A contract of guarantee ensures that the creditors have an additional layer of security when they are extending credits or loans. In this arrangement, a surety promises to fulfill the duties of a principal debtor in case he defaults, and that's how this agreement safeguard the interests of a creditor. However, the role of the surety comes with significant responsibilities and corresponding rights to protect their position. The rights of surety in contract of guarantee include protections against the creditor, principal debtor and co-sureties. Additionally, specific conditions allow a surety to be discharged from liability, and judicial interpretations also provide clarity on these provisions.
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What is a Contract of Guarantee?
A contract of guarantee, as defined under Section 126 of the Indian Contract Act, 1872, is an agreement to perform the promise or discharge the liability of a third person (the principal debtor) in case of their default. It involves three parties
Surety: The individual or entity providing the guarantee.
Principal Debtor: The person whose obligation is guaranteed.
Creditor: The party to whom the guarantee is given.
For example, if Mr. X lends Rs. 25,000 to Mr. Y, and Mr. Z promises to repay the loan if Mr. Y defaults, Mr. Z is the surety, Mr. Y is the principal debtor and Mr. X is the creditor. The guarantee can be oral or written and must meet the requirements of a valid contract.
Essential Components of a Contract of Guarantee
A contract of guarantee requires three parties, the principal debtor, the creditor and the surety, who guarantees the debtor’s obligation. It must include mutual consent, a valid consideration, and a lawful object, as per the Indian Contract Act, 1872
Three Parties: The surety, principal debtor and creditor must be involved, forming a tripartite agreement.
Promise to Pay or Perform: The surety undertakes to fulfill the principal debtor’s obligation in case of default.
Primary Liability: The principal debtor must have a primary obligation to the creditor, which the surety guarantees.
Consideration: As per Section 127, any act or promise made for the benefit of the principal debtor serves as sufficient consideration for the surety’s guarantee.
Valid Contract Requirements: The agreement must satisfy essentials like offer, acceptance, lawful object, and free consent, as required for any contract under the Indian Contract Act.
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Rights of Surety in Contract of Guarantee
The surety, while assuming secondary liability, is entitled to several rights to safeguard their interests. These rights are categorized based on the party against whom they are exercised.
Rights of the Surety Against the Creditor
Right to Securities (Section 141): The surety is entitled to the benefit of every security held by the creditor against the principal debtor at the time the contract of guarantee is made, regardless of whether the surety is aware of such securities. If the creditor loses or parts with these securities without the surety’s consent, the surety is discharged to the extent of the security’s value. For instance, if a creditor holds property worth Rs. 2,00,000 as collateral and loses it without the surety’s consent, the surety’s liability (Section 128) may be reduced accordingly.
Right to Set-Off: The surety can deduct any claims the creditor has against the principal debtor from the liability under the guarantee, reducing their obligation.
Rights of the Surety Against the Principal Debtor
Right of Subrogation (Section 140): Upon paying the debt, the surety steps into the creditor’s shoes and can exercise all rights the creditor had against the principal debtor, including the right to sue for recovery. For example, if a surety pays Rs. 1,00,000 to the creditor, they can seek this amount from the principal debtor.
Right to Indemnity (Section 145): The surety can recover from the principal debtor all sums paid and losses suffered, including legal costs incurred in defending any suit related to the guarantee. This ensures the surety is not financially burdened by the debtor’s default.
Rights of the Surety Against Co-Sureties
Right to Contribution (Sections 146 & 147): When multiple co-sureties guarantee the same debt, they are liable to contribute equally to the loss unless otherwise agreed. If one surety pays more than their share, they can recover the excess from other co-sureties. For example, if three co-sureties guarantee a Rs. 90,000 debt and one pays the full amount, they can claim Rs. 30,000 from each of the others.
Right Against Release of Co-Surety (Section 138): If the creditor releases one co-surety, the others remain liable, and the released co-surety is still accountable to the others for their share of the liability.
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Conditions Under Which the Surety Can Be Discharged from Liability
A surety can be discharged from liability if the creditor and principal debtor alter the contract terms without the surety’s consent, if the creditor releases the principal debtor or if the creditor’s actions impair the surety’s remedies or securities. Additionally, the surety is discharged if the debt becomes time-barred or the guarantee is obtained by misrepresentation or fraud. Lets look into it in detail:
Revocation by Notice (Section 130): In a continuing guarantee, the surety can revoke their liability for future transactions by notifying the creditor.
Death of Surety (Section 131): For continuing guarantees, the surety’s death revokes the guarantee for future transactions.
Variance in Contract Terms (Section 133): Any change in the contract between the creditor and principal debtor without the surety’s consent discharges the surety for transactions after the change.
Release or Discharge of Principal Debtor (Section 134): If the creditor releases the principal debtor, the surety is discharged, as the primary liability no longer exists.
Arrangement with Principal Debtor (Section 135): An agreement between the creditor and principal debtor, such as granting extra time for payment without the surety’s consent, discharges the surety.
Impairment of Surety’s Remedy (Section 139): If the creditor acts in a way that impairs the surety’s remedies against the principal debtor (e.g., by losing securities), the surety is discharged.
Summary
A contract of guarantee is a tripartite agreement where the surety undertakes to cover the principal debtor’s default, providing security to the creditor. Governed by the Indian Contract Act, 1872, it includes rights for the surety against the creditor (e.g., access to securities), the principal debtor (e.g., indemnity and subrogation), and co-sureties (e.g., contribution). Sureties can be discharged through revocation, death, contract variances, or creditor actions impairing their remedies.
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Rights of Surety in Contract of Guarantee: FAQs
Q1. What are the rights of surety in a contract of guarantee?
A surety in a contract of guarantee has the right to subrogation (stepping into the creditor’s shoes to recover payments), the right to indemnity from the principal debtor, and the right to benefit from any securities held by the creditor.
Q2. What are the rights of surety in Section 140?
Under Section 140 of the Indian Contract Act, 1872, a surety, upon paying the creditor, acquires the right to all securities held by the creditor against the principal debtor, whether known to the surety or not.
Q3. What are the common law rights of a surety?
Common law grants a surety rights to subrogation, indemnity from the principal debtor, contribution from co-sureties, and access to securities or remedies available to the creditor against the debtor.
Q4. What are the rights and liabilities of a guarantor?
A guarantor has rights to indemnity, subrogation, and contribution, but is liable to pay the creditor if the principal debtor defaults, with liability typically limited to the guaranteed amount.
Q5. What is called surety?
A surety is a person who guarantees to pay a creditor if the principal debtor fails to fulfill their obligation under a contract of guarantee.
