A contract of guarantee provides a legal mechanism to secure obligations through third-party assurances. As defined under Section 126, it involves three parties: the surety, who gives the guarantee, the principal debtor, whose default triggers the guarantee and the creditor, to whom the guarantee is provided. This contract ensures that if the principal debtor fails to meet their obligations, the surety steps in to fulfill them. Guarantees are widely used in financial and commercial transactions, such as loans, credit sales and employment agreements, which offers creditors an additional layer of security. The Indian Contract Act categorizes guarantees based on the nature of the transaction, the guarantor’s identity, the purpose, conditions, number of sureties and extent of liability. This article explores the types of contract of guarantee in detail, providing examples and legal insights to clarify their application.
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What is a Contract of Guarantee in Indian Contract Act, 1872
A contract of guarantee is given under Section 126 of the Indian Contract Act, 1872 which says that its a tripartite agreement where the surety undertakes to perform the promise or discharge the liability of the principal debtor in case of their default. The key parties are
Surety: The person who provides the guarantee.
Principal Debtor: The individual or entity whose obligations are guaranteed.
Creditor: The party to whom the guarantee is given.
The contract can be oral or written, express or implied, and must meet the essentials of a valid contract, such as lawful consideration and free consent (Sections 142-143). The surety’s liability is co-extensive with that of the principal debtor unless otherwise specified (Section 128). This mechanism is crucial in scenarios where trust in the debtor’s ability to perform is supplemented by the surety’s assurance, such as in loan agreements or commercial contracts.
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Types of Contract of Guarantee in Indian Contract Act, 1872
The Indian Contract Act, 1872 and recognize various types of guarantees, classified based on the transaction, guarantor, purpose, conditions, number of sureties and liability extent. Below is a detailed explanation of each type, supported by examples and legal references.
1. Specific Guarantee
A specific guarantee is limited to a single debt or transaction. Once the debt is paid or the obligation fulfilled, the guarantee terminates, which is why a specific guarantee is straightforward, covering only one specific obligation without extending to future transactions. It is commonly used for one-time deals. For example, S supplies books worth Rs. 10,000 to P, and K guarantees P’s payment. Once P pays the amount, the liability of K will end.
2. Continuing Guarantee
A continuing guarantee is given under Section 129 and it extends to a series of transactions and remains effective until revoked by the surety or upon their death (Sections 130-131). This type is ideal for ongoing relationships, such as recurring credit sales or banking transactions. It can be revoked for future transactions by notice to the creditor. For example, M guarantees to C that P will pay for all goods supplied by C to P over a year. The guarantee covers all transactions during this period unless M revokes it.
3. Personal Guarantee
A personal guarantee is provided by an individual, often to secure loans or obligations of a company or another person. This type places the individual’s personal assets at risk and is commonly used when corporate entities require additional security for loans. For example, an individual guarantees a bank loan for a company and if the company defaults, the individual must repay the loan.
4. Corporate Guarantee
A corporate guarantee is issued by a company to secure the obligations of another entity, who is often a subsidiary or partner. This is prevalent in corporate financing where a parent company guarantees a subsidiary’s debt to enhance creditworthiness. For example, company A guarantees a loan taken by Company B from a bank and if Company B defaults then Company A will be held liable.
5. Bank Guarantee
A bank guarantee is issued by a bank on behalf of its client, assuring a third party that the client’s obligations will be met. It is common in commercial transactions, bank guarantees can be direct (issued by the client’s bank) or indirect (via another bank). They are often unconditional for quick invocation. For example, a contractor provides a bank guarantee to a client to ensure project completion and if the contractor fails, the bank pays the client up to the guaranteed amount.
6. Performance Guarantee
A performance guarantee ensures the principal debtor fulfills contractual obligations, often used in construction or service contracts. It is typically a type of bank guarantee, it compensates the creditor for non-performance or delays. For example, a contractor provides a performance guarantee to a client, ensuring a construction project is completed as agreed.
7. Financial Guarantee
A financial guarantee ensures repayment of a debt or financial obligation. This type secures loans or credit facilities, protecting the creditor against default. For example, a parent company provides a financial guarantee for a subsidiary’s loan, ensuring repayment if the subsidiary defaults.
8. Advance Payment Guarantee
An advance payment guarantee ensures that an advance payment is refunded if the principal debtor fails to perform. It is common in contracts involving upfront payments and protects the creditor’s advance. For example, a supplier receives an advance payment from a buyer and provides an advance payment guarantee and if the supplier fails to deliver, the guarantee will have to refund the advance.
9. Deferred Payment Guarantee
A deferred payment guarantee ensures payment after a specified period and is often in installment-based contracts. This type is used when payments are deferred, which makes sure that the creditor receives the agreed amount. For example, in a deferred payment contract, a buyer agrees to pay after six months, and a bank guarantees the payment.
10. Conditional Guarantee
A conditional guarantee requires specific conditions to be met before it can be invoked. The creditor must prove the conditions, such as default or specific events in order to claim the guarantee. For example, a guarantee is invocable only if the principal debtor defaults after a specified date or event.
11. Unconditional Guarantee
An unconditional guarantee can be invoked without conditions, typically on the creditor’s first demand. It is often used in bank guarantees, it allows quick access to funds without proving default. For example, a bank guarantee allows the beneficiary to claim the amount on first demand, without proving the debtor’s default.
12. Joint Guarantee
Multiple sureties are jointly liable, requiring the creditor to sue all sureties together. The sureties are treated as a single unit and the creditor cannot pursue one without including others. For example, two individuals jointly guarantee a loan. The lender must sue both if the borrower defaults.
13. Several Guarantee
Each surety is liable separately, allowing the creditor to sue them individually. Each surety’s liability is independent, offering flexibility to the creditor. For example, two individuals separately guarantee a loan. The lender can sue either or both individually if the borrower defaults.
14. Limited Guarantee
The surety’s liability is capped at a specific amount. This limits the surety’s exposure, regardless of the total debt. For example, a surety guarantees up to Rs. 50,000 for a Rs. 1,00,000 loan. Their maximum liability is Rs. 50,000.
15. Unlimited Guarantee
The surety’s liability has no cap, covering the entire debt. The surety is fully responsible for the principal debtor’s obligations. For example, a surety guarantees the full amount of a loan without any limit on their liability.
Type | Description | Example |
Specific Guarantee | Covers a single transaction, ends when fulfilled. | K guarantees P’s payment for books worth Rs. 10,000. |
Continuing Guarantee | Extends to a series of transactions, revocable for future transactions. | M guarantees P’s payments for goods supplied by C over a year. |
Personal Guarantee | Given by an individual for another’s obligations. | Individual guarantees a company’s bank loan. |
Corporate Guarantee | Issued by a company for another entity’s obligations. | Company A guarantees Company B’s loan. |
Bank Guarantee | Bank assures client’s obligations to a third party. | Contractor provides bank guarantee for project completion. |
Performance Guarantee | Ensures contract performance, often a bank guarantee. | Contractor guarantees project completion. |
Financial Guarantee | Secures debt repayment. | Parent company guarantees subsidiary’s loan. |
Advance Payment Guarantee | Ensures refund of advance if debtor fails to perform. | Supplier guarantees refund of buyer’s advance payment. |
Deferred Payment Guarantee | Ensures payment after a delay. | Bank guarantees buyer’s deferred payment. |
Conditional Guarantee | Requires conditions for invocation. | Guarantee invocable only after a specific event. |
Unconditional Guarantee | Invocable without conditions, on first demand. | Bank guarantee claimable on first demand. |
Joint Guarantee | Multiple sureties liable together. | Two individuals jointly guarantee a loan. |
Several Guarantee | Sureties liable individually. | Two individuals separately guarantee a loan. |
Limited Guarantee | Liability capped at a specific amount. | Surety guarantees up to Rs. 50,000 for a loan. |
Unlimited Guarantee | No cap on liability, covers entire debt. | Surety guarantees full loan amount without limit. |
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Summary
Contracts of guarantee under the Indian Contract Act, 1872, offer a robust framework for securing obligations through third-party assurances. From specific guarantees for single transactions to continuing guarantees for ongoing dealings, and from personal to corporate and bank guarantees, each types of contract of guarantee serves unique purposes in financial and commercial contexts. Conditional and unconditional guarantees provide flexibility in invocation, where joint, several, limited and unlimited guarantees address the number of sureties and liability extent. Understanding these classifications is important for drafting effective contracts and managing risks, where legal consultation is also recommended in order to ensure compliance and clarity in specific cases.
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Types of Contract of Guarantee: FAQs
Q1. What are the different types of contract guarantees?
Contract guarantees include performance guarantees (ensuring contract obligations are met), payment guarantees (securing payment obligations), and bid guarantees (ensuring bidders honor their bids). They provide financial security against default or non-performance.
Q2. What are the four types of contracts?
The four main types of contracts are fixed-price contracts, cost-reimbursement contracts, time and materials contracts, and unit price contracts. Each type defines how costs, risks, and payments are structured between parties.
Q3. What are the 5 special contracts?
The five special contracts under the Indian Contract Act are indemnity, guarantee, bailment, pledge, and agency. These contracts involve specific legal obligations and relationships between parties.
Q4. What is specific and continuing guarantee?
A specific guarantee covers a single, particular transaction or debt, but a continuing guarantee extends to a series of transactions over time.
Q5. What are the three types of guarantees?
The three types of guarantees are personal guarantees (individual liability), bank guarantees (bank-backed assurance) and performance guarantees (ensuring contractual obligations are met). Each serves to mitigate financial or performance risks.
