GUARANTEE AGREEMENT- HOW FAR SURETY IS PROTECTED?

GUARANTEE AGREEMENT:

The word “Guarantee” is defined to be the assurance and affirmation that a legal agreement will be fittingly enforced. A Guarantee Agreement is administered and regulated by the Indian Contract Act of 1872 and it consists of three parties out of which one party functions as a surety if the defaulting party does not carry out its responsibilities and obligations. Guarantee Agreements are substantially needed in cases where a party calls for loans, employment or goods. In these agreements, the guarantor makes the creditor content and satisfied that needy person is reliable and can be believed, and in any kind of default, he/she will assume the liability to pay. Therefore, it is very clear that the guarantee agreement is hidden security provided to the creditor.?

According to Section 126 of the Indian Contract Act of 1872, a contract of guarantee is defined to be an agreement to deliver the promise or carry out the liability of the defaulting party in instances where the party fails to carry out the obligations. A guarantee might be either written or verbal. Basically, a contract of guarantee is the agreement to fulfil the promise and carry out the obligation, of a party in case of any default on the part of the party.

Basically, there are three contracting parties under the guarantee agreement. They are the following:

1. The Principal Debtor: A person who borrows or who is bound to pay and on default of whom the guarantee is provided, is called the Principal Debtor.?

2. The Creditor: The contracting party who has provided his/her valuable goods or things to borrow and is entitled to payment for such valuables or goods and he/she is the one who is provided or given the guarantee. This party to the contract is termed as the Creditor.

3. Guarantor/Surety: The contracting party who provides the guarantee to serve or settle in instances of default on the part of the principal debtor, is known as the Guarantor or Surety.

In addition, a guarantee agreement is a secondary agreement that arises out of a primary agreement or contract among the principal debtor and the creditor. The guarantee agreement can be implied or expressly stated through the contracting parties’ conduct.?

For instance, Nirmala provides or lends a loan amount of Rs. 25,000 to Vinayak and Vinayak’s senior manager Anurag makes a promise that if Vinayak does not succeed to return back the money, he would repay the money back to Nirmala. In such a case, Nirmala becomes the Creditor, Vinayak becomes the Principal Debtor, and Anurag becomes the Guarantor or Surety.

Within the case of P.J. Rajappan v. Associated Industries during the year 1983, the surety did not sign the guarantee agreement and tried to get out of the position. He stated that he was not a part of the agreement since he was not the guarantor. Some evidences were against him as he was concerned and involved with the agreement and he had given the nod to sign the agreement at a later point of time. The High Court of Kerala held that the guarantee agreement, being a tripartite pact involves the creditor, principal debtor and the guarantor and in cases which involves evidences against the guarantor over his inclusion in the agreement, a failure on the guarantor’s part in not signing the contract is not enough to dismantle or else the evidence of his inclusion in the deal concluding that he acted as the guarantor in fulfilment of the agreement by the leading debtor. If the court has to ascertain if someone has acted as the guarantor or surety in fulfilment of the obligations by the principal debtor under the agreement, every circumstance involving the deal are taken into picture and consideration.

ESSENTIALS OF A GUARANTEE AGREEMENT

A. The Contract of Guarantee should be formed with the agreement of all the three contracting parties:?

Each and every contracting party, which involves the Creditor, the Guarantor/Surety and the Principal Debtor, should give a nod for the formation of a guarantee agreement with the agreement of each one of them. Importantly, the guarantor should undertake the liability for the repayment of the lent valuables due to the failure on the part of the leading debtor, only on the behest of the principal debtor. Therefore, either implied communication or expressly stated modes of communication by the debtor to the guarantor is mandatory. The guarantor’s communication with the creditor to come into a guarantee agreement without the debtor’s awareness or knowledge about it would not be termed as a guarantee agreement.

B. Consideration:

Section 127 of the ICA, 1872 says that if anything has happened or any obligation is made which is beneficial for the principal debtor, the consideration is enough for the guarantor to provide the guarantee. There should be a new consideration provided by the creditor and it must not be a consideration of the past. It is not mandatory that the surety will get any consideration and in some instances of default, mere tolerance on part of the creditor is sufficient consideration.?

C. No Misrepresentation:

The guarantee must not be procured through misrepresentation of the facts to the guarantor. Even if the guarantee agreement is not a contract of absolute good faith and shall not need full revelation of the material facts by the creditor or the debtor to the guarantor before the guarantor/surety becomes a party to the contract but the facts which can have an impact on the guarantor’s duties and responsibilities, should be truthfully presented without any false information.

D. Liability:

The guarantor’s liability is secondary in a guarantee agreement. This statement says that though the agreement in its primary terms is between the leading debtor and the creditor, the liability for the realization of the obligations vest mainly on the leading debtor. The guarantor is liable to repay the lent valuables and fix the situation, only when there is default on the part of the leading debtor.

E. No Concealment of Facts:

The facts which can impact the responsibilities of the guarantor, must be represented by the creditor to the guarantor. The guarantee which is procured through hiding and concealing? these facts is wrong and not valid. Therefore, the guarantee becomes invalid when it is procured through hiding of the material facts by the creditor.

F. Existence of a Debt:

The primary motive of the guarantee agreement is to secure and protect the payment of the loan/debt borrowed by the leading debtor. When no debt exists, there is nothing for the guarantor to protect and secure. Therefore, in instances where there are time-barred and void debts, there is no liability on the part of the guarantor. In the Swan v. Bank of Scotland case of 1836, the House of Lords held that when there is no principal debt, there is no existence of a valid guarantee.

G. A Guarantee Agreement should include all the essentials of a valid contract:

Since a guarantee agreement is like a contract, every essential of a valid contract must be fulfilled in guarantee agreement also. Therefore, the essentials like valid consideration, offer, acceptance, free consent and intention to form a legal binding, which form a valid contract must be applied in case of guarantee agreements also.

TYPES OF GUARANTEE AND RIGHTS OF A SURETY

1. Specific or Simple Guarantee:

When a guarantee is provided with respect to a particular transaction or a single debt and it will stop when the debt is cleared or the obligation is sincerely carried out, it is known as a simple or specific guarantee. For instance, Raman sells books and gave some books to Vivek under the agreement that Vivek’s cousin Mithilesh will pay for the books. In this case, the agreement is a specific guarantee agreement and Mithilesh’s liability will stop at the instance he pays money to Raman for the books.??

2. Continuing Guarantee:

Section 129 of the ICA, 1872 defines continuing guarantee as a type of guarantee which is applied to a set of transactions. The continuing guarantee refers to all the transactions made down by the principal debtor till it is nullified by the guarantor/surety. Hence, banks give preference to continuing guarantee such that the surety’s liability is not restricted to the actual advances and will also increase to further debts. The essential aspect of a continuing guarantee is that it is applied to a set of different, heterogeneous transactions. Thus, if a guarantee is provided for a whole consideration, it is not referred to as the continuing guarantee. For instance, Pratham is employed as the manager of Naveen, a rich landlord through Sanskriti’s endorsement of Pratham to Naveen. Pratham has been given a responsibility to obtain rents from Naveen’s tenants each month and remit it to Naveen on the first weekend of all the months. Sanskriti provides to guarantee and in case of default, she would fix the problem. It is a continuing guarantee agreement.

Revocation of Continuing Guarantee:

As long as a guarantee provided for an existing debt is taken into picture, the guarantee could not be revoked because an offer once accepted, becomes final but a continuing guarantee could be annulled and revoked in case of future transactions and the guarantor would be liable for the transactions which have already occurred. A continuing guarantee agreement could be revoked in the following ways:

A. Through Notice: A continuing guarantee could be annulled through providing notice to the creditor; however, it is concerned with future transactions only, because merely through

roviding notice, the guarantor is not wriggled out of his/her responsibility and he/she stays liable for every transaction that has taken place before he/she provided the notice (Section 130).

B. Through demise of Surety: The guarantor’s death serves as a method for the annulment of the continuing guarantee with respect to the transactions bound to happen after the guarantor’s demise due to the absence of agreement, unless specified against it in the agreement. The limitation period for asserting a guarantee is three years from the date of the execution of the guarantee letter.

HOW FAR SURETY IS PROTECTED IN A GUARANTEE AGREEMENT?

After paying and discharging the liability of the leading debtor, the guarantor/surety receives certain rights. These rights are the following:

A. Rights against the Principal Debtor:

(i) Right of Subrogation: The right of subrogation (Section 140) states that if the guarantor has provided a guarantee to the creditor and the creditor is out of the scenario after receiving the payment, the guarantor will deal with the principal debtor in a manner such that he is the creditor. Therefore, the guarantor is provided with the right to recover the money which had given to the creditor and it might comprise the principal money, interest and the costs.

(ii) Right of Indemnity: Under all the guarantee agreements, there is a presence of an implied obligation/promise by the leading debtor to indemnify the guarantor (Section 145), and the guarantor is empowered to recover the amount of money which he/she had paid under the agreement, from the leading debtor. It is due to the fact that the guarantor has incurred a loss because of the failure in fulfilment of the obligation by the principal debtor and hence, the guarantor/surety has a right of compensation against the principal debtor.

B. Rights against the Creditor:

(i) Rights to Securities: When there is payment default on part of the principal debtor and the guarantor clears the debt of the leading debtor, the guarantor/surety becomes empowered to demand all the securities which were provided by the debtor to the creditor. The Guarantor gets the right to all securities, if received before or after the formation of guarantee and it is of no value whether the guarantor is aware of the securities or not.

(ii) Right to Set Off: If the creditor proceeds against the guarantor for payment of the debtor’s liabilities, the guarantor could demand set off, or counterclaim, which the debtor had against the creditor.

C. Rights against the Co-Sureties:?

(i) Effect of releasing a Surety: If the debt repayment of the debtor is guaranteed by one or more than one guarantor, this set of people are known as Co-Sureties and they are liable to provide as decided under the payment of the guaranteed debt. The release of one of the surety by the creditor would not mean the discharge of other sureties and it does not even free the released guarantor from his obligations to the co-sureties.

(ii) Right to Contribution: The co-sureties are bound to contribute or pay equally under Section 146 and this terminology will be applied even if the co-sureties’ liability is several or joint, whether within similar or distinct agreements, and whether having the knowledge of each other or not.

Discharge of Surety from Liability:

A Surety/Guarantor is discharged from his/her liability under the following situations:

1. Through the revocation of the guarantee agreement.

2. Through the conduct of the Creditor.

3.Through the invalidation of the guarantee agreement.

The facts which can impact the responsibilities of the guarantor, must be represented by the creditor to the guarantor. The guarantor’s liability is secondary in a guarantee agreement. The guarantor is liable to repay the lent valuables and fix the situation, only when there is default on the part of the leading debtor. The guarantor has certain rights against other contracting parties and the guarantor’s liability is taken to be co-extensive with the liability of the principal debtor, unless specified against it under the agreement. In instances where the agreement is entered into by false representation or concealment of facts by the creditor to the guarantor, the agreement becomes invalid. In these ways, the surety or guarantor is protected in a guarantee agreement.

CONCLUSION

The guarantor is provided with the right to recover the money which had given to the creditor and it might comprise the principal money, interest and the costs. Also, it is due to the fact that the guarantor has incurred a loss because of the failure in fulfilment of the obligation by the principal debtor and hence, the guarantor/surety has a right of compensation against the principal debtor. The guarantor has certain rights against other contracting parties and the guarantor’s liability is taken to be co-extensive with the liability of the principal debtor, unless specified against it under the agreement. Therefore, the surety or guarantor is protected in a guarantee agreement.