Section 126 of the Indian Contract Act, 1872 Define the contract of guarantee. State the essential feature of a contract of guarantee. Distinction between a contract of indemnity and a contract of guarantee.

Contract of Guarantee :- 

Section 126 of the Indian Contract Act, 1872 defines a contract of guarantee as contract of guarantee is a contract to perform the promise or discharge the liability, of a third person in case of his default. The Section further provides that the person who gives the guarantee is called the “surety”, the person in respect of whose default the guarantee is given is called “principal debtor”, and the person to whom the guarantee is given is called the “creditor”. For example, A takes a loan from a bank. 

A promise to the bank to repay the loan. B also makes promises to the bank saying that if A does not repay the loan “then I will pay.” In this case, A is the principal debtor, who undertakes to repay the loan; B is the surety, whose liability is secondary because he promises to perform the same duty in case there is default on the part of A. The bank in whose favour the promise has been made is the creditor.

Main features of Contract of Guarantee

The Contract may be either oral or in writing:-

According to Section 126, a guarantee may be either oral or written. On this point, the position in India is different from that in England. According to English law, for a valid contract of guarantee, it is necessary that it should be in writing and signed by the party to be charged therewith.

Consent of the surety should not have been obtained by misrepresentation:-

The creditor should not obtain guarantee by any misrepresentation of any material facts concerning the transaction. If the guarantee has been obtained that way, the guarantee is invalid. The position is explained by sections 142.

“Section 142. Guarantee obtained by misrepresentation invalids. - 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.”

Consent of the surety should not have been obtained by misrepresentation or concealment :-

Any guarantee which the creditor has obtained by means of keeping silence as to material circumstances is invalid. Sec (143)

Examples

A engages B as clerk to collect money for him. B fails to account for some of his receipts and A in consequences calls upon him to furnish security for his duly accounting. C gives his guarantee for B’s duly accounting. A does not acquaint C with B’s previous conduct. B afterwards makes default. The guarantee is invalid.

A guarantee to C payment for iron to be supplied by him to B to the amount of 2,000 tons. B and C have privately agreed that B should pay five rupees per ton beyond the market price, such excess to be applied in liquidation of an old debt. This agreement is concealed from A. A is not liable as a surety.”

Tripartite Agreement:- 

A contract of guarantee is a tripartite agreement between the principal debtor, creditor and surety. There are three contracts as under

1. Contract between creditor and principal debtor

2. Contract between surety and principal debtor

3. Contract between surety and the creditor

Consent of the parties:-

1. There must be consent of all the three parties.

2. Distinction between a contract of indemnity and a contract of guarantee

Number of Parties: 

Indemnity contract includes two parties namely, indemnifier and indemnity holder. But guarantee contract includes three parties namely creditor, Principal debtor and surety.

Number of Contracts: 

In case of indemnity contract, as there are only two parties, there is possibility for existence of one contract only. But a contract of guarantee includes three sub-contracts.

Nature: 

As indemnity contract includes two parties and one contract, it can be said that indemnity contract is simple in nature. But guarantee contract includes three parties and three sub-contracts and hence be said that guarantee contract is complex in nature.

Liability: In contract of guarantee there will be two types of liabilities namely:

primary and secondary liabilities which will be with principal debtor and surety respectively. But in contract of indemnity there is no classification and sharing of liability where the absolute liability rests with indemnifier.

Recovery: 

In case of indemnity contract the indemnifier, after compensating indemnity holder`s loss, cannot recover that amount from any person. But in contract of guarantee, if surety makes payment to creditor, he (surety) can recover that amount from principal debtor.

Interest of parties: 

Indemnity contract gets formed upon indemnifier`s interest and guarantee contract gets formed upon principal debtor`s interest.