CONTRACT OF GUARANTEE - OBTAINED UNLAWFULLY

    

INTRODUCTION

According to Section 126 of Indian Contract Act 1872 the 'Contract of guarantee' is a contract to perform the promise or discharge the liability of a third person in case of his default. There are three parties involved in this transaction i.e.,the person who gives the guarantee namely 'surety', the person in respect of whose default the guarantee is given namely 'principal debtor'(The third person) and the person to whom the guarantee is given namely 'creditor'. 

Guarantee may be either oral or written.

Example of guarantee- 

A enters into the contract of guarantee with B that if she delivers the goods to C within the next 5 days, A himself will pay for this. Subsequently B delivers the goods to C in 5 days and then A pays for the goods.

This was a contract of guarantee and the consideration was the promise to pay for the goods when the order is complete. 

(Section 127 of Indian contract act, 1872- Consideration for guarantee)

CONTINUING GUARANTEE

According to section 129 of Indian Contract Act, 'Continuing guarantee' is the guarantee which extends to a series of transactions. 

It means that the guarantor will be liable for the obligation of contract to the creditor in default of principal debtor for a series of contracts which are made and renewed over time.

For example-

A enters into a contract of continuing guarantee with B that if she delivers the goods to C every 10 days, B will make the payments of goods when the delivery is fulfilled. Subsequently B delivers the goods to C every 5 days and A pays for them timely.

A enters into the contract of continuing guarantee with B to deliver the goods for Rs 1000 every month to C on payment made by A. C delivers goods in the first month and payment is made. For the second month, she delivers the goods for Rs 2000. Here the liability of A is to only the goods worth Rs 1000. 

GUARANTEE OBTAINED UNLAWFULLY

The Indian Contract Act 1872 renders the guarantee obtained through unlawful means like misrepresentation and concealment to be invalid. This protects the right of the surety from any such exploitative contracts. Since it is clearly stated in section 14 of Indian contract act that to enter into a legally valid contract, the free consent of the parties is required i.e., the consent that is not obtained by Coercion, undue influence, fraud (which constitutes active concealment) and misrepresentation. All of these are exploitative to the party to the contract and render the contract voidable. Thus it is important to declare the guarantee obtained through misrepresentation and concealment, invalid.

Section 142 and 143 of Indian Contract Act states the invalidity of guarantee obtained by misrepresentation and concealment respectively. 

GUARANTEE BY MISREPRESENTATION

According to Section 142 of Indian Contract Act 1872, any guarantee which has been obtained by the means of misrepresentation made by the creditor, or with his knowledge and assent, concerning a material part of the transaction is invalid.

This means that in case when the creditor with his full knowledge makes the misrepresentation of any material part of the contract to obtain a guarantee from the surety in default of the principal debtor, this kind of unlawful contract which lacks free consent, renders the said guarantee invalid. 

Important point to note here is that under section 17 and 18, both intentional and innocent misrepresentation are stated respectively. But the specific language in section 142 of ICA that said," knowledge and assent" point towards the specific intentionality of the creditor to misrepresent the terms of contract in order to obtain guarantee from the surety. 

For example- A obtains the guarantee from B in default of C that he will deliver high quality goods to C for which B will pay monthly. On the delivery of goods, it was found out that the goods are in fact low quality and A misrepresented the material fact about his products to enter into a contract of guarantee with B. 

This guarantee stands invalid due to the misrepresentation in the terms of contract by the creditor. 

In the case of Stone vs Compton [1] it was held that “if with the knowledge and assent of the creditor, any material part of the transaction between the creditor and his debtor is misrepresented to the surety, the misrepresentation being such that but for the same having taken place, either the suretyship would not have been entered into at all, or being entered into, the extent of the surety’s liability might be thereby increased, the security so given is void on the ground of fraud.”

In Hamilton vs Watson[2], it was held that a guarantee was not invalid due to non-disclosure of circumstances not forming a material part of the transaction, but which if disclosed might have deterred the surety from contracting. This was not an invalid guarantee. 

In the case of The Secretary of State of India vs Nilamekam Pillai[3], it was observed that "mere silence as to facts likely to affect the willingness of a person to enter into a contract is not fraud." Thus the guarantee obtained in such is valid.

On the other hand in the case of Railton vs Matthews [4], it was held that silence amounting to a fraudulent misrepresentation of circumstances, which would affect the willingness of the proposed surety to contract, invalidates the contract. 

This is very important to differentiate between the creditor's liability to disclose the material facts to the surety versus the exercise of right of silence by the creditor in assumption of due diligence of surety in a transaction. It is for the court to decide on the material facts of the case.

Thus any guarantee obtained through the active misrepresentation of the material facts of the contract renders the guarantee invalid in the eyes of law. 

GUARANTEE BY CONCEALMENT

According to Section 143 of Indian Contract Act 1872, any guarantee which the creditor has obtained by the means of keeping silence as to material circumstance, is invalid.

This means an active concealment of the material fact/s of a transaction between creditor and the principal debtor. The active concealment of the material fact has to be distinguished from the passive concealment or non disclosure. The passive concealment of the material facts of the transaction does not raise liability to the creditor as he has the right to remain silent unless the surety themselves ask about those specific facts. 

For example- A engages B as a clerk to collect money for him. B fails to account for some of his receipts, and A in consequence calls upon him to furnish security for his duly accounting. C gives his guarantee for B's duly accounting. A does not aquaint C with B's previous conduct. B afterwards makes default. The guarantee is invalid.[5] 

In the case of Balkrishna V. N. Kirtikar v. The Bank of Bengal (1891)[6], held that the expression "keeping silence" in Section 143 of the Contract Act clearly implies intentional concealment as distinguished from mere nondisclosure and the withholding must be fraudulent, as necessarily is the case when a material circumstance is intentionally concealed.

In the case of London General Omnibus Co Ltd v Holloway[7], The fidelity bond was given by A, a relative of B, without either the bus company( where B works) or B disclosing the fact that B had previously misappropriated money due to the bus company. The bus company then sued A to recover further sums misappropriated by B. 

It was held that “…where a surety to a fidelity bond was not told of the particular dishonesty of the employee the surety was not liable for a subsequent act of dishonesty of the employee.”

There is no hard and fast rule to determine what is material facts to a contract and what is not. It depends from case to case with different circumstances and hence it is for the court to determine whether there has been the concealment of material facts of the case i.e., some facts which could've changed the course of the transaction. 

CONCEPT OF UBERRIMA FIDES

The Latin maxim ' uberrima fides' means the utmost good faith i.e., The parties to the contract are responsible to disclose each in every detail of the contract to each other. This concept is generally used in insurance contracts. But the contract of guarantee does not employ the concept of uberrima fides', in fact it is quite contrary to this concept. 

One of the examples that shows that a contract of guarantee does not base off 'good faith' is the bank contract.

In case of Imperial Bank v Avinashi [8], it was observed that .“… a bank-agent is entitled to assume that the cautioner (surety) has informed himself upon the various matters material to the obligation he is about to undertake. The agent is not bound to volunteer any information or statement as to the accounts, although if information be asked he is bound to give it, and give it truthfully.” Moreover, it was also observed that "A guarantee will fail if the creditor misrepresents to the surety the state of accounts between the principal and himself. But a surety proposing to guarantee a banking account should inquire whether there is any adverse balance already existing; he is not entitled to assume there is not." [9]  

Thus it is not based upon the good faith of the creditor. He has the right to non-disclosure of facts in certain cases and the expectation of due diligence falls upon the surety. The contract of  guarantee is the antithesis of the concept of Uberrima fides. 

GUARANTEE INVALID DUE TO ABSENCE OF CO- SURETY

According to Section 144 of Indian Contract Act 1872, where a person gives a guarantee upon a contract that the creditor shall not act upon it until another person has joined in it as co-surety, the guarantee is not valid if that other person does not join.

This means that when a surety signs a guarantee upon a contract which specifically stipulates that the creditor cannot act upon it until and unless the co- surety has joined it. In case the co- surety never joins, the guarantee becomes invalid.

In case of Shri TS Vishwanathan vs Bank of Baroda [10], the facts of the case goes as- The respondent took the loan from the bank and soon became a defaulter. The bank sold off their properties to recover money. The petitioner, who was respondent before the Debts Recovery Appellate Tribunal, Chennai submitted before the court that he was only giving technical and professional support to the company in question and he had signed the Guarantee Agreement in good faith, particularly when the Bank made him to believe that the other facilities granted to the borrower company would be further secured by the personal guarantee to be obtained from the other Directors. The petitioner contends that the Bank having not done so, had misrepresented the matter and misled him.

The petitioner has particularly relied upon Section 144 of the Indian Contract Act, 1872 to argue that when he had given the guarantee only on the assurance that other persons would be joined as co-guarantors, his guarantee cannot be considered as valid when other persons were not so joined. 

Held- 

The plea was dismissed due to the terms of contract that petitioner agreed to i.e., "contract between the parties that the guarantee of the petitioner would not be affected by any other securities taken or held by the Bank or for the loss of any collateral or other securities or for Bank's failure to recover from the collateral securities or otherwise." 

https://thelegallock.com/final/contract-of-indemnity-section-124-125

CONCLUSION

Under contract act, the guarantee can be revoked in case of misrepresentation and concealment by the creditor. This is to safeguard the rights of surety against exploitative contracts. It also defeats the principle of free consent hence such guarantees stand invalid. 

[1]Stone v. Crompton, Case No. 1:11-cv-821 (W.D. Mich. Aug. 2, 2012)

[2]Hamilton v. Watson, 215 Ala. 550, 112 So. 115 (Ala. 1927)

[3]1937 5 ITR 424 Mad

[4](1844) 3 Bell 56

[5]Section 143, Indian Contract Act 1872, illustration (a).

[6](1891)ILR15BOM585

[7][1912] 2 KB 72, England and Wales

[8](1930) 59 MLJ 513

[9] Mr. Justice Rowlatt's work on Principal and Surety, p. 155. At page 154

[10] 8 June, 2018 Author: Chief Justice Dixit

https://indiankanoon.org/doc/605015/#:~:text=142.,of%20the%20transaction%2C%20is%20invalid.

Muskan Gupta

BBA LLB

GIBS (GGSIPU)