Nobody can really guarantee the future. The best we can do is size up the chances, calculate the risks involved, estimate our ability to deal with them and make our plans with confidence.
– Henry Ford II
MEANING AND DEFINITION OF CONTRACT OF GUARANTEE
A guarantee can be many a things. It can be assurance of a particular outcome or that something will be performed in a specified manner. A guarantee is a way of assuming responsibility for paying another’s debts or fulfilling another’s responsibilities. It can be a promise for the execution, completion, or existence of something. A guarantee can also be a promise or an assurance attesting to the quality or durability of a product or service.
The English law defines a ‘guarantee’ as a ‘promise to answer for the debt, default or miscarriage of another’.
Section 126 of the Indian Contract Act, 1872 says that a Contract of Guarantee is a contract to perform the promise or discharge the liability or a third person in case of his default.
► Illustration: If A gives an undertaking stating that if ` 200 are lent to C by B and C does not pay, A will pay back the money, it will be a contract of guarantee. Here, A is the surety, B is the principal debtor and C is the creditor.
Surety is the person gives the guarantee, the Principal Debtor is one for whom the guarantee is given and the creditor is the person to whom the guarantee is given. Contract Act uses the word ‘surety’ which is same as ‘guarantor’ Prima facie, the surety is not undertaking to perform should the principal debtor fail; the surety is undertaking to see that the principal debtor does perform his part of the bargain. A contract of guarantee pre-supposes a principal debt or an obligation that the principal debtor has to discharge in favour of the creditor.
Anything done, or any promise made, for the benefit of the principal debtor, is deemed sufficient consideration to the surety for giving the guarantee. It is sufficient inducement that the person for whom the surety has given guarantee has received a benefit or the creditor has suffered an inconvenience. While Section 2 (d) of the ICA, 1872 says that past consideration is good consideration, illustration (c) of Section 127 of the ICA, 1872 seems to negate this point. Those who favor the validity of past consideration state that law is not supposed to be guided by illustrations. But there have been conflicting judgments about whether past consideration is good consideration.
► Illustration: B requests A to sell and deliver to him goods on credit. A agrees to do so, provided C will guarantee the payment of the price of the goods. C promises to guarantee the payment in consideration of A’s promise to deliver the goods. This deemed sufficient consideration for C’s promise.
► Illustration: A sells and delivers goods to B. C afterwards requests A to forbear to sue B for the debt for a year, and promises that, if he does so, C will pay for them in default of payment by B. A agrees to forbear as requested. This is a sufficient consideration for C’s promise.
► Illustration: A sells and delivers goods to B. C afterwards, without consideration, agrees to pay for them in default of B. The agreement is void.
The most basic function of a contract of guarantee is to enable a person to get a job, a loan or some goods as the case may be. In case, a person is desirous of buying a car on a hire- purchase agreement by making monthly payments over a period of time but the car dealer asks for guarantee. Then someone would have to assure him that he will make the monthly payments in case of default by the person who is buying the care. Such an undertaking results in a contract of surety ship or guarantee. Guarantee is security in form of a right of action against a third party called the surety or the guarantor.
ESSENTIALS OF CONTRACT OF GUARANTEE
- Essentials of a valid contract: Since Contract of Guarantee if a species of a contract, the general principles governing contracts are applicable here. There must be free consent, a legal objective to the contract, etc. Though all the parties must be capable of entering into a contract, the principal debtor may be a party incompetent to contract, ie., a minor. This scenario is discussed later in this chapter.
- A principal debt must pre-exist: A contact of gurantee seeks to secure payment of a debt, thus it is necessary there is a recoverable debt. There can not be a contract to guarantee a time barred debt.
- Consideration received by the principal debtor is sufficient for the surety. Anything done, or any promise made for the benefit of the principal debtor can be taken as sufficient consideration to the surety for giving guarantee.
NATURE OF CONTRACT OF GUARANTEE
The contract of guarantee has to be clear. A letter clearly stating the intention to guarantee a transaction will go on smoothly or one will behave appropriately conduct himself at work place will suffice. But a promise to pay extra attention or to take care of it does not constitute a guarantee.
In India, a contract of guarantee may be oral or written. It may even be inferred from the course of conduct of the parties concerned. Under English Law, a guarantee is defined as a promise made by one person to another to be collaterally answerable for the debt, default or miscarriage of the third persons and has to be in writing.
There are three parties in a contract of guarantee; the creditor, the principal debtor and the surety. In a contract of guarantee, there are two contracts; the Principal Contract between the principal debtor and the creditor as well as the Secondary Contract between the creditor and the surety. The contract of the surety is not contract collateral to the contract of the principal debtor but is an independent contract. Liability of surety is secondary and arises when principal debtor fails to fulfill his commitments. Even an acknowledgement of debt by the principal debtor will bind the surety.
It is not essential that the Principal Contract must be in place/existence at the time of the Contract of Guarantee being made. The original contract between the debtor and the creditor may be about to come into existence. Similarly, in certain situations, a surety may be called upon to pay though the principal debtor is not liable at all. For example, in cases where the principal debtor is a minor, the surety will be liable though the minor will not be personally liable.
A contract of guarantee is to be enforced according to the terms of the contract.
A guarantee is a contract of strictissima juris that means liability of surety is limited by law; a surety is offered protection by law and is treated as a favored debtor in the eyes of the law. A contract of guarantee is not a contract ‘uberrimae fidei’ (requiring utmost good faith). Still the suretyship relationship is one of trust and confidence and the validity of the contract depends upon the good faith of the creditor. However, it is not a part of the creditor’s duty to inform the surety about all his previous dealings with the principal debtor.
In WYTHES vs. LABON CHARE 1858, Lord Chelmsford held that the creditor is not bound to inform the matters affecting the credit of the debtor or any circumstances unconnected with the transaction in which he is about to engage which will render his position more hazardous.
Since it is based on good faith, a contract of guarantee becomes invalid if the guarantee is obtained from the surety by misrepresentation or concealment as given in Sections 142 and 143 of the ICA, 1872.
► Illustration: If a clerk in an office occasionally fails to account for some of the receipts for money collected, he may be asked for surety. In case the person who steps up to be a surety for the clerk in the office is not informed of the occasional lapses on part of the clerk which lead to the requirement of a surety, any guarantee given by him is invalid as something of importance and directly affecting his decision to act as a surety was concealed from him.
► Illustration: A guarantees to C payment for iron to be supplied by him to B to the amount of 2,000 tons. B and C have privately agreed that B should pay ` five per ton beyond the market price, such excess to be applied in liquidation of an old debt. This agreement is concealed from A. A is not liable as a surety.
But where the surety ship is with regard to an advance to be made by a bank, the bank need not disclose past indebtedness to the surety unless it relates to the particular transaction.
The Indian Contract Act, 1872 is also referred to ICA, 1872 in this chapter. The Sections discussed in this chapter are from the Indian Contract Act, 1872 unless otherwise specified.