GUARANTEE

WHAT IS GUARANTEE ?

• Assurance given by one person to another in relation to the default of “third” person.
• An undertaking to answer for the payment or performance of another person's debt or obligation in the
event of a default by the person primarily responsible for it.

Objective: For securing payment of money in commercial transactions / additional security to the Creditor
Eg. A takes loan from ABC Bank. Bank always needs a guarantor. B thus, tells the Bank, if A is unable to repay, “I
will pay” – This I will pay is a Contract of Guarantee.

HALSBURY’S LAW OF ENGLAND:

“A guarantee is an accessory contract whereby the promisor undertakes to be answerable to the promisee for the debt,
default or miscarriage of another person whose primary liability to the promise must exist or to be contemplated.”
 SECTION 126

S. 126. " Contract of guarantee"," surety", principal debtor" and" creditor"-

A contract of guarantee is a contract to perform the promise, or discharge the liability, of a
third person in case of his default.

Parties- 1. Surety (Gives the guarantee)

2. The Principal Debtor (In respect of whose default its given) (Third Person)
3. Creditor (To whom it is given).
Type: A guarantee may be either oral or written.
Contract – Valid Contract – Conditions of S. 10 be fulfilled
Contract for? S promises to perform the promise i.e. the Original promise between
C and D or discharge liability of D.
His default – D’s failure/ miscarriage - Secondary liability
 FEATURES

* Tripartite Agreement
Contract 1.
PRINCIPAL CONTRACT
A – Creditor (guarantee in his favor) B – Principal Debtor (defaulter)

Contract 2. Contract 3.
CONTRACT OF GUARANTEE CONTRACT OF INDEMNITY

C – Surety (gives the guarantee)

Contract 1: Principal contact – Between A(Creditor) and B(Debtor)

Contract 2: Contract Of Guarantee - Between A(Creditor) and C(Surety)
Contact 3: Contact of Indemnity – Between B(Debtor) and C(Surety)
 ESSENTIALS

1. 3 parties- All essentials of a contract;

2. Principal debt– No debt no Guarantee;
3. Consideration;
4. Promise by the Surety – could be at the express request or implied request of the PD;
(Prasanjit Mahtha v United Commercial Bank)
5. A guarantee may be either oral or written;
6. If liability, it should be legally enforceable;
7. The Principal Debtor must be principally liable, Surety is secondary;
8. Surety shall come into play only and only when there has been default by the Principal
Debtor;
9. The liability of the surety similar to the principal debtor;
10.Consent of surety should not have been obtained by misrepresentation or concealment.
(Section 142 & 143 ICA)
 INDEMNITY VS GUARANTEE

Indemnity Guarantee
Bi – Party (2 parties) Tripartite (3 parties)
- Indemnifier - Creditor
- Indemnity Holder - PD
- Surety
Only one contract i.e. between Indemnifier and Three contracts – (a) Creditor and Principal
Indemnified Debtor
(b) Creditor and Surety
(c) Surety and PD
The liability of the indemnifier arises on the The liability of the surety arises if there is a
happening of an uncertain event default by the PD.
The object – to reimburse the loss To provide security to the creditor
Stranger to the contract cannot sue Stranger to the Contract can sue. If the surety
discharges the debt of PD – he steps into the
shoes of creditor and becomes entitled to realize
the money paid

Liability of indemnifier is primary and Surety’s liability is secondary

independent
Discussion 1: D promises C to deliver goods by Friday. C is doubtful because D has
defaulted before on various occasions. D asks S to assure C that he will deliver the goods.
S says – Don’t worry, D will deliver the goods, trust me ! Guarantee ?
 CONSIDERATION

Consideration Section 2(d) : "When at the desire of the promisor, the promisee has done or abstained from
doing, or does or abstains from doing, or promises to do or abstain something, such an act or abstinence or
promise is called consideration for the promise.”
S. 127 –
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.
i.e- Principal Contract will work as a consideration in the Agreement btw surety and creditor.

Discussion 2: Is past consideration Valid ?

Refer: Ram Narain v Hari Singh (AIR 1964 Raj. 76)
Refer: M.N.A. Khan v Commercial and Industrial Bank (AIR 1969 AP294)
• Illustration 1: (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 a sufficient consideration for C’s promise.

• Illustration 2:(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.

• Illustration 3:(c) A sells and delivers goods to B. C afterwards, without consideration, agrees to pay for them in
default of B.
• The agreement is void.
 DISCUSSION

C sells and delivers goods to D on credit for 2 years. one year lapses but D does not
make payment. C is scared that he may not receive payment so begins to threaten D
that he will proceed against him in the Court. D shares this with S and S then requests
C from refraining from legal action against D and if he does so, he would pay C the
amount due. Guarantee ?
- Yes, benefit of D.

D buys goods on credit from C. D pays half the amount by mid year and promises to pay
the amount due by the end of the year. D has received payment from his client and was
about to pay C the leftover amount. S walks in and says, I guarantee to pay the amount
due by D. Guarantee ?
- No, S. 127 says, for the benefit of the PD. D has the means to pay. Where is
the default?
 EXTENT OF SURETY'S LIABILITY (DISCUSSION QUESTIONS)

• 1. What if Debtor performs the obligation, what Cause of Action(COA) does

Creditor has against surety?
• 2. If the Surety performs the obligation due to Debtor’s default , can he seek
indemnification from the Debtor?
• 3. What if the original terms/ obligations under the contract are changed without
Surety’s consent? (Section 133)
• 4. What if some material circumstance is concealed from the surety? (Section 143)
 LIABILITY OF SURETY

S. 128 - Surety' s liability.- The liability of the surety is co- extensive with that of the principal
debtor, unless it is otherwise provided by the contract.
E.g. - S guarantees to C the payment of a cheque by D, the issuer. The cheque bounces. “S is
liable not only for the amount of the cheque but also for any interest and charges which
may have become due on it.”
- Held in -- Zaki Husain v Deputy Commr. Of Gonda, AIR 1929 All 687
- Unless there is an agreement capping the amount
- E.g. – There is a debt of Rs. 10,000/- and the agreement states that the Surety cannot
be liable for more than Rs. 5,000/- in the event of default by the PD. Surety is liable for
only Rs. 5,000/-

Discussion: A loan agreement between ABC Bank and D for an amount of Rs. 50,000/-. S is the
Surety. However, in the next one year D pays off Rs. 20,000/-. What is the liability of S ?
- Rs. 30,000/-. Co-extensive with the PD.
 EXTENT OF SURETY'S LIABILITY (DISCUSSION QUESTIONS)

• 1. If Principal contract is breached, Creditor has COA against whom?

• Both. The liabilities are co-extensive.
• “ A surety’s liability to pay the debt is not removed by the reason of the creditor’s omission to sue the PD;
nor is the creditor bound to exhaust his remedy against the PD before the surety. A creditor cannot be
restrained from action against the surety, on the ground that PD is solvent (can pay)” – Bank of Bihar Ltd.
v. Damodar Prasad. ( AIR 1969 SC 297) - The liability of surety is “joint” and “several”
• “ It is the choice of the creditor to recover the amount either from the PD after his default or from the
surety” – National Projects Construction Com. Ltd. v. Sadhu & Co. (AIR 1990 P&H 300)

• 2. When should the Creditor give notice to the Surety?

• “ He is not entitled to any notice of the default unless the terms of guarantee so require” (Meaning when
demand is a necessary ingredient of creditor’s COA against the surety) – P.C. Chetty v. Premier Bank of
India (AIR 1959 AP 96)
 TYPES OF GUARANTEE

1. Specific & Simple Guarantee – For a specific purpose – one time transaction – fixed sum. The
liability of a surety comes to an end when the guaranteed debt is discharged or promise is duly
performed.
2. Continuing Guarantee – S. 129 – A guarantee which extends to a series of transactions.
A surety’s liability continues to all the transactions until the revocation of the guarantee.
E.g. – S guarantees C, a raw material supplier, for a value of Rs. 10,000/- for any amount of and any
kind of material supplied to D, as and when required for construction of his house.
- Now what if D pays the amount of Rs. 10,000/- for the first time when it falls due? Guarantee
continued?
- What if D defaults in payment the second time?
- What if S said that he’d pay for one time transaction?
- What if D starts building his Office? Will the S be liable to pay construction money?
• “A guarantee for the payment, by instalments of a certain sum within a definite time
is not a continuing guarantee.”
• - B. R.Vani v. Secy. Of State for India ( AIR 1926 Bom. 465)
 RELEASE OF SURETY

Modes of Revocation

By Notice Death of Surety Discharging

S. 130 S. 131 Surety

Performance Variance Release of PD Arrangement Creditor’s loss of

act/omission security
 SECTION 130

• Section 130 - Revocation of continuing guarantee-

A continuing guarantee may at any time be revoked by the surety, as to future transactions, by notice to the creditor.
- Till the time not revoked, guarantee and its liability exists.

• Discussion :
• 1) A, in consideration of B’s discounting, at, A’s request, bills of exchange for C, guarantees to B, for twelve
months, the due payment of all such bills to the extent of 5,000 rupees. B discounts bills for C to the extent
of 2,000 rupees. Afterwards, at the end of three months, A revokes the guarantee.Valid?
• This revocation discharges A from all liability to B for any subsequent discount. But A is liable to B for the
2,000 rupees, on default of C.
• Discussion: A guarantees to B, to the extent of 10,000 rupees, that C shall pay all the bills that
B shall draw upon him. B draws upon C, C accepts the bill. A gives notice of revocation. C
dishonours the bill at maturity. Liability?
• A is liable upon his guarantee.

• “When the contract of suretyship prescribes a particular mode of giving notice of

termination of a continuing guarantee by surety, notice must be given in that mode. No other
mode will be effective.”
- Seth Dhanoomal Parsaram v. P. Kuppuraj, AIR 1977 Mad. 274.
 SECTION 131

Section 131 - Revocation of continuing guarantee by surety' s death-

The death of the surety operates, in the absence of any contract to the contrary, as a
revocation of a continuing guarantee, so far as regards future transactions.

Discussion:
1. What if there are multiple sureties and one of them die. Will the rest be liable for the future
transactions?
2. What if the transactions were made before the Surety’s death? Who would complete surety’s
obligations?
3. What if the PD dies before fulfilling his obligation? Is surety still liable?
 SECTION 133 – VARIANCE

S.133. Discharge of surety by variance in terms of contract -

Any variance, made without the surety's consent, in the terms of the contract between the principal debtor and the
creditor, discharges the surety as to transactions subsequent to the variance.
- When the guarantor agrees to give guarantee on certain terms they should remain the same
throughout the period of guarantee
- The surety is not liable for altered contracts
- What if Consent is given?
Discussion:
1. Vishal guarantees XYZ law firm that Rohan’s conduct will be up to the mark during his employment.
Rohan is employed by XYZ law firm.Vishal enters a CoG for certain standards and conduct to be
maintained. These standards are altered without Vishal’s consent. Is Vishal discharged from his liability?
2. C contracts to lend D 5,000 rupees on the 1st March. S guarantees repayment. C pays the 5,000 rupees
to D on the 1st January. Is S Discharged?
• 3. S gives to C a continuing guarantee to the extent of 3,000 rupees for any oil supplied by C to D on credit.
Afterwards without the knowledge of S , D and C contract that C shall continue to supply D with oil for ready
money, and that the payments shall be applied to the then, existing debts between D and C.

S is not liable on his guarantee for any goods supplied after this new arrangement.

• Discussion: - If an alteration is made which does not affect the liability of the surety, would he still be discharged?

• “If alteration is not substantial and to the prejudice of the surety, the surety would not be discharged” – M. S.
Anirudhan v. Thomco’s Bank Ltd. (AIR 1963 SC 746)

• – ( A case where the Guarantee document was given for Rs. 25,000 and was reduced to Rs. 20,000 by the Debtor
without consent, Court held that the intention was to give a loan upto Rs. 25,000, which includes the lowered
amount. )

• Also held in – S. Perumal Reddiar v Bank of Baroda (AIR 1981 Mad 180)
 SECTION 134

S. 134 - Discharge of surety by release or discharge of principal debtor-

The surety is discharged by any contract between the creditor and the principal debtor, by which the principal
debtor is released or by any act or omission of the creditor, the legal consequence of which is the discharge of
the principal debtor.
Discussion:
1. S guaranteed D’s loan. D has paid all the money due. Is S discharged?
2. D contracts with C for a fixed price to build a house for C within a stipulated time, with C supplying the
necessary timber. S guarantees D’s performance. C fails to supply the timber. Is S discharged?
3. Suspension of debt for a while – will it amount to discharge of surety’s liability ?
- No, it does not fulfill the conditions of S. 134
4. Would every kind of breach by the Creditor discharge the surety?
- A breach by the creditor of the terms of the principal contract will not discharge the guarantor, unless
it is a repudiatory breach. - National Westminster Bank v. Riley
5. What if the Debtor is discharged by the law? Is the surety discharged from his obligations?
- Yes, as held in Aypunni Mani v. D. Kochouseph (AIR 1966 Ker. 203)
 SECTION 135

S. 135 - Discharge of surety when creditor compounds with, gives time to, or agrees not to sue principal debtor-
A contract between the creditor and the principal debtor, by which the creditor makes a composition with, or promises
to give time to, or not to sue, the principal debtor, discharges the surety, unless the surety assents to such contract.
- Composition – private arrangement b/w Creditor and PD, Something done at the back of the Surety –
unless expressly agreed
-If the C promises not to sue the PD, that means he would only sue the surety
- Any Variance Prejudicial to surety would discharge the surety
- Liabilities are co-extensive
- Extension of time means variance in the term of the contact

Discussion: K supplied goods to employees of M. M was a surety for his employees to pay. K makes a statement –
“M is a good man, I do not intend to file a suit against M’s employees”.
- It is just a statement. His right is pretty much existent. K needs to extinguish his right to sue and for
provisions of S. 135 to come into play for surety to be discharged.
- Unless the Contract of Guarantee states so.
 SECTIONS 136 & 137

S. 137 - Creditor' s forbearance (willful restraint from taking legal action) to sue does not
discharge surety-
Mere forbearance on the part of the creditor to sue the principal debtor or to enforce any other remedy
against him does not, in the absence of any provision in the guarantee(contract) to the contrary,
discharge the surety.
- Just like S. 133 – a mere time delay in suing does not count

Difference between 135 & 137.

“Section 135 deals with cases in which the surety is discharged by a contract between the creditor
and principal debtor, entered into without the surety’s consent . This section deals with the case of
‘mere forbearance’ to sue, as distinguished from the forbearance arising from a contact.”
- As held in- Radhe Kunwar v. Ram Narain (AIR 1952 All 587)

Discussion: D owes to C a debt guaranteed by A. the debt becomes payable. C does not sue D for a
year after the debt has become payable. Is S discharged from his promise?
- No.
Discussion: C gives a loan to D for Rs. 6,000/-. S is the guarantor. The contract reads that C will
demand after exact four months and if D defaults he will sue him. C does not make any demand? Is
surety discharged?
-What if C demanded after exact four months and D defaulted, but C did not institute any
suit thereafter?
- Is there an agreement stating C will not take action? (Sec 135)

“Mere forbearance on the part of the creditor to sue the principal debtor or to enforce any other
remedy against him does not, in the absence of any provision in the guarantee(contract) to the
contrary, discharge the surety”
- As held in – Bank of Baroda v. Avdoot Bhagwant Naik (AIR 2005 Bom. 224)
S. 138 - Release of one co- surety does not discharge others-
Where there are co- sureties, a release by the creditor of one of them does not discharge the others; neither does it
free the surety so released from his responsibility to the other sureties.

Discussion : S1 and S2 are co-sureties for the debt payable by their friend D to a man named C. After the
principal contract between C and D was completed, C demanded for the payment of Debt. However, D
failed to fulfill his obligation. In the meanwhile, S2 died of heart attack. S1 now stated that he has been
discharged of all his liabilities/obligations. True?

- Liabilities of sureties are joint and several

- If the creditor seeks to enforce the guarantee against two of the four guarantors, the other two
will not be discharged.
- Similarly, if one out of four sureties dies and his LRs are not brought on record does not mean
the other three are discharged too.
- As held in – United Bank of India v. Modern Stores Ltd. (AIR 1988 Cal. 18)
 SECTION 139

S. 139 - Discharge of surety by creditor' s act or omission impairing surety's eventual

remedy-
If the creditor does any act which is inconsistent with the rights of the surety, or omits to do any act
which his duty to the surety requires him to do, and the eventual remedy of the surety himself against
the principal debtor is thereby impaired, the surety is discharged.

Principle - negligence or mistake on the part of the creditor cannot make surety liable
- Creditor must do an act which is inconsistent with the right of the surety
- something behind the back anything that affects the right of the surety to remedy
against PD (like sec. 134)
Eg. A stipulation/Condition in the contract which is not followed by the creditor
- Inter connected to S. 141.
Discussion: If the creditor causes delay in recovering an amount, can he claim an interest on it?

Discussion: D contracts to build a ship for C for a certain sum to be paid by installments as the
work reaches certain stages. S becomes surety for C for D’s due performance of the Contract. C
without the Knowledge of the S, prepays to D the last two installments. Is S discharged?

Discussion: Does the omission on part of the C, to not sue the PD first and to directly sue the S,
discharges the S?

“Where, due to negligence of the C, the security given by the PD is lost and the right of surety
against the PD is impaired, due to any action or inaction of the C, the surety is discharged to the
combined effect of Section 139 and Section 141 of the Indian Contract Act.”
- State Bank of Saurashtra v. Chitranjan Rangnath Raja ( AIR 1980 SC 1528)
 RIGHTS OF SURETY- SUBROGATION (SECTION 140)

S. 140 - Rights of surety on payment or performance-

Where a guaranteed debt has become due, or default of the principal debtor to perform a guaranteed duty has taken
place, the surety, upon payment or performance of all that he is liable for, is invested with all the rights which the
creditor had against the principal debtor.

Essentials:
(a) Right of surety – Even without a necessity of a transfer, the law vests in the surety all the rights of the creditor.
The surety will be entitled to every remedy that the creditor has against PD. Including securities U/S. 141.
Like S. 69 of the Act - Reimbursement of person paying money due by another, in payment of which he is
interested-

(b) Payment of debt – default of the PD occurs (performance) – even if it is a fraction of the debt, the moment the
fraction is paid, right to subrogation

(c) Invested – right gets transferred to the surety without the necessity of any written assignment
 SECTION 141

S. 141 - Surety' s right to benefit of creditor' s securities-

A surety is entitled to the benefit of every security which the creditor has against the principal debtor at the time
when the contract of suretyship is entered into, whether the surety knows of the existence of such security or not;
and, if the creditor loses, or, without the consent of the surety, parts with such security, the surety is discharged to
the extent of the value of the security.
- The section comprehends a situation where the debtor has offered more than one security, one of
which is the personal guarantee of the surety
- Similar to S. 140, however, where S. 140 enforces the right S. 141 deals with the protection of a
guarantee and reduction of the surety’s liability in proportion to the security lost or parted with by the
creditor without surety’s consent

- Discussion: C advances to Da loan on the guarantee of S. C has also a further security for
the 2,000 Rs by a mortgage of D’s furniture. C cancels the mortgage. D becomes insolvent, C
sues S on his guarantee. Is S discharged?
- Discussion: This section applies to specific or continuing guarantee?
- Discussion: what is the purpose of this section.
- Discussion: Will mere inaction of creditor to realize from the goods/security mitigate the
surety’s liability?
* NOVATION – S. 62 - Effect of novation, rescission, and alteration of contract-
If the parties to a contract agree to substitute a new contract for it, or to rescind or alter it, the
original contract need not be performed.

Novation means substitution of a new contract of guarantee in the place of an old/existing CoG.
Novation could be between the same parties or different parties – under same terms or different
terms and conditions.

Eg. A owes Rs. 1,000 to B under a contract. It is agreed between A, B and C that B shall
thenceforth accept C as his debtor, instead of A. The debt of A to B is at an end, and now C is
liable to pay Rs. 1,000/- to B.

* Another method for discharge of surety.

 SECTIONS 142, 143 & 146

S. 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.

S. 143 - Guarantee obtained by concealment invalid-

Any guarantee which the creditor has obtained by means of keeping silence as to material
circumstances is invalid.
- Different for a Bank – A bank is not expected to disclose about its past indebtedness

S. 145- Implied promise to indemnify surety-

In every contract of guarantee there is an implied promise by the principal debtor to indemnify the
surety, and the surety is entitled to recover from the principal debtor whatever sum he has
rightfully paid under the guarantee, but no sums which he has paid wrongfully.
S. 146 - Co- sureties liable to contribute equally -
Where two or more persons are co-sureties for the same debt or duty, either jointly or severally, and whether
under the same or different contracts, and whether with or without the knowledge of each other, the co- sureties,
in the absence of any contract to the contrary, are liable, as between themselves, to pay each an equal share of
the whole debt, or of that part of it which remains unpaid by the principal debtor.

Discussion: R, P, S, T and Q are sureties to Z for the sum of Rs. 5,000/- lent to Y. If Y defaults, R, P, S,
T and Q will be liable to pay how much each?
- R, P, S, T and Q will be liable to pay Rs. 1, 000/- each.

Discussion: A, B and C are sureties to D for the sum of Rs. 20,000/- lent to E. A contract between A, B
and C reads that that A is liable to the extent of one-half, B to the extent of one-quarter and C to the extent of
one-quarter. E defaults what would be the liability?
- now A will be liable to pay Rs. 10,000/-, B Rs. 5,000/- and C Rs. 5,000/-.

S. 147 - Liability of co- sureties bound in different sums-

Co- sureties who are bound in different sums are liable to pay equally as far as the limits of their respective
obligations permit.
 BANK GUARANTEE

• A bank guarantee is a guarantee made by a bank on behalf of a customer (usually an established

corporate customer) should it fail to deliver the payment, essentially making the bank a co-signer for
one of its customer's purchases – its absolute and irrevocable.

• A guarantee from a lending institution, financial institution, guaranteeing that the liabilities of a
debtor will be met. If the debtor fails to settle a debt, the bank will cover it.

• ‘Bank Guarantee’- enables the customer (debtor) to acquire goods, buy equipment, and thereby
expand business activity

• Ordinary guarantees - leads to unnecessary disputes and litigation, arising from the main contract,
these disputes block the flow of money during litigation.
• Hence, bank guarantee – innovative instrument - whereby, if the beneficiary perceives that there has
been a breach of contract by the other party, he can encash the guarantee and avail of the amount
immediately, without having to undergo the hassles of litigation.

• The customer has to pay a fee chargeable by the bank and hypothecate its securities.
• The invocation of a bank guarantee by the beneficiary can be restrained by an injunction under
C.P.C.
• “However, Courts are reluctant to restrict the enforcement of a BG, otherwise the purpose of BG is
defeated and the trust in internal and international commerce would be irreparably damaged
• If a bank guarantee has to be restrained, it has to satisfy the following conditions: Fraud and
Irretrievable injustice or injury.”
• - As held in – M.G.S.S.K v. National Heavy Engg. Co-op. Ltd. (AIR 2007 SC 2716)
• - Also held in many other cases like – U.P State Sugar Corporation v. Sumac International
Limited. (AIR 1997 SC 1644)
• Letter of Credit (LOC)- Way of buyer to pay the seller. Buyer would ask a bank to
give a letter of credit in favor of the seller. Bank would undertake to pay a stated
amount on furnishing of certain documents as per the arrangement.

• “ Since the BG or the LOC is an independent and a separate contract and is

absolute in nature, the exeistence of any dispute between the parties to the
contract is not a ground for issuing an injunction to restrain its enforcement, . –
Himadari Chemicals Industries Ltd. V. Coal Tar Refining Comapany. (AIR
2007. SC 2798)