A contract of guarantee is a special contract and is defined under section 126[i] of the contract act, wherein one party promises to discharge the liability, of a third party in case of his default. This contract includes primarily three parties i.e. surety, principal debtor and the creditor. The principal debtor herein is responsible for accruing debt or liability and the surety takes the responsibility to pay for any defaults thereafter made by the principal debtor. The creditor is the person who provides the debt.
The contract of guarantee takes place between the surety and the creditor, primarily, however, the principal debtor is a third party that must be an indirect party to the contract as well i.e. a principal debt must exist at the time when the surety gives his guarantee with respect to the principal debtor.
As per section 128 [ii] the extent of surety’s liability is co-extensive with that of the principal debtor i.e. equal to the liability of the principal debtor until and unless the surety made some provisions against it in the contract of guarantee.
What is Co-extensive liability?
This entails that the surety is directly liable for all that the principal debtor owes to the creditor and not one penny less or more than that amount. It is the maximum limit to which the surety can be made liable in regards to his guarantee. In the case of Maharaja of Benaras v Har Narain Singh[iii] under the agreement in this case and even otherwise, the surety is liable not only for the principal amount but also for the interest on the principal amount and charges incurred in enforcing this liability. The court held that the trial court erred in decreeing the suit against the surety for the only principal amount excluding interest and costs. Therefore, we can conclude the entirety of the liability of the principal debtor also becomes the liability of the surety once the debtor defaults in the payment.
It must also be noted that the liability wholly depends upon the terms of the contract and hence must be followed completely.
Terms of Contract
1. Condition precedent
The surety before entering into the contract of guarantee may put forward some condition precedent to his liability wherein he would not be held liable until and unless such a condition is fulfilled, the surety cannot be held liable. Partial recognition of this concept is also found in section 144[iv] of the act according to which if any person gives their guarantee upon a contract that the creditor must not be allowed to act upon such a contract until another person has joined in it as co-surety, the guarantee won’t be valid. An example of this point is the National Provincial Bank of England v Brackenbury[v]. Under this case, the defendant signed a guarantee which on the face of it was intended to be a joint and several guarantees of three other persons with him. One of them did not sign. There being no agreement between the bank and the co-guarantors to dispense with his signature, the defendant was held not liable.
2. Proceeding against surety without exhausting remedies against the debtor
Where the liability is otherwise unconditional i.e. co-extensive the creditor cannot be compelled to exhaust his remedies against the debtor first to be able to or to be allowed to sue the surety i.e. the creditor can sue the surety for the default made by the principal debtor without furthering any proceedings against the debtor first. This was held in the case of Bank of Bihar Ltd v Damodar Prasad[vi] under this case the supreme court ruled in favour of the creditor and held that it makes no sense or value to the contract of guarantee if the creditor first has to exhaust all his remedies against the principal debtor to be able to make surety liable for the default.
Similarly, it must be noted that the creditor can take against the debtor alone as well and his suit cannot be rejected on the grounds that he did not include the guarantor as the defendant to the suit or vice versa i.e. the surety can be sued alone irrespective to the fact that the principal debtor has been added as a defendant to the suit.
3. Death of principal debtor
The surety is not discharged of his liability towards the creditor under a contract of guarantee under a situation wherein the principal debtor is dead.
Surety’s right to limit his liability or make it conditional
It is open to the surety to place a limit upon his liability. He may either expressly declare his guarantee to be limited to a fixed amount. The surety can do this by capping the limit to the amount to which he can be held liable or by insisting upon collateral security to be submitted by the principal debtor to the creditor against the debt to reduce the burden of liability.
It must also be noted that the surety will not be discharged of his liability wherein there exists a doctrine of impossibility of performance, as had been held in the case of Florence Mabel R.J. v State of Kerela[vii].
It must be understood that a guarantee may extend over a series of transactions under which the surety binds himself to the default in each and every transaction separately and is liable to the creditor. The concept has been defined in section 129[viii] of the Indian Contract Act. However, it may be revoked with the help of a notice, unlike the guarantee which is entered only in terms of a single transaction. The latter guarantee once entered into by the surety cannot be revoked at any moment into the contract.
On the other hand, the continuing guarantee may be revoked however, it will discharge the surety’s liability only in regards to any future transactions and not the past defaults if any. It must be noted that the surety is liable for the default of the principal but the situations of and provisions of each contract of guarantee can be different and hence the contract or agreement must explicitly govern the manner in which the surety’s liability must be calculated and then dealt with.
Under certain conditions or situations, the surety may also be allowed to discharge his liability wherein either the debtor is at fault or the creditor by his own fault or conduct does something which has the effect of discharging surety from his liability in regards of the contract of guarantee.
ENDNOTES[i] Section 126 of the Indian Contract Act [ii] Section 128 of the Indian Contract Act [iii] ILR (1906-07) 28 [iv] Section 144 of the Indian Contract Act [v] (1906) 22 TLR 797 [vi] AIR 1969 SC 297 [vii] AIR 2001 Ker 19 [viii] Section 129 of the Indian Contract Act
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