Start by asking what exactly the investor wants guaranteed. Equity carries no repayment obligation, so a guarantee of an equity cheque makes no sense in law and is usually a guarantee of something else: a convertible note or debenture that has a redemption date, a bridge loan, or the founders' warranties in the share subscription agreement. Each is a different animal. A guarantee of a redeemable instrument is a guarantee of debt and carries the full statutory consequences below. A promise to make good the warranties is an indemnity, and belongs in the discussion on caps and survival periods in the subscription agreement rather than in a guarantee deed at all.
Personal guarantee. Under Section 126 of the Indian Contract Act, 1872 a contract of guarantee is a contract to perform the promise, or discharge the liability, of a third person in case of his default. The founder is the surety, the company is the principal debtor and the investor is the creditor. It may be oral or written. Section 128 makes the surety's liability co-extensive with that of the principal debtor unless the contract provides otherwise, which the illustration to the section spells out: the surety of a dishonoured bill pays not only the amount but the interest and charges that have accrued on it.
What does signing actually expose me to?
Everything the company owes under the guaranteed obligation, on the day it defaults, without the investor having to sue the company first. Section 137 says mere forbearance by the creditor to sue the principal debtor does not discharge the surety. If the instrument is a continuing one, meaning it extends to a series of transactions (Section 129), you are liable for every advance made until you revoke it, and Section 130 lets you revoke a continuing guarantee only as to future transactions and only by notice to the creditor. Under Section 131 even your death revokes it only for the future, in the absence of a contract to the contrary. When you do pay, Section 140 puts you in the investor's shoes against the company and Section 145 gives you an implied right to be indemnified by it, which is of limited comfort if the company is the reason you are paying.
Are there statutory protections, and can the investor draft around them?
There are, and the standard form is written to remove them. Section 133 discharges you if the terms between the company and the investor are varied without your consent, as to later transactions. Section 134 discharges you if the investor releases the company. Section 135 discharges you if the investor compounds with the company, gives it time or agrees not to sue it, unless you assent. Section 139 discharges you where the investor's act or omission impairs your eventual remedy against the company. Section 141 gives you the benefit of every security the investor holds against the company, and discharges you to the extent of the value of any security the investor loses or parts with without your consent. Investor forms routinely include a clause by which the guarantor consents in advance to every variation, extension, release and dealing with security. That single paragraph is what keeps the guarantee alive in the situations the Act would otherwise end it. Read for it and strike it. Two protections cannot be drafted away: under Sections 142 and 143 a guarantee obtained by the creditor's misrepresentation, or by keeping silence about a material circumstance, is invalid.
What is the insolvency exposure everyone warns about?
Since 1 December 2019 the personal-guarantor provisions of Part III of the Insolvency and Bankruptcy Code, 2016 have been in force for individuals who are guarantors to corporate debtors, and the Supreme Court upheld that notification in Lalit Kumar Jain v. Union of India on 21 May 2021. The same judgment held that approval of a resolution plan for the company does not discharge the personal guarantor, whose liability arises from an independent contract. In practice this means the investor can apply under Section 95 to initiate insolvency resolution against you personally, and Section 60(2) puts that application before the same NCLT that is dealing with the company. On the day the application is filed, Section 96 imposes an interim moratorium on all your debts, which sounds protective but also freezes your ability to deal with your own affairs. If admitted, Section 101 brings a moratorium of up to one hundred and eighty days and Section 105 requires you to propose a repayment plan to your creditors, drawn with a resolution professional. We walked through what such a plan looks like in our note on a personal guarantor repayment plan in the NCLT. That is where an uncapped guarantee ends.
| Term | What to ask for | Why, in law |
|---|---|---|
| Cap | A fixed rupee amount, well below the facility, inclusive of interest and costs | Section 128 applies unless the contract provides otherwise, so the cap has to be in the deed |
| Sunset | Automatic release on conversion of the instrument, on the next priced round, or on a date | A continuing guarantee otherwise runs until revoked by notice under Section 130, and only for the future |
| Several, not joint and several | Each founder liable only for a stated share | Co-sureties otherwise contribute equally under Section 146 and the creditor may pursue any one of you for the whole |
| Company first | Demand on the company and a cure period before any demand on you | Section 137 means forbearance to sue the company does not discharge you, so the sequence must be contractual |
| No advance consent to variation | Delete the clause waiving Sections 133, 134, 135, 139 and 141 | Those sections discharge you on variation, release, composition or loss of security unless you have assented |
| Carve-outs | No liability for losses caused by the investor's own breach, or for consequential loss, or after you cease to be a director | The deed can limit liability, and a guarantee of a person's conduct after he has left is a guarantee of strangers |
| Information | Copies of every notice, amendment and default the company receives | You cannot revoke, assent or object to what you do not know about |
Is there a version that is acceptable?
Sometimes. A short, capped guarantee of a bridge loan that is to convert within a few months, several as between the founders, released automatically on conversion, with no advance-consent clause, is a commercial compromise many founders accept and survive. A guarantee of a redeemable debenture that runs to maturity, uncapped, joint and several, with waiver of every statutory discharge, is a personal loan dressed as equity, and the honest answer is that you should walk away from that investor or price the risk into the valuation. Also check the founders' own arrangements: if one founder signs and the others do not, the contribution rules in Sections 146 and 147 will not rescue him, because they operate only between co-sureties.
What I tell founders across the table
Ask the investor to say in writing which obligation the guarantee secures, then read that obligation before reading the guarantee. Most of the fear in this conversation is about numbers nobody has written down. When the number is written down and capped, the sunset is tied to conversion, and the waiver paragraph is gone, a founder guarantee becomes a bounded promise you can hold in your head. Our guide to reading a term sheet covers where this clause usually hides, and the distinction between financial and operational debt under the IBC explains the distinction that decides how an investor's claim against the company is classified.