According to Section 126 of Indian Contract Act, a contract of guarantee is a contract where a surety gives an undertaking to a creditor in respect of the payment default of a third person, principal debtor towards the creditor.
In essence, a contract of guarantee is where A promises B : “If C is liable to you and fails to pay you, I will pay you”
The consent of the surety regarding the transaction should not be obtained by any misrepresentation or concealment of any material facts concerning the situation. If the guarantee is obtained that way, it is invalid. The position explained under section 142 and section 143 as misrepresentation regarding the material fact should be made by the creditor and whether with his knowledge or assent. Also, if he kept silence to material facts.
According to the provisions, consent obtained to act as surety either by misrepresentation, or keeping silence as to material facts is invalid. Keeping silence as consider material facts, which could affect the surety’s mind to enter into the contract, would render the guarantee void. Also, every surety undertakes the risk of default so if the creditor is aware of circumstances which affect the risk, he should make the surety equally liable.
The Indian Contract Act, 1872 provides that a contract of guarantee can be rendered invalid under a particular set of situations. The Act considers contracts of guarantee as invalid which are made by willful misrepresentation and concealment. It also provides the presence of free consent of the contracting parties as a fundamental requirement in deciding the validity of a contract. Misrepresentation and Concealment defy the element of consent from the surety. Thus, the purpose behind providing nullity of a guarantee contract is justified. This provision also serves the purpose of guarding the surety from any form of exploitation that he may be subject to by purposeful misrepresentation and concealment.
When Section 142, Section 17 (Fraud) and Section 18 (Misrepresentation) of Indian Contract Act are read together, they hint at the presence of innocent and fraudulent misrepresentation. But in a contract of guarantee, the relevant section takes into account both misrepresentations by creditor himself and also that done with his assent. Hence, it suggests that the factor of intentionality is required for disqualification of a guarantee contract due to misrepresentation. If any material part of the transaction between the creditor and his debtor is misrepresented to the surety with the creditor’s knowledge or assent due to which surety might have entered into the contract or the surety’s liability might be increased, the security is void on the ground of fraud. The law also takes into account the situations where the responsibility is upon the creditor himself to keep the surety informed about material facts. Though, it is not inclusive of the situations where the surety can understand the facts on the basis of ordinary diligence. There exists a difference in situations where the creditor has a liability to disclose information to the surety and where the creditor exercises on the assumption of ordinary diligence of the surety. But, when the court decides on the extent of creditor’s duty as per the facts of the case, the contract of guarantee will be invalid irrespective of whether the misrepresentation was innocent or intentional.
Section 143 of Indian Contract Act states “Guarantee obtained by concealment, invalid.”[1] The section mentions that in a guarantee contract the expression keeping silent clearly implies intentional concealment and is different from mere non-disclosure (a kind of passive concealment) of facts. Thus, the possibility of passive concealment to be a vitiating factor for contract of guarantee is clearly ruled out.
It also provides that, if the creditor does not provide information regarding the material facts and circumstances affecting the transaction, it is not considered to be under the ambit of concealment unless surety seeks for information from the creditor. The creditor does not come under the ambit of concealment unless he actively conceals some facts related to the transaction between creditor and principal debtor.
The distinction between the mere non-disclosure of material facts and the area where active concealment begins is a situation similar to the one under Section 142, where it is not the creditor’s liability to disclose such information that can be understood by the surety on the basis of ordinary diligence. This section once again, hints at the question of the role and extent of silence in a guarantee contract.
In respect of creditor’s duty to disclose information to surety, it is found that such duty exists only to the extent of material facts which are likely to impact the surety’s entry into the contract. If such duty is breached by misrepresentation, irrespective of whether innocent or fraudulent and active concealment, it will invalidate the contract of guarantee. The creditor does have a duty to disclose information but the duty is not absolute. It is subjective and varies on a case-to-case basis. It depends on the material nature of such information which can likely affect the surety’s decision to enter into the contract. Section 142 and 143 as remedies for the benefit of the surety, discharge him of any liability that he might have falsely entered into based on misrepresentation and concealment by the creditor.
[1] . The Indian Contract Act, 1872(Act 9 of 1872), s.143
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