Judicial Interpretations to Protect the Surety

It is important to look at judicial interpretations to protect the surety because the Indian Contract Act, 1872 contains detailed provisions regarding the surety’s rights and liabilities but there can be a great deal of ambiguity or lack of clarity while analysing these sections. It is in this instance that the role of judiciary attains paramount importance. The judiciary has over the years clarified the legal position regarding the surety’s rights and liabilities. In this article, the author seeks to analyse the same by looking at it through judicial interpretation.

I. Introduction

Section 126 of the Indian Contract Act, 1872, (hereafter referred as “the Act”) defines a ‘Surety’ as a person who gives the guarantee to perform the promise or discharge the liability of a third person, in case of his default to the creditor in a Contract of Guarantee. Simply put, a surety gives assurance for the acts of a principal debtor.

It is important to note that the liability of the surety is only secondary and arises only when the principal debtor defaults. It is not a primary liability but rather collateral in nature. The courts have in many instances taken a stand which is favourable to the surety. Moreover, a look at the provisions of the Act reveals that there are numerous sections incorporated to protect the surety’s interest.

II. Surety as the Favoured Debtor

The courts of law and equity have always taken zealous care of the surety’s interest. The surety is often referred to as the favoured debtor.[1] This is because the courts of law seem to be more sympathetic towards the surety as held by the court in the early case of State v. Churchill [2]. The reason for this favourable disposition on the part of the courts towards the problems as regards the rights and obligations of the surety is that a person who stands surety for another aids the conclusion of the main transaction, although he does not possess an active interest in it—except his interest in assisting the debtor in performing of the latter’s obligations.

The reason why courts favour sureties is primarily due to their important contribution in commercial transactions. They have great economic importance as they facilitate the supply of credit in business transactions. Looking at it from this perspective, it appears that the judiciary adopts a lenient attitude towards the surety to encourage co-operation in commercial transactions by reducing their risk to a minimum.

In the early case of Law v. East India Co.,[3] the court had held that where any thing is done by the creditor which has the effect of injuring the surety, the court is very glad to lay hold of it in favour of the surety. It must be noted that there is no moral obligation on the surety beyond his legal obligation.[4]

III. Liability of the Surety

Section 128 of the Act lays down that the liability of the surety is ‘Co-Extensive’ with that of the principal debtor unless it is explicitly provided in the contract of guarantee. The term “Co-extensive” implies that the surety is liable for the whole of the amount for which the debtor is liable and he is liable for no more. However, it has been held by the courts that in case of guarantee for which the creditor is entitled to interests and other charges from the principal debtor, the liability of the surety will be limited to the principal amount only and will not be liable for the interest unless specifically provided in the contract of guarantee.

This principle was laid down in Maharaja of Benares v. Har Narain Singh[5] wherein the creditors demanded both arrears of rent and interest from the surety. But the court held that the liability of the surety extended only towards the arrears of rent as provided in the contract of guarantee and not for the interest as it was not explicitly mentioned in the contract. However, in the case of Zaki Husain v. Deputy Commissioner of Gonda,[6]the court differed from the view in the Maharaja of Benaras case and held that a surety is liable not only for the principal amount but also for interest due under the contract.

IV. Limiting the Surety’s Liability

It is possible to limit the liability of the surety by means of a special contract. The fact that the surety’s liability is co-extensive with that of the principal debtor is not an absolute principle. There are circumstances when the surety’s liability is limited to some part of the debt. As provided under S. 128, it is possible to limit the liability of the surety by explicitly providing it in the terms of the contract. In the case of State of Maharashtra v Dr M.N Kaul[7], the SC held that under law, the guarantor cannot be made liable for more than he has undertaken; that he is the favoured debtor.

V. Condition Precedent to Surety’s Liability

It is possible that a contract of guarantee may contain certain condition precedents, only following which the surety’s liability shall commence. Section 144 of the Act partially recognizes this principle. The section provides that,

“Where a person gives a guarantee upon a contract that the creditor shall not act upon it until another person has joined in it as co-surety, the guarantee is not valid if that other person does not join.”

In addition to this, the surety may include other conditions in the contract of guarantee regarding his liability which must be fulfilled for the liability to commence. In the early English case of 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 since there was no agreement between the bank and the co-guarantors to do away with the signature, the defendant was not liable. The same principle was reiterated in the case of James Graham & Co (Timber) Ltd. v. Southgate Sands.[9]

However, in cases where there are no conditions stipulated in the contract of guarantee, the creditor has the right to proceed against the surety once the liability commences even without exhausting his right against the principal debtor as laid down by the SC in the case of SBI v. Indexport Registered. [10]

There were contrasting views adopted by the courts in this regard in the earlier years. For instance, in the case of Union Bank of India v. Manku Narayana,[11] the SC had held that the creditor must first proceed against the mortgaged property and then only against the surety for the balance, even if the decree is a composite one against the principal debtor, mortgaged property and the guarantor. This decision was overruled by the SBI v. Indexport case.

VI. Discharge of Surety from his liability by Variance in the Contract

The courts view the surety as the favoured debtor and hence, once the contract of guarantee is entered into, absolute good faith is imposed upon the creditor. This is reflected in Section 133 of the Act wherein a surety is discharged from his liability if the creditor makes any changes in the terms or nature of his contract with the principal debtor without the surety’s consent. The Indian law received authoritative expression on this point as early as 1934 through a Privy Council decision in Pratap Singh v. Keshavlal.[12] Lord Atkin clarified the legal position on this and held that the surety cannot be held bound to something for which he has not contracted.

“If the original parties have expressly agreed to vary the terms of the original contract, no further question arises. The original contract has gone, and unless the surety has assented to the new terms, there is nothing to which he can be bound, for the final obligation of the principal debtor will be something different from the obligation which the surety guaranteed.”

The courts have held that an alteration in the principal contract not only discharges the surety from his personal liability but also releases any property, if any, the surety had included in the contract as enunciated in Bolton v. Salmon.[13]

VII. Right of Subrogation

This is one of the most important rights available to a surety. Once the surety has paid all that he is liable for, he is invested with all the rights which the creditor had against the principal debtor. It means that the surety will step into the shoes of the creditor and he can sue the principal debtor to recover the money paid by him. This principle is incorporated in S. 140 of the Act.

In the case of Lamplugh Iron Ore Co Ltd, re,[14] the court held that:

“The surety will become entitled to every remedy which the creditor has against the PD, to enforce every security and all means of payment; to stand in place of the creditor to have the securities transferred to him, even though there was no stipulation for that; and to avail himself of all those securities against the debtor”.

This right of subrogation is not only based on the contract but also upon the principles of natural justice as held in the case of Mamata Ghosh v. United Industrial Bank.[15]

VIII. Right to Securities

Section 141 of the Act recognizes and incorporates the general rule of equity as expounded in Craythorne v. Swinburne,[16] that the surety is entitled to every remedy which the creditor has against the principal debtor, including enforcement of every security. The expression ‘security’ in Section 141 is not used in any technical sense and includes all rights which the creditor had against the property of the debtor at the date of the contract as laid down by the SC in the case of State of M.P Kaluram.[17]

IX. Conclusion

The judiciary has played a significant role in interpreting the legal provisions relating to Contract of Guarantee, especially those provisions relating to the surety/guarantor. It is evident from the analysis of the abovementioned judgements that the liability of the surety is co-extensive with that of the principal debtor which the judiciary has reiterated from time to time.

The judiciary has laid down some important principles in the cases discussed above in this article. These decisions by the judiciary have been instrumental in clearly understanding the extent of the surety’s rights and their liabilities. The judiciary plays a significant role in removing any ambiguities which exist concerning the surety’s rights and liabilities.

The judicial interpretation on the surety’s right to subrogation, right to indemnity, right to securities, etc. have ensured that the law relating to the surety in India is well settled. Also, it is evident from foreign judgements as well as the decision of the SC in the MK Kaul judgement that the surety is the favoured debtor and the courts adopt a more liberal approach while considering their liability than that of the principal debtor.

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References

[1] William H. Lloyd, The Surety 66 University of Pennsylvania Law Review 40 (1909- 1910), Available Here

[2] 48 Ark. 426 (1886)

[3] 4 Ves. 824 (1799).

[4] Winston v. Rives, 4 S. & P. (Ala.) 269 (1833).

[5] ILR (1905) 28 All 25

[6] AIR 1929 All 687

[7] AIR 1967 SC 1634

[8] (1906) 22 TLR 797

[9] 1986 QB 80

[10] AIR 1992 SC 1740

[11] AIR 1987 SC 1078

[12] AIR 1935 P.C. 21

[13] (1891) 2 Ch 48

[14] (1927) 1 Ch 308

[15] AIR 1987 Cal 280

[16] (1807) 14 Ves 160

[17] AIR 1967 SC 1105

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1. Contract Law; Notes, Case Laws And Study Material
2. A Comprehensive Guide to the Contract Of Guarantee under Indian Law