Protecting A Guarantor When The Principal And Debtor Amend The Agreement Without The Guarantor’s Consent
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.
Summary
An illustrated rapid resolution example is intended for lawyers. Useful when lawyers draft contracts for clients who enter into business arrangements, which involve an agreement of guarantee and quick resolution of disputes arising out of amendments to the agreements.
Keywords: Contract of Guarantee, Purchase Agreements, Sale Agreements, Loan Agreements, Amendment of Contracts, Consent
Reference: The Indian Contract Act: Section 23: Illustration (b)
Indian Contract Act: Section 23
Section 23 of the Indian Contract Act, 1872, talks about the legality of the consideration and object of the agreement between the parties. It says that every agreement of which consideration or object is unlawful is void. According to Section 23, consideration or object of a contract is considered unlawful when:
1. It is forbidden by law;
2. It would defeat the provisions of any law;
3. It is fraudulent;
4. It involves or implies injury to the person or property of another;
5. The Court regards it as immoral, or;
6. The Court deems it as opposed to public policy.
Illustration (b) — Contract Act: Section 23
The second illustration of section 23 is as follows:
“A, promises to pay, B, 1,000 rupees at the end of six months, if C, who owes that sum to B, fails to pay it. B promises to grant time to C accordingly. Here, each party’s promise is the consideration for the promise of the other party, and they are lawful considerations.”
In the above illustration, while there is not likely to be any dispute over the legality of the transaction, the dispute would arise in a situation where A and C alter the terms of their agreement without the consent of A.
An illustration of this type, in a modern business context, is given below
Illustration 1 — A modern-day example
“X, a bank, entered into a contract with Z, a small company, to advance to Z a Rupees 50 lakh loan. As part of the agreement, J, a non-executive director of X, entered into an agreement with X, guaranteeing repayment of the loan, in the event Z defaulted on the loan.
Subsequently, Z restructured the loan with the Bank without J’s consent. When Z defaulted on the restructured loan, the Bank sued both Z and J.
J took the defense that, since he was not informed about the restructuring, his guarantee was void. However, the Bank contended that he would have been deemed to know since he was a director.
Interpretation and scenarios
A valid contract existed between X, Z, and J, whereby the consideration and the agreement’s object were lawful as per Section 23.
But, as soon as X and Z entered into an arrangement without J’s consent, J is discharged from his obligations under his guarantee to X.
In a modern-day situation, there would likely be two agreements in this transaction:
- A loan agreement between X and Z
- A guarantee agreement between X and J
In the event of Z defaulting on a payment to X, X would sue both Z and J in Court.
In this situation, J is likely to contend in his defense that the guarantee agreement between himself and X became void the moment X and Z changed the terms of their agreement without his consent.
Making this Rapid Resolution friendly — Strategy
A dispute arising out of the above example would be friendly to a rapid resolution if both contracts that form part of the transaction stipulate that, unless the guarantor consents, in writing, to the amendment of the main agreement, the guarantee would be voided if the contract was amended without his consent.
In the absence of these terms, even though the law is clear that the guarantor is discharged from his guarantee if the main agreement is amended without his consent, substantial amounts of evidence would be required to determine whether or not the consent was obtained, especially in a situation where a director of a company is guaranteeing a payment obligation of the company.
Adding a few simple clauses in each contract would protect the guarantor and make a dispute regarding the guarantor’s consent rapid resolution friendly
The Drafting Solutions
Solution 1- Protects the Guarantor
In a transaction where there is a sale-purchase or loan agreement, as well as a separate agreement of guarantee, both agreements must contain a clause stating that any amendment to the main agreement must be done only with the written consent of the guarantor, and this consent would be incorporated as a schedule to the amended agreement.
Additionally, the guarantee agreement must contain a clause specifically stating that, unless the consent of the guarantor for amending the main agreement is obtained in writing and made a part of the amended agreement as a schedule, any amendment to the main agreement would void the guarantee agreement.
Solution 2 — accelerates dispute resolution for both parties (Pre-decides contentious elements of the Arbitration process)
Both agreements must contain a clause that gives 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 the institution or ODR platform promises a process that binds the arbitrator to rapid resolution. Platforms often do this by minimizing oral hearings, not accepting documentation delays, and not allowing adjournments unless in emergencies.
Conclusion
In conclusion, it is fair to say that disputes arising from questions of the validity of an agreement of guarantee in the event the main agreement has been amended (as in The Contract Act — Section 23, Illustration b) can be made very friendly to rapid resolution, provided the right clauses are incorporated into the agreements.
Simple Explainer For The Layman
JLOP Ltd., a private limited company, took a 50 lakh loan with Ganesh Sahkari Bank. As part of the loan transaction, Mahesh, one of the company’s Directors, entered into a guarantee agreement with the Bank.
Before the loan was repaid, JLOP and the Bank restructured the loan without Mahesh’s knowledge or consent. However, when JLOP defaulted on the restructured loan, the Bank sued both the company and Mahesh for the recovery of the loan.
In his defense, Mahesh claimed that his guarantee was voided by the loan’s restructuring without his consent. On the other hand, the Bank contended that, as a Director, Mahesh’s consent was implied when the company restructured the loan.
Mahesh eventually proved that, due to disputes between him and the Board, he was not involved in the day to day working of the company at the time the loan was restricted and hence, was not aware of what had happened. However, the trial was long and expensive.
There were a few clauses Mahesh’s lawyers could have added to the agreements that could have ensured that a trial was avoided.
First, both the loan agreement and the guarantee agreement ought to have had a clause stating that any amendment to the loan agreement would be done only with the guarantor’s written consent, and this consent would be incorporated as a schedule to the amended agreement.
Second, the guarantee agreement ought to have had a clause stating that unless the guarantor’s consent for amending the main agreement was obtained in writing and made a part of the amended loan agreement as a schedule, the amendment to the main agreement would void the guarantee.
Finally, both contracts ought to have had an ODR friendly arbitration clause that pre-decided contentious aspects of the dispute resolution process.
About the Authors
Dushyant Krishnan is a Mumbai based lawyer and the co-founder of House Court, an online dispute resolution platform.
Devansh Garg is a third-year law student at the Vivekananda Institute of Professional Studies, and an associate editor of Indian Law Portal, an online legal news publication
