Practical Problems_Contract Act_86

X advances to Y Rs.10,000 on the guarantee of Z. The loan carries interest at ten percent per annum. Subsequently, Y becomes financially embarrassed. On Y’s request, X reduces the interest to six per cent per annum and does not sue Y for one year after the loan becomes due. Y becomes insolvent. Can X sue Z?

X cannot sue Z, because a surety is discharged from liability when, without his consent, the creditor makes any change in the terms of his contract with the principal debtor, no matter whether the variation is beneficial to the surety or does not materially affect the position of the surety.

Contract Act_Practicle Problems_72

C, the holder of an over due bill of exchange drawn by A as surety for B, and accepted by B, contract with X to give time to B, Is A discharged from his liability?

Where a contract to give time to the principal debtor is made by the creditor with a third person, and not with the principal debtor, the surely is not discharged. Accordingly, A is not discharged from his liability.

Contract Act Practicle Problems_71

A contracts with B for a fixed price to construct a house for B within a stipulated time. B would supply the necessary material to be used in the construction/ C guarantee A’s performance of the contract. B does not supply the material as per the agreement. IS C discharged from his liability?


The surely is discharged by any act or omission of the creditor, the legal consequence of which is the discharge of the principal debtor. Failure to supply the necessary material by B (i.e., the creditor) amounts to an omission on the part of the creditor resulting in discharge of A (i.e., the principal debtor), and consequently, C (i.e., the surety) is discharged.

What is the difference between a bank guarantee and a usual guarantee?

Following are some points of difference between a bank guarantee and a usual guarantee:A usual guarantee is governed by Sec. 126 of the Indian Contract Act, 1872. A bank guarantee is not directly governed by Sec. 126. An ordinary guarantee is a tri-partite (3 parties) agreement involving the surety, the debtor and the creditor.

But a bank guarantee is a contract involving two parties i.e. the bank and the beneficiary. In an ordinary guarantee, the contract between the surety and the creditor arises as a subsidiary to the contract between the creditor and the principal debtor. The bank guarantee is independent of the main contract. In an ordinary guarantee, the inter se disputes between the debtor and the creditor have a material effect upon the surety's liability. However, the bank guarantee is independent of the disputes, arising ex contractu (arising out of the contract). An ordinary guarantee does not have any time limit before which the debt has to be claimed. Bank guarantees generally have a specific time within which they are functional.

Can the invocation of a bank guarantee be prevented by initiating arbitration proceedings?

If the bank guarantee is unconditional, arbitration proceedings would in no way affect the enforcement of the guarantee. This is because an unconditional bank guarantee is independent of the main contract which refers disputes to arbitration.However, if the bank guarantee includes a clause to the effect that it could not be invoked prior to the decision of the arbitrators, such a bank guarantee, which is conditional, cannot be invoked and an injunction can be granted.

How can a beneficiary restrain the invocation of a bank guarantee?

The invocation of a bank guarantee by the beneficiary can be restrained by an injunction under the Civil Procedure Code, 1908, or the Specific Relief Act, 1963. However, the normal considerations, which apply in granting an injunction, will not apply in cases of a bank guarantee.Courts are usually reluctant to grant an injunction against a bank guarantee. If a bank guarantee has to be restrained, it has to satisfy the following conditions:

Fraud;

Irretrievable injustice or injury

How do bank guarantees help in commercial contracts?

Guarantees are important instruments used to minimize the risks that are involved in commercial contracts. For the enforcement of ordinary guarantees, as construed dependence of the guarantee on the main contract may lead to unnecessary disputes and litigation, arising from the main contract. These disputes may have a material effect on the guarantee, thereby blocking funds in litigation. Hence, there was a need for an innovative instrument which would enable the guarantee to serve its original purpose; namely, providing a form of security.The bank guarantee is one such innovative financial instrument whereby, if the beneficiary perceives that there has been a breach of contract by the other party, he can encash the guarantee and avail of the amount immediately, without having to undergo the hassles of litigation. Thus, the relevance of a bank guarantee achieves relevance.

What does the term 'bank guarantee' mean?

A bank guarantee is a commercial instrument in the nature of a contract, intended between two parties, to secure compliance with the contract. It is an off-shoot of the main contract between two parties. A bank gaurantee is a guarantee made by a bank on behalf of a customer (usually an established corporate customer) should it fail to deliver the payment, essentially making the bank a co-signer for one of its customer's purchases.

Contract Act_Practical Problems_63

A’ stands surety for ‘B’ for any amount which ‘C’ may lend to B from time to time during the next three months subject to a maximum of Rs. 50,000. One month later A revokes the guarantee, when C had lent to B Rs. 5,000. Referring to the provisions of the Indian Contract Act, 1872 decide whether ‘A’ is discharged from all the liabilities to ‘C’ for any subsequent loan. What would be your answer in case ‘B’ makes a default in paying back to ‘C’ the money already borrowed i.e. Rs. 5,000?

The problem as asked in the question is based on the provisions of the Indian Contract Act 1872,
as contained in Section 130 relating to the revocation of a continuing guarantee as to future
transactions which can be done mainly in the following two ways:

1. By Notice: A continuing guarantee may at any time be revoked by the surety as to future
transactions, by notice to the creditor.

2. By death of surety: 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.
(Section 131).

The liability of the surety for previous transactions however remains.
Thus applying the above provisions in the given case, A is discharged from all the liabilities
to C for any subsequent loan.

Answer in the second case would differ i.e. A Is liable to C for Rs. 5,000 on default of B
since the loan was taken before the notice of revocation was given to C.

Contract Act_Practical Problems_58

Mr. X, is employed as a cashier on a monthly salary of Rs.2,000 by ABC bank for a period of three years. Y gave surety for X’s good conduct. After nine months, the financial position of the bank deteriorates. Then X agrees to accept a lower salary of Rs.1,500/- per month from Bank. Two months later, it was found that X has misappropriated cash since the time of his appointment. What is the liability of Y?

If the creditor makes any variance (i.e. change in terms) without the consent of the surety, then
surety is discharged as to the transactions subsequent to the change. In the instant case Y is
liable as a surety for the loss suffered by the bank due to misappropriation of cash by X during the first nine months but not for misappropriations committed after the reduction in salary. [Section 133, Indian Contract Act, 1872].