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Unit 8: Contract of Guarantee

Introduction Notes

In last unit, you studied about Contract Act and breach and anticipatory breach of contract. When
a company needs some money for its business it approaches a bank. The bank requires that the
managing director M promises to repay the loan personally should the company default. When
the directors of the company including M execute the promissory note on behalf of the company,
they sign as company’s offi cials. M, the managing director signs again as an individual. The
relationship between M and the bank is called a guarantee or surety ship. It is a contractual
relationship resulting from the unconditional promise of M (known as the surety or guarantor) to
repay the loan to the creditor (the bank) for the obligation of the principal debtor (the company)
should it default. If the company fails to repay the loan, the bank can approach M for the payment.
The law relating to the contract of guarantee is given in the Indian Contract Act, 1872 (Ss.126-147).
The sections quoted in this unit refer to the contract of guarantee and contract of indemnity.

8.1 Meaning and Purpose of the Contract of Guarantee

In this unit our primary concern is with the contract of guarantee which are used for securing
loan.

8.1.1 Meaning of Guarantee

A contract of guarantee is defined as “a contract to perform the promise, or discharge the liability,
of a third person in case of his default”. The person who gives the guarantee is called ‘surety’;
the person for whom the guarantee is given is called the ‘principal debtor’, and the person to
whom the guarantee is given is called the ‘creditor’. A contract of guarantee may be either oral
or in writing.
From the above discussion, it is clear that in a contract of guarantee there must, in effect, be
two contracts, a principal contract between the principal debtor and creditor, and a secondary
contract between the creditor and the surety. In a contract of guarantee there are three parties,
viz., the creditor, the principal debtor and the surety. Therefore, there is an implied contract also
between the principal debtor and the surety.

Example: When A requests B to lend ` 10,000 to C and guarantees that C will repay the
amount within the agreed time and that on C failing to do so, he will himself pay to B, there is a
contract of guarantee.

The contract of surety is not contract collateral to the contract of the principal debtor, but is an
independent contract. There must be a distinct promise on the party of the surety to be assumable
for the debt. It is not necessary that the principal contract, between the debtor and the creditor,
must exist at the time the contract of guarantee is made; the original contract between the debtor
and creditor may be about to come into existence. Similarly, under certain circumstances, a surety
may be called upon to pay though principal debtor is not liable at all.
Also, where a person gives a guarantee upon a contract that the creditor shall not act upon it until
another person has joined in it as co-surety, the guarantee is not valid if that other person does
not join (s.144).

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