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Unit 8: Contract of Guarantee

Case: (i) X guarantees repayment of advances made to A within 6 months subject to a maximum Notes
of ` 20,000. If ` 10,000 has been advanced by the end of 2 months, guarantee is irrevocable insofar
as this advance of ` 10,000 is concerned.
(ii) A guarantees to B to the extent of ` 10,000 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. A is liable upon his guarantee.

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. (s.131).

8.2.3 A Guarantee may either be for the Whole Debt or a Part of the Debt

Difficult questions arise in case of guarantee for a limited amount because there is an important
distinction between a guarantee for only a part of the whole debt and a guarantee for the whole debt
subject to a limit. For instance, where X owes Y ` 50,000 and A has stood as surety for ` 30,000, the
question may arise whether A has guaranteed ` 30,000 out of ` 50,000 or whether he has guaranteed
the full amount of ` 50,000 subject to a limit of ` 30,000. This matter becomes important if X is
adjudged insolvent and Y wants to prove in X’s insolvency and also enforce his remedy against A.
If A stood surety only for a part of the debt and if X’s estate can pay only 25 paisa dividend in the
rupee, then Y can get ` 30,000 the full amount of guarantee from A and ` 5,000 from X’s estate, being
¼ of the balance, i.e., ` 50,000 – ` 30,000 = ` 20,000 which was not guaranteed. Since after paying
` 30,000 to Y, A can claim from X’s estate, he will get ` 7,500 being ¼ of ` 30,000 paid by A to Y.
If on the other hand, A had stood surety for the whole debt of ` 50,000 subject to a limit of ` 30,000
then Y can recover from A ` 30,000 and from X’s estate ` 12,500, i.e., ¼ of ` 50,000. A will not get
any dividend unless Y has been fully paid. This can happen only if X’s estate declares a higher
dividend.

8.3 Rights and Obligations of Creditors

8.3.1 Rights of a Creditor

Rights of creditors are as follows:
1. The creditor is entitled to demand payment from the surety as soon as the principal debtor
refuses to pay or makes default in payment. The liability of the surety cannot be postponed
till all other remedies against the principal debtor have been exhausted. In other words,
the creditor cannot be asked to exhaust all other remedies against principal debtor before
proceeding against surety. The creditor also has a right of general lien on the securities of
the surety in his possession. This right, however, arises only when the principal debtor has
made default and not before that.

2. Where surety is insolvent, the creditor is entitled to proceed in the surety’s insolvency and
claim the pro rata dividend.

8.3.2 Obligations imposed on a Creditor in a Contract of Guarantee

Obligations imposed on a creditor in a contract of guarantee are as follow:
1. Not to change any terms of the original contract: The creditor should not change any terms
of the original contract without seeking the consent of the surety. Section 133 provides.
“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 the transactions subsequent
to the variance”.

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