Guarantee

A contract of guarantee is defined in Section 126 of the ICA as a contract to perform the promise, or discharge the liability, of a third person in case of their default. The three parties to a contract of guarantee are: (1) the surety (also called guarantor) — who gives the guarantee; (2) the principal debtor — whose obligation is being guaranteed; and (3) the creditor — in whose favour the guarantee is given. The surety's obligation is secondary and collateral — it arises only on the principal debtor's default. The primary obligation remains with the principal debtor; the surety steps in only when the principal debtor fails to perform.

The key incidents of a contract of guarantee under the ICA: (1) Section 128 — the surety's liability is co-extensive with that of the principal debtor unless otherwise provided by the contract; the surety can be sued for the same amount for which the principal debtor is liable; (2) Section 129 — a 'continuing guarantee' extends to a series of transactions; it can be revoked (for future transactions) by the surety by notice to the creditor; (3) Section 130 — revocation of continuing guarantee — where a surety revokes, they remain liable for transactions already entered into before revocation; (4) Section 133 — the surety is discharged where the creditor varies the terms of the contract with the principal debtor without the surety's consent; and (5) Section 140 — on payment or performance, the surety is subrogated to the creditor's rights against the principal debtor.

Bank guarantees are instruments governed by these principles but with a significant commercial modification — bank guarantees are generally 'unconditional and payable on demand.' The Supreme Court in Hindustan Steel Workers Construction Ltd. v. G.S. Atwal & Co. (1995) recognised that bank guarantees are autonomous undertakings — the bank's obligation to pay on demand is independent of the underlying contract between the parties. Courts will not ordinarily restrain payment under a bank guarantee merely because the underlying contract is disputed — only fraud or irretrievable injustice justifies restraining a bank guarantee payment.

The surety's right of subrogation under Section 140 ICA is one of the most important rights of a surety: on paying off the creditor's claim (whether as direct payment or by allowing the creditor to appropriate a security), the surety is entitled to stand in the creditor's shoes and sue the principal debtor for the full amount paid. This right of subrogation enables sureties to recover from the party who is ultimately liable. In banking, when a corporate guarantor pays off a bank guarantee, the guarantor is subrogated to the bank's rights against the borrower — including the right to enforce any security the bank held.

For advocates, guarantee law is central to: (1) banking matters — enforcing personal guarantees from directors and promoters of corporate borrowers; (2) construction contracts — where parent company guarantees are common for performance; (3) commercial contracts — where advance payment guarantees and performance guarantees are standard; and (4) discharge of sureties — whether a variation of the principal debtor's contract (restructuring, moratorium, change in interest rate) without the guarantor's consent has discharged the guarantee.