Section 126 of Indian Contract Act 1872 defines a contract of

guarantee as follows: "A contract of guarantee is a contract to perform

the promise, or to discharge the liabilities of a third person in case of his
default. The person who gives the guarantee is called Surety, the person
in respect of whose default the guarantee is given is called Principal
Debtor, and the person to whom the guarantee is given is called
Creditor. A Guarantee may be either oral or written."
For example, when A promises to a shopkeeper C that A will pay for the
items being bought by B if B does not pay, this is a contract of
guarantee. In this case, if B fails to pay, C can sue A to recover the
balance.  The same was held in the case of Birkmyr vs Darnell 1704,
where the court held that when two persons come to a shop, one person
buys, and to give him credit, the other person promises, "If he does not
pay, I will", this type of a collateral undertaking to be liable for the
default of another is called a contract of guarantee.

A contract of guarantee has the following essential elements - 

1. Existance of Creditor, Surety, and Principal Debtor - The

economic function of a guarantee is to enable a credit-less person to get
a loan or employment or something else. Thus, there must be a principal
debtor for a recoverable debt for which the surety is liable in case of the
default of the principal debtor. 
In the case of Swan vs Bank of Scotland 1836, it was held that a
contract of guarantee is a tripartite agreement between the creditor, the
principal debtor, and the surety.
2. Distinct promise of surety - There must be a distinct promise by the
surety to be answerable for the liability of the Principal Debtor.
3. Liability must be legally enforceable - Only if the liability of the
principal debtor is legally enforceable, the surety can be made liable. For
example, a surety cannot be made liable for a debt barred by statute of
limitation.

4. Consideration - As with any valid contract, the contract of guarantee

also must have a consideration.  The consideration in such contract is
nothing but anything done or the promise to do something for the benefit
of the principal debtor. Section 127 clarifies this as follows:
"Anything done or any promise made for the benefit of the principal
debtor may be sufficient consideration to the surety for giving the
guarantee."
Illustrations:
    1. A agrees to sell to B certain goods if C guarantees the payment of
the price of the goods. C promises to guarantee the payment in
consideration of A's promise to deliver goods to B. This is a sufficient
consideration for C's promise.
    2. A sells and delivers goods to B. Later on, C, without any
consideration, promises to pay A if B fails to pay. The agreement is void
for lack of consideration.
{However, there is no uniformity on the issue of past consideration.  In
the case of Allahabad Bank vs S M Engineering Industries 1992 Cal
HC, the bank was not allowed to sue the surety in absence of any
advance payment made after the date of guarantee. But in the case
of Union Bank of India vs A P Bhonsle 1991 Mah HC, past debts
were also held to be recoverable under the wide language of this section.
In general, if the principal debtor is benefitted as a result of the
guarantee, it is sufficient consideration for the sustenance of the
guarantee.}
5. It should be without misrepresentation or concealment - Section
142specifies that a guarantee obtained by misrepresenting facts that are
material to the agreement is invalid, and section 143 specifies that a
guarantee obtained by concealing a material fact is invalid as well.
Illustrations – 
1. A appoints B for collecting bills. B fails to account for some of the
bills. A asks B to get a guarantor for further employment. C
guarantees B's conduct but C is not made aware of B previous mis-
accounting by A. B, afterwards, defaults. C cannot be held liable.
2. {A promises to sell Iron to B if C guarantees payment. C
guarantees payment however, C is not made aware of the fact that
A and B had contracted that B will pay 5 Rs higher that the market
prices. B defaults. C cannot be held liable.}
In the case of London General Omnibus vs Holloway 1912, a
person was invited to guarantee an employee, who was previously
dismissed for dishonesty by the same employer. This fact was not
told to the surety. Later on, the employee embezzled funds but the
surety was not held liable.

Continuing Guarantee: As per section 129, a guarantee

which extends to a series of transactions is called a continuing
guarantee.
Illustrations –
1. A, in consideration that B will employ C for the collection of
rents of B's zamindari, promises B to be responsible to the amount
of 5000/- for due collection and payment by C of those rents. This
is a continuing guarantee.
2. A guarantees payment to B, a tea-dealer, for any tea that C may
buy from him from time to time to the amount of Rs 100.
Afterwards, B supplies C tea for the amount of 200/- and C fails to
pay. A's guarantee is a continuing guarantee and so A is liable for
Rs 100.
3. A guarantees payment to B for 5 sacks of rice to be delivered by
B to C over a period of one month. B delivers 5 sacks to C and C
pays for it. Later on B delivers 4 more sacks but C fails to pay. A's
guarantee is not a continuing guarantee and so he is not liable to
pay for the 4 sacks.
Thus, it can be seen that a continuing guarantee is given to allow
multiple transactions without having to create a new guarantee for
each transaction. In the case of Nottingham Hide Co vs Bottrill
1873, it was held that the facts, circumstances, and intention of
each case has to be looked into for determining if it is a case of
continuing guarantee or not.

Revocation of Continuing Guarantee

1. As per section 130, a continuing guarantee can be revoked at
any time by the surety by notice to the creditor. 
Once the guarantee is revoked, the surety is not liable for any
future transaction however he is liable for all the transactions
that happened before the notice was given.
Illustrations – 
1. A promises to pay B for all groceries bought by C for a
period of 12 months if C fails to pay. In the next three
months, C buys 2000/- worth of groceries. After 3 months,
A revokes the guarantee by giving a notice to B. C further
purchases 1000 Rs of groceries. C fails to pay. A is not
liable for 1000/- rs of purchase that was made after the
notice but he is liable for 2000/- of purchase made before
the notice.
 2. This illustration is based on the old English case
of Oxford vs Davies. 
In the case of Lloyd's vs Harper 1880, it was held that
employment of a servant is one transaction. The guarantee
for a servant is thus not a continuing guarantee and cannot
be revoked as long as the servant is in the same
employment. However, in the case of Wingfield vs De St
Cron 1919, it was held that a person who guaranteed the
rent payment for his servant but revoked it after the
servant left his employment was not liable for the rents
after revocation.
3. A guarantees to B, to the amount of 10000 Rs, that C shall
pay for the bills that B may draw upon him. B draws upon
C and C accepts the bill. Now, A revokes the guarantee. C
fails to pay the bill upon its maturity. A is liable for the
amount upto 10000Rs.
2. As per section 131, the death of the surety acts as a revocation of a
continuing guarantee with regards to future transactions, if there is no
contract to the contrary.
It is important to note that there must not be any contract that keeps the
guarantee alive even after the death. In the case of Durga Priya vs
Durga Pada AIR 1928, Cal HC held that in each case the contract of
guarantee between the parties must be looked into to determine whether
the contract has been revoked due to the death of the surety or not. If
there is a provision that says death does not cause the revocation then the
contract of guarantee must be held to continue even after the death of the
surety.

NATURE OF SURETY:- Section 128 surety liability is co-

extensive with that of the principal debtor which means that on a default
having been made by the principal debtor the creditor can recover from
surety the all what he could have recovered from the principal debtor.
Example:- The principal debtor makes a default in the payment of a
debt of Rs.10,000.00, the Creditor may recover from the surety the sum
of Rs.10000/- plus interest becoming due thereon as well as the amount
spent by him in recovering that amount.
LIABILITY OF SURETY:- A bare perusal of section 128 of the
Contract Act would make it clear that the liability of a surety is co-
extensive with that of he principal debtor. The word co-extensive
denotes that extent and can relate only to quantum of the principal debt.
Refer a case of Industrial Financial Corporation of India v/s Kannur
Spinning & Weaving Mills Ltd, 2002: However the liability of the
surety does not cease merely because of discharge of the principal debtor
from liability.
Bank of Bihar Ltd. v/s Damodar Prasad, 1969: The Supreme
Court held that the liability of the surety is immediate and cannot be
defended until the creditor has exhausted all his remedies against the
principal debtor.Maharashtra Electricity Board Bombay v/s Official
Liquidator and Another, 1982: under a letter of guarantee the bank
undertook to pay any amount not exceeding Rs.50000/- to the Electricity
Board. It was held that the Bank is bound to pay the amount due under
the letter of guarantee given by it to the Board.

Rights of the Surety

A contract of guarantee being a contract, all rights that are available to
the parties of a contract are available to a surety as well. The following
are the rights specific to a contract of guarantee that are available to the
surety.

Rights against principal debtor

1. Right of Subrogation
As per section 140, where a guaranteed debt has become due or
default of the principal debtor to perform a duty has taken place,
the surety, upon payment or performance of all that he is liable for,
is invested with all the rights which the creditor had against the
principal debtor. This means that the surety steps into the shoes of
the creditor.  Whatever rights the creditor had, are now available to
the surety after paying the debt.
In the case of Lampleigh Iron Ore Co Ltd, Re 1927, the court
has laid down that the surety will be entitled, to every remedy
which the creditor has against the principal debtor; to enforce
every security and all means of payment; to stand in place of the
creditor to have the securities transferred in his name, though there
was no stipulation for that; and to avail himself of all those
securities against the debtor. This right of surety stands not merely
upon contract but also upon natural justice.
In the case of Kadamba Sugar Industries Pvt Ltd vs Devru
Ganapathi AIR 1993, Kar HC held that surety is entitled to the
benefits of the securities even if he is not aware of their existence.

In the case of Mamata Ghose vs United Industrial Bank AIR

1987, Cal HC held that under the right of subrogation, the surety
may get certain rights even before payment. In this case, the
principal debtor was disposing off his personal properties one after
another lest the surety, after paying the debt, seize them. The
surety sought for temporary injunction, which was granted.

2. Right to Indemnity
As per section 145, in every contract of guarantee there is an
implied promise by the principal debtor to indemnify the surety;
and the surety is entitled to recover from the the principal debtor
whatever sum he has rightfully paid under the guarantee but no
sums which he has paid wrong fully.
Illustrations –
    B is indebted to C and A is surety for the debt. Upon default, C
sues A. A defends the suit on reasonable grounds but is compelled
to pay the amount. A is entitled to recover from B the cost as well
as the principal debt.
    In the same case above, if A did not have reasonable grounds for
defence, A would still be entitled to recover principal debt from B
but not any other costs.
    A guarantees to C, to the extent of 2000 Rs, payment of rice to
be supplied by C to B. C supplies rice to a less amount than 2000/-
but obtains from A a payment of 2000/- for the rice. A cannot
recover from B more than the price of the rice actually suppied.

This right enables the surety to recover from the principal debtor
any amount that he has paid rightfully. The concept of rightfully is
illustrated in the case of Chekkara Ponnamma vs A S
Thammayya AIR 1983. In this case, the principal debtor died
after hire-purchasing four motor vehicles. The surety was sued and
he paid over. The surety then sued the legal representatives of the
principal debtor. The court required the surety to show how much
amount was realized by selling the vehicles, which he could not
show. Thus, it was held that the payment made by the surety was
not proper.
Rights against creditor
1. Right to securities
As per section 141, a surety is entitled to the benefit of every
security which the creditor has against the principal debtor at the
time when the contract of suretyship is entered into whether the
surety knows about the existance of such securty or not; and if
the creditor loses or without the consent of the surety parts with
such security, the surety is discharged to the extent of the value
of the security.
Illustrations - 
    C advances to B, his tenant, 2000/- on the guarantee of A. C
also has a further security for 2000/- by a mortgage of B's
furniture. C cancels the mortgage. B becomes insolvent and C
sues A on his guarantee. A is discharged of his liability to the
amount of the value of the furniture.
    C, a creditor, whose advance to B is secured by a decree, also
receives a guaratee from A. C afterwards takes B's goods in
execution under the decree and then without the knowledge of
A, withdraws the execution. A is discharged.
A as surety for B makes a bond jointly with B to C to secure a
loan from C to B. Afterwards, C obtains from B a further
security for the same debt. Subsequently, C gives up the further
security. A is not discharged.
This section recognizes and incorporates the general rule of
equity as expounded in the case of Craythorne vs Swinburne
1807 that the surety is entitled to every remedy which the
creditor has agains the principal debtor including enforcement
of every security.
The expression "security" in section 141 means all rights which
the creditor had against property at the date of the contract. This
was held by the SC in the case of State of MP vs Kaluram
AIR 1967. In this case, the state had sold a lot of felled trees for
a fixed price in four equal installments, the payment of which
was guaranteed by the defendent. The contract further provided
that if a default was made in the payment of an installment, the
 State would get the right to prevent further removal of timber
and the sell the timber for the the realization of the price. The
buyer defaulted but the State still did not stop him from
removing further timber. The surety was then sued for the loss
but he was not held liable.
It is important to note that the right to securities arises only after
the creditor is paid in full. If the surety has guaranteed only part
of the debt, he cannot claim a proportional part of the securities
after paying part of the debt. This was held in the case
of Goverdhan Das vs Bank of Bengal 1891.

2. Right of set off

If the creditor sues the surety, the surety may have the benefit of
the set off, if any, that the principal debtor had against the
creditor. He is entitled to use the defences that the principal
debtor has against the creditor. For example, if the creditor owes
the principal debtor something, for which the principal debtor
could have counter claimed, then the surety can also put up that
counter claim.

Rights against co-sureties

1. Effect of releasing a surety
As per section 138, where there are co-sureties, a release by
the creditor of one of them does not discharge the others;
neither does it free the surety so released from his
responsibility to the other sureties. 
A creditor can release a co-surety at his will. However, as
held in the case of Sri Chand vs Jagdish Prashad 1966, the
released co-surety is still liable to the others for contribution
upon default.
2. Right to contribution
As per section 146, where two or more persons are co-
sureties for the same debt jointly or severally, with or without
the knowledge of each other, under same or different
contract, in the absence of any contract to the contrary, they
are liable to pay an equal share of the debt or any part of it
that is unpaid by the principal debtor.
Illustrations – 
A, B, and C are sureties to D for a sum of 3000Rs lent to E. E
fails to pay. A, B, and C are liable to pay 1000Rs each.

    A, B, and C are sureties to D for a sum of 1000Rs lent to E

and there is a contract among A B and C that A and B will be
liable for a quarter and C will be liable for half the amount
upon E's default. E fails to pay. A and B are liable for 250Rs
each and C is liable for 500Rs.
As per section 147, co-sureties who are bound in different
sums are liable to pay equally as far as the limits of their
respective obligations permit.
Illustrations - 
    A, B and C as sureties to D, enter into three several bonds,
each in different penalty, namely A for 10000Rs, B for 20000
Rs, and C for 30000Rs with E. D makes a default on
30000Rs. All of them are liable for 10000Rs each.

    A, B and C as sureties to D, enter into three several bonds,

each in different penalty, namely A for 10000Rs, B for 20000
Rs, and C for 40000Rs with E. D makes a default on
40000Rs. A is liable for 10000Rs while B and C are liable for
15000Rs each.
    A, B and C as sureties to D, enter into three several bonds,
each in different penalty, namely A for 10000Rs, B for 20000
Rs, and C for 40000Rs with E. D makes a default on
70000Rs. A, B and C are liable for the full amount of their
bonds.

Discharge of Surety
A surety is said to be discharged from liability when his
liability comes to an end. Indian Contract Act 1872 specifies
the following conditions in which a surety is discharged of
his liability – 
1. Section 130 - By a notice of revocation -  discussed above.
2. Section 131 - By death of surety -  discussed above.
3. Section 133 - By variance in terms of contract - A
variance made without the consent of the surety in terms of
the contract between the principal debtor and the creditor,
discharges the surety as to the transactions after the variance.

Illustrations – 
    A becomes a surety to C for B's conduct as manager in C's
bank. Afterwards, B and C contract without A's consent that
B's salary shall be raised and that B shall be liable for 1/4th
of the losses on overdrafts. B allows a customer to overdraft
and the bank loses money. A is not liable for the loss.

B appoints C as a salesperson on a fixed yearly salary upon

A's guarantee on due account of sales by C. Later on, without
A's consent, B and C contract that C will be paid on
commission basis. A is not liable for C's misconduct after the
change.
In Anirudhan vs. Thomco’s Bank, 1963 it was held that
when the alteration is to the benefit of the surety, that is not a
material alteration. Such an alteration is unsubstantial and
that does not discharge the surety from liability.
4. Section 134 - By discharge of principal debtor - The
surety is discharged by any contract between the creditor and
the principal debtor by which the principal debtor is
discharged; or by any action of the creditor the legal
consequence of which is the discharge of the principal
debtor.

Illustrations
    A gives a guarantee to C for goods to be delivered to B.
Later on, B contracts with C to assign his property to C in
lieu of the debt. B is discharged of his liability and A is
discharged of his liability.

    A contracts with B to grow indigo on A's land and deliver

it to B at a fixed price. C guarantees A's performance. B
diverts a stream of water that is necessary for A to grow
indigo. This action of B causes A to be discharged of the
liability. Consequently C is discharged of his suretyship as
well.

    A contracts with B to build a house for B. B is to supply

timber. C guarantees A's performance. B fails to supply
timber. C is discharged of his liability.
If the principal debtor is released by a compromise with the
creditor, the surety is discharged but if the principal debtor is
discharged by the operation of insolvency laws, the surety is
not discharged. This was held in the case of Maharashtra
SEB vs Official Liquidator 1982.
5. Section 135 - By composition, extension of time, or
promise not to sue - A contract between the principal debtor
and the creditor, by which the creditor makes a composition
with, or promises to give time to, or promises to not sue the
principal debtor, discharges the surety unless the surety
assents to such a contract.
It should be noted that as per section 136, if a contract is
made by the creditor with a third person to give more time to
the principal debtor, the surety is not discharged. However, in
the case of Wandoor Jupitor Chits vs K P Mathew AIR
1980, it was held that the surety was not discharged when the
period of limitation got extended due to acknowledgement of
debt by the principal debtor.
Further, as per section 137, mere forbearance to sue or to not
make use of any remedy that is available to the creditor
against the principal debtor, does not automatically discharge
the surety.
Illustration - 
    B owes C a debt guaranteed by A. The debt becomes
payable. However, C does not sue B for a year. This does not
discharge A from his suretyship.
It must be noted that forbearing to sue until the expiry of the
period of limitation has the legal consequence of discharge of
the principal debtor and thus as per section 134, will cause
the surety to be discharged as well. If section 134 stood
alone, this inference was correct. However, section 137
explicitly says that mere forbearance to sue does not
discharge the surety. This contradiction was removed in the
case of Mahanth Singh vs U B Yi by Privy Council. It held
that failure to sue the principal debtor until recovery is
banned by period of limitation does not discharge the surety.

6. Section 139 -  By imparing surety's remedy - If the

creditor does any act that is inconsistent with the rights of the
surety or omits to do an act which his duty to surety requires
him to do, and the eventual remedy of the surety himself
against the principal debtor is thereby impaired, the surety is
dischared.

Illustrations – 
    C contracts with B to build a ship the payment of which is
to be made in installments at various stages of completion. A
guarantee's C's performance. B prepays last two installments.
A is discharged of his liability.

    A appoints M as an apprentice upon getting a guarantee of

M's fidelity by B. A also promises that he will at least once a
month see M make up the cash. A fails to do this. M
embezzeles. B is discharged of his suretyship.

    A lends money to B with C as surety. A also gets as a

security the mortgate to B's furniture. B defaults and A sells
his furniture. However, due to A's carelessness very small
amount is received by sale of the furniture. C is discharged of
the liability.
State of MP vs Kaluram - Discussed above.
In the case of State Bank of Saurashtra vs Chitranjan
Ranganath Raja 1980, the bank failed to properly take care
of the contents of a godown pledged to it against a loan and
the contents were lost. The court held that the surety was not
liable for the amount of the goods lost.
Creditor's duty is not only to take care of the security well but
also to realize it proper value.  Also, before disposing of the
security, the surety must be informed on the account of
natural justice so that he can have the option to take over the
security by paying off the debt. In the case of Hiranyaprava
vs Orissa State Financial Corp AIR 1995, it was held that
if such a notice of disposing off of the security is not given,
the surety cannot be held liable for the shortfall.

However, when the goods are merely hypothecated and are in

the custody of the debtor, and if their loss is not because of
the creditor, the surety is not discharged of his liability.

Extent of Surety's Liability

As per section 128, the liability of a surety is co-extensive
with that of the principal debtor, unless it is otherwise
provided in the contract.
Illustration - A guarantees the payment of a bill by B to C.
The bill becomes due and B fails to pay. A is liable to C not
only for the amount of the bill but also for the interest.
This basically means that although the liability of the surety
is co-extensive with that of the principal debtor, he may place
a limit on it in the contract. Co-extensive implies the
maximum extent possible. He is liable for the whole of the
amount of the debt or the promises. However, when part of a
debt was recovered by disposing off certain goods, the
liability of the surety is also reduced by the same amount.
This was held in the case of Harigopal Agarwal vs State
Bank of India AIR 1956.
The surety can also place conditions on his guarantee.
Section 144 says that where a person gives guarantee upon a
contract that the creditor shall not act upon it untill another
person has joined it as co-surety, the guarantee is not valid if
the co-surety does not join. In the case of National
Provincial Bank of England vs Brakenbury 1906, the
defendant signed a guarantee which was supposed to be
signed by three other co-sureties. One of them did not sign
and so the defendant was not held liable.
Similarly, a surety may specify in the contract that his
liability cannot exceed a certain amount.
However, where the liability is unconditional, the court
cannot introduce any conditions. Thus, in the case of Bank of
Bihar Ltd. vs Damodar Prasad AIR 1969, SC overruled
trial court's and high court's order that the creditor must first
exhaust all remedies against the principal debtor before suing
the surety.