 Introduction:-

 Guaranteeisanundertakingtoanswerforanother’sliabilityandcollateralth
ereto.Itisa
 collateralundertakingtopaythedebtofanotherincasehedoesnotpayit.
 Itisaprovisiontoanswerforthepaymentofsomedebt,ortheperformanceofso
me
 dutyinthecaseoffailureofsomepersonwho,inthefirstinstance,isliableforsuc
h
 paymentorperformance.
 Bouvier’sLawDictionarygivesthemeaningofguaranteeasapromisetoansw
erforthe
 debt,default,ormiscarriageofanotherperson1.Guaranteeisan.undertakin
gtobe
 collaterallyresponsibleforthedebt,defaultormiscarriageofanother.Inaban
king
 contextitisanundertakinggivenbytheguarantortothebankeracceptingresp
onsibility
 forthedebtoftheprincipaldebtor,thecustomer,shouldheorshedefaultThe
 guarantormayormaynotbeacustomer1.
 7Sec.126oftheIndianContractAct1872,whichdealswiththecontractofguar
antee,
 hasdefineditas“Acontracttoperform
thepromise,ordischargetheliabilityofathird
 personincaseofhisdefaults”.
 Example:AadvancesaloanofRs.10,000toB,andCpromisesAthatifBdoesno
t
  repaytheloan,Iwillrepayit.Thisisacontractofguarantee.Itinvolvesthreepa
rties
 namely,
 1.Surety,whogivestheguarantee.
 2.PrincipalDebtor,inrespectofwhosedefaulttheguaranteeisgiven.

 3.Creditor,towhomtheguaranteeisgiven.1. As between A and B [A supplies

goods to B on credit who promises that he would pay].

2. As between A and C [C gives guarantee the price of goods, I will pay].

3. As between C and B [B indemnifies C in case of B’s default in paying the amount to A).

Furthermore though a contract of guarantee may be oral or in writing in India it must be required
to be in writing only in England.

Oral Guarantee

In P.J. Rajappan v Associated Industries (P) Ltd [1990 (1) All India Bkg Law Judgments 321], the
guarantor, having not signed the contract of guarantee, wanted to wriggle out ofthe situation. He
contended that he did not stand surety for the performance ofthe contract. Evidence showed
involvement of the guarantor in the deal, having promised to sign the instrument later.

The Kerala High Court held that a contract of guarantee is a tripartite agreement, involving the
principal debtor, surety and the creditor. In a case where there is an evidence of involvement of
the guarantor, the mere failure on his part in not signing the agreement is not sufficient to demolish
otherwise acceptable evidence of his involvement in the transaction leading to the conclusion that
he guaranteed the due performance of the contract by the principal debtor. When a court has to
decide whether a person has actually guaranteed the due performance of the contract by the
principal debtor all the circumstances concerning the transactions will have to be necessarily
considered. Court cannot adopt a hyper technical attitude that the guarantor has not signed the
agreement and so he cannot be saddled with the liability. Due regard has to be given to the relative
position of the contracting parties and to the entire circumstances which led to the contract.

Under Section 126 of the Contract Act, a contract of guarantee need not necessarily be in writing;
it may be express by words of mouth, or it may be tacit or implied and may be inferred from the
course of the conduct of the parties concerned. Contracts of guarantee have to be interpreted taking
into account the relative position of the contracting parties in the backdrop of the contract. The
court has to consider all the surrounding circumstances and evidence to come to a finding when
the guarantor refutes his lability.

In Mathura Das v Secretary ofState (AIR 1930 All 848) and in Nandlal Chanandas v Firm
Kishinchand (AIR 1937 Sindh 50), it was held that contract of guarantee can be created either by
parol or by written instrument and that it may be express or implied and may be inferred from the
course of the conduct of the parties concerned. There is overwhelming evidence in this case that
the second defendant had guaranteed the due performance ofthe contract by the first defendant,
principal debtor. Hence the mere omission on his part to sign the agreement cannot absolve him
from his liability as the guarantor. To be legally effective a guarantee must be given for debt which
is enforceable. If the debt is not enforceable, the guarantee will not be enforceable. Thus a minor
not being answerable for a debt he incurs, a guarantee for such debt is likewise void4.

Some banks include a clause in their form of guarantee providing that where the debtor is under a
legal disability, such as minor, etc., the surety shall be liable as principal.

A guarantee is a very convenient form of security, and because of the ease with which it can be
given, a banker should be careful to make clear to a proposed surety the nature of the document
which he has to sign, although such a party cannot later plead ignorance of the contents of the
guarantee.

A contract of guarantee should be entered into freely and voluntarily by the guarantor. Fry J. in
Davies v London and Provincial Marine Insurance Co.5 said "Everything like pressure used by the
intending creditor will have a very serious effect on the validity of the contract". It is essential that
a guarantee form should be most carefully drawn so as to create an effective security, and bankers
have their own printed forms of guarantees drafted so as to meet, as far as possible, the various
requirements of a good and complete guarantee.

Value of the Guarantee

A guarantee is probably the simplest form of banking security, more easily obtained than any other
and yet frequently most difficult to realize. It is an intangible security which may or may not be of
adequate value when it is most needed. Few guarantors ever expect to be called upon to honour
their contract and therefore it is imperative that the lending banker should exercise the greatest
care in obtaining the guarantee and thereafter in ensuring that it is at all times worth what is
required from it. The best advice from experience is, perhaps, not to lend relying solely on a
guarantee unless the bank is completely satisfied that the guarantor is really undoubted for the
amount required and that he is ofsuch unquestionable standing that no attempt will be made to
avoid the liability.

The real value of any guarantee depends entirely on the financial ability or solvency of the
guarantor to meet the liability with reasonable promptitude when called upon to do so. The
undoubted standing of theguarantor must apply not only when the contract is signed, but
throughout the subsistence of the contract of guarantee. Fortunes can still change overnight, so that
a vigilant watch must always be maintained on the financial position of the guarantor upon whom
reliance is placed.

Essentials of a Guarantee

To a layman a guarantee is a baffling document. The main obligation, namely to pay ifthe borrower
does not pay, is expressed in two or three lines. Why then does there have to be a long document
bristling with curious legalese?

In fact many of the technical provisions are vital to the protection of a lender. Some are so
fundamental that, if they are not there, the lender could find himself with a useless guarantee by
reason of some seemingly trivial action on his part. Guarantees are encrusted with law. This is no
doubt attributable to the fact that guarantors have, historically, sought every available legal means
to avoid a liability which, human nature being what it is, they did not expect to have to meet when
they gave the guarantee.

The best approach to the subject of guarantees is to recognise the following essentials :

1. Concurrence of All the Parties

All the three parties namely, the principal debtor, the creditor and the surety must agree to make
such a contract.

2. Liability
In a contract of guarantee, liability of the surety is secondary i.e., the creditor must first proceed
against the debtor and if the latter does not perform his promise, then only he can proceed against
the surety.

3. Existence of a Debt
A contract of guarantee pre-supposes the existence of a liability, which is enforceable at law. If no
such liability exists, there can be no contract of guarantee. Thus, where the debt, which is sought
to be guaranteed is already time barred or void, the surety is not liable.

4. Consideration
There must be consideration between the creditor and the surety so as to make the contract
enforceable. The consideration must also be lawful. In a contract of guarantee, the consideration
received by the principal debtor is taken to be the sufficient consideration for the surety.
‘Anything done, or any promise made, for the benefit of the principal debtor may be sufficient
consideration to the surety for giving the guarantee’1

1
Sec. 127 of indian contract act
Thus, any benefit received by the debtor is adequate consideration to bind the surety. But past
consideration is no consideration for a contract of guarantee. There must be a fresh consideration
moving from the creditor.

5. Writing not Necessary

A contract of guarantee may either be oral or written. It may be express or implied from the conduct
of parties.

Note: A Contract of Guarantee must always be in writing under English Law.

6. Essentials of a Valid Contract
It must have all the essentials of a valid contract such as offer and acceptance, intention to create
a legal relationship, capacity to contract, genuine and free consent, lawful object, lawful
consideration, certainty and possibility of performance and legal formalities.
7. No Concealment of Facts
The creditor should disclose to the surety the facts that are likely to affect the surety’s liability.
The guarantee obtained by the concealment of such facts is invalid. Thus, the guarantee is invalid if
the creditor obtains it by the concealment of material facts.
8. No Misrepresentation
The guarantee should not be obtained by misrepresenting the facts to the surety. Though the
contract of guarantee is not a contract of uberrimae fidei i.e., of absolute good faith, and thus, does
not require complete disclosure of all the material facts by the principal debtor or creditor to the
surety before he enters into a contract. But the facts, that are likely to affect the extent of surety’s
responsibility, must be truly represented

Liability

The word ‘liability’ in Section 126 of the Indian Contract Act, 1872,means a liability which is
enforceable at law, and if that liability does not exist, there cannot be a contract of guarantee. A
surety, therefore, is not liable on a guarantee for payment of a debt which is statute – barred.2

2
Manju Mahadev v Shivappa (1918) 42 Bom. 444; 46 IC 122
The Supreme Court in Chattanatha Karayalar v Central Bank of India Ltd3 laid down that if a
transaction is contained in more than one document between the same parties, they must be read
and interpreted together. Although a guarantor may join the principal debtor in executing

the promissory note he will not be a co - obligant where the underlying transaction and the
conduct of the parties show that he is a surety under Section 126 of the Contract Act.

Guarantor, a Preferred Debtor

Bankers always insist on getting the contracts signed on their printed

guarantee forms with practically no loophole since, to make a guarantor

liable, the terms of the guarantee are to be interpreted strictly. The

Supreme Court in the State ofMaharashtra v Dr. M.N.Kaul4confirmed

the view that under the law a guarantor cannot be made liable for more

than he has undertaken; a surety is a favoured debtor and he can be bound

"to the letter of his engagement".

Consideration for Guarantee

Section 127 of the Contract Act provides that anything done, or any promise made, for the
benefit of the principal debtor may be a sufficient consideration to the surety for giving the
guarantee. Consideration is the legal detriment incurred by the promisee at the promisor’s
request and it is immaterial whether there is or is not any apparent benefit to the promisor9.

A contract of guarantee executed after the contract between the creditor and principal debtor and
without consideration is void. It must be contemporaneous with the contract of the creditor and
principal debtor. Past benefit to the principal debtor is not a good consideration10. The mere fact
that A lends money to B on the recommendation of C is no consideration for a subsequent
promise by C to pay the money in default of B5

3
AIR 1965 SC 1856
4
AIR 1967 SC 1634
5
Muthukaruppa v Kathappudayan (1914) 27 MLJ 249
In an interesting case decided by the Kerala High Court, the Branch Manager of New Bank of
India Ltd made irregular advances on the advice of a clerk. Later on an undertaking was given
by the employees namely the manager and the clerk that the amount ofthe two advances will be
repaid within a month and also undertook to be personally responsible for such payment (i.e.
ifthe customers do not pay, they would pay). As the amounts were not paid the bank filed suit
against those two customers and also joined the said two employees who were responsible for
the two irregular transactions and as per their undertaking, these employees stated that their
guarantee was without consideration and therefore it could not be enforced against them. The
court however held that the fact of not taking disciplinary action against the two employees was
sufficient consideration for the undertaking for their misconduct and payment agreement as the

said undertaking amounted to a lawful contract of indemnity. On the question of limitations the
court held that the limitation began to run one month from the date of the undertaking and as the
suit was not brought within 3 years after the expiry of one month ofthe undertaking it was time

- barred against the said two employees and as such dismissed.6

Thus it will be clear that it is not necessary that consideration should imply something done for
the benefit of the guarantor but anything done for the benefit of the principal debtor is considered
as ah adequate consideration for the guarantor to make the contract valid. Even forbearance on
the part of the bank not to sue the debtor will constitute a good consideration.

In State Bank of India v Premco Saw Mill13, the State Bank gave notice to the debtor -
defendant and also threatened legal action against her, but her husband agreed to become surety
and undertook to pay the liability and also executed promissory note in favour of the State

Bank and the Bank refrained from threatened action. It was held that such forbearance on the
bank’s part constituted good consideration for guarantor.

In Bank of Credit and Commerce International S.A. v V.KAbdul Rahiman14, the Kerala High
Court observed that a guaranteeis a collateral engagement to answer for the debt, default or
miscarriage of another as distinguished from an original and direct engagement for the party’s

6
New Bank of India Ltd v Govinda Prabhu AIR 1964 Kerala 267
own act. For the validity of a contract of guarantee it is adequate consideration if anything is
done or any promise made for the benefit of the principal debtor. The creditor must have done
something for the principal debtor to sustain the validity of the contract of guarantee. Anything
done or any promise made for the benefit of the principal debtor must be contemporaneous to the
surety’s contract of guarantee in order to constitute consideration therefor. A contract of
guarantee executed afterwards without any consideration is void. The word ‘done’ in the Section
127 of the Indian Contract Act, 1872 is not indicative of the inference that past benefit to ‘the

principal debtor can be good consideration.

The consideration for the surety’s promise has not to come from principal debtor, but from the
creditor. It need not benefit surety although

it may do so and it may consist wholly of some advantage given to or conferred on the principal
debtor by the creditor at the surety’s request. The consideration may take the form of forbearance
by the creditor at the surety’s request, to sue the principal debtor or of the actual suspension of

pending legal proceedings against him. The mere fact of forbearance is not,

however, of itself a consideration for a person’s becoming surety for the

payment of a debt. There must be either an undertaking to forbear or an

actual forbearance at surety’s express or implied request. An agreement to

forbear for a reasonable time will provide sufficient consideration to

support a surety’s promise.

Conclusion

A contract of Guarantee is governed mainly by the provisions of the Indian Contract Act, 1872 (“Contract
Act”). Section 126 of the Contract Act defines a it 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 the
“surety”, the person in respect of whose default the guarantee is given is called the “principal debtor”
and the person to whom the guarantee is given is called the “creditor”. The Contract Act uses the word
‘surety’ which is same as a ‘guarantor’. Furthermore, a guarantee accommodates an obligation far-
reaching with that of the principal. At the end of the day, the guarantor can’t be at risk for much more
than the client. The document will be understood as a guarantee if, on its actual development, the
commitments of the surety are to “remained behind” the principal and just go to the fore once a
commitment has been broken as between the principal and the lender. The commitment is an auxiliary
one, reflexive in character.