CONTRACT OF GUARANTEE: AN ANALYSIS

INDIAN CONTRACT ACT- II

Submitted by

Rahul Tambi

SM0119036

Faculty in charge:

Mrs. Daisy Changmai

NATIONAL LAW UNIVERSITY AND JUDICIAL ACADEMY, ASSAM

GUWAHATI

20th MAY, 2021

 TABLE OF CONTENTS

TABLE OF CASES .................................................................................................................... i

TABLE OF STATUTES............................................................................................................. i

TABLE OF ABBREVIATIONS ...............................................................................................ii

CHAPTER 1 .............................................................................................................................. 1

INTROUCTION ........................................................................................................................ 1

1.1 OVERVIEW..................................................................................................................... 1

1.2 LITERATURE REVIEW…….........……………………………………………………2

1.3 RESEARCH QUESTIONS. ............................................................................................. 2

1.4 SCOPE AND OBJECTIVES ........................................................................................... 3

1.5 RESEARCH METHODOLOGY ..................................................................................... 3

CHAPTER 2 .............................................................................................................................. 4

2.1 CONTRACT OF GUARANTEE ..................................................................................... 4

2.2 ESSENTIALS OF A CONTRACT OF GUARANTEE .................................................. 5

CHAPTER 3 .............................................................................................................................. 8

3.1 KINDS OF GUARANTEE .............................................................................................. 8

3.2 REVOCATION OF CONTINUING GUARANTEE ...................................................... 9

CHAPTER 4 ............................................................................................................................ 11

4.1 RIGHTS OF A SURETY ............................................................................................... 11

4.2 DISCHARGE OF SURETY FROM LIABILITY ......................................................... 13

CHAPTER 5 ............................................................................................................................ 16

5.1 JUDICIAL PRONOUNCEMENTS ............................................................................... 16

CONCLUSION ........................................................................................................................ 20

BIBLIOGRAPHY .................................................................................................................... iii

TABLE OF CASES

• Birkmyr v. Darnell
• P.J. Rajappan v. Associated Industries
• State Bank of India v. Premco Saw Mill
• Offord v. Davies
• State Bank Of India v. Nagesh Hariyappa Nayak And Ors
• Bank of Credit and Commerce International S.A. v. V.K Abdul Rahiman
• Margaret Lalitha Samuel v. Indo Commercial Bank Ltd
• Montosh Kumar Chatterjee v. Central Calcutta Bank Ltd
• Bank of Bihar Ltd v. Damodar Prasad and Another
• Hukumchand Insurance Co Ltd v. Bank of Baroda
• Madras High Court in Balakrishnan v. Chunnilal Bagmar
• State Bank of India v. G.J.Herman and others
• Lachman Joharimal v. Bapu Khandu and another
• State Bank of India v. Indexport Registered

TABLE OF STATUTES

1872- Indian Contract Act

i
TABLE OF ABBREVIATIONS

1. Anr Another
2. AIR All India Reporter
3. & And
4. Bom Bombay
5. Cal Calcutta
6. HC High Court
7. Ltd. Limited
8. Ors. Others
9. SC Supreme Court
10. SCC Supreme Court Cases
11. Sec Section
12. vs. Versus

ii
 CHAPTER 1
INTROUCTION

1.1 OVERVIEW

Guarantee is an undertaking to be collaterally responsible for the debt, default or

miscarriage of another. In a banking context it is an undertaking given by the guarantor to
the banker accepting responsibility for the debt of the principal debtor, the customer, should
he or she default. The guarantor may or may not be a customer.1 In Lord Halsbury’s Laws
of England a guarantee is defined as "an accessary contract whereby the promisor
undertakes to be answerable to the promisee for the debt, default or miscarriage of another
person whose primary liability to the promisee must exist or be contemplated. The words
surety and guarantor are used as synonymous terms in Indian law and English Law.
In India, Contract of Guarantee is included in the Indian Contract Act, 1872 and is defined
under section 126 as follows:
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.
In England, a guarantee to be enforceable at law must be in writing. By the Statute of Frauds
(29 Car. II, c.3) Section 4, it is enacted that "no action shall be brought whereby to charge
the defendant upon any special promise to answer for the debt, default or miscarriage of
another person, unless the agreement upon which such action shall be brought, or some
memorandum or note there of shall be in writing and signed by the party to be charged
therewith, or some other person thereunto by him lawfully authorised". Though a contract
of guarantee may be oral or in writing in India it must be required to be in writing only in
England.

1
F.E. Perry & G.Klein, DICTIONARY OF BANKING 134 (3rd Edn, 1988)

1
1.2 LITERATURE REVIEW

1. AVTAR SINGH, LAW OF CONTRACT & SPECIFIC RELIEF (Eastern book

company 2017).
Dr. Avtar Singh is an authoritative and most sought after book on the subject. The book
deals with the intricacies of contract law in a straightforward and lucid style. The book
covers many new developing areas in contract law which are of practical and academic
importance. The book covers recent decisions on issues arising out of modern-day trade
and commerce, which have thereby contributed to the development of the law on the
subject. This book provides great explanation on contract of guarantee that involves three
parties. It relates to the performance of contract on behalf of the third person whereby
fulfilling his obligation under the contract by the guarantor. Along with extensive
knowledge on the Contract Law, this book provides a list of case laws which are immensely
helpful to the law students.

2. F.E. Perry & G.Klein, Dictionary of Banking (Macdonald and Evans, 1983).
The dictionary offers the student a complete explanation of specialised banking
terminology through clear and detailed definitions of over 3,000 items which are
extensively cross-referenced. The new edition addresses the tremendous changes that have
taken place in the banking industry in the past few years in terms of demanding,
introduction of new technology, increasing competition and the economic recession. It also
defines the term Guarantee in the context of banking which is of utmost importance to law
students who must be well-versed with such terms before entering the legal arena.

1.3 RESEARCH QUESTIONS

1. What is the meaning of Contract of Guarantee?

2. What are the essentials of Contract of Guarantee?

3. What are the Kinds of Guarantee?

4. What are the Rights of the Surety?

2
1.4 SCOPE AND OBJECTIVES

SCOPE:

The Scope of this Project is limited to the analysis of Contract of Guarantee with the help of
case laws.

OBJECTIVES:

1. To know the meaning of Contract of Guarantee.

2. To understand the essentials of Contract of Guarantee.

3. To know the kinds of Guarantee.

4. To know the Rights of the Surety.

1.5 RESEARCH METHODOLOGY

Approach to Research: In this project doctrinal research was involved. Doctrinal Research is
a research in which secondary sources are used and materials are collected from libraries,
archives, etc. Books, journals, articles were used while making this project.

Types of Research: Explanatory type of research was used in this project, because the project
topic was not relatively new and unheard of and also because various concepts were needed to
be explained.

Sources of Data collection: Secondary source of data collection was used which involves in
collection of data from books, articles, websites, etc. No surveys or case studies were conducted

3
 CHAPTER 2

2.1 CONTRACT OF GUARANTEE

Section 126 defines the Contract of Guarantee–

A contract of guarantee involves three parties. It relates to the performance of contract on behalf
of the third person whereby fulfilling his obligation under the contract by the guarantor.
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.
Purpose of Contract of Guarantee

It enables a person to get a loan, or goods on credit or employment. Some person comes forward
and ensures the lender or the supplier or the employer that he may be trusted and in case of any
untoward incident, “I undertake to be responsible”.2
In the old case of Birkmyr v Darnell the court said: Where a collateral guarantee arises when
two persons come to shop, one of them to buy, the other to give credit, thereby promising the
seller stating if he doesn’t pay I will’’. This is a collateral guarantee.
In English law, a guarantee is defined as ‘’a promise to pay for the debt, default or failure of
another’’. “Guarantees are a backup when the principal fails the guarantee act as second
pockets”.
Thus, here we can infer that there the 3 parties to the contract

• Principal Debtor – The one who borrows or is liable to pay and on whose default
the guarantee is given
• Creditor – The party who has given something of value to borrow and stands to
receive the payment for such a thing and to whom the guarantee is given
• Surety/Guarantor – The person who gives the guarantee to pay in case of default
of the principal debtor3

Also, we can understand that a contract of guarantee is a secondary contract that emerges from
a primary contract between the creditor and the principal debtor.

2
Diva Rai, A guide to Contract of Guarantee, IPLEADERS (May 12, 2021, 7:PM), https://blog.ipleaders.in/a-
guide-to-contract-of-guarantee/.
3
Id.

4
 • Illustration
Ankita advances a loan of INR 70000 to Pallav. Srishti who is the boss of Pallav promises
that in case Pallav fails to repay the loan, then she will repay the same. In this case of a
contract of guarantee, Ankita is the Creditor, Pallav the principal debtor and Srishti is the
Surety.
A contract of guarantee may either be oral or written. It may be express or implied from
the conduct of parties.4
In P.J. Rajappan v Associated Industries (1983) d [1990 (1) All India Bkg Law Judgments
321] the guarantor, having not signed the contract of guarantee, wanted to wriggle out of
the situation. He said that he did not stand as a surety for the performance of the contract.
Evidence showed the involvement of the guarantor in the deal and had promised to sign the
contract 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
evidence of the 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.

2.2 ESSENTIALS OF A CONTRACT OF GUARANTEE

1) Must be made with the agreement of all three parties

All the three parties to the contract i.e the principal debtor, the creditor, and the surety must
agree to make such a contract with the agreement of each other. Here it is important to note
that the surety takes his responsibility to be liable for the debt of the principal debtor only
on the request of the principal debtor. Hence communication either express or implied by
the principal debtor to the surety is necessary. The communication of the surety with the
creditor to enter into a contract of guarantee without the knowledge of the principal debtor
will not constitute a contract of guarantee.5

4
Id.
5
Srishti Chawla, What is Contract Of Guarantee, IPLEADERS (May 13, 2020, 10:00 AM)
https://blog.ipleaders.in/contract-of-guarantee/

5
 • Illustration
Sam lends money to Akash. Sam is the creditor and Akash is the principal debtor. Sam
approaches Raghav to act as the surety without any information to Akash. Raghav
agrees. This is not valid.
2) Consideration
According to section 127 of the act, anything is done or any promise made for the benefit
of the principal debtor is sufficient consideration to the surety for giving the guarantee. The
consideration must be a fresh consideration given by the creditor and not a past
consideration. It is not necessary that the guarantor must receive any consideration and
sometimes even tolerance on the part of the creditor in case of default is also enough
consideration.6
• In State Bank of India v Premco Saw Mill(1983),7 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 a promissory note
in favor of the State Bank and the Bank refrained from threatened action. It was held
that such patience and acceptance on the bank’s part constituted good consideration for
the surety.

3) Liability
In a contract of guarantee, the liability of a surety is secondary. This means that since the
primary contract was between the creditor and principal debtor, the liability to fulfill the
terms of the contract lies primarily with the principal debtor. It is only on the default of the
principal debtor that the surety is liable to repay.

4) Presupposes the existence of a Debt

The main function of a contract of guarantee is to secure the payment of the debt taken by
the principal debtor. If no such debt exists then there is nothing left for the surety to secure.
Hence in cases when the debt is time-barred or void, no liability of the surety arises. The
House of Lords in the Scottish case of Swan vs. Bank of Scotland (1836) held that if there
is no principal debt, no valid guarantee can exist.

6
Indian Contract Act, 1872, No. 9, Acts of Parliament, 1872 (India).
7
State Bank of India v. Premco Saw Mill, AIR 1984 Guj 93.

6
 5) Must contain all the essentials of a valid contract
Since a contract of guarantee is a type of contract, all the essentials of a valid contract will
apply in contracts of guarantee as well. Thus, all the essential requirements of a valid
contract such as free consent, valid consideration offer, and acceptance, intention to create
a legal relationship etc are required to be fulfilled.
To know more about the essentials of a valid contract, please read this

6) 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.

7) 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 Uberrima fides 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.8

8
Chawla, supra note 5.

7
 CHAPTER 3
3.1 KINDS OF GUARANTEE

Contracts of guarantees may be classified into two types: Specific guarantee and
Continuing guarantee. When a guarantee is given in respect of a single debt or specific
transaction and is to come to an end when the guaranteed debt is paid or the promise is duly
performed, it is called a specific or simple guarantee. However, a guarantee which extends
to a series of transactions is called a continuing guarantee (Section129).9 The surety’s
liability, in this case, would continue till all the transactions are completed or till the
guarantor revokes the guarantee as to the future transactions.
• Illustrations
a) S is a bookseller who supplies a set of books to P, under the contract that if P does not
pay for the books, his friend K would make the payment. This is a contract of specific
guarantee and K’s liability would come to an end, the moment the price of the books is paid
to S.
b) On M’s recommendation S, a wealthy landlord employs P as his estate manager. It was
the duty of P to collect rent every month from the tenants of S and remit the same to S
before the 15th of each month. M, guarantee this arrangement and promises to make good
any default made by P. This is a contract of continuing guarantee.

CONTINUING GUARANTEE
A continuing guarantee is defined under section 12910 of the Indian Contract Act, 1872. A
continuing guarantee is a type of guarantee which applies to a series of transactions. It
applies to all the transactions entered into by the principal debtor until it is revoked by the
surety. Therefore, Bankers always prefer to have a continuing guarantee so that the
guarantor’s liability is not limited to the original advances and would also extend to all
subsequent debts.
The most important feature of a continuing guarantee is that it applies to a series of
separable, distinct transactions. Therefore, when a guarantee is given for an entire
consideration, it cannot be termed as a continuing guarantee.

9
Indian Contract Act, 1872, No. 9, Acts of Parliament, 1872 (India).
10
Id.

8
 • Illustration
K gave his house to S on a lease for ten years on a specified lease rent. P guaranteed that
S, would fulfill his obligations. After seven years S stopped paying the lease rent. ‘K sued
him for the payment of rent. P then gave a notice revoking his guarantee for the remaining
three years. P would not be able to revoke the guarantee because the lease for ten years is
an entire indivisible consideration and cannot be classified as a series of transactions and
hence is not a continuing guarantee.11

3.2 REVOCATION OF CONTINUING GUARANTEE

So far as a guarantee given for an existing debt is concerned, it cannot be revoked, as once
an offer is accepted it becomes final. However, a continuing guarantee can be revoked for
future transactions. In that case, the surety shall be liable for those transactions which have
already taken place.
A contract of guarantee can be revoked in the following two ways-

1) By giving a notice (Section 130)

Continuing guarantees can be revoked by giving notice to the Creditor but this applies only
to future transactions. Just by giving a notice the surety cannot waive off his responsibility
and still remains liable for all the transactions that have been placed before the notice was
given by him. If the contract of guarantee includes a clause that a notice of a certain period
of time is required before the contract can be revoked, then the surety must comply with
the same as said in Offord v Davies (1862).12
• Illustration
A guarantees to B to the extent of Rs. 10,000, that C shall pay for all the goods bought by
him during the next three months. B sells goods worth Rs. 6,000 to C. A gives notice of
revocation, C is liable for Rs. 6,000. If any goods are sold to C after the notice of revocation,
A shall not be, liable for that.
2) By Death of Surety (Section 131)
Unless there is a contract to the contrary, the death of surety operates as a revocation of the
continuing guarantee in respect to the transactions taking place after the death of surety due

11
Chawla, supra note 5.
12
Offord v. Davies, (1862) 12 C. B. (N.S) 748.

9
 to the absence of a contract. However, his legal representatives will continue to be liable
for transactions entered into before his death. The estate of deceased surety is, however,
liable for those transactions which had already taken place during the lifetime of the
deceased. Surety’s estate will not be liable for the transactions taking after the death of
surety even if the creditor had no knowledge of surety’s death.
Period of Limitation
The period of limitation of enforcing a guarantee is 3 years from the date on which the letter
of guarantee was executed. In State Bank Of India vs Nagesh Hariyappa Nayak And
Ors13, against the advancement of a loan to a company, the guarantee deed was executed
by its directors and subsequently a letter acknowledging the load was issued by same
directors on behalf of the company. It was held that the letter did not have the effect of
extending the period of limitation. Recovery proceedings instituted after three years from
the date of the deed of guarantee were liable to be quashed.

13
State Bank of India vs Nagesh Hariyappa Nayak And Ors, ILR 2003 KAR 1435.

10
 CHAPTER 4

4.1 RIGHTS OF A SURETY

After making a payment and discharging the liability of the principal debtor, the surety gets
various rights. These rights can be studied under three heads:
(i) Rights against the, principal debtors.
(ii) Rights against the creditor, and
(iii) Rights against the co-sureties.
(i) Rights against the Principal Debtor
1) The right of surety on payment of debt or the Right of subrogation (Section 140)14
The right of subrogation means that since the surety had given a guarantee to the creditor
and the creditor after getting the payment is out of the scene, the surety will now deal with
the debtor as if he is a creditor. Hence the surety has the right to recover the amount which
he has paid to the creditor which may include the principal amount, costs and the interest.15
2) The right of Indemnity (Section 145)
In every contract of guarantee, there is an implied promise by the principal debtor to
indemnify the surety, and the surety is entitled to recover from the principal debtor
whatever sum he has rightfully paid under the guarantee. This is because the surety has
suffered a loss due to the non-fullfillment of promise by the principal debtor and therefore
the surety has a right to be compensated by the debtor16
• Illustration
Luthra and co has taken a loan from Khaitan and co where Amarchand acts as security
on behalf of Luthra. Khaitan demands payment from Amarchand and on his refusal
sues him for the amount, Amarchand defends the suit having reasonable grounds for
doing so, but he is compelled to pay the amount of the debt with costs. He can recover
from Luthra the amount paid by him for costs, as well as the principal debt.
(ii) Rights against the Creditor
1) Right to securities given by the principal debtor(section 141)
On the default of payment by the principal debtor, when the surety pays off the debt of the
principal debtor, he becomes entitled to claim all the securities which were given by the

14
Indian Contract Act, 1872, No. 9, Acts of Parliament, 1872 (India).
15
Chawla, supra note 5.
16
Id.

11
 principal debtor to the creditor. The Surety has the right to all securities whether received
before or after the creation of the guarantee and it is also immaterial whether the surety has
knowledge of those securities or not.17
• Illustration
On the guarantee of Priya, Anita lent rs 100000 to Sita. This debt is also secured by
security for the debt which is the lease of Sita’s house. Sita defaults in paying the debt
and Priya has to pay the debt. On paying off Sita’s liabilities Priya is entitled to receive
the lease deed in her favor.
2) Right to set off
When the creditor sues the surety for the payment of principal debtor’s liabilities, the surety
can claim set off, or counterclaim if any, which the principal debtor had against the creditor.

(iii) Rights against the Co-sureties

1) Release of one co-surety does not discharge others (Section 138)
When the repayment of debt of the principal debtor is guaranteed by more than one person
they are called Co-sureties and they are liable to contribute as agreed towards the payment
of guaranteed debt. The release by the creditor of one of the co-sureties does not discharge
the others, nor does it free the released surety from his responsibility to the other sureties.
Thus when the payment of a debt or performance of duty is guaranteed by co-sureties and
the principal debtor has defaulted in fulfilling his obligation and thus the creditor compels
only one or more of the co-sureties to perform the whole contract, the co-surety sureties
performing the contract are entitled to claim contribution from the remaining co-sureties.18
2) Co-sureties to contribute equally (Section 146)
According to Section 146, in the absence of any contract to the contrary, the co-sureties are
liable to contribute equally. This principle will apply even when the liability of co-sureties
is joint or several, and whether under the same or different contracts, and whether with or
without the knowledge of each other.
• Illustration
A, B, C, and D are co-sureties for a debt of Rs. 2,0000 lent by Z to R. R defaults in
repaying the loan. A, B, C, and D are liable to contribute Rs. 5000 each.

17
Indian Contract Act, 1872, No. 9, Acts of Parliament, 1872 (India).
18
Chawla, supra note 5.

12
 3) Liability of co-sureties bound in different sums (Section 147)
When the co-sureties have agreed to guarantee different sums, they have to contribute
equally subject to the maximum of the amount guaranteed by each one.
• Illustration
A, B and C, sureties for D, enter into three separate bonds, each in a different penalty,
A for Rs. 10,000, B for Rs. 20,000 and C for Rs. 40,000. D makes default to the
extent of Rs. 30,000. A B and C are liable to pay Rs. 10,000 each. Suppose this
default was to the extent of Rs. 40,000. Then A would be liable for Rs. 10,000 and B
and C Rs. 15,000 each.

4.2 DISCHARGE OF SURETY FROM LIABILITY

Under any of the following circumstances a surety is discharged from his liability:
i) by the revocation of the contract of guarantee,
ii) by the conduct of the creditor, or
iii) by the invalidation of the contract of guarantee

• Revocation of the Contract of Guarantee. As discussed earlier, this includes by

giving notice or death or the surety.
• Conduct of the Creditor

1) Variance in terms of the contract (Section 133)

When a contract of guarantee has been materially altered through an agreement between
the creditor and principal debtor, the surety is discharged from his liability. This is because
a surety is liable only for what he has undertaken in the guarantee and any alteration made
without the surety’s consent will discharge the surety as to transactions subsequent to the
variation.19
• Illustration
A becomes surety to C for B’s conduct as a manager in C’s bank. Afterward, B and C
contract, without A’s consent, that B’s salary shall be raised, and that he shall become liable
for one-fourth of the losses on overdrafts. B allows a customer to over-draw, and the bank
loses a sum of money. A is discharged from his suretyship by the variance made without
his consent and is not liable to make good this loss.

19
Indian Contract Act, 1872, No. 9, Acts of Parliament, 1872 (India).

13
 2) Release or discharge of the principal debtor (Section 134)
A surety is discharged if the creditor makes a contract with the principal debtor by which
the principal debtor is released, or by any act or omission of the creditor, which results in
the discharge of the principal debtor.
• Illustration
A supplies goods to B on the guarantee of C. Afterwards B becomes unable to pay and
contracts with A to assign some property to A in consideration of his releasing him
from his demands on the goods supplied. Here, B is released from his debt, and C is
also discharged from his suretyship. But, where the principal debtor is discharged of
his debt by operation of law, say, on insolvency, this will not operate as a discharge of
the surety.
3) Arrangement between principal debtor and creditor
According to section 135 when the creditor, without the consent of the surety, makes an
arrangement with the principal debtor for composition, or promise to give him time to, or
not to sue him, the surety will be discharged. However, when the contract to allow more
time to the principal debtor is made between the creditor and a third party, and not with the
principal debtor, the surety is not discharged (Section 136).
• Illustration
C, the holder of an overdue bill of exchange drawn by A as surety for B, and accepted
by B, contracts with M to give time to B, A is not discharged.
4) Loss of security (Section 141)
If the creditor parts with or loses any security given to him at the time of the guarantee,
without the consent of the surety, the surety is discharged from liability to the extent of the
value of the security.20
• Illustration
A, as surety for B, makes a bond jointly with 3 to C to secure a loan from C to B. Later
on, C obtains from B further security for the same debt. Subsequently, C gives up
further security. A is not discharged.
• By Invalidation of the Contract

A contract of guarantee, like any other contract, may be avoided if it becomes void or voidable
at the option of the surety. A surety may be discharged from liability in the following cases:

20
Id.

14
 1) Guarantee obtained by misrepresentation (Section 142)
When a misrepresentation is made by the creditor or with his knowledge or consent, relating
to a material fact in the contract of guarantee, the contract is invalid
2) Guarantee obtained by concealment (Section 143)
When a guarantee is obtained by the creditor by means of keeping silence regarding some
material part of circumstances relating to the contracts, the contract is invalid
3) Failure of co-surety to join a surety (Section 144)
When a contract of guarantee provides that a creditor shall not act on it until another person
has joined in it as a co-surety, the guarantee is not valid if that other person does not join.21

EXTENT OF A SURETY’S LIABILITY

In the absence of a contract to the contrary, the liability of a surety is co-extensive with that
of the liability of the principal debtor. It means that the surety is liable to the same extent
to which the principal debtor is liable.
Illustration
A guarantees to B the payment of a bill of exchange by C, the acceptor. On the due date,
the bill is dishonored by C. A is liable, not only for the amount of the bill but also for any
interest and charges which may have become due on it.22

21
Id.
22
Id.

15
 CHAPTER 5

5.1 JUDICIAL PRONOUNCEMENTS

Bank of Credit and Commerce International S.A. v. V.K Abdul Rahiman

In Bank of Credit and Commerce International S.A. v V.K Abdul Rahiman2314, the Kerala
High Court observed that a guarantee is 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 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.

Margaret Lalitha Samuel v Indo Commercial Bank Ltd

In Margaret Lalitha Samuel v Indo Commercial Bank Ltd,24 the Supreme Court held that in
continuing guarantee the period of limitation will commence to run only from the date of
breach. In this case an overdraft was given by the bank to the company and the Director
executed a continuing guarantee bond. The Supreme Court held that so long as the account is

23
Bank of Credit and Commerce International S.A. v V.K Abdul Rahiman, (1998) 92 Camp. Cas. 739 (Kerala)
24
Margaret Lalitha Samuel v Indo Commercial Bank Ltd, (1979) 49 Comp. Cas 86; AIR 1979 SC 102

16
a live account in the sense it is not settled and there is no refusal on the part of the guarantor -
director to carry out the obligation the period of limitation does not commence to run.
Limitation will run only from the date of the breach under Article 115 of the schedule to the
Indian Limitation Act, 1908.

Montosh Kumar Chatterjee v Central Calcutta Bank Ltd

It was held by the Calcutta High Court in Montosh Kumar Chatterjee v Central Calcutta Bank
Ltd25 that the effect of a continuing guarantee is not to secure amounts advanced on different
occasions but to secure the floating balance which may be due from time to time and it is the
date of the accrual of that balance which is relevant for the purposes of limitation when it is
sued for. The surety’s obligation to pay would arise immediately on default committed by the
principal debtor and once a cause of action against the surety has arisen the commencement of
the running of time is not further postponed till the making of a demand.

Bank of Bihar Ltd v Damodar Prasad and Another26

The plaintiff- bank had lent moneys to Demodar Prasad (Defendant No.l) on the guarantee of
P.N. Sinha (Defendant No. 2). In terms of his guarantee bond, Sinha had agreed to pay and
satisfy the liability of the principal debtor upto Rs.12,000/- and interest thereon two days after
demand by the bank. The bond also provided that the bank would be at liberty to enforce and
recover upon the guarantee, notwithstanding any other guarantee, security or remedy which the
bank might hold or be entitled to in respect of the amount secured. As, despite its demands, the
bank could not recover the dues from either the borrower or the surety it filed a suit against
both of them. The trial court decreed against them, but ordered that the hank could enforce its
dues in question against the surety, only after having exhausted its remedies against the
borrower. The bank’s appeal to the Patna High Court against this order was dismissed. The
bank successfully appealed to the Supreme Court.

The Supreme Court held that the demand for payment of the liability of the principal debtor
was the only condition for the enforcement of the bond. The condition was fulfilled. Neither
the principal debtor nor the surety discharged the admitted liability of the principal debtor in
spite of demands. Under Section 128 of the Indian Contract Act, save as provided in the
contract, the liability of the surety is co - extensive with that of the principal debtor. The surety

25
Montosh Kumar Chatterjee v Central Calcutta Bank Ltd, (1953) 23 comp. Cas. 49.
26
Bank of Bihar Ltd v Damodar Prasad and Another, AIR 1969 SC 297.

17
became thus liable to pay the entire amount. His liability was immediate. It was not deferred
until the creditor exhausted his remedies against the principal debtor.

State Bank of India v Indexport Registered

State Bank of India v Indexport Registered27,the Supreme held in this case that a surety’s
liability to pay the debt is not removed by the reason ofthe creditor’s omission to sue the
principal debtor. The creditor is not bound to exhaust his remedies against the principal before
suing the surety, and a suit is maintainable against the surety though the principle has not been
sued. The Supreme Court cited the following passage from Chitty on Contracts33: "Prima facie
the surety may be proceeded against without demand against him and without first proceeding
against the principal debtor". The court also cited the following passage from Halsbury’s Laws
of England, "It is not necessary for the creditor, before proceeding against the surety, to request
the principal debtor to pay, or to sue him, although solvent, unless this is expressly stipulated
for". The Supreme Court emphasized the principle of Section 128 of the Contract Act and
referred to Bank of Bihar Ltd v Damodar Prasad and Another (AIR 1969 SC 297) quoted
supra. The Supreme Court also approved the Karnataka High Court decision in the case of
Hukumchand Insurance Co Ltd v. Bank of Baroda,28 Venkatachellich J (as His Lordship then
was) speaking for the Division Bench observed as follows: "The question as to the liability of
the surety, its extent and the manner of its enforcement have to be decided on first principles
as to the nature and incidents of suretyship. The liability of a principal debtor and the liability
of a surety which is co - extensive with that of the former are really separate liabilities, although
arising out of the same transaction. Notwithstanding the fact that they may stem from the same
transaction, the two liabilities are distinct". The aforesaid principles laid down by the Supreme
Court were later followed by Madhya Pradesh High Court in State Bank of India v. M.P. Iron
and Steel (P) Ltd and Madras High Court in Balakrishnan v. Chunnilal Bagmar.29 The
Kerala High Court in State Bank of India v. G.J.Herman and others30 following the Supreme
Court decision made the following observations while dwelling on the liabilities of the co -
surety:

27
State Bank of India v Indexport Registered, AIR 1992 SC 1740.
28
Hukumchand Insurance Co Ltd v Bank of Baroda, AIR 1977 Kant 204.
29
Madras High Court in Balakrishnan v Chunnilal Bagmar, AIR 1998 Madras 175.
30
State Bank of India v G.J.Herman and others, AIR 1998 Kerala 161.

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In the year 1869, the Bombay High Court in the case Lachman Joharimal v Bapu Khandu
and another31 stated as under. "This Court is of the opinion that a creditor is not bound to
exhaust his remedy against the principal debtor before suing the surety and when a decree is
obtained against a surety, it may be enforced in the same manner as a decree for any other
debt".

Thus it is clear that the contract of guarantee is an independent contract making the liability of
the surety co - extensive with that of the principal debtor, unless otherwise agreed upon. The
creditor can opt to proceed to recover debt against the surety independently of the principal
debtor. Even though the contract of surety may originate from the same transaction it creates
rights and liabilities "separate and distinct" from the rights and liabilities created by contract
between the principal debtor and the creditor. The two cannot be mixed up. It is, therefore,
clear that subject to contract to the contrary, liability of surety remains intact so long as the
debt of the principal debtor is not discharged. This is what the word "co - extensive" in Section
128 of the Indian Contract Act, 1872 means. Since the contract of surety is an independent
contract, the surety cannot require the creditor to recover the debt from the principal debtor
personally or from the securities furnished by the principal debtor. It is submitted that Section
128 of the Contract Act indicates the liability of the surety and not the manner of discharge of
the debt of the principal debtor. Thus the guarantor’s liability is absolute

31
Lachman Joharimal v Bapu Khandu and another, (1869) 4 Bom HC Rep 241.

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 CONCLUSION

The contract of guarantee is a specific contract for which the Indian Contract Act has laid some
rules. As we have discussed, the basic function of a contract of guarantee is to protect the
creditor from loss and to give him confidence that the contract will be enforced with the
promise of the surety. Every contract of guarantee has three parties and there exist two types
of guarantees i.e. specific guarantee and continuing guarantee. The type of Guarantee used
depends on the situation and the terms of the contract. The surety has some rights against the
other parties and liability of the surety is considered to be co-extensive with that of the principal
debtor unless it is otherwise provided by the contract. In case the contracts are entered into by
misrepresentation made by the creditor regarding material circumstances or by concealment of
material facts by the creditor, the contract will be considered invalid.

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 BIBLIOGRAPHY

BOOKS

Avtar Singh, Law of Contract & Specific Relief, 12th Edition, 2017, Reprinted 2019, Eastern
Book Company.

F.E. Perry & G.Klein, Dictionary of Banking (3rd Edn, 1988)

INTERNET WEBSITES

Diva Rai, A guide to Contract of Guarantee, IPLEADERS https://blog.ipleaders.in/a-guide-

to-contract-of-guarantee/

Srishti Chawla, What is Contract Of Guarantee, IPLEADER

https://blog.ipleaders.in/contract-of-guarantee/

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