Extent of Surety's Liability: Judicial Interpretation

The surety’s liability, as provided in Section 128, is co-extensive with that of the principal debtor. However, it is not a hard and fast rule. The liability need not always be co-extensive, but if there is no limit on the extent of liability, it would be co-extensive with that of the principal debtor. Read about the extent of Surety’s Liability: Judicial Interpretation here.

Introduction

Section 126 of the Indian Contract Act defines a contract of guarantee. According to this section, a contract of guarantee is a contract to perform the promise or discharge the liability, of a third person in case of his default. There are three parties to a contract of guarantee: principal debtor, creditor and surety. The person who gives the guarantee is called the surety, the person on whose default the guarantee is given is called the principal debtor and the person to whom the guarantee is given is called the creditor. Surety is the person who promises the creditor that in case the principal debtor makes a default, he will perform the promise or discharge the liability of the third party. Thus, the surety acts as an assurance to the creditor for the act of the principal debtor.

Liability of the Surety

The liability of the surety is laid down in Section 128. It says that the surety’s liability is co-extensive with that of the principal debtor unless the contract of guarantee provides otherwise. In Central bank of India v. C.L Vimla[1], the court held that: “The liability of the guarantor is co-extensive with that of the debtor. The only exception to the nature of the liability of the guarantor is provided in the section itself, which is only if it is stated explicitly to be otherwise in the contract.”

The word co-extensive relates to the quantum of the principal debt. ‘Co-extensive with that of the principal-debtor’ means that the surety is liable to the same extent to which the principal-debtor is liable. In the case of Maharaja of Benares v. Har Narain Singh[2], the plaintiffs demanded from the defendants, who were the sureties or the representatives of the surety, a sum representing arrears of rent with interest, which the plaintiff, in spite of having obtained decrees therefor, had been unable to recover. The defendants demanded that under their agreement they were not liable for interest on arrears of rent due by their principal, but only for the arrears themselves. In the bond, it was written that “in case of default by the lessee and non-payment of the arrears by us, the sureties, the Sarkar will have the power to realize the arrears from us personally or by attachment, etc.” It was held that as there was no mention of the interest on the rent, the liability of the surety was confined to the arrears. Thus, in this case, the principal was laid down that the surety to the debt is not liable for the interest on the debt because the principal debtor himself was not liable for the interest. Also, it was held in the case that unless there is a mention of the interest, the surety will be liable for the principal amount only.

Extent and Commencement of Liability

The extent of the liability undertaken by the surety will depend upon the terms of the contract of guarantee. A bank was not allowed to recover from the surety, the liability which was due under the debts existing beforehand when there was no mention of such liability in the guarantee which the bank had itself framed. Thus, it was held that the liability of the guarantor cannot go beyond the terms of the guarantee.[3] The liability of the surety need not be co-extensive with that of the principal-debtor, but if there is no limit on the extent of liability, it would be co-extensive with the liability of the principal-debtor[4]. In the case of State of Maharashtra v. MN Kaul[5], it was held that the guarantor cannot be made liable for more than he has undertaken. In case of ambiguity when all other rules of construction fail, the Courts interpret the guarantee contra preferentem i.e. against the guarantor. But whatever be the mode employed, the cardinal rule is that the guarantor must not be made liable beyond the terms of his agreement. Another important principle was laid down in Zaki Husain v. Deputy Commissioner of Gonda[6], where the court said that a surety is liable not only for the principal amount but also for interest due under the contract.

As regards the commencement of the liability, it depends on the terms of the contract of guarantee. The parties can agree to the condition that the liability of the surety shall arise only on a particular contingency. In the case State Bank of India v. Saksaria Sugar Mills Ltd[7], it was laid down that if there is a default of the principal debtor which resulted in a loss to the creditor, the liability of the surety is immediate and it is not deferred until the creditor exhausted his remedies against the principal debtor. He is not entitled to receive any notice of the default unless the terms of the contract so require.

Condition precedent to the surety’s liability

The contract of guarantee may provide for certain conditions precedent to the surety’s liability. The surety will not be liable unless that condition is first fulfilled. Section 144 recognizes this principle. It says that when a person gives the guarantee upon a contract that the creditor shall not act upon it until there are other persons as co-sureties, the guarantee is not valid if that other person does not join. In the case National Provincial Bank of England v. Brackenbury[8], the defendant agreed to become the surety in a contract of guarantee with the condition that three other people will become co-sureties alongside him. Two of them agreed. However, one of them did not sign. It was held that as there was no agreement between the bank and the co-guarantors to do away with the signature, the defendant was not liable as a surety. The same result followed in James Graham & Co (Timber) Ltd. v. Southgate Sands[9], where the signatures of one of the co-sureties were forged so as to make it appear that he had joined. The court said that a joint guarantor is not liable if the signature of one of the other guarantors is forged, since there is no contract of guarantee unless all the anticipated parties to the contract in fact become bound.[10]

Placing limits on the liability by means of a contract

The phrase in section 128 ‘unless it is otherwise provided by the contract’ provides scope to the surety to limit his liability by a contract. He may limit his guarantee to a particular amount. In the case of Yarlagadda Bapanna v. Devata China Yerkayya[11], a clause in the contract, which made the surety liable up to ₹15,000 further declared that he would be liable for any amount that might be finally decreed. It was held that the clause should be construed as meaning not exceeding ₹15,000. Similarly, in Aditya Narayan Chourasia v. Bank of India[12], the guarantors bound themselves to a particular maximum limit. It was held that their liability was limited to that amount and not beyond that.

Proceeding against surety without exhausting remedies against debtor

Unless provided expressly in the contract, the creditor is not bound to exhaust his remedies against the principal debtor before suing the surety. A surety may be proceeded against though the principal debtor has not been sued. The surety does not have the right to dictate the creditor as to how he should make the recovery. The liability of the surety is immediate, and before payment the surety has no right to ask the creditor to exhaust his remedies against the principal debtor first.

Different judgements have been given on the question that whether the creditor can sue the surety without using up all the remedies against the principal-debtor. The Supreme Court gave judgement in the affirmative in the case of Bank of Bihar Ltd. v. Damodar Prasad[13]. In that case, the defendants guaranteed a bank’s loan. A default took place and the defendant was sued. The trial court gave the decision that the bank shall enforce the guarantee in question only after having exhausted its remedies against the principal debtor. The Patna High Court upheld the decision of the trial court, but the Supreme Court overruled it. Explaining the decision, the court said: “The very object of the guarantee is defeated if the creditor is asked to postpone his remedies against the surety. The trial court gave the reason that the principal was solvent. But, the solvency of the principal is not a sufficient ground for restraining execution of the decree against the surety. The surety has a duty to pay the decretal amount. “Before payment the surety has no right to dictate terms to the creditor and ask him to pursue his remedies against the principal in the first instance. The surety is a guarantor, and it is his business to see that the principal pays, and not that of the creditor”.[14] The Allahabad High Court held a similar viewpoint in U.P. Financial Corporation v. Garlon Polyfeb Industries[15] (without referring to the decision of the Supreme Court in the above-mentioned case). A guarantee was given on the loans of a company. The guarantee required that the liability of the surety would arise on demand. There was no such condition that the financial corporation would first have to recover the amount from the hypothecated property, and the corporation could straightaway proceed against the surety without proceeding against the company. It was held that the order which directed the corporation to first proceed against the company was not proper.

The Supreme Court gave a dissenting opinion in Union of India v. Manku Narayana[16]. In the case, the principal debtor borrowed a sum of ₹5100 from the appellant bank against mortgage of his property and the independent guarantee of the respondent. On the sum remaining unpaid, a suit was instituted and a composite decree passed which included making the respondent personally liable. The respondent resisted execution against him on the ground that the Bank must exhaust the remedies against the principal debtor and the mortgaged property first. The execution court and the High Court upheld the plea. Rejecting the appeal, the Supreme Court said that since a portion of the decreed amount is covered by the mortgage, the decree-holder Bank has to proceed against the mortgaged property first and then proceed against the guarantor. Again, in the case, State Bank of India v. M/s Indexport Registered and Others[17], the decision of the Manku Narayana case was overruled. In that case, the appellant bank had granted a Packing Credit Facility to the respondent 1 firm to the extent of ₹1,00,000. There were two partners in the firm- one ‘A’ (since deceased) and respondent 2 (defendant 2). For the loan, respondent 2 had created an equitable mortgage of his shop as security and respondent 4 (father of A) stood as guarantor for the loan. The appellant bank sued the respondent 3 (mother of A) in place of the deceased son for money decree. The trial court passed a composite decree which consisted of two decrees- a personal money decree against all the defendant-judgement debtors (respondents 1 to 4) for recovery of the decretal amount with interest and costs, and a mortgage decree against respondent 2 (defendant 2) which gave the bank the right to sell the mortgaged shop if the decretal amount was not paid within three months from the date of the decree. The guarantor did not file an appeal against the passing of the decree. Thus, the decree became final. Then the appellant filed an application for the purpose of execution of the decree against the respondent 4. The court, following the decision of the Supreme Court in Manku Narayana, said that since the decree was a composite one and the mortgaged property was also involved, the bank should have proceeded against the mortgaged shop first and as it has not done so, the application for execution against the guarantor does not lie. The decision was upheld by the High Court, which also reiterated the above-mentioned decision of the Supreme Court. Now, the apex court overruled the decisions of the subordinate courts and said the composite decree does not put ant restriction on the decree-holder to execute it against any particular party. The choice is left entirely with the decree-holder, and he can proceed in any way he likes.

Liability of the Surety when the principal contract is rendered impossible

This question was addressed in Florence Mabel R.J. v. State of Kerala[18]. The petitioner had guaranteed a loan taken by the respondent from a co-operative society for the purpose of bee-keeping. The bees died in consequence of a viral infection and there was a total failure of business which disabled the respondent from repaying the loan. The petitioner argued that there was a frustration of contract and he is not liable to pay. The court said that that he cannot take the defence of frustration as he had agreed that in case the principal fails to pay off the instalments, he would be liable jointly and severally.

Conclusion

The surety’s liability, as provided in Section 128, is co-extensive with that of the principal debtor. However, it is not a hard and fast rule. The liability need not always be co-extensive, but if there is no limit on the extent of liability, it would be co-extensive with that of the principal debtor. The Judiciary, from time to time, has reiterated the principle of co-extensiveness in its decisions. The role of Judiciary can also be seen in the cases related to the extent and the commencement of the surety’s liability, where in cases like MN Kaul and Zaki Husain it has laid down important principles regarding the liability of the surety. As regards the issue of proceeding against the surety without exhausting the remedies against the debtor, there has been differences in opinions. The Supreme Court and Allahabad High Court had the same stance in the cases of Damodar Prasad and Garlon Polyfeb Industries respectively that the surety can be sued before the using up of remedies against the debtor, but then in Manku Narayana case, the Supreme Court itself overruled its previous decision and held that the mortgaged property of the principal debtor should be proceeded against before the guarantor. Thus, we can see that the Judiciary has been, by its decisions from time to time, removing the ambiguities regarding the extent of surety’s liability. The Judiciary has interpreted this topic on various occasions and has, each time, made the picture clearer. However, there is always a scope of improvement, and in future also the surety’s liability will be pondered upon, and the Courts will expound and delineate this topic.

-By Rohit Ranjan

NUSRL, Ranchi

REFERENCES

Primary sources

• The Indian Contract Act, 1872 (Act 9 of 1872)

Secondary source

• Avtar Singh, Law of Contract and Specific Relief (Eastern Book Company, Lucknow, 12^th edition, 2017)
• Pollock & Mulla, The Indian Contract & Specific Relief Acts (Lexis Nexis, Gurgaon, 15^th edition, 2017)
• manupatra.com
• scconline.com

FOOTNOTES

[1] (2015) 7 SCC 337

[2] ILR (1905) 28 All 25

[3] Central Bank of India v. Virudhunagar Steel Rolling Mills Ltd., (2016) 3 SCC (Civ) 664

[4] Pollock and Mulla, The Indian Contract & Specific Relief Acts 1305 (LexisNexis, Gurgaon, 15^th edition, 2017)

[5] AIR 1967 SC 1634

[6] AIR 1929 All 687

[7] AIR 1986 SC 868

[8] (1906) 22 TLR 797

[9] 1986 QB 80

[10] Avtar Singh, Law Of Contract and Specific Relief 611 (Eastern Book Company, Lucknow, 12^th edition, 2017)

[11] AIR 1966 AP 151

[12] AIR 2000 Pat 222

[13] AIR 1969 SC 297

[14] Supra note 10 at 612

[15] AIR 2011 All 286

[16] (1987) 2 SCC 335

[17] (1992) 3 SCC 159

[18] AIR 2001 Ker 19

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