INVALID GUARANTEES: THE EXTENT OF

CREDITOR’S DUTY TO DISCLOSE.

-Ankita Sen.

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INDEX OF AUTHORITIES:
Cases

Hamilton v. Watson, 8 E.R. 1339 (1845, House of Lords). ...................................................................... 8

London General Omnibus Co. Ltd. V. Holloway, 2 K.B. 72 (1912, Court of Appeal). .......................... 8, 9
Secretary of State for India v. Nilamekam Pillai, (1883) 6 ILR 406........................................................ 11
Stone v. Compton, 5 Bing. (1838, Court of Common Pleas). .................................................................. 7

Statute

Indian Contract Act, 1872.......................................................................................................................6

Books and Dictionary

Black's Law Dictionary, 1520 (6th ed., 1990). ......................................................................................... 9

Good Faith in Contract and Property Law, 87 (A. D. M. Forte, Angelo D. M. Forte, 1st ed., 1999). .... 10
H.K. Saharay, Dutt on Contract- The Indian Contract Act, 1872, 748 (10th ed., 2006). ........................... 9
H.K. Saharay, Dutt on Contract- The Indian Contract Act, 1872, 749 (10th ed., 2006). ..................... 8, 11

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LIST OF ABBREVIATIONS:
Bing. - Bingham New Cases

K.B. - King’s Bench

E.R. - England Reports

ed. - Edition

ILR Mad. - Indian Law Reports Madras Series

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A slight deviation from a general bipartite contract is a contract of guarantee that is, by
nature a tripartite agreement, characterised by the inclusion of a maximum number of three
contractual relationships under the singular head of a guarantee contract. Governed by
Section 126 of the Indian Contract Act, 1872, a contract of guarantee is essentially
constituted by three parties- the creditor, principal debtor and the surety. The surety in this
tripartite agreement, enters into a contractual relationships with both the creditor and the
principal debtor to guarantee the fulfilment of obligation (contractual, tortuous or statutory),
defaulted by the principal debtor, thus assuring safety and reliability to the creditor.
However, assurances also need to be provided to the third party, the surety against all forms
of exploitation. This is mainly because it is plain and easy for both the principal debtor and
the creditor to strike the surety to meet their own ends. The Indian Contract Act, 1872, by
inserting the element of nullity vey tactfully protects the surety from such potential areas of
manipulation. The author in this paper will focus mainly on the criteria that might render a
contract of guarantee invalid and the creditor’s contribution to such invalidity.

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1. INVALIDITY OF A CONTRACT OF GUARANTEE:
A contract of guarantee can be rendered invalid in a particular set of situations as provided by
the Indian Contract Act, 1872. The purpose behind providing for the nullity of a guarantee
contract is clear. The Indian Contract Act, 1872 considers contracts of guarantee made by
wilful misrepresentation and concealment as the material elements in such contract, invalid.
Here, it must be noted that, the presence of free consent of the contracting parties is a
fundamental requirement in deciding the validity of a contract. Misrepresentation and
concealment defy the very element of consent on the side of the surety. Hence, it is justified
to declare such contracts of guarantee invalid. It also serves the purpose of shielding the
surety from any form of exploitation that he may be subject to by purposeful
misrepresentation and concealment.

1.1. A Contract of Guarantee invalid due to MISREPRESENTATION

Section 142 of the Indian Contract Act renders invalid any contract of guarantee that has been
entered into “...by means of misrepresentation made by the creditor, or with his assent,
concerning a material part of the transaction”1. A combined reading of Section 142 , Section
17 and Section 18 of the Indian Contract Act, 1872 will hint at the presence of both innocent
and fraudulent misrepresentation. As far as the invalidity quotient in a contract of guarantee
is concerned, it needs to be focussed on that, the relevant section in this regard, takes into
account both misrepresentations by the creditor himself and that done with his assent. The
presence of assent immediately brings in the factor of intentionality in the ambit of
disqualification of a guarantee contract due to misrepresentation. A look into the timeline of
cases will clarify further the nature of misrepresentation that is accepted by the law. In the
case of Stone v. Compton, it was held that, “if with the knowledge and assent of the creditor ,
any material part of the transaction between the creditor and his debtor is misrepresented to
the surety, the misrepresentation being such that but for the same having taken place, either
the suretyship would not have been entered into at all, or being entered into, the extent of the
surety’s liability might be thereby increased, the security so given is void on the ground of
fraud.”2 On the other hand, in a latter case, London General Omnibus Co. Ltd. V. Holloway,
it was clearly decided that, “Innocent misrepresentation is sufficient, and, although the
doctrine by which uberrima fides is required in insurance cases is not applicable to the same
extent in suretyship cases, still the surety is entitled to relief on the ground of non-disclosure

1
S. 142, The Indian Contract Act, 1872.
2
Stone v. Compton, 5 Bing. (1838, Court of Common Pleas).

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of matters which ought to have been communicated to him, whether the non-communication
was or was not innocent.”3 Thus, it stands clear that, a contract of guarantee initiated by
misrepresentation of any kind, regarding the material facts of the case, is rendered invalid in
the eyes of law.

The law also takes into account situations where, the creditor has an onus upon himself to
keep the surety informed about material facts. “A creditor must reveal to the surety every fact
which under the circumstances the surety would expect not to exist; for the omission to
mention such a fact does exist is an implied misrepresentation.”4However, the disclosure of
material facts must not include clarifying facts that can be understood by the surety on the
basis of ordinary diligence. There exists a fine line of distinction between the creditor’s
liability to disclose information to the surety and the exercise of silence by the creditor on the
assumption of ordinary diligence of the surety. But, once, the Courts decide on the extent of
the creditor’s duty as per the peculiar facts of the case, it is clear that, misrepresentation,
whether innocent or intentional will render the contract of guarantee invalid.

1.2. A Contract of Guarantee invalid due to CONCEALMENT:

Concealment as to the material circumstances pertaining to the agreement between the
creditor and the principal debtor, must refer to any form of active concealment. “The
expression ‘keeping silence’ clearly implies intentional concealment as distinguished from
mere non-disclosure.”5 Dutt. This rules out the possibility of passive concealment of material
circumstances as a vitiating factor for a contract of guarantee. It essentially implies that, if the
creditor does not provide information regarding material facts and circumstances pertaining
to the transaction, he is not covered under the ambit of concealment, unless the surety
explicitly seeks information from the creditor, that is, the creditor does not come under the
ambit of concealment unless he actively conceals some fact and situations pertinent to the
transaction between the creditor and the principal debtor.

Importance must again be laid on the distinction between non disclosure of material facts (a
kind of passive concealment) and the area where active concealment begins. The situation is
one similar to that under misrepresentation, where, it is not the creditor’s liability to disclose
such information that can be discovered by the surety as a reasonable prudent man. This once
again, hints at the question as to the role and extent of silence in a contract of guarantee.

3
London General Omnibus Co. Ltd. V. Holloway, 2 K.B. 72 (1912, Court of Appeal).
4
Hamilton v. Watson, 8 E.R. 1339 (1845, House of Lords).
5
H.K. Saharay, Dutt on Contract- The Indian Contract Act, 1872, 749 (10th ed., 2006).

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2. Misrepresentation and Concealment must be regarding MATERIAL
FACTS and CIRCUMSTANCES:
The point that is concurrent in both Section 142 and Section 143 of the Indian Contract Act,
1872 is- for a contract of guarantee to be rendered invalid on grounds of misrepresentation
and concealment, such vitiating factors must pertain to the material facts and situations
involved in the transaction between the creditor and the principal debtor, likely to affect the
surety. This is important because, else, it will make mandatory for the creditor to disburse any
information, irrespective of their importance to the surety, pertaining to the obligation
existing between the creditor and the principal debtor. It also ensures that the surety consents
to the suretyship only after obtaining adequate material knowledge of the consequences of
such a contractual relationship. For instance, “...where a surety to a fidelity bond was not told
of the particular dishonesty of the employee the surety was not liable for a subsequent act of
dishonesty of the employee.”6 It must be noted here, that, considering the nature of the
contract was that of fidelity, information as to the past moral behaviour of the debtor is a
situation material for the surety to be aware of. It is hence clear that, there is no singular
definition as to what is a material fact. The nature of the case determines as to which fact
situation must be considered as one of substance and material. For instance, “...non disclosure
of the fact that a previous surety is withdrawing from the suretyship agreement”7 is not a fact
material to the surety.

Hence, from the above discussion it is clear that, material facts and situations are only such
situations that are likely to have a strong impact on the surety’s decision to enter into the
suretyship agreement. Unless misrepresentation and concealment tamper with the revelation
of the material facts and circumstances, the guarantee contracts cannot be considered invalid
on this ground.

3. CREDITOR’S DUTY TO DISCLOSE:

3.1. Concept of Uberrima Fides:
The Latin expression ‘uberrima fides’ means – “the absence of any concealment or
deception, however slight.”8 The question as to whether the creditor must act in good faith,
arose while discussing the extent of duty that the creditor owes to the surety. A contract of

6
London General Omnibus Co. Ltd. V. Holloway, 2 K.B. 72 (1912, Court of Appeal).
7
H.K. Saharay, Dutt on Contract- The Indian Contract Act, 1872, 748 (10th ed., 2006).
8
Black's Law Dictionary, 1520 (6th ed., 1990).

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guarantee is, however, not governed by ‘uberrima fide’ or good faith. There exists “no
universal obligation on the creditor to make disclosure of the whole state of matters to the
proposed cautioner; in other words, guarantee is not like insurance, a contract uberrimae
fidei where full disclosure is required on the part of one of the contracting parties.”9

A strong example of a guarantee contract antithesis to the concept of ‘good faith’, is a bank
guarantee. Here, it must be observed that, “...there may be a duty to disclose all material
facts. There is no such duty in the case of a bank which takes a guarantee from a person to
disclose the indebtedness at the date of guarantee.” Moreover, “... a bank-agent is entitled to
assume that the cautioner (surety) has informed himself upon the various matters material to
the obligation he is about to undertake. The agent is not bound to volunteer any information
or statement as to the accounts, although if information be asked he is bound to give it, and
give it truthfully.”(imperial bank v avinasi)

With bank guarantee being just an example, it is thus, important to note that, contracts of
guarantee cannot be read in lines of ‘good faith’, quite unlike insurance contracts, which
entail an apparent huger risk allocation. However, the question that now arises is, whether or
not acting beyond the ambit of good faith involves an absolute non disclosure of material
facts to the surety. This question will be dealt with subsequently in Section 3.2.

3.2. Role of Silence in a contract of guarantee:

It has already been observed that, a contract of guarantee is not guided by the well established
concept of uberimma fide. However, this in no way should mean that, in a contract of
guarantee the surety is left without any form of assurance as to his safety against
misrepresentation and intentional concealment of facts. This is when we resort to Section 142
and Section 143 of the Indian Contract Act, 1872. These Sections in an attempt to protect the
rights of the surety against any form of manipulation render invalid any contract of guarantee
that is affected by the elements of misrepresentation or concealment.

It is well known that, making misleading statements is prima facie a case of

misrepresentation capable of rendering the contract invalid. However, when the question
arises under Section 143, it is important to understand the threshold of silence, on crossing
which the creditor will be contribute to rendering the contract invalid on grounds of
concealment. Also, in common parlance, silence can itself be misleading. In the context of a

9
Good Faith in Contract and Property Law, 87 (A. D. M. Forte, Angelo D. M. Forte, 1st ed., 1999).

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contract of guarantee, silence as to the facts of the legal relationship between the creditor and
the principal debtor can be construed by the creditor as mere neutral silence, not concerning
the surety. The surety, on the other hand, might in an attempt to escape liability under the
contract of guarantee interpret such silence as misleading and form of concealment and
implied misrepresentation. At this juncture, it is necessary to understand the demarcation
between mere silence and non disclosure of material facts and circumstances. To this effect, it
has been held in the case Secretary of State for India v. Nilamekam Pillai- “To avoid a
guarantee under this Section, it must be proved not only that there was silence as to material
circumstance, but the guarantee was by means of such silence.”10 This is precisely what must
be looked into before construing silence as a mode of concealment by the creditor. It needs to
be understood that, if the silence is not pertinent to the material facts of the transaction
between the creditor and the principal debtor, it is not likely to be of value to the surety. In
such a situation, silence would not in any way influence the surety’s entering into the
suretyship and hence, would plainly amount to mere silence. However, if the silence is such
that, the surety is not well aware of the material facts and has entered into the suretyship
contract under some misconceived assumption founded by such silence, the silence would
then be equivalent to a concealment or non disclosure of material facts and situations
affecting the surety. Under such circumstance, the surety must not be forced to fulfil his
obligation under the suretyship contract and it is thus, only justified to discharge him of such
liability by declaring the contract invalid.

However, it often becomes a little gruelling to understand as to which fact can be left
concealed under the garb of silence and which fact should be revealed to the surety so as to
facilitate his free consent to the guarantee contract, not vitiated by any form of
misrepresentation or concealment. The test for the same is such that “whether there is
anything that might not naturally be expected to take place between the parties who are
concerned in the transaction, that is, whether there be a contract between the creditor and
the debtor, to the effect that his position shall be different from that which the surety might
naturally expect, and, if so, the surety is to see whether that is disclosed to him too...”11
Hence, it indicates that anything that might affect the decision of the surety by virtue of being
a deviation from normal circumstances, must be actively communicated to the surety, not
otherwise. Silence, thus, has a very subjective role to play in case of contracts of guarantee

10
Secretary of State for India v. Nilamekam Pillai, (1883) 6 ILR Mad. 406.
11
H.K. Saharay, Dutt on Contract- The Indian Contract Act, 1872, 749 (10th ed., 2006).

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CONCLUSION:
After the entire discussion on the invalidity of guarantees, we have arrived at a plausible
answer to the question that we initiated our research with. It must be said that, in respect of
the creditor’s duty to disclose information to the surety, it has been found that, such duty
exists only to the extent of material facts and situations likely to decisively impact the
surety’s entering the guarantee contract. Breach of such duty by misrepresentation, whether
innocent or fraudulent and active concealment, invalidates the contract of guarantee. Our
hypothesis is thus partially proved, in the view that, the creditor does have a duty to disclose
information to the surety, but such duty is not absolute. It is subjective, varying on a case-to-
case basis, depending on the material nature of such information likely to affect the surety’s
decision of entering into the contract. Hence, the remedy under Section 142 and Section 143
is for the benefit of the surety, to discharge him of any liability that he might have mistakenly
entered into based on misrepresentation and concealment by the creditor.

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