A “contract of guarantee” is a contract to perform the promise, or discharge the liability, of a third person in case of his default.

Contracts of guarantee are entered into in cases when a party requires a loan, buy some goods on credit or seek some employment. The guarantor in such contracts assures that the person may be trusted and, in case of any default, he shall undertake the responsibility to pay.

A contract of guarantee requires consensus of three persons

The person in respect of whose default, the guarantee is given, is called the ‘principal debtor’. For example, A takes a loan from B, and C promises to pay back the amount, if A fails to pay it on time. In this case, A is said to be the principal debtor.

The person who gives the guarantee is called the ‘surety’. For example, A takes a loan from B and C promises to pay back the amount, if A fails to pay it on time. In this case, C is said to be a surety. A person may become a surety without the knowledge and consent of the principal debtor, but the only rights which he acquires in that case are those given by sections 140, 141 and 145 of the Indian Contract Act.Muthu Raman Chetty vs Chinna Vellayan Chetty¹⁾

The person to whom the guarantee is given is called the ‘creditor’. A guarantee may be either oral or written. For example, A takes a loan from B, and C promises to pay back the amount, if A fails to pay it on time. In this case, B is said to be the creditor.

A contract of guarantee is a tripartite agreement, involving the principal debtor, surety and the creditor.

1. There must be a contract, first of all, between the principal debtor and the creditor. That lays the foundation for the whole transaction.
2. Then there must be a contract between the surety and the creditor, by which the surety guarantees the debt. The consideration for that contract may move either from the creditor or from the principal debtor or both.
3. There must be a third contract by which the principal debtor expressly or impliedly requests the surety to act as surety. Unless that element is present, it is impossible to work out the rights and liabilities of the surety under the Contract Act.See: Jayakrishna Trading Company vs Kandasamy Weaving Factory²⁾

The transaction is not complete, in case there is the absence of three parties, in which one is a principal debtor and another, a creditor, unless the third party, who is the surety, agrees to make good the loss. Individual contracts between the principal debtor and creditor, and between the creditor and surety, are not enough to make a contract of guarantee. There must be the existence of a third contract either expressly made or arising by the conduct of the parties by which the principal debtor agrees to assure the claim of the surety. If the surety satisfies the claim of the creditor without such contract, the action of the surety would be voluntary. In such a case, the debtor may deny all liability for the payment made by the surety, on the ground that he had never requested the surety to make any payment.Ramchandra Loyalka vs Shapurji N. Bhownagree³⁾

A contract of guarantee requires concurrence of three persons. This being the situation, a contract of guarantee, because of section 126 of the Contract Act, has always to be considered as a tripartite document in India. By virtue of the provisions of section 126 of the Indian Contract Act, 1872, every bank guarantee is a tripartite contract between the banker, the beneficiary and the person at whose instance the bank issues the bank guarantee. Thus, if a contract between two persons postulates that one of them shall furnish a bank guarantee, then the bank guarantee cannot be independent of the principal contract on account of which the bank guarantee was issued by the banker in favour of the beneficiary.Punjab National Bank Ltd. vs Shri Vikram Cotton Mills Ltd⁴⁾

In a contract of guarantee, the surety accepts his liability, taking into consideration all the relevant facts as they exist at the time when the surety gives his guarantee. Subsequently, if the liability of the principal debtor is to be extended over a longer period for any reason, unless the surety has expressly consented to be bound by grant of such extension or has exhibited an unequivocal conduct to be so bound, he could not be held liable as a surety for the extended liability of the principal debtor. ⁵⁾

In case, the guarantee is given for single debt or obligation and that guarantee comes to an end when the debt guaranteed has been paid or obligation guaranteed has been discharged, there is said to be specific guarantee.

A specific guarantee covers only a single transaction within a fixed period of time. It comes to an end when the liability under that transaction ends. Where the payment of a single specific sum is guaranteed, it is a simple guarantee.

Thus, where A gives a loan to B for which C stands guarantee, it is a case of a specific guarantee. In this case, there is a specific debt and the guarantee shall come to an end the moment the loan is repaid.

A continuing guarantee is given in respect of a series of transactions to be undertaken between the principal debtor and the creditor over a period of time. Whether a guarantee is a continuing guarantee or not simply depends on the facts and circumstances as well as terms and conditions prescribed in the guarantee.

Thus, where the guarantee given is not for a single or specific debt or obligation, but for a series of debts, there is said to be continuing guarantee. For example, A, in consideration that B will employ C in collecting the rents of B’s zamindari, promises B to be responsible, to the amount of 5,000 rupees, for the due collection and payment by C of those rents. This is an example of continuing guarantee.

In the continuing guarantee, surety continues to be liable for further goods or loans given by the creditor to the principal debtor. He is liable for any amount which may become due from time to time dealings or transactions between the creditor and the debtor. However, he is discharged from his liability when he revokes his guarantee. Whereas in a simple guarantee, the liability of surety is in respect of only one transaction and this liability comes to an end as soon as the debtor paid his debt but in a continuing guarantee, the surety is liable until the transactions or credits contemplated by the parties and covered by the guarantee have been exhausted or until the guarantee itself has been revoked. ⁶⁾

Adv. Sunil Sharma is a writer for about 25 years and has authored more than 40 books on Law.