A contract of guarantee, as defined under Section 126 of the Indian Contract Act, 1872, is an agreement where one person (the surety) promises to perform the promise or discharge the liability of another person (the principal debtor) in case of their default. This tripartite arrangement is essential in both commercial and personal transactions, providing creditors with assurance that their dues will be met, either by the principal debtor or the surety. This article explores parties in contract of guarantee, the roles, responsibilities and legal obligations of the principal debtor, creditor and surety, supported by relevant provisions and case law.
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What is a Contract of Guarantee?
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 their default. The person giving the guarantee is the "surety," the person whose default triggers the guarantee is the "principal debtor," and the person to whom the guarantee is given is the "creditor." The contract can be oral or written.
The purpose is to ensure the creditor’s security by having a surety step in if the principal debtor fails to fulfill their obligation. For example, if A borrows ₹1 lakh from B, with C guaranteeing repayment, A is the principal debtor, B is the creditor and C is the surety. If A defaults, C must pay B.
Parties Involved in a Contract of Guarantee
A contract of guarantee involves three parties, each with distinct roles. All parties must be competent to contract under Section 10 of the Indian Contract Act, 1872, meaning they must be of the age of majority, of sound mind and not disqualified by law:
Principal Debtor: The individual or entity primarily responsible for fulfilling the obligation, such as repaying a loan.
Creditor: The person or entity to whom the obligation is owed, such as a lender.
Surety: The person who guarantees the principal debtor’s obligation, stepping in if the debtor defaults.
Party | Definition |
Principal Debtor | The person responsible for the primary obligation (e.g., repaying a loan). |
Creditor | The person to whom the obligation is owed, benefiting from the guarantee. |
Surety | The person who guarantees the principal debtor’s obligation in case of default. |
Role and Responsibilities of Principal Debtor
The principal debtor is primarily liable for fulfilling the obligation, such as repayment of a loan or performance of a contractual duty. Their responsibilities include
Meeting the terms of the contract with the creditor.
Ensuring timely fulfilment to avoid default.
For example, if A borrows ₹1 lakh from B then A must repay the amount as per the agreement between the two. In cases of insolvency or default, the creditor can seek recovery from the surety. The principal debtor’s failure triggers the surety’s liability but they remain primarily accountable.
Role and Rights of the Creditor
The creditor is the beneficiary of the guarantee, entitled to
Recover dues from the principal debtor.
Seek recovery from the surety if the principal debtor defaults.
Under Sections 142–144 of the Indian Contract Act, 1872, the creditor must act in good faith, disclosing material facts that could affect the surety’s decision to guarantee the debt. Failure to disclose, as seen in London General Omnibus Co v Holloway, may release the surety from liability.
The creditor’s remedies include suing the principal debtor or, upon default, the surety. This dual recourse strengthens the creditor’s position in the transaction.
Read what are Non-Commercial Contracts
Role and Liability of the Surety
The surety guarantees the obligation of a principal debtor with liability that is secondary and contingent on the default by the principal debtor. Section 128 states that the surety’s liability is co-extensive with the principal debtor’s, meaning they are liable for the same amount unless the contract specifies otherwise.
For example, if A defaults on a ₹1 lakh loan guaranteed by then C must pay B the full amount. The surety has rights including
Right of Subrogation: After paying the creditor, the surety can step into the creditor’s shoes to recover from the principal debtor.
Right of Indemnity: The surety can claim reimbursement from the principal debtor for payments made.
Legal Essentials Involving All Three Parties
A valid contract of guarantee requires some essential elements which are essential for any valid contract like having free consent, clear terms and lawful consideration
Free Consent: All parties must agree without coercion, fraud, or misrepresentation (Sections 13–22).
Clear Terms: The contract must clearly outline the obligations, especially for the surety.
Lawful Consideration: Consideration, such as a benefit to the principal debtor or creditor’s forbearance, is necessary (Section 127). Past debts can also serve as valid consideration.
Learn about the Essentials of Contract Negotiation
Difference Between Contract of Guarantee and Other Contracts
A contract of guarantee differs from a contract of indemnity
Contract of Indemnity: Involves two parties (indemnifier and indemnified), with the indemnifier promising to cover losses caused by their own or another’s actions.
Contract of Guarantee: Involves three parties with the surety’s liability being secondary to the principal debtor’s.
Aspect | Contract of Guarantee | Contract of Indemnity |
Number of Parties | Three (principal debtor, creditor, surety) | Two (indemnifier, indemnified) |
Liability | Surety’s liability is secondary | Indemnifier’s liability is primary |
Purpose | Ensures third party’s obligation is met | Covers loss from specific actions |
Additionally, guarantees differ from contracts with independent liability (e.g., bank guarantees payable on demand) and counter-guarantees, which protect the original guarantor.
Summary
A contract of guarantee under the Indian Contract Act, 1872, is a tripartite agreement ensuring a creditor’s security through the principal debtor’s primary obligation and the surety’s secondary liability. The principal debtor must fulfil the obligation, the creditor can recover from either party, and the surety steps in upon default, with rights like subrogation and indemnity. Legal essentials, such as free consent and lawful consideration, are critical and case law reinforces strict adherence to contract terms. Understanding these roles and distinctions from other contracts, like indemnity, is essential for navigating guarantee agreements effectively.
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Parties in Contract of Guarantee: FAQs
Q1. How many parties are in a contract of guarantee?
Three parties.
Q2. Who are the parties to a contract of guarantee?
Principal debtor, creditor and surety.
Q3. Who are the parties involved in a contract of indemnity?
Two parties: indemnifier and indemnified.
Q4. What is involved in a contract of guarantee?
A promise by the surety to perform the principal debtor’s obligation or discharge their liability to the creditor in case of default, as per Section 126 of the Indian Contract Act, 1872.
Q5. How many parties can be in a contract?
At least two parties, but it can involve more depending on the contract type (e.g., three in a guarantee).
