Provision of Indian Contract Act applicable on Personal Guarantors under IBC and judicial pronouncements

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Decoding the Code

All about Personal Guarantor under IBC

Guarantees are usually taken to provide a second pocket to pay if the first should be empty.1

The Insolvency and Bankruptcy Code, 2016 (IBC) classifies individuals into three classes, namely, personal guarantors to Corporate Debtors, partnership firms and proprietorship firms, and other individuals, to enable implementation of individual insolvency in a phased manner.

The Central Government, vide notification S.O. 4126(E) dated 15th November, 2019, appointed 1st December, 2019 as the date for commencement of the provisions of the Code relating to personal guarantors to Corporate Debtors.

This part of the Decoding of Code decodes the provisions for Personal Guarantors in followings steps:

Part-I Provisions of Guarantee under the Indian Contract Act, 1872 and judicial pronouncements.
Part-II Provisions of Insolvency & Bankruptcy Code, 2016 applicable on personal guarantors with judicial pronouncements.
Part-III Insolvency Process for Personal Guarantors to Corporate Debtors.
Part-IV Bankruptcy Process for Personal Guarantors to Corporate Debtors.

Part-I

Provisions of Guarantee under Indian Contract Act, 1872
and
Judicial Pronouncements

Part-II→(Coming Soon)

The preamble to the Indian Contract Act, 1872 states that the Indian Contract Act, 1872 defines and amends certain parts of the law relating to contracts. The preamble therefore is an indication that, the Indian Contract Act, 1872 does not deal with the entirety of the law relating to contracts. There are other statutes governing the field of contracts such as the Specific Relief Act, 1963. The Indian Contract Act, 1872 is divided into 11 chapters. Chapter VIII of the Act deals with indemnity and guarantee.  Section 126 to 147 cover the guarantee. Provisions of guarantee under Indian Contract act are analysed in following points.

1. Definition of Guarantee & Contract of Guarantee

A general definition that a Guarantee is a promise by one person, who is called the ‘guarantor’ or ‘surety’ to answer for the present or future debt of another person who is called the ‘principal debtor’, such promise being made to the party to whom the principal debtor is, or will become, liable.

Section 126 of the Indian Contract Act, 1872 defines a contract of guarantee to be a contract to perform the promise, or discharge the liability of a third person in case of his default.

1.1 Parties in the Contract of Guarantee

As per section 126, 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”. So, a contract of guarantee has three parties:

 

1.2 Oral or Written Guarantee & sign of surety on the contract

As per Section 126, a guarantee may be either oral or written.

Mere omission of sign on the agreement cannot absolve him from his liability as the guarantor:

In P.J. Rajappan v Associated Industries (P) Ltd. the guarantor, having not signed the contract of guarantee, wanted to wriggle out of the situation. He contended that he did not stand surety for the performance of the contract. Evidence showed involvement of the guarantor in the deal, having promised to sign the instrument later. The Kerala High Court held that a contract of guarantee is a tripartite agreement, involving the principal debtor, surety and the creditor. In a case where there is an evidence of involvement of the guarantor, the mere failure on his part in not signing the agreement is not sufficient to demolish otherwise acceptable evidence of his involvement in the transaction leading to the conclusion that he guaranteed the due performance of the contract by the principal debtor. When a court has to decide whether a person has actually guaranteed the due performance of the contract by the principal debtor all the circumstances concerning the transactions will have to be necessarily considered. Court cannot adopt a hyper technical attitude that the guarantor has not signed the agreement and so he cannot be saddled with the liability. Due regard has to be given to the relative position of the contracting parties and to the entire circumstances which led to the contract.

In Mathura Das vs. Secretary of State, Allahabad High Court held that A contract of indemnity or a contract of guarantee may be created either by parol or by a written instrument. A contract of guarantee need not necessarily be in writing; it may be express, by words of mouth, or it may be tacit or implied and may be inferred from the course of conduct of the parties concerned.

1.3 Invalid Guarantee

a. Obtained by misrepresentation: As per Section 142, any guarantee which has been obtained by means of misrepresentation made by the creditor, or with his knowledge and assent, concerning a material part of the transaction, is invalid.

b. Obtained by concealment: Any guarantee which the creditor has obtained by means of keeping silence as to material circumstances, is invalid. [Sec. 143]

c. Invalid if that other person does not join: As per section 144, 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.

1.4 Continuing Guarantee

A guarantee which extends to a series of transactions, is called a “continuing guarantee” as per section 129.

a. Revocation of continuing guarantee: A continuing guarantee may at any time be revoked by the surety, as to future transactions, by notice to the creditor.[Sec. 130].

b. Revocation of continuing guarantee by surety’s death: Section 131 provides that the death of the surety operates, in the absence of any contract to the contrary, as a revocation of a continuing guarantee, so far as regards future transactions.

 

2. Consideration for Guarantee

As per section 127 of the Contract Act, 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. That is the creditor must have done some thing for the benefit of the principal debtor to sustain the validity of a contract of guarantee.

Whether the benefit is given at the time of the execution of the guarantee or even a past benefit can constitute a valid consideration for the sustenance of such an engagement. In Ram Narain v Lt. Col. Hari Singh, Rajasthan High Court held that that anything done or any promise made for the benefit of the principal debtor must be contemporaneous to the surety’s contract of guarantee in order to constitute consideration therefor. A contract of guarantee executed afterwards without any consideration is void.

 

3. Surety’s liability

Section 128 of the Indian Contract Act stipulates that the liability of the surety is co-extensive with that of the principal debtor, unless it is otherwise provided by the contract.

The onus is on the surety to establish that, the contract of guarantee provided anything to diminish the liability of the surety under the contract of guarantee excepting the liability of the surety being coextensive as that of the company.

The Supreme Court in Maharashtra State Electricity Board that the fact that the company which is the principal debtor has gone into liquidation would not have any effect on the liability of the guarantor. In the facts of that case, a company in respect of which a bank issued a guarantee in favour of the Electricity Board, went into liquidation. The Supreme Court held t hat the liability is absolute and unconditional. The fact that the Company in liquidation i.e. the principal debtor has gone into liquidation also would not have any effect on the liability of the Bank i.e. the guarantor. Under section 128 of the Indian Contract Act, the liability of the surety is co-extensive with that of the principal debtor unless it is otherwise provided by the contract. A surety is no doubt discharged under section 134 of the Indian Contract Act by any contract between the creditor and the principal debtor by which the principal debtor is released or by any act or omission of the creditor, the legal consequence of which is the discharge of the principal debtor. But a discharge which…….Read more.

References

1 Wood Security and Guarantees 313.

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