What is Contract of Guarantee?

Contract of Guarantee

Section 126 of the Indian Contract Act, 1872, defines a contract of guarantee as under : “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 Section further provides that: “The person who gives the guarantee is called the “surety”, the person in respect of whose default the guarantee is given is called “principal debtor”, and the person to whom the guarantee is given is called the “creditor”.

A guarantee may be either oral or written.”

For example, A takes a loan from a bank. A promises to the bank to repay the loan. B also makes a promise to the bank saying that if A does not repay the loan “then I will pay.” In this case, A is the principal debtor, who undertakes to repay the loan, B is the surety, whose liability is secondary because he promises to perform the same duty in case there is default on the part of A. The bank in whose favour the promise has been made is the creditor.

Object of the Contract of Guarantee

The object of a contract of guarantee is to provide additional security to the creditor in the form of a promise by the surety to fulfil a certain obligation, in case the principal debtor fails to do that.

Number of Parties in Contract of Guarantee

In every contract of guarantee, there are three parties, the creditor, the principal debtor and the surety.

Number of Contracts in Contract of Guarantee

There are three contracts in a contract of guarantee. Firstly, the principal debtor himself makes a promise in favour of the creditor to perform a promise, etc.(Section 126) Secondly, the surety undertakes to be liable towards the creditor if the principal debtor makes a default. (Section 126) Thirdly, an implied promise by the principal debtor in favour of the surety that in case the surety has to discharge the liability of the default of the principal debtor, the principal debtor shall indemnify the surety for the same.(Section 145) When a borrower and a guarantor both sign an agreement in favour of a bank, they are jointly and severally liable under that contract.

The contract of guarantee is no doubt tripartite in nature but it is not necessary or essential that the principal debtor must expressly be a party to that document. In a contract of guarantee, the principal debtor may be a party to the contract by implication. Thus, there is possibility that a person may become a surety without the knowledge and consent of the principal debtor.

Read Also What is contract of indemnity?

A surety is a person who comes forward to pay the amount in the event of the borrower failing to pay the amount. In the event of a decree in favour of the creditor against the principal borrower, the wings of the decree can also be extended against the sureties as their liability is coextensive with the principal debtor.

But when a suit against the principal debtor was dismissed for default and the decision became final, there being no liability surviving against the debtor, the surety’s liability gets automatically terminated.( Kurhool Chief Funds (P.) Ltd. v. P. Narasimha, A.I.R. 2008 A.P. 38.)

Main Features of Contract of Guarantee

1. The contract may be either oral or in writing

According to Section 126, a guarantee may be either oral or written. On this point, the position in India is different from that in England. According to English law, for a valid contract of guarantee, it is necessary that it should be in writing and signed by the party to be charged therewith.

Read Also Contract of Indemnity and Insurance
2. There should be a principal debt

A contract of guarantee pre-supposes a principal debt or an obligation to be discharged by the principal debtor. The surety undertakes to be liable only if the principal debtor fails to discharge his obligation. If there is no such principal debt, but there is a  promise by one party in favour of another for compensating in a certain situation, and the performance of this promise is not dependent upon the default of somebody else, it is a contract of indemnity. Thus, when A and B go to a shop, A purchases goods and B tells the seller “if A does not pay you, I will”, it is a contract of guarantee. On the other hand, if A is not the principal debtor, but only B makes a promise to the shopkeeper to pay, for instance, B tells the shopkeeper ‘Let him (A) have the goods, I will be paymaster’, it is a contract of indemnity.( Birkmyr v. Darnell, (1704) 1 Salk, 27 at 28)

3. Benefit to the principal debtor is sufficient consideration

As in any other contract, the consideration is also needed for a contract of guarantee. For the surety’s promise, it is not necessary that there should be direct consideration between the creditor and the surety, it is enough that the creditor had done something for the benefit of the principal debtor. Benefit to the principal debtor constitutes a sufficient consideration to the surety for giving the guarantee. This is clear from Section 127, which reads as under :

“Anything done, or any promise made for the benefit of the principal debtor may be a sufficient consideration to the surety for giving the guarantee.”


(a) B requests A to sell and deliver to him goods on credit. A agrees to do so, provided C will guarantee the payment of the price of the goods. C promises to guarantee the payment in consideration of A’s promise to deliver the goods. This is sufficient consideration for C’s promise.

(b) A sells and delivers goods to B. C afterwards requests A to forbear to sue B for the debt for a year, and promises that if he does so, C will pay for them in default of payment by B. A agrees to forbear as requested. This is a sufficient consideration for C’s promise.

In Illustration (a) above, the basis of promise by the surety is sale of goods on credit to the principal debtor.

Read Also When can an indemnifier be made liable ?

In Illustration (b), even though the goods have already been sold but C stands as a surety for B, if A forbears to sue B. In these Illustrations, there is either a benefit to the principal debtor or detriment to the creditor which prompts the surety to give the guarantee. If the promise of a person making the guarantee is not on the basis of any benefit to the principal debtor but independent of it, for instance, it is made subsequent to the benefit conferred by A upon B, it cannot be deemed to be a valid contract. The subsequent promise is deemed to be without consideration. This is clear from Illustration (c) to Section 127, which is as follows: A sells and delivers goods to B. C afterwards, without consideration, agrees to pay for them in default of B. The agreement is void.

4. Consent of the surety should not have been obtained by misrepresentation or concealment

The creditor should not obtain guarantee either by any misrepresentation or concealment of any material facts concerning the transaction. If the guarantee has been obtained that way, the guarantee is invalid. The position is explained by Sections 142 and 143, which are as under :

“142. Guarantee obtained by misrepresentation invalid. Any guarantee which has been obtained by means of misrepresentation made by the creditor, or with his knowledge and assent, concerning a material part of the transaction, is invalid.”

“143. Guarantee obtained by concealment invalid.-Any guarantee which the creditor has obtained by means of keeping silence as to material circumstance is invalid.


(a) A engages B as clerk to collect money for him. B fails to account for some of his receipts and A in consequence calls upon him to furnish security for his duly accounting. C gives his guarantee for B’s duly accounting. A does not acquaint C with B’s previous conduct. B afterwards makes default. The guarantee is invalid.

(b) A guarantees to C payment for iron to be supplied by him to B to the amount of 2,000 tons. B and C have privately agreed that B should pay five rupees per ton beyond the market price, such excess to be applied in liquidation of an old debt. This agreement is concealed from A. A is not liable as a surety.”

According to the above stated provision, obtaining a person’s consent to act as a surety either by misrepresentation, or keeping silence as to material circumstances, renders such a contract invalid.

Keeping silence as regards material circumstances, which could affect the surety’s mind to stand as surety or not, would render the guarantee void. Thus, if a cashier has been found guilty of embezzlement, but this fact is not disclosed when a surety has been made to guarantee the future conduct of the cashier, the surety will not be liable as such, under these circumstances.

Similarly, if a surety is made to guarantee an employee’s existing and future liabilities, without being informed that the said employee is already indebted to an extent more than that of the guarantee, the guarantee is invalid. Lee v. Jones, (1863) 17 C.B.N.S. 482 (Ex. Ch.).

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