Page 92 - DMGT102_MERCANTILE_LAWS_I

Mercantile Laws-I

Notes 7.1.2 Definition and Nature of the Contract of Guarantee (S.126)

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).
7.1.3 Fiduciary Relationship

A contract of guarantee is not a contract “uberrimae fi dei” (requiring utmost good faith).
Nevertheless, the surety ship relation is one of trust and confidence and the validity of the

contract depends upon good faith on the part of the creditor. A creditor must disclose all those
facts which, under the circumstances, the surety would expect not to exist. So where guarantee is
given for good conduct of an employee, the employer’s failure to inform the surety of any breach
on the part of employee, will discharge the surety. Similarly, where X guarantees the existing
and future liabilities of A to B up to a certain amount which limit has already been exceeded, the
contract of guarantee can be avoided on the ground of concealment of a materiel fact. However, it
should be noted that it is no part of the creditor’s duty to inform the surety about all his previous
dealings with the debtor.

7.2 Kinds of Guarantee

There are various kinds of guarantee such as oral, written, specifi c, continuing and whole debt
or a part of debt.

7.2.1 Oral or Written Guarantee

A contract of guarantee may either be oral or in writing (s.126), though a creditor should always
prefer to put it in writing to avoid any dispute regarding the terms, etc. In case of an oral

agreement, the existence of the agreement itself is very difficult to prove.

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