Guarantee in general means, "an agreement assuming responsibility to perform, execute, or complete something and offering security for that agreement".
Section 126 to 147 of the Indian Contract Act, 1872 deals with Contract of Guarantee.
Section 126 of the Indian Contract Act, 1872 defines A "contract of guarantee" is a contract to perform the promise, or discharge the liability, of a third person in case of his default.
ILLUSTRATION:
A requests B to give 25,000 to C and guarantees that C will repay the amount within a year. If C does not, A himself will pay the amount to B. This contract would be an example for contract of guarantee.
CASE LAW:
1) State Bank of India vs Premo Saw Mill (1983)
2) Bank of Bihar v. Damodar Prasad & Others
PARTIES TO THE CONTRACT:
1) Surety- Person who gives the guarantee.
2) Principal Debtor- Person in respect of whose default, the guarantee is given.
3) Creditor- Person to whom the guarantee is given.
ESSENTIAL ELEMENTS OF A CONTRACT OF GUARANTEE:
1) A contract of guarantee can only be between atleast 3 parties (Surety, Principal Debtor and Creditor)
2) Must contain all the essentials of a valid contract
3) It can be oral or written, can't be an implied contract.
4) A contract of guarantee requires complete disclosure of all the material facts by the Principal Debtor or the creditor to the surety before the contract is entered into by him.
5) There must be no concealment of facts and misrepresentation.
6) Surety's obligation arises only when the Principal Debtor makes a default in the performance of his obligation i.e., doesn't repay the debt. When the suit against the debtor was dismissed for there being no liability surveying against the debtor then the surety's liability automatically gets terminated.
7) Primary liability in a contract of guarantee is that of the Principal Debtor. The liability of surety is secondary.
8) Consideration
Section 127 of the Indian Contract Act, 1872 talks about the Consideration for guarantee,
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.
Illustration: B asks A to provide him with things on debt and sell them to him. A consents to do so under the condition that C will ensure payment of the purchase price for the products. In exchange for A's pledge to deliver the items, C offers to guarantee the money. This serves as sufficient explanation for C's pledge.
To believe the existence of debt which says that the main function of a contract of guarantee is to secure the payment of the debt taken by the principal debtor. If no such debt exists then there is nothing left for the surety to secure. Hence in cases when the debt is time-barred or void, no liability of the surety arises. The House of Lords in the Scottish case of Swan vs. Bank of Scotland (1836) held that if there is no principal debt, no valid guarantee can exist.