Contract of Guarantee under Sections 126 to 128 of the Indian Contract Act, 1872: The Three Parties, Essentials, Oral and Written Guarantees, Consideration under Section 127 and the Co-Extensive Liability of the Surety

A contract of guarantee is unusual in the law of contract because it involves three parties and three relationships, and because the surety undertakes a liability for a debt that is not his own and from which he gets nothing. Two features of the Indian provisions are distinctive and both favour the creditor. A guarantee need not be in writing, which departs from English law. And the surety's liability is co-extensive with that of the principal debtor, which the Supreme Court has held to mean that the creditor may proceed against the surety first, without exhausting his remedies against the principal debtor or against any security.

1. The Definition and the Parties

Sections 126, 127 and 128, Indian Contract Act, 1872

126. Contract of guarantee, surety, principal debtor and creditor. A contract of guarantee is a contract to perform the promise, or discharge the liability, of a third person in case of his default. The person who gives the guarantee is called the surety; the person in respect of whose default the guarantee is given is called the principal debtor; and the person to whom the guarantee is given is called the creditor. A guarantee may be either oral or written.

127. 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.

Illustrations. (a) B requests A to sell and deliver to him goods on credit. A agrees to do so, provided C will guarantee the payment of the price of the goods. C promises to guarantee the payment in consideration of A's promise to deliver the goods. This is a sufficient consideration for C's promise. (c) A sells and delivers goods to B. C afterwards requests A to forbear to sue B for the debt for a year, and promises that if he does so, C will pay for them in default of payment by B. A agrees to forbear as requested. This is a sufficient consideration for C's promise.

128. 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.

Illustration. 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.

1.1 The three relationships

Creditor and principal debtor, the primary obligation which the guarantee secures.
Creditor and surety, the contract of guarantee itself, under which the surety undertakes a secondary and collateral liability.
Principal debtor and surety, from which the implied promise of indemnity under Section 145 and the surety's right of subrogation under Section 140 arise.

2. Essential Elements

A principal debt or obligation must exist, or be contemplated. A guarantee is accessory: if there is no principal obligation there is nothing to guarantee, and the guarantee fails with it. This is the point on which a guarantee most fundamentally differs from an indemnity.
Three parties, and each must be a party to the arrangement, though not necessarily to a single document.
The surety's undertaking must be conditional on default. A promise to pay in any event, regardless of the debtor's default, is an indemnity and not a guarantee.
Consideration, supplied by Section 127, which is considered below.
All the requirements of a valid contract under Section 10, including capacity, free consent and a lawful object. A minor cannot be a surety.
No misrepresentation or concealment by the creditor, failing which Sections 142 and 143 make the guarantee invalid.
A guarantee for the debt of a minor is problematic, because the principal debt is void. The better view is that the person who gives such an undertaking is in substance an indemnifier, primarily liable, since there is no principal obligation for a guarantee to attach to.

2.1 Oral and written guarantees

⚠ A guarantee need not be in writing in India

Section 126 states expressly that a guarantee may be either oral or written, which is a deliberate departure from Section 4 of the English Statute of Frauds, 1677, under which a special promise to answer for the debt, default or miscarriage of another is unenforceable unless evidenced in writing and signed. The Indian draftsmen abolished the Statute of Frauds so far as it applied here, and the consequence is that an oral guarantee is fully enforceable, subject only to proof. In practice the difficulty is evidential rather than legal, and a creditor relying on an oral guarantee must prove its terms, the request of the principal debtor and the consideration.

3. Consideration: Section 127

Section 127 solves a problem that would otherwise defeat most guarantees. The surety receives nothing; the benefit goes to the principal debtor. Section 2(d) already permits consideration to move from or to a person other than the promisee, and Section 127 puts the matter beyond doubt for guarantees: anything done, or any promise made, for the benefit of the principal debtor is sufficient consideration for the surety's promise.

A fresh advance or a fresh supply of goods to the principal debtor, as in Illustration (a).
Forbearance to sue the principal debtor at the surety's request, as in Illustration (c). Forbearance is an abstinence within Section 2(d) and is good consideration.
Extension of time given to the principal debtor at the surety's request.
A past debt is not, by itself, consideration. Illustration (b) to Section 127 shows the point: where the goods have already been sold and delivered, and the guarantee is given afterwards without any fresh forbearance or advance, there is no consideration and the guarantee is void. This is sometimes described, loosely, as the rule that past consideration will not support a guarantee, and it should be read with the general Indian rule in Section 2(d) that past consideration given at the promisor's desire is good.
The benefit need not move to the surety at all, and the section makes that explicit.

4. The Surety's Liability: Section 128

Section 128 states the rule in a single line: the liability of the surety is co-extensive with that of the principal debtor, unless otherwise provided by the contract. Three propositions follow.

Co-extensive in amount. The surety is liable for the whole of what the principal debtor owes, including interest, costs and charges, as the Illustration shows. He is not liable for more, and if the principal debt is reduced his liability is reduced with it.
Co-extensive in character. If the principal debt is void or unenforceable, there is in principle nothing to guarantee. Where the principal debt is merely time-barred, however, the surety's liability is not automatically extinguished, because limitation bars the remedy against the principal debtor and not the debt itself, and the guarantee is a separate contract with its own period.
Subject to a contract to the contrary. The parties may limit the surety's liability to a stated amount, to a period, or to particular transactions, and most commercial guarantees do.

4.1 The creditor need not proceed against the principal debtor first

📖 Bank of Bihar Ltd. v. Damodar Prasad, AIR 1969 SC 297

Facts: A bank sued the principal debtor and the surety and obtained a decree. The trial court directed that the bank should not enforce the decree against the surety until it had exhausted its remedies against the principal debtor, and the High Court upheld that direction. The bank appealed.

Held: The Supreme Court set aside the direction. The liability of the surety is immediate and is co-extensive with that of the principal debtor under Section 128; it is not deferred until the creditor has exhausted his remedies against the principal debtor. The Court observed that the very object of a guarantee is defeated if the creditor is asked to postpone his remedies against the surety, and that a guarantee is a device for securing prompt payment. In the absence of a contract to the contrary, the creditor may proceed against the surety without first suing the principal debtor.

Ratio: The surety's liability under Section 128 is immediate and unconditional on the principal debtor's default. The creditor is not bound to exhaust his remedies against the principal debtor, or to sue him at all, before proceeding against the surety.

📖 State Bank of India v. Indexport Registered, (1992) 3 SCC 159

Facts: A bank granted a packing credit facility to a firm. One partner created an equitable mortgage of his shop as security and a third person executed a deed of guarantee. The bank obtained a composite decree, both a money decree against all the defendants personally and a mortgage decree against the mortgaged shop. In execution the bank proceeded first against the guarantor, who objected that the mortgaged property should be sold first.

Held: The Supreme Court held that the decree-holder was entitled to execute against the guarantor first. The liability of the guarantor is co-extensive with that of the principal debtor, and a guarantor can be sued without even suing the principal debtor. There is no principle requiring the creditor to proceed against the mortgaged property before enforcing the personal decree against the surety, and the executing court cannot go behind the decree to impose such a condition.

Ratio: A creditor holding both a security and a guarantee may enforce them in any order. The surety cannot insist that the security be realised first, and a decree may be executed against him without recourse to the principal debtor or to the mortgaged property.

The three parties, the three contracts, and the governing sections

5. Kinds of Guarantee

Kind	Description	Governing provision or principle
Specific or simple guarantee	Covers a single transaction or a defined obligation, and is exhausted when it is performed	Section 126, and the contrast in Illustration (c) to Section 129
Continuing guarantee	Extends to a series of transactions and is not exhausted by payment of any one of them	Sections 129 to 131
Conditional guarantee	Liability arises only on the happening of a further condition, such as another surety joining	Section 144, and the general law of contingent contracts
Retrospective guarantee	Given for an existing debt	Section 127, and Illustration (b): a past debt alone is not consideration
Prospective guarantee	Given for a debt to be incurred in future	Section 127, Illustration (a)
Bank guarantee, performance or financial	An undertaking by a bank, usually payable on demand and independent of the underlying contract	Governed by its own terms; the courts restrain encashment only in cases of established fraud or special equities

6. Guarantee Compared with Indemnity

Parties. A guarantee has three; an indemnity has two.
Nature of liability. The surety's is secondary and arises on the principal debtor's default; the indemnifier's is primary and independent.
A prior obligation. A guarantee presupposes one; an indemnity does not.
Rights on payment. Section 140 gives the surety subrogation and Section 145 an implied indemnity from the principal debtor; the Act gives the indemnifier no equivalent.
Effect of the principal obligation being void. A guarantee has nothing to attach to and generally fails; an indemnity stands on its own footing.

7. The Position Stated Shortly

Section 126 defines a guarantee as a contract to perform the promise or discharge the liability of a third person in case of his default, and names the three parties.
A guarantee may be oral or written, the Statute of Frauds having been abolished for India.
A principal obligation must exist or be contemplated; without one there is nothing to guarantee.
Section 127 makes anything done or promised for the benefit of the principal debtor sufficient consideration for the surety.
A past debt alone is not consideration, per Illustration (b), but forbearance to sue or an extension of time at the surety's request is.
Section 128 makes the surety's liability co-extensive with the principal debtor's, in amount and in character, subject to a contract to the contrary.
Bank of Bihar v. Damodar Prasad: the creditor need not exhaust his remedies against the principal debtor before proceeding against the surety.
SBI v. Indexport: a creditor holding both a security and a guarantee may enforce them in any order, and may execute against the guarantor first.
A guarantee differs from an indemnity in the number of parties, the character of the liability, the need for a prior obligation, and the rights conferred by Sections 140 and 145.

8. Related Topics and Provisions

Topic or provision	Connection
Continuing Guarantee under Sections 129 to 131	Revocation and the effect of the surety's death
Discharge of the Surety	Sections 133 to 139 and 142 to 144
Rights of the Surety under Sections 140 to 147	Subrogation, securities and contribution
Contract of Indemnity under Sections 124 and 125	The two-party comparison
Sections 126 to 128, Indian Contract Act	Definition, consideration and co-extensive liability
Section 2(d), Indian Contract Act	Consideration moving from any other person
Sections 11 and 12, Indian Contract Act	Capacity, and why a minor cannot be a surety
Sections 142 and 143, Indian Contract Act	Guarantee obtained by misrepresentation or concealment