Contract of Guarantee

Mr. Baidya nath Mukherjee Assistant professor Noida International University [email protected] Contract of Guarantee (S.126)

 Guarantee means “security or assurance”.  When Creditor gives loan and 1. Goods are given as security then this is Pledge or 2.Immovable property are given as security then this is Mortgage or 3. Person given as security then this is Guarantee.  Example: A goes to shop with D and says to the shopkeeper- 1. Give him goods- I’ll pay 2. Give him goods- I”ll see you paid 3. Give him goods- If he doesn’t pay, then I’ll pay.  The first 2 are simply contract of sale of goods where A is buyer and shopkeeper is seller. But in the 3rd case, A is Guarantor or Surety, D is debtor and shopkeeper is creditor and it’s a Contract of Guarantee because A discharges the liability of D. • So, the test of COG is “whether one discharges the liability of 3rd person or not”. • Also remember one more rule- “the liability of surety is dependent on the liability of the Debtor”. – If debtor is liable then surety is liable and – If debtor is not liable then surety will also not liable. But, in some cases there may be a situation like this- cont… 2 positions of surety

Surety doesn’t know debtor is Surety knows debtor is minor minor • Debtor not liable as an • Debtor not liable as an agreement made with the agreement made with the minor is void. minor is void. • But, surety knows that • But , surety doesn’t the debtor is minor then in that status of minor, then he will case, surety will be liable as also not be liable. a debtor as if he taken the loan himself. [Kashiba v. Sripat]. Definition & Meaning

 Definition u/s 126- “It’s a contract to perform or discharge the liability of a third person in case of his default”.  Meaning- when one party gives his guarantee to pay the loss in case of default made by the principal debtor i.e the surety’s liability arises only when default made by the principal debtor.  Examples: 1. A bank gives a loan of Rs 20 lacs to B on the guarantee of C. Thus, A is the creditor, B is the Principal Debtor and C is the Surety. 2. S requests C to lend Rs. 10000 to P.D and guarantees that if P.D fails to pay the amount, he will pay. Thus, S is the surety, C is the Creditor and P.D is the Principal Debtor. Essentials of COG

1. Two parties- Promisor and Promisee. The promisor is called Surety and promisee is called Creditor. 2. Promise is to discharge the liability of 3rd person i.e debtor. 3. Consideration - loan by creditor to debtor. 4. A single transaction involves 3 persons: Surety, Creditor and Debtor.  Surety- The person who gives the guarantee is called the surety.  Principal Debtor (PD)- The person in respect of whose default the guarantee is given is called the Principal Debtor.  Creditor- The person to whom the guarantee is given is called the Creditor. 5. Number of Contracts- There may be atleast two or three contracts: First between Surety & Creditor- called Contract of Guarantee Second between Debtor & Creditor- called Simple contract of loan. Third between Surety & Debtor- called Contract of Indemnity. 5. Nature of Liability- the liability of the debtor is Original or Absolute and the liability of the surety is Collateral or Parallel or Alternative. This has been confirmed by the following sources: i) [Held in Birkmyr v. Darnell] and the same was confirmed in ii)[Arthill v. Arthill]. iii) Indian landmark case- Bank of Bihar v. Damodar Prasad (SC) iv) Even, Mulla supported the view that surety’s liability is collateral or parallel and not secondary. 6. Extent of Liability of Surety [S.128]- the liability of surety is co-extensive with that of the debtor. The SC in Bank of Bihar v. Damodar Prasad held that- i) Co-extensive means equality in amount and equality in time. ii)The creditor can proceed against surety without exhausting remedies against the debtor. iii) The creditor bank is at liberty to recover the loan amount jointly and severally from the defendants (PD or Surety). cont… 7. Commencement of Surety’s liablility- Question: surety promises to creditor to give loan of Rs. 50000 to debtor for one year on 1 Jan 2014. loan date expired on 1st jan 2015. who will be liable to pay on 2nd jan 2015. • Ans. Both as the liability will fall on both on 2nd jan 2015. The creditor has a right to claim either from the debtor or surety or both. It means he can claim severely (separately) or jointly. • One jurist held that- “in COG, the creditor has 2 pockets from where he can get the repayment of loan. The pocket no. 1 is debtor and the pocket no. 2 is surety”. • The SC in Transcore v. UOI (2008) held that “it’s very strange that transaction is one and the liability is on 2 persons”. 8. Right of Indemnity (u/s 145) - There is an implied promise by the principal debtor to indemnify the surety after making the payment by the surety to the creditor. 9. Right of Subrogation (u/s 140) – Subrogation means substitution or replacement of a person by another. When surety makes the payment then he occupies the place of creditor. Creditor is replaced by surety. Now, surety becomes creditor of debtor. The surety will step into the shoes of the creditor. This is called subrogation. 10. Co-Sureties- when there are more than one surety, then they are called co-sureties. If creditor releases one of the co-sureties- it has 3 consequences: 1. That co-surety is not liable to creditor. 2. Other co-surety will be fully liable to creditor. It means that creditor can recover all the debts from non-released co-sureties. 3. Released co-surety is not released from his liability to contribute to co-sureties. It means Theory of Contribution will apply upon him. Kinds of Guarantee

Specific Guarantee Continuing Guarantee S.129 1. It extends to a single 1. It extends to a series of transactions. transaction. 2. Series of transactions 2. One transaction covered covered by one guarantee. by one guarantee. 3. It can be revoked as to future transactions. 3. It can’t be revoked. It Example: S has given a comes to an end when guarantee to C to give his the guaranteed debt is flat to D at monthly rent of Rs. 20000. If in any month, D duly discharged. doesn’t pay the rent, then the S will pay. This is a continuing guarantee. Difference between:

 C of Indemnity - S. 124  C of Guarantee- S.126 1. It’s a contract by which “one 1. “It’s a contract to perform or party promises to save the discharge the liability of a other loss caused to him by third person in case of his the conduct of the default”. Indemnifier or any other 2. Example: A bank gives a loan person”. of Rs 20 lacs to B on the 2. Example: A student signs an guarantee of C. Thus, A is the indemnity bond of Rs 10000 creditor, B is the Principal for an institute that if he Debtor and C is the Surety. breaks any belongings of the institute, deduct money from the deposit. 3. There are only two 3. There are three parties parties i.e Indemnifier i.e Creditor, Principal and Indemnified. Debtor and Surety. 4. There is only one 4. There may be atleast 2 contract between and maximum 3 also: Indemnifier and a) Creditor and Indemnified. Surety, b) Creditor and Debtor and c) Surety and Debtor 5. The liability of the 5. The liability of the Debtor Indemnifier is Primary, is original and absolute Original or Absolute. and the surety is collateral 6. The liability of the or parallel. Indemnifer arises only 6. The liability of the surety on the loss suffered by arises only when the debtor the Indemnified. commits default in making 7. The nature of the contract payment to the creditor. is for the reimbursement 7. The nature of the contract of the loss of the is for the safety and Indemnified. security of the creditor. 8. The Indemnified is 8. The Creditor is not entitled to sue 3rd entitled to sue the party. Debtor or Surety. 9. The scope of COI is 9. The scope of COG is Narrower because wider because the the Indemnified can Creditor can sue sue only Indemnifier. severely or jointly to debtor & surety. Discharge of Surety from Liability

A Surety can be discharged in the following ways:- 1. By Notice (u/s 130)- A specific guarantee cannot be revoked by the surety if the liability has already accrued. But, a continuing guarantee may be revoked at anytime by giving a notice to the creditor. However, this revocation shall be effective only in respect of future transactions. 2. Death of Surety (u/s 131)- The death of the surety operates as a revocation of a continuing guarantee so far as regards future transactions. The liability of the previous transactions however remains. The deceased surety’s estate will not be liable for any transactions entered into between the creditor and the principal debtor after the death of the surety, even if the creditor has no notice of the death. 3. By variance in the terms of the Contract (u/s 133)- A surety is liable for what he has undertaken in the contract. When the terms of the contract between the principal debtor and the creditor are varied without the surety’s consent, the surety is discharged as to the transactions subsequent to the variance. 4. By release or discharge of the principal debtor (u/s 134)- The surety is also discharged by any act or omission of the creditor, the legal consequence of which is discharge of the principal debtor. 5. By compounding with the principal debtor (u/s 135)- 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. 6. By creditor’s act or omission impairing surety’s eventual remedy (u/s 139)- If the creditor does any act which is inconsistent with the rights of the surety, or omits to do some 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.

7. By loss of security (u/s 141)-. If the creditor loses or without the consent of the surety, parts with any security given to him at the time of the contract of guarantee, the surety is discharged from liability to the extent of the value of security. Rights of Surety

1. Rights against Principal Debtor i) Right of Indemnity (u/s 145) - there is an implied promise by the principal debtor to indemnify the surety. The surety is entitled to claim all the sums from the principal debtor which he has rightfully paid to the creditor. ii) Right of Subrogation (u/s 140) - on payment of a debt, the surety shall be entitled to all the rights which the creditor could claim against the principal debtor.

2. Rights against Creditor i) Right to claim securities (u/s 141) -The surety can claim all the securities which the creditor had at the time of the giving of guarantee. ii) Right to set off- any amount recoverable by the principal debtor or surety may be claimed as deduction. 3. Rights against Co-sureties i) Right to contribution (u/s 146 and 147) - When a debt is guaranteed by two or more sureties, they are called co-sureties. All the co-sureties shall contribute equally or in different sums towards the guaranteed debt. When one of the co-sureties makes payment to the creditor, he has a right to claim contribution from the other co-surety or co-sureties. ii) Right to share benefit of securities- if one co- surety receives any security, all the other co-sureties are entitled to share the benefit of such security. THANKS!