Understanding the

Law of Guarantee:
Key Principles and
Applications
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HARSHITHA
(Assistant Professor)
Introduction to the Law of
Guarantee

The Law of Guarantee is a crucial aspect of financial

and legal transactions. It involves a promise made by
one party to assume the liability of another if they fail
to meet their obligations. Understanding this law is
essential for both creditors and debtors in managing
risks effectively.
A contract of guarantee is one of the key types of
contracts covered under the Indian Contract Act, 1872.
This contract plays a crucial role in commercial
transactions by providing security to creditors. A
guarantee involves three parties, namely the creditor,
the principal debtor, and the surety, with the surety
agreeing to be liable for the debt or obligation of the
principal debtor to the creditor if the principal debtor
defaults.
Definition of Contract of
Guarantee

Section
126 of the Indian Contract Act, 1872, defines a contract of
guarantee:
"A contract of guarantee is a contract to perform the promise, or
discharge the liability, of a third person in case of his default."
In simpler terms, it is an agreement where the surety agrees to
be responsible for the debt or performance of a contract by the
principal debtor to a creditor. If the principal debtor defaults, the
surety becomes liable to fulfill the debt or obligation.

The key components of a contract of guarantee are:

The promise of the principal debtor (which may be express
or implied).
The surety's promise to perform the debtor’s obligations if the
debtor defaults.
The creditor’s benefit, which is the primary purpose of the
guarantee contract.
 Objectives of a Contract of
Guarantee
The contract of guarantee serves several important
objectives in business and legal transactions:
. To Provide Security: It gives creditors a sense of
security by ensuring that they will receive payment
or performance even if the debtor defaults.
. To Facilitate Credit: The surety's guarantee allows
individuals or businesses to obtain credit or engage
in transactions that they may not have otherwise
been able to, based on their own financial capacity.
. To Encourage Trust: Guarantee contracts help foster
trust and confidence between the parties,
particularly when dealing with large or
risky transactions.
 Nature and Scope of
Contract of Guarantee Nature of Guarantee:

A guarantee is a secondary liability, meaning the

surety only becomes liable when the
principal debtor fails to fulfill his obligations.
It is an accessory contract, as it is directly related
to another primary contract, typically a loan or
credit arrangement.

Scope of Guarantee:

. The scope of the surety’s liability depends on the

terms of the contract. It may cover all liabilities of
the debtor or may be restricted to a specific
amount or particular obligation.
. A contract of guarantee can be unconditional or
conditional depending on whether it is
dependent on a particular event.
 A valid contract of guarantee must include the following
Essentials of a valid essential features:

contract 1. Presence of Three Parties:

Principal Debtor: The person who owes the debt or
obligation.
Creditor: The party to whom the debt is owed.
Guarantor: The person who promises to pay the debt or
perform the obligation if the principal debtor defaults.

2. Written or Oral Agreement: A guarantee contract can be

either written or oral, though certain jurisdictions may require
it to be in writing to be enforceable, especially when it
pertains to large amounts.

3. Consideration Sec 127: A valid contract requires

consideration. For a contract of guarantee, the guarantor's
promise must be supported by some form of consideration,
such as the creditor’s promise to provide goods, services, or
other benefits.Benefit to the principal debtor is sufficient
consideration.

4. Legality of Purpose: The contract of guarantee must be for

a legal purpose. A guarantee cannot support an illegal debt or
obligation.
 5. Clear Terms of Guarantee: The terms of the guarantee
Essentials of a valid must be specific and unambiguous. This includes defining the
amount guaranteed, the conditions under which the
contract guarantee can be enforced, and the duration of
the guarantee.

6. Legal Capacity: All parties must have the legal capacity to

enter into the contract. For example, minors, individuals of
unsound mind, or those prohibited by law may not be able to
act as a guarantor.

7. Conditionality: The guarantee is often a secondary or

contingent obligation. The guarantor’s responsibility to pay
arises only if the principal debtor defaults or fails to perform
the contract.

8.Notice of Default (if applicable): In some cases, the creditor

must notify the guarantorof the principal debtor’s default,
triggering the guarantee obligation.However, in some cases,
this may not be required.

9. No Duress or Undue Influence: The contract must be free

from any undue pressure or influence. The guarantor must
voluntarily agree to take on the responsibility.
Essentials of a valid
10. Consent: There must be mutual consent between all
parties involved—the principal debtor, the creditor, and the

contract
guarantor. No coercion or undue influence should exist. The
creditor should not obtain guarantee either by any
misrepresntation or concealment of any material facts
concerning the transaction, if the guarantee has been
obtained that way, that guarantee is invalid.
Section 142, Guarantee obtained by misreprentation invalid.
Section 143, Guarantee obtained by concealment invalid.

11. Three Contract: There must be three contract in contract of

guarantee;
Principal Contract: Between Primcipal debtor and creditor;
principal debtor has primary liability towards creditor.
Secondary contract: Between Creditorr and surety; Surety
will pay incase the principal debtor doesnot pay the money
Implied Contract: Between Surety and principal debtor; If
surety pays the money to the creditor or behalf of the
principal debtor, the principal debtor has to return the
money to surety ( Hidden Contract).
Case Laws
1. Amrit Lal Goverdhan Lalan v. State bank of Travancore
In this case SC held that for a contract of gurantee, there must be a
consideration between the creditor and surety. the essential
elements required for a valid contract of guarantee include a triparti
agreement involving the creditor, principal debtor and surety and
an agreement to discharge the debt in case of default.

2. Bank of Bihar Ltd., v. Damodhar Prasad

The SC held that a creditor can directly enforce the surety's liability
without first attempting to recover from the principal debtor.

3. State bank of India v. M/s Indexport registered

Emphasized the co-extensive nature of surety's liability and the
immediate enforceability of the surety's obligations upon the
debtor's default.
 Types of Guarantees
There are various types of guarantees, such
as
personal guarantees,
bank guarantees, and
performance guarantees.
Each type serves different purposes in
ensuring that obligations are met, thus
providing security to the creditor against
potential defaults.
Rights of the Surety against the principal Debtor Rights and Duties of Surety
Right of Subrogation (Section 140): The term Subrogation
means to substitute. The surety, upon discharging the
principal debtor’s liability, has the right to step into the shoes
of the creditor and pursue the principal debtor for
reimbursement. Section 145 further explains that after the
surety has made the payment or performed the duty on
default of the principal debtor, he is conferred with the same
rights which the creditor had against the principal debtor.

Right to be indemnified ( Section 145): The surety has the

right to be indemnified by the principal debtor for any
payments made on their behalf.

Illustration: If a person guarantees a loan for a friend, and the

friend defaults, the surety may pay the debt and then recover
the amount from the friend under the right of subrogation.
Rights of the Surety against the Creditor Rights and Duties of Surety
Right to Securities (Section 141): If the creditor holds
any security from the principal debtor, the surety is entitled to
claim the benefit of such security if he has discharged the
liability.
Illustration:
If a creditor A holds gold as a security from the principal debtor
B, the surity C can claim the gold as security if surety had repaid
the debt on behalf of B.
Rights of the Surety against the co surety Rights and Duties of Surety
Co-sureties are entitled to contribution among themselves
(Section 146 for same sum; Section 147 for different sum): A
surety who pays the debt of the principal debtor has the right
to claim contribution from the other co-sureties. This ensures
fairness by distributing the debt burden equally among all
sureties.This means that when one surety pays the entire
debt, they are entitled to claim a proportionate share from
the other co-sureties.

Illustration:
. A, B, and C are co-sureties for ₹30,000. If A pays the full
amount, A can recover ₹10,000 from B and ₹10,000 from C
(since liability is equal among them).
. A, B, and C have agreed that A's liability is 50%, B's is 30%, and
C's is 20%. If A pays ₹30,000, A can recover ₹15,000 from B
and ₹6,000 from C based on their respective shares.
. A, B, and C are co-sureties for ₹30,000. If A pays voluntarily, A
might not be able to claim contribution from B and C unless
there was a prior agreement or legal obligation.
1. Bishundeo Narain v. Seogeni Rai, The Supreme Court held that
CASE LAWS
a surety who discharges the debt is entitled to claim
contribution from co-sureties according to their respective
liabilities.

2. Union of India v. S. Raghunathan, Reinforced that one surety

who pays the debt can claim proportionate contribution from
the other co-sureties.

3. State of Punjab v. Surjit Singh, The court affirmed the right of

a surety to recover the amount paid from co-sureties, based on
the agreement or equal shares in the absence of an agreement.

4. Dundee v. Public Works Contractors, In this case, the Calcutta

High Court ruled that the surety’s liability is secondary and can
only be enforced after the principal debtor defaults. The court
emphasized that the surety has aright to be discharged from
their liability if the creditor does not act within the terms of the
contractor if the principal debtor's debt isaltered without the
surety's consent.
5. Bhashyam and Co. v. N.D. Somasundaram, In this case, the
Madras High Court addressed therights of the surety when the CASE LAWS
principal debtor defaults. The court held that thesurety is
discharged if the terms of the original contract between the
creditor and the principal debtor are changed without the
surety’s consent. If the creditor relieves the principal debtorof
the obligation or changes the conditions, the surety’s obligation
is extinguished.

6. Bank of Bihar v. Damodar Prasad, This landmark case by

theSupreme Court dealt with therights of the surety against the
creditor and the principal debtor. The court held that the surety
is not liable if the creditor delay sthe enforcement of the debt or
extends time for payment to the principal debtor without the
surety’s consent. The surety has the right to be discharged if the
creditor does not take prompt action to recover the debt from
the principal debtor.
7. National Insurance Co. Ltd. v. J.K. D'Costa, In this case, the
Supreme Court ruled that the surety’s liability is co-extensive CASE LAWS
with the principal debtor’s liability unless the contract provides
otherwise. If the creditorfails to demand payment from the
principal debtor within a reasonable time, the surety can be
discharged from the liability.

8. S.L. Bhatia v. State Bank of India, The Delhi High Court dealt
with the rights of the surety when the creditor fails to act on the
default of the principal debtor. The court ruled that the surety is
entitled to know about the default and has the right to be
informed before any further action is taken. If the creditor fails to
act or disclose default within reasonable time, the surety can be
discharged.

9. Gajanan Moreshwar v. Moreshwar, In this case, the Bombay

High Court highlighted that thesurety’s liability is extinguished if
the creditor releases the principal debtor or if there is anovation
of contract between the creditor and the principal debtor. The
court ruled that the surety is not liable in such cases unless the
surety consents to the new arrangement
10. United India Insurance Co. Ltd. v. M/s. Kiran Constructions, In
this case, the Supreme Court ruled on the rights of the surety in CASE LAWS
a guarantee contract. The court held that if the terms of the
original contract between the creditor and the principal debtor
are altered without the surety’s knowledge or consent, the
surety can be discharged from liability.

11. Ranjith Singh v. Shamsher Bahadur, This case estabhlished

that a surety, after paying off the debt has the right to
subrogation, allowing them to step, into the shoes of the creditor
and recover the debt from the principal debtor.
Duties of the Surety: Rights and Duties of Surety
Duty to Perform the Promise: The surety must perform the
principal debtor’s obligation if the debtor defaults.

Duty to Pay: If the principal debtor defaults, the surety

must repay the creditor for any unpaid debt or fulfill the
promise.

Duty to Act in Good Faith: The surety must not act in a

manner that would increase the risk or liability of the
contract.

Illustration: If the surety guarantees payment of a debt, he must

ensure that payment is made when the debtor defaults. If he
fails to do so, he violates his duty under the contract.
 Co-Surety
A co-surety is a situation where two or more persons are sureties
for the same debt or obligation. Each co-surety is equally
responsible for the liability, unless the guarantee provides
otherwise.

. Liability of Co-Sureties: Co-sureties are jointly and severally

liable, meaning that the creditor can choose to recover the full
amount from one surety or split the liability among them.
. Right to Contribution: If one co-surety pays more than his share,
he can claim contribution from the other co-sureties.

Illustration: If two people co-guarantee a loan of ₹2,00,000, each

co-surety is liable for the full amount, but they have the right to
share the burden equally or in the proportion specified in the
contract.

In Jai Narain v. Union Bank of India, the court held that where there
are multiple sureties, the sureties are jointly and severally liable.
Section 130 of the Indian Contract Act provides for the discharge of
the surety from his liabilities. A surety can be discharged in the
following circumstances:
Discharge of Surety
By Revocation (Section 130): A surety may revoke his guarantee,
but revocation does not affect any liability incurred before the
revocation.
By Notice: A surety can discharge themselves from future liability
by giving notice to the creditor, as per Section 130 of the Indian
Contract Act, 1872. This discharge applies only to future obligations,
and the surety remains liable for debts incurred before the notice.
By the Death of the Surety(Section 131): The death of the surety
discharges him from the liability unless the contract expressly
states otherwise.
By Variation of the Terms of the Contract: If the creditor and
the principal debtor agree to a material alteration of the terms of
the contract without the consent of the surety, the surety is
discharged.
By Release or Discharge of the Principal Debtor: If the creditor
releases the principal debtor from the debt or obligation, the
surety is also discharged.
By Payment or Performance: If the surety has discharged the
liability by fulfilling the promise, he is discharged from any further
obligations.
By Novation (Section 62): If the contract is reneiwed/ changed
new contract is brought.
Discharge of Surety
By Variation of the Terms of the Contract (Section 133): If the
creditor and the principal debtor agree to a material alteration of
the terms of the contract without the consent of the surety, the
surety is discharged.
By Release or Discharge of the Principal Debtor (Section 134): If
the creditor releases the principal debtor from the debt or
obligation, the surety is also discharged.
By Payment or Performance: If the surety has discharged the
liability by fulfilling the promise, he is discharged from any further
obligations.
By arrangement between creditor and debtor (Section 135): A
surety is discharged if there is a material alterationin the terms of
the contract between the creditor and the principal debtor without
the surety's consent. This includes any new arrangement or
agreement that changes the original terms of liability.
By Loss of Security (Section 141): A surety is discharged if the
creditor loses or releases the security that was provided for the
debt without the surety's consent. The loss or release of security
extinguishes the surety's liability for the debt.
By creditor's act or omission (Section 139): a surety is discharged if
thecreditor's act or omissionimpairs the surety’s eventual remedy, Discharge of Surety
such as byincreasing the riskof the surety or making it harder to
recover the debt. The surety can be relieved from liability due to the
creditor’s failure to take necessary actions to protect their rights.
By invalidation of contract: A surety is discharged if the contract of
guarantee becomes invalid due to factors such as lack of
consent,fraud, orillegality. When the underlying contract is void, the
surety is no longer bound by the guarantee.
By guarantee is obtained by misrepresentation (Section 142): a
surety is discharged if the guarantee is obtained by misrepresentation
of facts. The misrepresentation must be material, and the surety is not
liable for the debt if the guarantee was based on false information.
By guarantee is obtained by concealment of material facts (Section
143) : a surety is discharged if the guarantee is obtained by
concealment of material facts. If the creditor hides important
information that would affect the surety's decision, the surety is no
longer liable for the guarantee.
By failure of co- surety to join the surety (Section 144) : a surety is
discharged if the co-surety fails to joinin the guarantee or fulfill their
obligations. The surety’s liability is affected if the creditor allows the
co-surety’s non-participation without the surety’s consent.
1. Bishundeo Narain v. Seogeni Rai, In this case, the Supreme Court
held that asurety is dischargedwhen there is amaterial alterationin Case Laws
the contract between the principal debtor and the creditor, without
the surety’s consent. The court emphasized that the surety's liability
could be extinguished if the creditor makes any change to the terms
of the guarantee or the original contract without consulting the
surety.

2. Union of India v. S. Raghunathan, This case dealt with the issue of

the discharge of a surety when the principal debtor is given time
extensions or relief by the creditor without consulting the surety.
The Supreme Court held that the surety is discharged from liability if
the creditor grants the principal debtor more time for payment or
makes any changes in the contract without the surety's consent.

3. National Insurance Co. Ltd. v. J.K. D'Costa, In this case, the

Supreme Court ruled thatif the creditor acts in a manner that
prejudices the rights of the surety, such as delaying enforcement of
the debt, the surety can be discharged from liability. The court
further clarified that the creditor'sfailure to actpromptly in
recovering the debt could lead to the discharge of the surety from
the liability.
4. Chandrakant R. Patel v. Central Bank of India, The Gujarat High
Court discussed the discharge of the surety when the principal debtor
is granted time extensionsby the creditor without consulting the Case Laws
surety. The court held that this constitutes amaterial alteration and
will discharge the surety from their liability.

5. Kumar V. State Bank of India, In this case, the Bombay High Court
held that the surety is discharged when the creditor modifies the
terms of the original contract without informing the surety or
obtaining their consent. The court emphasized that the surety’s
liability cannot be increased or modified by the actions of the creditor
without the surety’s explicit consent.

6. K.K. Verma v. Union of India, In this case, the Allahabad High Court
ruled that a surety is discharged if the creditor releases the principal
debtor from the obligation, either in full or partially, without the
consent of the surety. The court clarified that the surety’s obligation is
extinguished if the creditor, by releasing the principal debtor, alters
the original contract.

7. In Chandermal v. Union of India, the court ruled that a surety is

discharged whenthe creditor alters the terms of the agreement
without the consent of thesurety.
 Di erence between Contract of Indemnity and Contract of
Guarantee
Contract of Guarantee Contract of Indemnity

Definition Definition
A contract where one party agrees to perform the A contract where one party agrees to compensate
promise of another if the latter defaults another for a loss suffered due to the act of the
promisor.

Number of Parties Number of Parties

Involves three parties: the creditor, the principal debtor, Involves two parties: the indemnifier and the indemnity
and the surety. holder.

Nature of Liability Nature of Liability

Primary liability: Principal debtor's liability arises Primary liability: The indemnifier is directly responsible
only upon the Creditor. for the loss incurred.
Secondary liability: Surety’s liability arises only upon
default of the principal debtor.

Object Object
The object of a contract of gurantee is the security The object of contract of indemnity is made to protect
of the creditor. promise against some likely loss.
 Di erence between Contract of Indemnity and Contract of
Guarantee
Contract of Guarantee Contract of Indemnity
Contract Contract
There are three contract: There is only one contract, i.e., between the
between creditor and debtor indemnity holder and indemnifier.
creditor and surety
debtor and surety

Example Example
Aperson guaranteeing a loan for a friend. A person agreeing to compensate another for losses
arising from a business transaction.

Section in the Act Section in the Act

Section 126 (Indian Contract Act, 1872) Section 124 (Indian Contract Act, 1872)

Arising of the liability Arising of the liability

The liability of the surety origin only when the the liability of the indemnifier origin only in case of the
principal debtor commits default in making actual loss to the indemnity holder.
payment to the creditor.
Conclusion and Best Practices
In conclusion, understanding the Law of Guarantee is
essential for effective risk management. Parties involved
should always seek legal advice and ensure clear terms are
set in guarantees to protect their interests. This approach
fosters trust and mitigates potential disputes.