Basic Essentials of a Valid Guarantee Contract

By | October 7, 2019
principle debt

A valid guarantee contract must include a  and must be drawn up orally or in writing. Section 126 of the Indian Contract Act, 1872 defines a ‘Contract of guarantee’ as “a contract to perform the promise, or discharge the liability, of a third person in case of his default”.

1. Principle Debt

A contract of guarantee has one main purpose, and that is to ensure that a debt is paid between parties. In order for this debt to be paid off debt needs to exist in the first place. Without a principal debt amount, a valid contract of guarantee can not exist. As the name suggests the principle debtor is the individual/ party liable to pay his dues. The individual/ party known as the surety in the contract becomes liable upon the failure of payment or default of the principle debtor.

The word “liability” is mentioned in section 126, it is an enforceable liability in the court of law. In a contract of guarantee, the liability is upon the principle debtor. Without said liability, a principal debt would not exist, and so a valid guarantee contract would not exist.

It is essential to have a recoverable debt, the same can be better understood with the help of the Scottish case Swan v. Bank[1] in the year 1836. The facts of the case are-

“The payment of the overdraft of a banker’s customer was guaranteed by the defendant. The overdrafts were contrary to a statute, which not only imposed a penalty upon the parties to such drafts but also made them void. The customer having defaulted, the surety was sued for the loss.”   (Singh)

While delivering the judgment the House of Lords held that the surety was not liable. This was as there was no actual debt that was due, therefore there was no recoverable debt making the contract invalid. The surety was not held liable and was considered a “co-obliger” in the judgement. This is as the banker was not allowed to have any claim against the customer and this carries over to the surety too, making the surety not liable. In the case Manju Mahadev v. Shivappa[2] it was held that a surety is not liable in a guarantee contract if the payment of the debt by any way is disallowed by a statute in place.

Coutts and Co v. Browne-Lecky and Others[3] is a famous case about a contract of guarantee of a minor’s debt. The debt is void according to the Irish statute the Infants’ relief Act, 1874  in section 1.  A question of whether a surety is liable for the default of a minor’s guaranteed debt arises and sets English law and Law followed in India apart. In the said case, it was held that the surety will not be liable. Oliver J’s judgement on the matter stated;

“the plaintiffs could not recover. Under section 1 of the Infants Relief Act, the loan to the first defendant was ‘ absolutely void ‘. There was, therefore, no liability on the part of the infant. A guarantee was a contract to make good a debt, default or miscarriage of another person. But in this case there was no debt because the statute says so; there was no default because the first defendant was entitled to refrain from paying; for the same reason there was no miscarriage.” (Cohn)

The case was decided at a time when there was a lack of judicial precedent with regards to minors in a guaranteed contract. At the time the Court of King’s Bench was persuaded by just two authorities. Yet, it is important to know the case Wauthier v. Wilson[4] which at the time provided obiter remarks that viewed the liability of the surety differently. In the case money was lent to a minor, the father of the minor was the surety.

This was established as a promissory note was given to the creditor stating the same. The court held that even though under the Infants Relief Act, 1874 such a debt would be void the father remained liable as a surety. Pickford J in the matter held that a joint obligation between son and father was entered into, it was further explained that the father had ‘separate’ and ‘distinct’ liability.

The position of a contract of guarantee of a minor’s debt is similar in India. In the  Bombay High Court case Kashiba Bin Narsapa v. Narshiv Shripat, it was held that surety of a minor’s debt is liable at the time of default. The contract being void/voidable is of no consequence when it comes to the surety’s liability in the contract of guarantee. The judgement states “We see no reason why a person cannot contract to guarantee the performance by a third person of a duty of imperfect obligation.” (Singh)

2. Consideration

Much like the quintessential contract, a valid contract of guarantee should also include consideration, without which the contract would become void. Section 127  of the Indian Contract Act, 1872 defines ‘consideration for guarantee’ as-

“Anything did, or any promise made, for the benefit of the principal debtor, may be a sufficient consideration to the surety for giving the guarantee.”

A broad understanding of consideration in relation to contract law should typically include a case situation where a form of detriment is felt by the promisee at the promisor’s request. The position of the promisor when it comes to consideration is explained by Mulla, “it is immaterial whether there is or is not any apparent benefit to the promisor”. (Mulla) Section 127 opens by saying “Anything done”, this denotes that past consideration is good consideration for a contract of guarantee.

Any trade completed on credit on the basic principles of guarantee form good consideration, the same can be observed about the nature of loans. On the same matter  in the case Madan Lal Sobe v. Rajasthan State Industrial Development and Investment Corpn[5] Ltd it was discussed that

“where a creditor has already been given and the payment has become due, the creditor refrains from suing the principal debtor, that would be sufficient consideration for giving a guarantee.”

In the case Ujjal Transport Agency v. Coal India Ltd[6], a contract was formed to cut and extract timber from a forest. Payment for timber cutting was through a bank guarantee though the timber cutting was not permitted by the forest authorities. It was held that the consideration had failed and that nothing could be recovered by the principal debtor. The bank guarantee could also not be enforced due to the failed consideration.

Guarantee given for a past debt has been discussed in the Oudh High Court case M. Gulam Husain Khan v. M. Faiyaz Ali Khan[7]. The facts of the case were that a surety contract was established after the lessee agreed to pay his dues in the way of instalments. Section 127  of the ICA,1872 as discussed before includes the words “ Anything done”, the issue surrounding the consideration arises here as the act was done before the guarantee was given. The court relied on the judgement of the case Mathra Das v. Shamboo Nath[8] and held that there was good consideration. The judgement has been criticized by many legal scholars and has also been said to contradict the third illustration of the section.

The illustration is- (c)  “A sells and delivers goods to B. C afterwards, without consideration, agrees to pay for them in default of B. The agreement is void.”  Past consideration as valid consideration was further held in the Bombay High court case SICOM Ltd v. Padmashri Mahipatrai Shaah[9]. A guarantee is not only enforceable on a past debt but on a future debt too, yet this is only if there is some debt that is incurred after the guarantee. “There should be a clear undertaking to be liable for a past debt and as soon as some fresh obligation is incurred, the liability for all the obligations is coupled up.”

Good consideration is established as soon as the principal debtor receives benefit from the contract of guarantee. It is not necessary for the principal debtor to request the guarantee or consent to it. This stance was refuted in the case Prasanjit Mahttha v. United Commercial Bank Ltd.[10], the directors of a company after guaranteeing the company’s loans, stated that they have never asked for the guarantee.  The judgement relied upon Lord Loreburn’s statement from the case Duncan Fox and Co v. North and South Wales Bank[11]. Lord Loreburn stated that in a contract of surety, parties may be obligated to one another in all of three ways. The three ways include, all the parties concerned are a party to the contract, between the principal debtor and surety and one that is between the creditor and the surety.

3. Misrepresentation and Concealment

In order for a valid contract of guarantee the surety should be well aware about the contract agreed upon with his principal. Even though contracts of guarantee in nature are not uberrimae fides, yet it becomes the duty of the guarantor to inform the surety of all information that may affect or change the surety’s degree of responsibility. If the same is not done the party taking guarantee will be liable for the surety’s shortcoming.

In the case Shriniwas Shankar Potnis v. Raghukul Sahakari Griharachana Sanstha Maryadit[12],a piece of land was purchased by a person on behalf of a society. The fact that the property was being bought for a society was not disclosed to the surety. It was a material fact as the society was engaged in litigation, and so the surety would not have consented to the contract of suretyship. The court held in the matter that there was suppression of vital facts from the surety, hence he was not bound by the guarantee.

The same principles can be found in section 142 and section 143 of the Indian Contract Act, 1872. They read;

Section 142 “ ‘Guarantee obtained by misrepresentation- invalid.’—Any guarantee which has been obtained by means of misrepresentation made by the creditor, or with his knowledge and assent, concerning a material part of the transaction, is invalid.”

Section 143 “ ‘Guarantee obtained by concealment, invalid.’—Any guarantee which the creditor has obtained by means of keeping silence as to a material circumstance, is invalid.”

The case London General Omnibus Co v. Holloway[13] will help further ones understanding this principle better. The facts of the case are as follow-

“The defendant was invited to give a guarantee for the fidelity of a servant. The employer had earlier dismissed him for dishonesty, but did not disclose this fact to the surety. The servant committed another embezzlement.”

The court held that the surety was not liable as the fact that the servant was a thief and a dishonest man was not disclosed. The role of a surety in a contract of guarantee is surrounded by the risk or chance of default. A creditor must share with the surety any information that may change such a risk factor if the creditor is aware.

4. Guarantee both Written and Oral

A contract of guarantee must be either formed orally or in writing in India. Section 126 of the ICA, 1872 mentions “A guarantee may be either oral or written.”. English law’s position on the same is different, as they need a guarantee to be made in writing.


References

  1. Singh, Avtar. Law Of Contract. Eastern Book Co., 1996.
  2. Cohn, E. J. “Validity of Guarantees for Debts of Minors.” The Modern Law Review, vol. 10, no. 1, 1947, pp. 40–51. JSTOR, jstor.org/stable/1089652.
  3. Mulla, Sir Dinshaw Fardunji. The Indian Contract Act. 15th ed., Lexis Nexis, 2016, p. 256.

[1] (1836) 10 Bligh NS 627

[2] (1918) 42 Bom.444

[3] (1947) KB 10: (1946) 2 All ER 207

[4] (1912) 28 T.L.R. 239

[5] (2006) 135 DLT 554

[6] AIR 2011 Jha 34

[7] AIR 1940  Oudh 346

[8] AIR 1929 Lah 203

[9] (2005) 3 Mah Lj 125

[10] AIR 1979 Pat 151

[11] (1880) LR 6 AC 1 (HL)

[12] (2010) 1 Mah L j 368

[13] (1912) 2 KB 72 (CA)


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Mridul Crystelle
Author: Mridul Crystelle

Mridul Crystelle Singh is a second-year BA LLB student at O.P Jindal Global University. Her writing experience varies from working for Reader’s Digest India to writing scripts for a school’s annual production. She is a part of her university’s moot court society and hopes to write research papers on various topics in law in the future.

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