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All about Contract of Guarantee

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Contract of Guarantee Law Insider

By Abhijit Mishra-

Published on: August 14, 2022 at 19:15 IST

  1. A “contract of guarantee” is a contract to perform the promise, or discharge the liability, of a third person in case of his default.
  2. 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”.
  3. A guarantee may be either oral or written as defined by the Section 126 of the Indian Contract Act, 1872)

Section 126 of the Indian Contract Act 1872

“Contract of guarantee”, “surety”, “principal debtor” and “creditor”.—

A “Contract of Guarantee” is 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”. A guarantee may be either oral or written.

  1. A guarantee given by the principal debtor to the surety providing him continuing indemnity against any loss or damage that the surety may suffer on account of default on the part of the principal debtor, is called “counter- guarantee”.
  2. Example: A “bank guarantee” is a guarantee given by a bank on behalf of its client or account-holder to another person with whom the client has entered into a contract to perform some job or to do and call upon the bank to pay the guaranteed amount in the event of the contingency, mentioned in the guarantee, happening or not happening, as the case may be.

PURPOSE OF A GUARANTEE

  1. A guarantee which ensures the contracted performance of another person and under which the surety undertakes to compensate the person in whose favour the guarantee is given, in the event of failure on the part of the person on whose behalf the guarantee is given, is known as “performance guarantee”.
  2. The primary idea of a guarantee or suretyship is an undertaking to indemnify the creditors in case the principal debtor does not fulfil his promise; the contract of guarantee in that sense is a contract to indemnify. The central point in such a case is to determine what was the contingency which the parties had in their minds when the contract of guarantee was entered into.

FORM OF A GUARANTEE

  1. The law does not require a contract of guarantee to be necessarily in writing. It may be either oral or in writing. It may be express or it may even be implied. It might be even inferred from the course of conduct of the parties concerned.
  2. In Short, whatever may be the form of the contract, it must be satisfactorily proved. Like any other contract, a contract of guarantee must be supported by consideration.
  3. It is, however, not necessary that the consideration should flow from the creditor and be received by the surety. Consideration between the creditor and the principal debtor is a valid and good consideration for the guarantee given by the surety.
  4. A contract of guarantee as specified in Section 126 of the Indian Contract Act, 1872 presupposes the existence of a principal debtor and no such contract can be made before a sale has taken place when there is no principal debtor in existence in respect of whose default the guarantee can be given.

FIDELITY GUARANTEE

  1. A guarantee, guaranteeing an employer against the misconduct of an employee or to answer for the debt or default of another, is called a “fidelity guarantee”.
  2. A surety’s liability for the faithful discharge by another of his duties depends in each case on the exact terms of that guarantee.
  3. The surety is not discharged from the liability for the principal debtor’s default because the default would not have happened if the creditor had used all the powers of superintending the performance of the debtor’s duty which he could have exercised, because the employer of the servant whose due performance of work is guaranteed does not contract with the surety that he will use the utmost diligence in checking the servant’s work.
  4. If the employer of a servant whose fidelity has been guaranteed continues to employ him even after a proved act of dishonesty without notice to the guarantor, the surety is discharged.
  5. That is a basic principle implicit in the very nature of a fidelity guarantee. The guarantor in such a case guarantees the fidelity and ensures the loss against the risk of infidelity and not the fact of infidelity.
  6. If the employer wants to continue a dishonest servant after his dishonesty has been proved then he must give the guarantor notice of the fact of infidelity so that the guarantor may get an opportunity to say whether he would continue his guarantee or not for a man whose infidelity has been proved.

CONSTRUCTION OF A GUARANTEE

  1. The terms of a guarantee must be strictly construed. The surety receives no benefit and no consideration. He is bound, therefore, merely according to the proper meaning and effect of the written engagement that he has entered into.
  2. In construing a guarantee, the principle is that a guarantee will only extend to a liability precisely answering the description contained in the guarantee.

CONSIDERATION FOR A GUARANTEE

  1. Section 127 of the Indian Contract Act, 1872 defines consideration for guarantee as “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”.
  2. Consideration between the principal debtor and the creditor is good consideration for guarantee given by surety. It is not necessary that the thing done or the promise made for the benefit of the principal debtor should be at the desire of the surety.
  3. The word “done” in the above definition shows that past benefit to the principal debtor can be good consideration for a bond of guarantee.

Section 127 of the Indian Contract Act 1872

Consideration for guarantee.—

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.

SURETY’S LIABILITY

  1. According to Section 128 of the Indian Contract Act, 1872, the liability of the surety is co-extensive with that of the principal debtor, unless it is otherwise provided by the contract.

Section 128 of the Indian Contract Act, 1872

Surety’s liability.—

The liability of the surety is co- extensive with that of the principal debtor, unless it is otherwise provided by the contract

  1. The surety’s liability is not deferred until the creditor exhausts his remedies against the principal debtor. In the absence of some special equity, the surety has no right to restrain an action against him by the creditor on the ground that the principal debtor is solvent or that the creditor may have relief against the principal debtor in some other proceedings.
  2. The liability of the surety being co-extensive with that of the principal debtor is joint and several with the latter and, therefore, in the absence of a clear intention to the contrary it is at the option of the creditor, to decide whether he shall proceed against the surety or the principal debtor. Of course, a guarantor is prima facie entitled to have the debt proved as against him.

SUBROGATION OF SURETY TO THE RIGHTS OF CREDITOR ON PAYMENT

  1. The Surety’s right are protected under Section 140 & Section 141 of the Indian Contract Act.
  2. The said sections of the Contract Act invests a surety with all the rights which the creditor has against the principal debtor, where a guaranteed debt has become due, or default of the principal debtor to perform a guaranteed

duty has taken place, the surety has made the payment or performed all that he is liable for.

Section 140 of the Indian Contract Act, 1872

Rights of surety on payment or performance.—

Where a guaranteed debt has become due, or default of the principal debtor to perform a guaranteed duty has taken place, the surety upon payment or performance of all that he is liable for, is invested with all the rights which the creditor had against the principal debtor.

Section 141 of the Indian Contract Act, 1872

Surety’s right to benefit of creditor’s securities.—

A surety is entitled to the benefit of every security which the creditor has against the principal debtor at the time when the contract of suretyship is entered into, whether the surety knows of the existence of such security or not; and if the creditor loses, or, without the consent of the surety, parts with such security, the surety is discharged to the extent of the value of the security.

CONTINUING GUARANTEE

  1. A guarantee which extends to a series of transactions is called a “continuing guarantee”. It is defined under Section 129 of the Contract Act lays down that a guarantee which extends to a series of transactions is called a continuing guarantee

Section 129 of the Indian Contract Act 1872

“Continuing guarantee”.—A guarantee which extends to a series of transactions, is called a “continuing guarantee”.

  1. According to Section 130, a continuing guarantee may be revoked by the surety at any time as to future transactions, by notice to the creditor.

Section 130 of the Indian Contract Act 1872

Revocation of continuing guarantee.—A continuing guarantee may at any time be revoked by the surety, as to future transactions, by notice to the creditor.

CAVEAT & WORDS OF ADVICE:

  • This is general legal opinion of the law firm Abhi Mishra Inc.©
  • It is highly advised to consult your trusted legal practitioner, who would guide you as per your idiosyncrasy conditions.
  • This document is for information purpose and should not be even remotely considered as an advertisement or solicitation.

Specimen Deed of Bank Guarantee

Scenario: Bank Guarantee agreement on behalf of a Company for the Performance of a Contract in favour of State Government

THIS DEED OF GUARANTEE made on this day

of…..….…………. Two Thousand..….…………. between the (Bank)

..….…………. (hereinafter called “the Bank”) of the one part and the State of

…….………….represented by the Governor, Shri… (hereinafter called “the State”) of the other part.

WHEREAS by Acceptance of Tender No…..….………….

dated……..….…………. made between ….….…………. Ltd., a company incorporated under the Companies Act, 2013 having its Registered Office at

….….…………. agreed by the Company with the State for the supply of plant, machinery and equipment in accordance with the terms, specifications and conditions therein contained which inter alia to… % of the total value of the contract price, such payment to be secured by a Bank guarantee;

AND WHEREAS the bank has, at the request of the Company, agreed to stand surety for and guarantee refund of the said advance in case the plant, machinery and equipment of the value of Rs…………..….…………. aforesaid is not delivered to the State in accordance with the terms and conditions of the said agreement, and the State agreed to make the said advance on such bank guarantee as aforesaid:

NOW THIS DEED WITNESSES AS FOLLOWS:

  1. In consideration of the State of………..….…………. having agreed to advance a sum of Rs………..….………….to the Company, through the Bank, for the purpose hereinafter indicated, the bank, does hereby guarantee that in case the Company shall fail and/or neglect to supply the State, the plant, machinery and equipment of the value of Rs… in accordance with the terms, specifications and conditions contained in the Acceptance of Tender dated the… subject to any amendments or

modifications thereof, if any, when made, the bank shall repay to the State such amount or amounts as the bank may be called upon to pay subject to the maximum limit of Rs…………..….………….

  1. This guarantee of the Bank shall be effective immediately upon receipt of the sum of from the State for and on behalf of the

Company and shall continue in force until the supply of plant, machinery and equipment of the value of Rs… aforesaid is fully effected.

  1. The guarantee hereinbefore contained shall not be affected by any change in the constitution of the bank or of the Company nor in the event of any winding up being made against the Company.

IN WITNESS WHEREOF the parties hereto have set and subscribed their respective hands and seals the day, month and year first above-written.

For and on behalf of the Bank

Witness 1…………….. Company

Witness 2 …………….. For and on behalf of the State of

Specimen Deed of Guarantee for the Performance of a Contract

THIS DEED OF GUARANTEE made this …..….…………. day of

…..….…………. between Shri , son of Shri resident

of… (hereinafter called “the Guarantor”), which expression shall, unless repugnant to the context, include his heirs, legal representatives, assigns etc of the one part and Shri ………………………………….., son of …………………………………..

resident of ………………………………….. (hereinafter called “the Principal), which expression shall, unless repugnant to the context, include his heirs, legal representatives, assigns etc., of the other part.

WHEREAS BY AN AGREEMENT DATED made

between Shri… son of Shri…..….…………. resident of… etc., therein referred to as “the Contractor”, of the one part and the said..….………….

Shri herein referred to as “the Principal”, of the other part, it was

inter alia agreed by and between the parties as follows: (Here state the nature of the work to be done by the Contractor);

AND WHEREAS the said work was entrusted to the Contractor upon the Guarantor having agreed with the Principal as to its guarantee of performance by the Contractor and to indemnify and keep indemnified the Principal against all losses, damages, costs, charges and expenses arising out of performance or non- performance thereof. Now it is agreed and declared by and between the parties as follows:

  1. The Guarantor will see that the Contractor (unless relieved from the performance by operation of any clause of the contract or by statute or by virtue of the decision of any tribunal or court of competent jurisdiction, shall carry out, execute and perform the contract without any exception or reservation and in case he commits any breach thereof, the Guarantor will indemnify and keep indemnified the Principal and his estate against all losses, damages, costs, expenses or otherwise which he may suffer or otherwise incur by reason of any act, negligence, default or error in judgement on the part of the Contractor in performing or non-performing the contract.
  2. In case of any dispute or difference as regards the quantum of such losses, damages, costs, charges or expenses, the same shall be decided by reference to arbitration of one architect or engineer if the parties so agree or otherwise to two architects or engineers, one to be appointed by each, whose decision shall be final and binding on all parties.

IN WITNESS WHEREOF, the parties hereto have hereunto set and subscribed their respective hands and seals the day, month and the year first above-written.

Signed, sealed and delivered in the presence of

  1. Guarantor
  2. Principal
  3. Witness – 1
  4. Witness – 2

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