A contract of guarantee provides a mechanism to secure credit and ensure the performance of obligations. This contract involves a tripartite relationship that balances the interests of the creditor, principal debtor and the surety. This article offers an overview of the features of contract of guarantee by detailing its definition, parties, essential elements, types, liability, rights, discharge mechanisms and distinctions from related concepts like indemnity. As of 2025, the provisions of the Indian Contract Act, 1872, remain unchanged, ensuring the continued relevance of these features.
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What is a Contract of Guarantee
Under Section 126 of the Indian Contract Act, 1872, a contract of guarantee is a contract to perform the promise or discharge the liability of a third person in case of his default. This three parties given under the definition of contract of guarantee are:
Surety (Guarantor): The individual who provides the guarantee, agreeing to fulfill the principal debtor’s obligation in case of default.
Principal Debtor: The person who owes the debt or is responsible for the obligation and whose default triggers the surety’s liability.
Creditor: The person to whom the guarantee is given and who can enforce it against the surety.
For example, if Mohan borrows Rs. 5 lakhs from UCO Bank and Sohan guarantees repayment in case of Mohan’s default, Mohan is the principal debtor, UCO Bank is the creditor and Sohan is the surety. This tripartite structure is fundamental to the contract’s operation.
Read what are Non-Commercial Contracts
Features of Contract of Guarantee under Indian Contract Act, 1872
A contract of guarantee, as outlined in Section 126 of the Indian Contract Act, 1872, is a vital legal mechanism that secures a creditor against the default of a principal debtor through the promise of a surety. Its distinct features, including its secondary nature, flexibility in formation and specific rights and liabilities
Nature of the Contract
A contract of guarantee is a secondary contract which means that it depends on the existence of a primary contract between the creditor and the principal debtor. It serves as a backup in order to ensure the creditor is protected if the debtor fails to perform. The contract can be:
Oral or Written: Indian Contract Act allows guarantees to be oral or written, offering flexibility in formation.
Express or Implied: The guarantee can be explicitly stated or inferred from the conduct of the parties.
This adaptability makes the contract of guarantee suitable for various contexts i.e, from simple loans to complex commercial arrangements.
Essential Elements of Contract
A contract of guarantee must include several critical elements in order to be valid. These elements posses the same essential elements which is required for any other contract as per Indian Contract Act
Consent of All Parties: The creditor, principal debtor and surety must all agree to the terms. The principal debtor’s awareness and consent are essential, as illustrated by cases where a guarantee was deemed invalid due to lack of debtor knowledge.
Consideration: As per Section 127, the consideration for the guarantee is typically the benefit received by the principal debtor. For instance, in State Bank of India v. Premco Saw Mill (1983), the creditor’s forbearance to sue was deemed sufficient consideration.
Secondary Liability: The liability of a surety arises only upon the principal debtor’s default, making it secondary to the debtor’s primary obligation.
Existence of a Debt: A valid debt or liability must exist. If the debt is void or time-barred, the surety is not liable, as established in Swan v. Bank of Scotland (1836).
No Concealment or Misrepresentation: The creditor must disclose all material facts affecting the surety’s liability (Sections 142 and 143). Concealment or misrepresentation renders the contract void.
Compliance with Contract Law: The contract must meet general requirements of a valid contract, including offer, acceptance, lawful consideration, free consent and lawful object.
These elements ensure that the contract is legally enforceable and fair to all parties.
Types of Guarantees
Contracts of guarantee are categorized into two types based on their scope which are specific and continuing. Lets find out the meaning of these two types
Specific Guarantee: This applies to a single debt or transaction. Once the debt is paid or the transaction is completed, the guarantee terminates. For example, if S supplies books to P and K guarantees payment, K’s liability ends once P pays.
Continuing Guarantee: Defined under Section 129, this covers a series of transactions and remains in force until revoked or all transactions are completed. For example, a bank guarantee for a credit card limit is a continuing guarantee.
Revocation of Continuing Guarantee
A continuing guarantee can be revoked under specific circumstances given under Section 130 and Section 131 of the Indian Contract Act, 1872
By Notice (Section 130): The surety can revoke the guarantee for future transactions by notifying the creditor, but remains liable for transactions before the notice. For example, if A guarantees C’s purchases up to Rs. 10,000 and revokes after C buys Rs. 6,000 worth of goods, A is liable only for the Rs. 6,000.
By Death of Surety (Section 131): Unless the contract specifies otherwise, the death of a surety revokes the guarantee for future transactions, though the estate remains liable for prior transactions.
Liability of the Surety
The liability of a surety is governed by Section 128 of Indian Contract Act, which states that it is co-extensive with the liability of a principal debtor and that means:
The surety is liable for the same amount and in the same manner as the debtor, unless the contract limits the liability.
The creditor can sue the surety directly without first pursuing the debtor, as confirmed in Maharaja of Benares v. Har Narain Singh (1905).
However, the surety’s liability is secondary, arising only after the debtor’s default.
Rights of the Surety
The surety enjoys several rights to mitigate the risks of guaranteeing a debt:
Against the Principal Debtor
Right of Subrogation (Section 140): After paying the debt, the surety steps into the creditor’s shoes and can recover from the debtor, including principal, interest and costs.
Right to Indemnity (Section 145): The principal debtor has an implied obligation in order to indemnify the surety for amounts rightfully paid.
Against the Creditor
Right to Securities (Section 141): The surety is entitled to any securities the creditor holds from the debtor upon discharging the liability.
Against Co-sureties
Right to Contribution: If multiple sureties exist, they share liability equally unless otherwise agreed (Sections 138, 146 & 147).
Discharge of Surety
The surety can be discharged from liability under various circumstances:
Revocation: For continuing guarantees, by notice (Section 130) or death (Section 131).
Variance in Terms (Section 133): Any alteration in the contract terms without the surety’s consent discharges them.
Release of Principal Debtor (Section 134): If the creditor releases the debtor, the surety is discharged.
Arrangement with Debtor (Section 135): Agreements like giving the debtor more time to pay without the surety’s consent discharge the surety.
Creditor’s Act or Omission (Section 139): Actions by the creditor that impair the surety’s remedies against the debtor discharge the surety.
Period of Limitation
The limitation period for enforcing a contract of guarantee is three years from the date of execution, as established in State Bank of India v. Nagesh Hariyappa Nayak. An acknowledgment letter does not extend this period.
Distinction from Contract of Indemnity
A contract of guarantee differs from a contract of indemnity in several ways and these differences clarifies the unique role of guarantees in securing existing obligations
Aspect | Contract of Guarantee | Contract of Indemnity |
Parties Involved | Three: Surety, Principal Debtor, Creditor | Two: Indemnifier, Indemnity-holder |
Liability | Secondary, arises on debtor’s default | Primary, indemnifier is directly responsible |
Purpose | Secures existing debt or liability | Protects against future losses |
Legal Basis | Section 126, Indian Contract Act | |
Surety’s Recourse | Can recover from debtor | Cannot sue third parties in own name |
Summary
The contract of guarantee under the Indian Contract Act, 1872 is a vital tool for facilitating credit and securing obligations in commercial transactions. The features of contract of guarantee consist of the tripartite structure, secondary liability, types of guarantees, rights and discharge mechanisms that provide a balanced framework that protects all parties involved. By understanding these elements, individuals and businesses can navigate guarantee contracts with confidence, ensuring compliance with legal standards and financial security.
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Features of Contract of Guarantee: FAQs
Q1. What are the features of the contract of guarantee?
A contract of guarantee involves a promise by the guarantor to fulfill the principal debtor’s obligation if they default, requiring a principal debtor, creditor and guarantor, with the guarantor's liability being secondary and contingent.
Q2. What are the five features of a contract?
A contract requires an offer, acceptance, consideration, lawful object and capacity of parties to be legally binding.
Q3. What are the characteristics of a guarantee?
A guarantee is a promise to perform the principal debtor’s obligation if they fail, is secondary to the primary contract and requires mutual consent and a valid underlying obligation.
Q4. What are the features of the contract of indemnity?
A contract of indemnity involves one party promising to compensate another for loss caused by the promisor or a third party, requiring a clear agreement and a lawful purpose.
Q5. What are the 7 characteristics of a contract?
A contract must have an offer, acceptance, consideration, lawful object, capacity of parties, free consent and must not be expressly declared void.
