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Principal and Surety

creditor obligation contract suretyship

A contractual relationship whereby one party—the surety—agrees to pay the principal's debt or perform his or her obligation in case of the principal's default.

The principal is the debtor—the person who is obligated to a creditor. The surety is the accommodation party—a third person who becomes responsible for the payment of the obligation if the principal is unable to pay or perform. The principal remains primarily liable, whereas the surety is secondarily liable. The creditor—the person to whom the obligation is owed—can enforce payment or performance by the principal or by the surety if the principal defaults. The creditor must always first seek payment from the principal before approaching the surety. If the surety must fulfill the obligation, then he can seek recovery from the principal after satisfying the creditor. An example of a principal and surety relationship occurs when a minor purchases a car on credit and has a parent act as a surety to guarantee payment of the car loan.

A suretyship arises from an agreement. The parties must be competent; there must be an offer and acceptance; and valid consideration is necessary. The parties must openly assent to the contract so that all the parties are known to each other. The surety must be identified as such so that the creditor will not hold that person primarily liable. If the face of the contract indicates a suretyship, the creditor receives sufficient notice of the three-party arrangement.

No special form of contract is needed to create a principal and surety relationship. The agreement can be consummated by written correspondence or be in the form of a bond. No particular language is needed to identify the relationship, since courts will examine the substance and not the form of the contract to determine whether a suretyship exists. Courts will rarely imply a suretyship agreement, except when an involuntary suretyship arises out of an implied oral agreement. When joint debtors obtain a loan, each is a principal for a proportionate share of the debt and a surety for the remaining amount. In practice, however, each joint debtor is a principal and is primarily liable for the entire loan if the creditor seeks repayment. A joint debtor who pays the entire debt can, however, seek contribution from the other debtors.

The surety's liability is indicated by the terms of the contract. Unless otherwise provided, a surety assumes the obligation of the principal. A surety, however, can limit his liability to a certain amount since the obligations of the principal and surety do not have to be coextensive. When a surety agrees to be accountable for a certain amount, she cannot be held responsible for a sum greater than that for which she contracted. The surety becomes liable when the principal breaches a contract with the creditor. In the absence of a contractual limitation, a surety's liability is measured by the loss or damage resulting from the default by the principal. The liability of the surety terminates when the principal's obligation is fulfilled.

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