreed that the bank must first exhaust its remedies against the principal debtor before proceeding against the surety.
Issue: Must a creditor exhaust its remedies against the principal debtor before enforcing the guarantee?
Held: The Supreme Court set aside that direction. The surety's liability under S.128 is immediate and co-extensive with the principal debtor's. The creditor is not bound to first proceed against the principal debtor or to exhaust any security before calling on the surety.
Relevance: Leading Indian authority on the immediacy of the surety's liability. Essential in any problem where the surety argues that the creditor must sue the principal debtor first.
Kinds of Guarantee
| Kind | Meaning | Example |
|---|---|---|
| Specific (simple) guarantee | Covers a single debt or transaction; exhausted when that debt is discharged | Guarantee for one loan of Rs. 5 lakhs |
| Continuing guarantee (S.129) | Extends to a series of transactions over time | Guarantee for a running cash credit account |
| Retrospective guarantee | Given for an existing debt already incurred | Guaranteeing arrears already owed |
| Prospective guarantee | Given for a debt to be incurred in future | Guaranteeing a loan yet to be advanced |
| Fidelity guarantee | Guarantees the honesty and good conduct of an employee | Guarantee against embezzlement by a cashier |
Continuing Guarantee (S.129)
A continuing guarantee extends to a series of transactions rather than being confined to a single one. Whether a guarantee is continuing depends on the intention of the parties as gathered from the language of the instrument and the surrounding circumstances, not on any formula.
Why the distinction matters practically: A specific guarantee is discharged once the guaranteed transaction is completed, so the surety has no further exposure. A continuing guarantee keeps the surety liable for successive transactions until revoked. In running accounts the amount outstanding fluctuates, and the surety remains liable for the balance at any time within the guaranteed limit. Getting the classification wrong misstates the surety's exposure entirely.
Revocation: A continuing guarantee may be revoked as to future transactions by notice to the creditor (S.130), and is revoked by the surety's death as to future transactions (S.131), unless the contract provides otherwise. In both cases the surety remains liable for transactions already entered into.
Illustrations
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Guarantee distinguished from indemnity: A tells a shopkeeper, "supply goods to B, and if B does not pay I will." This is a guarantee: B remains primarily liable and A's liability is secondary. If instead A says "supply goods to B and charge them to my account," A assumes primary liability and it is an original promise, not a guarantee, applying Birkmyr v Darnell.
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Consideration under S.127: A bank advances Rs. 10 lakhs to B on C's guarantee. C receives nothing. The advance to B is sufficient consideration for C's promise. C cannot escape liability by pleading absence of consideration.
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Continuing guarantee in a running account: C guarantees B's cash credit account with a bank up to Rs. 20 lakhs. Over two years the balance fluctuates between Rs. 5 lakhs and Rs. 18 lakhs. C is liable for whatever is outstanding, up to Rs. 20 lakhs, at the time default occurs. This is a continuing guarantee under S.129, not a guarantee limited to the first drawing.
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Revocation as to future transactions: C gives a continuing guarantee for B's supplies. C serves notice of revocation on 1 June. Goods supplied before 1 June remain guaranteed; goods supplied after that date do not. S.130 permits revocation only prospectively.
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Void principal debt: A minor borrows money and C guarantees repayment. The minor's contract is void under Mohori Bibee v Dharmodas Ghose. Since there is no enforceable liability of the principal debtor, C is not liable as surety either, because a guarantee is accessory to the principal obligation.
Recall Check
- Name the three parties to a contract of guarantee and identify whose liability is primary.
- Under S.127, what constitutes sufficient consideration for a surety's promise?
- Can a creditor proceed directly against the surety without first suing the principal debtor?
Key Cases
Birkmyr v Darnell (1704) Birkmyr v Darnell 1704
Issue: Whether an oral promise to answer for another's default was a guarantee or an original independent undertaking.
Rule: A guarantee is collateral: the third party remains liable and the promisor's liability is secondary. An original promise makes the promisor primarily liable.
Held: The distinction turns on whether the third party remains liable. "I will see you paid" is a guarantee; "I will be your paymaster" is an original promise.
Bank of Bihar Ltd v Damodar Prasad (1969) Bank of Bihar v Damodar Prasad 1969
Issue: Whether a creditor must exhaust remedies against the principal debtor before enforcing the guarantee.
Rule: The surety's liability under S.128 is co-extensive with the principal debtor's and arises immediately on default.
Held: The creditor need not first proceed against the principal debtor or exhaust any security. A direction requiring it was set aside.
Distinctions
| Basis | Guarantee (S.126) | Indemnity (S.124) |
|---|---|---|
| Parties | Three: surety, principal debtor, creditor | Two: indemnifier and indemnity holder |
| Number of contracts | Three | One |
| Nature of liability | Secondary, arising on default | Primary, the indemnifier's own obligation |
| Existing liability | A recoverable debt or duty must exist | No existing liability; the loss is contingent |
| Purpose | Security for performance | Protection against loss |
| Recovery after payment | Surety may recover from the principal debtor (S.145) | Indemnifier has no such right |
| Request to act | Surety acts at the principal debtor's request | Indemnifier need not have been requested by anyone |
| Basis | Specific Guarantee | Continuing Guarantee (S.129) |
|---|---|---|
| Scope | One debt or transaction | Series of transactions |
| Exhaustion | Discharged when the transaction is complete | Continues until revoked |
| Revocation | Cannot be revoked once the transaction is entered into | May be revoked prospectively under S.130 |
| Effect of surety's death | No effect on existing liability | Revokes as to future transactions (S.131) |
| Typical use | A single term loan | A running cash credit or supply account |
Flashcards
Define a contract of guarantee under S.126.
A contract to perform the promise, or discharge the liability, of a third person in case of his default.
Name the three parties to a contract of guarantee.
The surety (who gives the guarantee), the principal debtor (in respect of whose default it is given), and the creditor (to whom it is given).
What is sufficient consideration for a guarantee under S.127?
Anything done, or any promise made, for the benefit of the principal debtor. The surety need not receive any benefit.
What does it mean that the surety's liability is co-extensive?
Under S.128 the surety is liable to the same extent as the principal debtor, unless the contract limits it. The liability arises immediately on default.
Must a creditor sue the principal debtor before the surety?
No. Bank of Bihar v Damodar Prasad (1969) held the creditor need not exhaust remedies against the principal debtor first.
What is a continuing guarantee?
A guarantee extending to a series of transactions (S.129), as distinct from one confined to a single transaction.
How may a continuing guarantee be revoked?
By notice to the creditor as to future transactions (S.130), and by the surety's death as to future transactions (S.131). Past transactions remain guaranteed.
Is a surety liable if the principal debt is void?
No. A guarantee is accessory to the principal obligation. If there is no enforceable liability of the principal debtor, there is nothing to guarantee.
Exam Scenario
Problem: Meera guarantees her nephew Arjun's cash credit facility with a bank "for all sums that may become due from time to time," up to Rs. 15 lakhs. Eighteen months later Meera writes to the bank withdrawing the guarantee. At that date Rs. 9 lakhs is outstanding. The bank permits Arjun to draw a further Rs. 4 lakhs after receiving Meera's letter. Arjun then defaults on the full Rs. 13 lakhs. The bank sues Meera for the entire amount, and separately Meera argues the bank must first recover from Arjun. Advise Meera.
Step 1: Classify the guarantee
The words "for all sums that may become due from time to time" and the cash credit structure indicate a continuing guarantee under S.129, covering a series of transactions rather than one drawing.
Step 2: Fix the effect of the revocation letter
S.130 allows a continuing guarantee to be revoked as to future transactions by notice to the creditor. Meera's letter is such notice.
| Advance | Timing against the notice | Meera's liability |
|---|---|---|
| Rs. 9 lakhs outstanding at the date of the letter | Before revocation | Liable. Revocation under S.130 operates prospectively only |
| Rs. 4 lakhs drawn after the letter | After revocation | Not liable. The bank cannot enlarge her exposure after revocation |
Step 3: Reject the argument that the bank must sue Arjun first
Apply S.128 and Bank of Bihar Ltd v Damodar Prasad (1969). The surety's liability is co-extensive with the principal debtor's and immediate on default.
The bank is not bound to proceed against Arjun first or to exhaust any security. Meera's argument on this point fails, and the bank may recover from her directly.
Step 4: Set out Meera's recourse after payment
- S.140 subrogation: on paying, Meera is invested with the bank's rights against Arjun.
- S.145 indemnity: she may recover from Arjun what she has paid, on the implied promise by the principal debtor to indemnify the surety.
Do not let the bank recover the whole Rs. 13 lakhs. The Rs. 4 lakhs advanced after the revocation notice falls outside the guarantee. Under S.130 the cut off is the date of the notice, not the date of default.
Conclusion. Meera is liable for Rs. 9 lakhs only. The bank may recover that sum from her directly without first suing Arjun, and on payment she is subrogated under S.140 and may recover from Arjun under S.145.
See Also
- Contract of Indemnity : the companion special contract, distinguished by its two-party structure and primary liability.
- Rights and Liabilities of Surety : the detailed consequences of the co-extensive liability rule introduced here.
- Discharge of Surety : the circumstances in which a surety's liability comes to an end.