Contract of Guarantee: Meaning and Examples

A guarantee means that they are completely responsible for the actions of another person. In a guaranteed contract, the surety guarantees loan repayment on behalf of the borrower who fails to fulfill the debts. As a result, it seeks to protect the other party from loss.

The Indian Contract Act of 1872 governs the guarantee contract. It includes three parties, one of whom serves as a surety if the breaching party fails to fulfill its responsibilities. Guarantee contracts are ones in which one party necessitates a loan, commodities, or work opportunities.

Meaning of Contract of Guarantee

A guarantee contract is a legal agreement in which one party ensures another party's accomplishment of a promise or reimbursement of a debt if the later party fails to discharge the liability or fulfill the commitment.

The contract of guarantee is covered under Section 126 of the Indian Contract Act. A guarantee contract is one in which a third party promises (or guarantees) to perform the contract or to discharge the party's liability under the contract in the case of its default.

Number of Parties Involved

As stated in Section 126 of the Contract Act, a contract of guarantee has three parties: the surety, the principal debtor, and the creditor.

• Surety − The person who gives the guarantee is referred to as the surety.

• Principal Debtor − The person whose default the guarantee is provided for is referred to as the principal debtor.

• Creditor − The creditor is the person to whom the guarantee is given.

For example, X contracts to sell 10 kg of rice to Y on credit for Rs. 5,000. Z, Y's friend, promises X rupees 5,000 if Y does not pay or fails to pay rupees 5,000. X is the creditor, Y is the principal debtor, and Z is the surety in this case.

Tripartite Contract

Tripartite means the existence of three parties. Due to the involvement of three parties in a guarantee contract, there are three different contracts among the parties themselves. These are the contracts −

• Between the principal debtor and the creditor (which is the main contract that is expressed),

• Between surety and creditor (express contract of guarantee) (express contract of guarantee)

• Between the surety and the principal debtor (it can be express or implied).

General Types of Guarantees

Major types of guarantees are −

Based on the Transaction

• Specific Guarantee − A specific guarantee is a type of guarantee that is limited to a single debt or transaction. Under such a guarantee, the liability is discharged as and when the debt is repaid or the promise is fulfilled.

• Continuing Guarantee − A continuing guarantee is a sort of guarantee that continues over many transactions. With such a guarantee, the surety's liability continues until the guarantee is revoked.

Based on Time

• Retrospective Guarantee − A retro guarantee is one given by the surety for an existing debt or promise.

• Prospective Guarantee − A prospective guarantee is any guarantee given by the surety for the ensuing debt or promise.

Kinds of Guarantee

Contracts of guarantee may be classified into two types −

Unilateral Contract of Commercial Credit

This is a type of guarantee contract that is commonly seen in business transactions. It commonly occurs between a wholesaler and a retailer. It also arises between a retailer and a consumer. Under this sort of guarantee contract, the goods are delivered for no payment but with an agreement. The parties' agreement is either written or oral. The agreement may or may not include any security against payment discharge at a later date.

• Bank Guarantee − This type of guarantee contract is common in government contracts. It is also common in contract tenders. This form of guarantee contract is a commercial transaction. The bank guarantee is autonomous and independent of the underlying contract.

• Letter of Credit − A letter of credit is a document written by one person to another about credit. The person who writes the letter requests that the reader give credit to the letter's bearer, or the person in whose favor the letter is written. This is a common practice in international trade. This can be a generic letter of credit made against all merchants or a special letter of credit drawn against a specific person with all information enclosed.

Absolute Performance Bonds

Absolute means both perfect and complete. In this sort of guarantee contract, the surety pays the amount specified in the contract if the person to whom the guarantee is given fails to discharge the contract.

• Retrospective Guarantee − A retrospective guarantee is one that is given for an existing obligation or debt.

• Prospective Guarantee − A prospective guarantee is one that is given for a future obligation or debt.

• Specific Guarantee − A specific or simple guarantee is one that is made in respect of a single debt or specific transaction and is to end when the guaranteed debt or promise is paid or the promise is duly performed.

• Continuing Guarantee − Section 129 of the Indian Contract Act of 1872 defines a continuing guarantee. A continuing guarantee is a guarantee that applies to many transactions. It applies to all transactions entered into by the principal debtor until the surety revokes it. As a result, bankers always prefer a continuing guarantee, which extends the guarantor's liability beyond the original advances to all subsequent debts.

Revocation of the Guarantee

Revocation of the guarantee means canceling or ending the contract. A normal contract of guarantee or a contract of continuing guarantee can be revoked in the following ways −

• If the surety gives the creditor a notice of revocation in relation to future transactions, as required by Section 130 of the Indian Contract Act,

• The death of the surety results in the automatic revocation of future transactions, as stated in Section 131 of the Indian Contract Act.

Conclusion

The contract of guarantee is a type of contract regulated by the Indian Contract Act. Every guarantee contract has three parties, and there are two sorts of guarantees: specific guarantees and continuing guarantees. The type of guarantee used is dependent on the situation and the contract terms.

The surety has some rights against the other parties, and the surety's liability is considered co-extensive with the principal debtor's unless otherwise stated by the contract. Contracts are considered invalid if they are entered into via misrepresentation of material circumstances by the creditor or concealment of material facts by the creditor.

Frequently Asked Questions (FAQ)

Q1. What are the features of the contract of guarantee in India?

Ans. It is a contract to pay the other party for their loss. It is a contract to perform a promise or discharge a third party's liability in the event of his default. The indemnifier and the indemnified are the only two parties. The surety, creditor, and principal debtor are the three parties involved.

Q2. What is the objective of a contract of guarantee?

Ans. A guarantee contract is a promise to answer for the payment of the principal debtor's debt to the creditor or the fulfillment of some duty. If the major debtor defaults, who is first liable to pay or perform. As a result, the principal debtor has the primary liability to pay.

Q3. What is the purpose of a contract of guarantee?

Ans. A guarantee contract is an accessory contract in which the promisor (i.e., the guarantor or surety) undertakes to accept liability on behalf of the promissee (i.e., creditor) for another person's debt, default, or miscarriage, whose principal liability to the promisee must exist or be contemplated.