The Various Aspects of Surety's Liability in India

Surety’s Liability: The Indian Contracts Act, 1872 has detailed provisions regarding surety rights. In this article, the author seeks to comprehensively analyse the nature and extent of surety’s rights with the help of legal provisions and judicial decisions. The author also briefly explains the discharge of surety rights and the various circumstances provided under the ICA, 1872.

I. Introduction

Section 126 of the Indian Contracts Act, 1872, (hereafter referred to as “the Act”) defines a Contract of Guarantee. As per the provision, the surety is 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. Thus, a surety gives assurance to the creditor for the act of the principal debtor.[1]

In a tripartite contract of guarantee, it is clear that the surety’s liability is collateral to the liability of the principal debtor. It means that there must be a conditional promise to be liable on the default of the principal debtor. Any liability that is independently incurred will not qualify as a surety’s liability under a contract of guarantee as explained by the court in the old English case of Birkmyr v. Darnell.[2]

The Act seeks to protect the interest of all three parties in a contract of guarantee, especially the interests of the surety. The surety is given so much importance because they play a very crucial role in commercial transactions.

II. The Nature & Extent of Surety’s Liability

• Co-extensive Liability

The nature and extent of a surety’s liability is laid down in Section 128 of the Act. It is evident that the fundamental principle regarding a surety’s liability is that it is co-extensive with that of the principal debtor. 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, ie., it depends on the amount of the principal debt. It shows that the maximum extent of the surety’s liability will be neither more nor less unless specifically provided in the contract of guarantee.

However, it is necessary to realize that in cases where loan bonds are guaranteed, the liability of the surety is not just limited to the principal amount, but rather shall extend to the interest and other charges which may become due on it. Also, any changes or effects on the principal debtor’s liability to the creditor shall simultaneously affect the surety as well. For instance, when a principal debtor acknowledges his liability and extends the period of limitation against him, the surety will also be affected by the same as noted in the case of Bank of India v. Surendra Kumar Mishra.[3]

• Limitation on Surety’s Liability

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. A surety’s liability can only extend till the terms set out in the contract of guarantee.[4]

For example, a surety may expressly declare his guarantee to be limited to a fixed amount or a specific percentage of the debt. In such cases, the surety’s liability cannot go beyond the amount specified irrespective of the amount due from the principal debtor. In contrast to the situation mentioned above, if a surety undertakes to guarantee only the principal amount of a loan, then he cannot be held liable for the interest and other charges on the loan.[5] Also, it important to note that the burden is upon the surety to prove that his liability is limited.[6]

• 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. It means that surety will only become liable if the conditions specified in the contract are fulfilled. 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”[7].

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. However, it is pertinent to realize that when there are no such conditions stipulated under the contract, then the court cannot on its own introduce any condition to it as pointed by the SC in Bank of Bihar Ltd v. Dr Damodar Prasad.[8]

If it is not specifically stipulated under a contract that the creditor shall not proceed against the surety before exhausting his remedies against the debtor, then the creditor has the freedom to proceed against the surety anytime he wants. If the court insists that the creditor must postpone his right against the surety, then the very object of the contract of guarantee is bound to fail.

III. Discharge/Termination of Surety’s Liability

The Indian Contract Act, following the Common law regime, lays down various circumstances under which the surety’s liability comes to an end. Discharge from liability indicates the point at which the surety’s liability to perform the promise in case of default by the principal debtor comes to an end. The Act lays down the following circumstances for the discharge of surety’s liability:

• Discharge by Revocation

Section 130 of the Act provides for revocation of a continuing guarantee by giving notice to the creditor. The provision clarifies that the revocation is only with respect to future transactions and not in case of those transactions which are already entered into. Thus, it is not possible to revoke by giving notice in case of specific guarantee as there are no future transactions which haven’t yet been entered into by specific guarantee.

In the case of Harigopal Agarwal v. SBI [9], the court held that when the directors of a company had guaranteed the company’s loans and subsequently resigned, then their liability was limited to the amount which was due till the date of their resignation. Any amount due after their resignation will not be their liability. However, when a person waives their right of revocation of a continuing guarantee in the terms of the contract, they will be held liable and cannot subsequently revoke the contract as provided in Sita Ram Gupta v. Punjab National Bank[10].

• Discharge by Death of Surety

Section 131 of the Act provides for revocation of a guarantee by the death of the surety. However, this discharge is only available for future transactions and not those transactions which have already been entered into. In such cases, there is an obligation on the legal heirs of the surety to settle the liabilities of the deceased surety. However, this liability can be enforced against the legal heirs of the surety only to the extent of the property inherited by them and not in a personal capacity as provided in R.K Diwan v. the State of UP.[11]

• Discharge by Variance

The Act has made several provisions to protect the surety’s interest and the courts also consider the surety as the favoured debtor and his liability is in strictissimi juris. It means that if there is no absolute good faith when a contract of guarantee is entered into, the duty of 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 surety is discharged from his liability because with the alteration of the contract, the parties have made it impossible for the guaranteed performance to take place. He clarified in this case that the application of this principle must always depend upon a correct analysis of the contract in fact made.

However, when the alteration made in the contract is not substantial or material or is in favour of the surety, then in all probability the surety will not be discharged from his liability as apparent from the decision of the SC in M.S Anirudhan v Thomco’s Bank Ltd. [13]

• Discharge by Release or Discharge of the Principal Debtor

Section 134 of the Act provides that the surety is discharged by any contract between the creditor and the principal debtor, by which the principal debtor is released or by any act or omission of the creditor, the legal consequence of which is the discharge of the principal debtor. In an early case before the Privy Council,[14] the court held that the surety is discharged from liability on the ground that the surety’s right to pay the debt at any time and after paying it to sue the principal in the name of the creditor is interfered with.

The section contemplates two types of discharge from liability. In the first instance, if the creditor makes any contract or compromises with the principal debtor by which the latter is released, the surety is also released. However, it must be realized that if a principal debtor is discharged by the operation of insolvency laws, or through liquidation in case of a company, that will not absolve the surety of his liability as held by the SC in the case of Maharashtra SEB v. Official Liquidator. [15]

The second scenario envisaged under the provision is the discharge of the surety by virtue of an or omission on part of the creditor. For instance, if a surety guarantees the performance of a contract by the principal debtor, which is depended on the supply of materials by the creditor and if the latter fails to do his part, it would discharge the debtor and the surety along with him.

• Composition, the Extension of Time and the Promise not to Sue

Another circumstance through which a surety can be discharged from his liability is found under S. 135 of the Act. Under this provision, “a contract between the creator and the principal debtor, by which the creditor makes a composition with, or promises to give time to, or not to sue, the principal debtor, discharges the surety unless “the surety assents to such contract”.

Three different circumstances releasing the surety of his liability have been envisaged in the section: (1) when a creditor compounds with the principal debtor; (2) when the former promises to give time to the latter; and (3) when the former agrees not to sue the latter.

The exceptions to the general rule in S. 135 can be found under S. 136 and 137 of the Act. Section 136 of the Act provides where a contract to give time to the principal debtor is made by the creditor with a third person, and not with the principal debtor, the surety is not discharged from his liability.

On the other hand, Section 137 provides that mere forbearance on the part of the creditor to sue the principal debtor or to enforce any other remedy against him does not, in the absence of any provision in the guarantee to the contrary, discharge the surety. Thus, if a creditor neglects to sue the principal debtor, in the absence of any contrary provision in the guarantee, that does not by itself cause the automatic release of the surety.

• Discharge when the Surety’s Remedy is Impaired

Section 139 of the Act has a wide ambit which covers the rest of the scenarios in which a surety’s rights can be discharged. According to the provision, if the creditor does any act which is inconsistent with the rights of the surety or omits to do any act which his duty to the surety requires him to do, and the eventual remedy of the surety himself against the principal debtor is thereby impaired, the surety is discharged. Thus, it is the duty of the creditor not to do something which will interfere with the surety’s rights subsequent rights against the debtor.

IV. Conclusion

To conclude, the Indian Contracts Act provides a wide array of circumstances in which the surety can be discharged from his liability to the creditor. Sections 130-139 of the Act encompasses these varied scenarios. The surety’s liability is a secondary liability which arises the moment the debtor defaults.

The unique features of the surety’s liability are that it is co-extensive with the debtor’s liability and at the same time a surety can put a limit on the amount he wants to guarantee. He can also stipulate the conditions in which his liability shall arise under the terms of the contract. It is very evident from these provisions and the various judgements that the courts of law and equity have always taken zealous care of surety’s interest.

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References

[1] S. 126 of the Indian Contracts Act, 1872, Available Here

[2] (1704) 91 ER 27: 1 Salk 27.

[3] (2003) 1 BC 45

[4] State of Maharashtra v. MN Kaul, AIR 1967 SC 1634

[5] S.N Prasad v Monnet Finance Ltd, (2011) 1 SCC 320.

[6] Bharat National Bank Ltd. and another v. Thakar Das Madhok, A.I.R, 1935 Lahore 729.

[7] Section 144 of the Act

[8] AIR 1969 SC 297

[9] AIR 1956 Mad 211

[10] AIR 2008 SC 2416

[11] 2005 All LJ 2067

[12] AIR 1935 P.C. 21

[13] AIR 1963 SC 746

[14] Mahanth Singh v. U Ba Y, A.I.R. 1939 P.C. 110.

[15] (1982) 3 SCC 358

16. Avatar Singh, Business Law (10^th, 2014)

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1. Contract Law; Notes, Case Laws And Study Material
2. Co-Suretyship under the Indian Contract Law: A Glance at the Rights and Liabilities