A contract of guarantee is a species of general contract and as such all the essentials of a valid contract must be present. However, it has the following special features:
1. Surety's obligation is dependent on principal-debtor's default:
There must be a conditional promise to pay on the default of the principal debtor. If the promise is not conditional on default, it will not be a contract of guarantee but of indemnity.
(1) A asks B to sell certain goods on credit to C promising "I will pay the amount in case C fails to pay." It is a contact of guarantee as the promise is contingent on the default of C.
(2) A asks a shopkeeper (o sell certain goods to C promising, "I will see that you are paid." This is not a contract of guarantee as the promise of the guarantee is not conditional on default of the buyer. It is a contract of indemnity.
2. Separate consideration for guarantee not necessary:
For a contract of guarantee, like any other contract, consideration is necessary. But Sec. 127 provides that anything done or any promise made, for the benefit of the principal-debtor, may be a sufficient consideration to the surety for giving the guarantee. Thus, there is no need for a separate consideration between the Principal debtor and the surety consideration received by the Principal debtor is sufficient for the surety.
3. Principal debtor need not be competent to contract:
Although the creditor and the surety must be capable of entering into contract, yet, the principal-debtor need not be competent to contract. In such a case, the principal-debtor is not liable but the surety is liable as the principal- debtor. [Kashiba v. Shripat],
4. There must be existing debt or promise whose performance is guaranteed:
For a contract of guarantee, there must be an existing debt or a promise whose performance is guaranteed. In case there is no such debt or promise, there cannot be a valid guarantee. Actually speaking, the debt or promise is the basis of guarantee, i.e., it is the consideration received by the debtor. Hence, if there is no consideration, there is no contract of guarantee. However, the debt may even be void. In that case, the surety himself will be liable to pay the debt.
Whether a contract of guarantee is a contract of Uberrimae Fidei, i.e., good faith.
Strictly speaking, a contract of guarantee is not a contract of uberrimae fidei, i.e., a contract of good faith requiring full disclosure of material facts likely to affect the willingness of the guarantor. However, there should not be any misrepresentation or active concealment of material facts by the creditor.
Nature of Surety's Liability:
Quantum of Surety's Liability :
The liability of the surety is co-extensive with that of the principal debtor unless it is otherwise provided by the contract (Sec. 128).
A guarantees to B the payment of a bill of exchange by C, the acceptor. The bill is dishonoured by C. A is liable not only for the amount of the bill but also for any interest and charges which may have become due on it.
The liability of the surety is equal to that of the principal-debtor. In the absence of a contract to the contrary it can neither be more nor less. However, by a special contract, the liability of the surety can be made less than that of the principal-debtor, but never greater.
Time when the Liability of the Surety Arises:
In some cases, the surety's liability may being simultaneously with the liability of the principal-debtor. In case the guarantee is contingent upon the happening of an event, the surety is liable when the contingency has actually happened. [Subhan Khan v. Lai Khan].
The liability of the surety arises only on default by the principal debtor. Therefore, the surety will not be liable unless there is a default by the principal-debtor. However, when the default has been committed, then immediately the liability of the surety begins. A suit can be filed against the surety without suing the principal-debtor.
Liability of Surety when Principal-debtor not Liable :
The law regards surety and principal-debtor as two distinct persons. Therefore, liability of the surety is independent of the liability of the principal-debtor. Thus, if the original contract between the principal- debtor and the creditor is void, e.g., when the debtor is a minor incapable of entering into contract, then the surety is not discharged from the liability but is liable as a principal-debtor. Again, if the creditor does not file a suit against the principal-debtor within the period of limitation although the principal-debtor is not liable in such a case, yet the surety is not discharged and he continues to be liable to the creditor under his contract of guarantee. [ Mahant Singh v. Bayi],
Even the operation of law will not discharge the surety from his liability. For example, where the principal-debtor dies or becomes insolvent before paying the debt, the surety is liable for the debt.
Further any admission by the principal-debtor or judgment obtained against the principal-debtor will not be enforceable against the surety.
A creditor cannot ask the surety to pay any sum when he himself (creditor) has failed to carry out the terms of the contract, e.g., conveyance of the property to the purchaser.
A surety is discharged from his liability when there is variation in the terms of the contract without his (surety's) consent.