A contract of guarantee is a type of contract in which one party (the guarantor) undertakes to fulfill the obligations of another party (the principal debtor) towards a third party (the creditor) in the event that the principal debtor fails to do so. In other words, the guarantor provides a promise to the creditor that they will be paid or their debt will be fulfilled, in the event that the principal debtor defaults.
Contracts of guarantee are a way for parties to provide assurance to a creditor that a debt or obligation will be fulfilled, even in case of default by the principal debtor. The Indian Contract Act contains various provisions related to contracts of guarantee, which define the scope of liability, the rights and duties of the parties, and the termination of the contract.
The Indian Contract Act, 1872 contains various provisions related to contracts of guarantee. Some of the key provisions are as follows:
- Definition: Section 126 of the Indian Contract Act defines a contract of guarantee as “a contract to perform the promise, or discharge the liability, of a third person in case of his default.”
- Parties: A contract of guarantee involves three parties – the creditor, the principal debtor, and the guarantor. The creditor is the person to whom the principal debtor owes a debt or obligation. The principal debtor is the person who is primarily responsible for fulfilling the obligation, and the guarantor is the person who provides a promise to the creditor to fulfill the obligation in case the principal debtor defaults.
- Types of guarantees: There are two types of guarantees – specific guarantees and continuing guarantees. A specific guarantee is a guarantee for a specific debt or obligation, while a continuing guarantee is a guarantee for all debts or obligations incurred by the principal debtor up to a certain limit.
- Consideration: Like any other contract, a contract of guarantee requires consideration from the parties involved. The consideration may be in the form of a fee or commission paid by the principal debtor to the guarantor for providing the guarantee.
- Liability of the guarantor: The liability of the guarantor is secondary to that of the principal debtor. In other words, the creditor must first exhaust all legal remedies against the principal debtor before making a claim against the guarantor.
- Rights of the guarantor: The guarantor has the right to insist on the creditor taking all necessary steps to recover the debt from the principal debtor before making a claim against the guarantor. The guarantor also has the right to be indemnified by the principal debtor in case they have to fulfill the obligation.
- Termination: A contract of guarantee terminates when the obligation has been fulfilled or the creditor releases the guarantor from their obligation.
Contract of Pledge
A contract of pledge is a type of contract in which a person (the pledgor) deposits his/her goods or securities with another person (the pledgee) as security for a debt or obligation owed by the pledgor to the pledgee. The pledgee has the right to retain the goods or securities until the debt is repaid or the obligation is fulfilled.
The Indian Contract Act, 1872 contains various provisions related to contracts of pledge. Some of the key provisions are as follows:
- Definition: Section 172 of the Indian Contract Act defines a contract of pledge as “the bailment of goods as security for payment of a debt or performance of a promise.”
- Parties: A contract of pledge involves two parties – the pledgor and the pledgee. The pledgor is the person who deposits the goods or securities, while the pledgee is the person who receives the deposit as security.
- Consideration: Like any other contract, a contract of pledge requires consideration from the parties involved. The consideration may be in the form of a loan or credit extended by the pledgee to the pledgor.
- Delivery of goods: In order for a contract of pledge to be valid, the pledgor must deliver the goods or securities to the pledgee. The goods must be in the possession of the pledgee or his/her agent, and must be returned to the pledgor when the debt is repaid or the obligation is fulfilled.
- Rights and duties of the parties: The pledgee has the right to retain the goods or securities until the debt is repaid or the obligation is fulfilled. The pledgee may also sell the goods or securities in case of default by the pledgor, and use the proceeds to repay the debt. The pledgor has the duty to repay the debt or fulfill the obligation, and may not claim the goods or securities until the debt is repaid or the obligation is fulfilled.
- Termination: A contract of pledge terminates when the debt is repaid or the obligation is fulfilled. The goods or securities must be returned to the pledgor in the same condition in which they were pledged, except for any wear and tear that may have occurred during the period of the pledge.
Contract of Guarantee and Pledge differences
| Contract of Guarantee | Contract of Pledge |
| In a contract of guarantee, a person (the guarantor) promises to be responsible for the debt or obligation of another person (the principal debtor). | In a contract of pledge, a person (the pledgor) deposits goods or securities with another person (the pledgee) as security for a debt or obligation. |
| The guarantor is not in possession of the goods or securities that are being used as collateral for the debt. | The pledgee is in possession of the goods or securities that are being used as collateral for the debt. |
| The guarantor’s liability is secondary to that of the principal debtor. If the principal debtor fails to pay the debt, the guarantor may be called upon to pay it. | The pledgee has the right to sell the goods or securities in case of default by the pledgor, and use the proceeds to repay the debt. |
| The guarantor does not have a right to the goods or securities being used as collateral for the debt. | The pledgor may reclaim the goods or securities once the debt is repaid or the obligation is fulfilled. |
| The guarantor’s liability is limited to the amount specified in the contract. | The pledgee’s right to the goods or securities extends to the full amount of the debt, including interest and costs. |
| A contract of guarantee is discharged by the payment or performance of the debt by the principal debtor. | A contract of pledge is discharged by the repayment of the debt or the fulfillment of the obligation, and the return of the goods or securities to the pledgor. |