Written by: Shubham Arun
1.1 Introduction
Guarantee is a frequently used term, which is widely used in our day to day life but it seldom comes to our mind what is the full extent of this term. The word “Guarantee” usually finds its application in the banking sector. In this article we will be discussing about the essential elements of a contract of guarantee and also about its application from the legal prospective.
1.2 Parties of Guarantee
A “contract of guarantee” is a contract to discharge the liability of a third person in case of any default by the principal debtor. A contract of guarantee is “tripartite” agreement, that is it is contract that involves three parties namely “surety” a person who gives guarantee; the person on whose behalf in case of default the guarantee is given is called the “principle debtor”, and the person to whom the guarantee is given is called the “creditor”. A valid contract of guarantee can be executed in both oral or written way.
1.3 Significance of Guarantee
“Guarantee” plays a great role in the economic scenario as it enables a person loan for various purpose or an employment. For example in case of Birkmyr v. Darnell[1] the Court said: “If two come to a shop and one buys, and the other to give credit, promises the seller, ‘If he does not pay you, I will.’” This kind security undertaking to be liable for the default of another is called a “contract of guarantee”.
2.1 Requisites of a Valid Guarantee
The main reason of a guarantee is that there is a sense of security that a debt will be paid and will be able to be recovered[2] from the surety in case of any default by the principle debtor. If there is no principle debt, there can be no valid guarantee[3]. Also where a loan is given to a minor and his “surety” knows that the principal debtor is a minor, in case of default by the minor the ‘surety’ should be held liable as a principle debtor himself[4].
Like every contract a contract of guarantee also requires some consideration, hence a contract without consideration is void[5] although no direct consideration is required between the ‘surety’ and ‘creditor’ as the benefit given to the principal debtor by the creditor is a sufficient consideration for the ‘surety’. Now a question rises that is a guarantee for a past debt invalid, technically it should be as when the loan was given to the borrower there was no third party, hence no contract of guarantee arises but in the decision given by various courts has interpreted the word “anything done”[6] of section 127 of the Indian Contract Act as inclusive of things done before the guarantee was given. Hence, a “past consideration is valid consideration”[7]. Also a contract where it is agreed by the ‘surety’ to cover for past debt as well as some future debt it is enforceable and all the liability incurred is coupled up.[8]
3.1 Protection to Guarantor
There is a very inevitable question that rises in the topic that is a guarantor protects the principal debtor but who will safeguard the interest of the guarantor. For this there is a provision where after the original guarantor pays and fulfils his obligation as a guarantor, he can call upon a ‘counter guarantor’ to remunerate him[9]. Also where a guarantee is obtained by misrepresentation or concealment of a fact which is likely to affect the credit of the customer or job applicant, is invalid[10].
According to section 145 of the Indian Contract Act, every contact of guarantee is an implied promise by the principal debtor to the ‘surety’ to indemnify him for any amount paid by him according to the contract and not which is out of the scope of contract.
3.2 Extent of Surety’s Liability
The liability of a ‘surety’ is same as of the principal debtor and it coexists unless the ‘surety’ has limited his liability in the agreement.[11]If they is a contingency to the ‘surety’s liability’, he will not be liable unless that condition is met first[12].If the principal debtor is in a good financial condition and is capable enough to discharge his liability, the creditor should promptly compel the principal debtor to discharge his debt and only then he is allowed to proceed against the guarantor[13].A suit against the principal debtor alone is enforceable ,although a dismissal of suits against the principal debtor does not gratis the surety from his obligation[14].Where a ‘surety’ is sued alone, it is maintainable if the creditor has reason not to proceed against the principal debtor.[15]
Where there is a death of the principal debtor the ‘surety’ will not be discharged and the court can proceed against him and the surety has the right to sue the legal representative of the deceased.
Where the bank fails to obtain additional security for principal debt, a guarantor is released if additional security is not taken, at least where the guarantor had intended for additional securities to be furnished by the principal debtor[16].
Another form of guarantee is “continuing guarantee” is a continuing guarantee is one in which guarantee extends to a number of transactions for a specific period of time beyond which the ‘surety’ is not liable beyond that period or some other condition such as any amount, conduct of a servant[17] etc.
In cases where bank is a guarantor the Supreme Court has laid down the following provision in the case Hindustan Steelworks Corpn Ltd v Tarapore & Co[18]:
· “A bank guarantee is an independent and distinct contract between the bank and the beneficiary and is not qualified by the underlying transaction and the primary contract between the person at whose instance the bank guarantee is given and the beneficiary.
· In the case of an unconditional bank guarantee the nature of the obligation of the bank is absolute and not dependent upon any dispute or proceeding between the party at whose instance the bank guarantee is and the beneficiary.
· The commitment by banks must be honoured free from interference by the court and it is only in exceptional cases, that is to say, in case of fraud, or in case where irretrievable injustice would be done if bank guarantee is allowed to encashed, that the court would interfere”.
4.1 Period Limitation
The period of limitation for suing a ‘surety’ is three years[19] from the date of guarantee came into being force and if a suit filed for recovery after three years is liable to be quashed[20].Where the liability is recognised by the principal debtor by part payment or by any other form it has the effect of extending the period of limitation, also as long as the principal debtor remains liable so does the ‘surety’ also continues to be liable there is no need for separate not from the guarantor.
5.1 Ways in Which a ‘Surety’ Is Discharged from His Liability
A continuing guarantee can be revoked at any time before a future transaction takes place although it doesn’t free a ‘surety’ from the liability that has already occurred. Where there is a guarantee against a load the proposal can be revoked at any time before any action is taken with respect to the proposal. When a ‘surety’ dies he is no longer a liable for any future transaction unless a contract is there to the contrary and the surety’s heirs can be sued for any liability that might have occurred. Also any change in the contract which the consent of the surety, absolves hum from any future liability[21] ,unless the change made is unsubstantial or gives benefit to the ‘surety’.
Conclusion:
From the above discussion about all the provisions it is clear that a guarantee is not as simple as it sounds to a common Indian citizen. This situation is largely due to lack of legal knowledge and the gravity of the situation which the post of a guarantor puts a person in. Most of the time position of guarantor is exploited by the principal where a guarantor is a person who is close family member or friend who are by default under influence. The creditor should also take interest and take the pain of explaining the gravity of the situation to such guarantors to avoid any future trouble for the creditor in recovery of the amount and also for the guarantor. Also
In case of bank guarantees a thorough check of the security is necessary and time to time of their assets of the principal as well as the creditor to avoid any sort of scam similar to the cases of Vijay Malya or Neerav Modi.
[1] (1704) 91 ER 27 [2] Mountstephen v. Lakeman, 1871 LR 7QB 196 [3] Manju & Mahadeo v. Shivappa, (1918) 42 Bom 444 [4] Allahabad Jal Sansthan v. State of U.P AIR 2004 All 366 [5] Ram Narain v. Hari Singh, AIR 1964 Raj 76 [6] Gulam Husain v . Faiyaz Ali AIR 1940 Oudh 346 [7] SICOM Ltd. Padmashri Mahipat J. Shah,(2005) 3 Mh LJ 125 [8] Carlesbery v. Soon Heng (1989) 1 Mal LJ 104 HC [9] Karnataka State Industrial Investment Corpn v. SBI, (2005) 1 CLT 437 [10] Omnibus Co v. Holloway (1912) KB 72 [11] Indian Overseas Bank v. G. Ramulu,(1999) 2 Andh LD 104 [12] Evans v Bremridge, (1856) 8 DMG 100 [13] Panpori v. Central Bank of India, (2002) 1 ICC 838(P&H) [14] Karnataka State Industrial Investment and Devp Corpn Ltd v. SBI, (2004) 4 Kal LJ 266(DB) [15]Vijay Singh Padolev. Sitcom Ltd,(2000 4 Mh LJ 772 [16] AIR 2001 Mad 1 [17] Hasan Ali v. Waliullah, AIR 1930 All 730 [18] (1996) 5 SCC 34 [19] AIR 1997 Ker 201 [20] Annama Jose v. Kerala Financial Corpn,AIR 2002 Ker 396 [21] Bonar v. Macdonald, (1850) 3 HLC 226