Contract of Guarantee: Essential Elements and Legal Principles
Contract of Guarantee: Definition and Legal Framework
A contract of guarantee is a significant special contract under the Indian Contract Act, 1872. In commercial and banking transactions, creditors often require additional security before granting loans or extending credit. Such security is provided by a third person who promises to discharge the liability if the debtor fails to do so. This promise creates a contract of guarantee. The provisions relating to guarantees are contained in Sections 126 to 147 of the Indian Contract Act, 1872.
According to Section 126, a contract of guarantee is a contract to perform the promise or discharge the liability of a third person in case of his default. The parties involved are:
- Surety: The person who gives the guarantee.
- Principal Debtor: The person whose default is guaranteed.
- Creditor: The person to whom the guarantee is given.
Essential Elements of a Contract of Guarantee
- Existence of Three Parties: A valid contract requires a principal debtor, a creditor, and a surety. Without these three parties, a contract of guarantee cannot exist.
- Existence of a Valid Debt or Liability: There must be a lawful and enforceable liability of the principal debtor. If the original liability is void or unlawful, the surety cannot be held liable.
- Promise to Discharge Liability on Default: The surety’s liability is secondary and conditional, arising only after the principal debtor fails to perform the obligation.
- Consideration: Per Section 127, anything done or any promise made for the benefit of the principal debtor is sufficient consideration for the surety. Direct benefit to the surety is not required.
- Competency of Parties: Parties must be competent to contract under Section 11 of the Indian Contract Act. The surety must be a major, of sound mind, and not disqualified by law.
- Free Consent: The surety’s consent must be voluntary. Guarantees obtained by coercion, fraud, misrepresentation, or concealment of material facts are invalid.
- Lawful Object: The object and consideration must be lawful; guarantees for illegal activities are void.
- Writing is not Necessary: Under Indian law, a contract of guarantee may be oral or written, though written agreements are preferred for evidentiary purposes.
Kinds of Guarantee
- Specific Guarantee: Given for a single transaction or a particular debt; it ends once the transaction is completed.
- Continuing Guarantee: Extends to a series of transactions and remains in force until revoked.
Difference Between Contract of Guarantee and Contract of Indemnity
| Basis of Difference | Contract of Guarantee | Contract of Indemnity |
|---|---|---|
| Parties | Three parties (Surety, Debtor, Creditor) | Two parties (Indemnifier, Indemnified) |
| Nature of Liability | Secondary and conditional | Primary and independent |
| Purpose | To provide security to the creditor | To reimburse loss |