This article is an illustrated example of disputes that may arise when an agreement of a continuing guarantee is unclear about the extent of the guarantor’s liability.
The article recommends and discusses drafting solutions that lawyers can adopt to minimize the chances of such disputes occurring and ensure the rapid resolution of disputes if they do arise.
Keywords: Guarantee Agreement, Continuing Guarantee, Loan Agreement, Purchase Agreement
Reference: Section 129, Indian Contract Act, Illustration (b)
Section 129 Indian Contract Act:
Section 129 of the Indian Contract Act defines a ‘continuing guarantee.’ A continuing guarantee is essentially a guarantee that extends to multiple transactions, i.e., the guarantor undertakes to cover the debtor’s liability to the creditor for more than one payment.
Section 129, Illustration (b)
A guarantees payment to B, a tea-dealer, to the amount of £ 100, for any tea he may from time to time supply to C. B supplies C with tea to above the value of £ 100, and C pays B for it. Afterward, B supplies C with tea to the value of £ 200. C fails to pay. The guarantee given by A was a continuing guarantee, and he is accordingly liable to B to the extent of £ 100.
In the above example, while it is clear that the guarantee is a continuing guarantee, the dispute concerns the extent of A’s liability to pay B for C’s default.
Company X, a ketogenic food startup, entered into an agreement with Company Y to use its commercial kitchen and staff. As X was a startup, Company Y insisted that C, X’s founder, guarantee payment in the event X defaulted. C agreed and executed a continuing guarantee agreement for a term of one year.
However, while the guarantee explicitly covered the kitchen’s rent, it was silent on staff salaries. Therefore, when X defaulted on a monthly payment and Y sued X and C for recovery of the amount, C contended that his guarantee only extended to the kitchen’s rent and did not cover the staff salaries.
In the above example, Y would contend that the guarantee covered both kitchen rent and the staff salaries, as that was the parties’ intention. C would contend that the agreement is silent about whether the guarantee extended to staff salaries showed that it did not, and Y could not claim otherwise.
A Court or Arbitrator would need to arrive at a finding based on the evidence led concerning the parties’ intention.
The dispute arose on account of the ambiguity in the agreement and could have been either avoided altogether or rapidly resolved with the addition of a few clauses, which are discussed below.
Solution 1 – Remove Ambiguity (Makes It Easy To Arrive At A Finding):
A contract of guarantee must be drafted so that there is no ambiguity whatsoever in respect of the following:
- The nature of the guarantee, i.e., fixed or continuing
- The term of the guarantee agreement
- The amounts or amounts covered under the guarantee
Ambiguity in any of the above will result in a long, potentially expensive dispute resolution process if a dispute does arise.
In our example, the agreement should have specified that the guarantee covered defaults on the rent for the kitchen and the staff salaries. It would also be advisable for the guarantee agreement to include a process by which Y communicates X’s default to C and invokes the guarantee.
Solution 2 – Accelerates the Dispute Resolution Process:
The agreement should have a dispute resolution clause giving the claimant the right to ask for the arbitrator’s appointment by a named institution or ODR platform, and for such appointment to be made within 35 days of receipt of the defendant receiving notice.
In these cases, it will better serve the parties if either the dispute resolution clause itself or the institution or ODR platform promises a process that binds the arbitrator to rapid resolution. ODR Platforms often do this by minimizing oral hearings, not accepting documentation delays, and not allowing adjournments unless in emergencies.
Simple Explainer For the Layman:
Mumbai Keto, a ketogenic foods cloud kitchen startup, entered into an agreement with Ramesh Caterers to use its commercial kitchen and staff. As Mumbai Keto was a startup, Ramesh Caterers insisted that Arvind, Mumbai Keto’s founder, guarantee payment in the event Mumbai Keto defaulted on it’s monthly liability. Arvind agreed and executed a continuing guarantee agreement for a term of one year.
However, while the guarantee explicitly covered the kitchen’s rent, it was silent on staff salaries. Six months into the agreements, Mumbai Keto defaulted on a monthly payment, and Ramesh Caterers invoked the guarantee. However, while Arvind paid the rent for the kitchen, he refused to pay the staff salaries, stating that his guarantee only extended to the kitchen’s rent and did not cover the staff salaries.
Ramesh Caterers sued both Mumbai Keto and Arvind for the recovery of the amounts due with respect to staff salaries.
In court, Arvind’s lawyers argued that since Arvind’s liability under the guarantee agreement did not explicitly extend to staff salaries, Ramesh Caterers could not claim anything to the contrary.
On the other hand, Ramesh Caterers argued that the intention of the parties was always for the guarantee to cover all defaults by Mumbai Keto, including staff salaries.
Had the guarantee agreement been unambiguous about Arvind’s liability, the dispute could have been quickly and inexpensively resolved using an ODR Platform.
About the Article
Rapid Contract Enforcement is an essential requirement for the growth and prosperity of India. It will enable more investment, entrepreneurship, and trust for all stakeholders in business and commerce. The community of lawyers in India does not have access to a practical and scholarly manual that gives them a path to deliver rapid contract enforcement to their clients. Such a manual will also help lawyers to draft contracts that enable timely enforcement. Quick enforcement requires the effective use of the Arbitration Act, the institutional framework, and technology-enabled dispute resolution infrastructure. This article belongs to a series where the author analyses each of the Illustrations available in the Contract Act and recommends practical approaches to rapid enforcement.
About the Author:
Dushyant Krishnan is a Mumbai based lawyer and the co-founder of House Court, an online dispute resolution platform.