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contract_laws:rights_of_the_surety

Rights of the Surety

A contract of guarantee being a contract, all rights that are available to the parties of a contract are available to a surety as well. The following are the rights specific to a contract of guarantee that are available to the surety.

Rights against principal debtor

1. Right of Subrogation As per section 140, where a guaranteed debt has become due or default of the principal debtor to perform a duty has taken place, the surety, upon payment or performance of all that he is liable for, is invested with all the rights which the creditor had against the princpal debtor. This means that the surety steps into the shoes of the creditor. Whatever rights the creditor had, are now available to the surety after paying the debt.

In the case of Lampleigh Iron Ore Co Ltd, Re 1927, the court has laid down that the surety will be entitled, to every remedy which the creditor has against the principal debtor; to enforce every security and all means of payment; to stand in place of the creditor to have the securities transfered in his name, though there was no stipulation for that; and to avail himself of all those securities against the debtor. This right of surety stands not merely upon contract but also upon natural justice.

In the case of Kadamba Sugar Industries Pvt Ltd vs Devru Ganapathi AIR 1993, Kar HC held that surety is entitled to the benefits of the securities even if he is not aware of theire existence.

In the case of Mamata Ghose vs United Industrial Bank AIR 1987, Cal HC held that under the right of subrogation, the surety may get certain rights even before payment. In this case, the principal debtor was disposing off his personal properties one after another lest the surety, after paying the debt, seize them. The surety sought for temporary injunction, which was granted.

2. Right to Indemnity As per section 145, in every contract of guarantee there is an implied promise by the principal debtor to indemnify the surety; and the surety is entitled to recover from the the principal debtor whatever sum he has rightfully paid under the guarantee but no sums which he has paid wrong fully.

Illustrations -

  1. B is indebted to C and A is surety for the debt. Upon default, C sues A. A defends the suit on reasonable grounds but is compelled to pay the amount. A is entitled to recover from B the cost as well as the principal debt.
  2. In the same case above, if A did not have reasonable grounds for defence, A would still be entitled to recover principal debt from B but not any other costs.
  3. A guarantees to C, to the extent of 2000 Rs, payment of rice to be supplied by C to B. C supplies rice to a less amount than 2000/- but obtains from A a payment of 2000/- for the rice. A cannot recover from B more than the price of the rice actually suppied.

This right enables the surety to recover from the principal debtor any amount that he has paid rightfully. The concept of rightfully is illustrated in the case of Chekkara Ponnamma vs A S Thammayya AIR 1983. In this case, the principal debtor died after hire-purchasing four motor vehicles. The surety was sued and he paid over. The surety then sued the legal representatives of the principal debtor. The court required the surety to show how much amount was realized by selling the vehicles, which he could not show. Thus, it was held that the payment made by the surety was not proper.

Rights against creditor

1. Right to securities As per section 141, a surety is entitled to the benefit of every security which the creditor has against the principal debtor at the time when the contract of suretyship is entered into whether the surety knows about the existance of such securty or not; and if the creditor loses or without the consent of the surety parts with such security, the surety is discharged to the extent of the value of the security.

Illustrations -

  1. C advances to B, his tenant, 2000/- on the guarantee of A. C also has a further security for 2000/- by a mortgage of B’s furniture. C cancels the mortgage. B becomes insolvent and C sues A on his guarantee. A is discharged of his liability to the amount of the value of the furniture.
  2. C, a creditor, whose advance to B is secured by a decree, also receives a guaratee from A. C afterwards takes B’s goods in execution under the decree and then without the knowledge of A, withdraws the execution. A is discharged.
  3. A as surety for B makes a bond jointly with B to C to secure a loan from C to B. Afterwards, C obtains from B a further security for the same debt. Subsequently, C gives up the further security. A is not discharged.

This section recognizes and incorporates the general rule of equity as expounded in the case of Craythorne vs Swinburne 1807 that the surety is entitled to every remedy which the creditor has agains the principal debtor including enforcement of every security.

The expression “security” in section 141 means all rights which the creditor had against property at the date of the contract. This was held by the SC in the case of State of MP vs Kaluram AIR 1967. In this case, the state had sold a lot of felled trees for a fixed price in four equal installments, the payment of which was guaranteed by the defendent. The contract further provided that if a default was made in the payment of an installment, the State would get the right to prevent further removal of timber and the sell the timber for the the realization of the price. The buyer defaulted but the State still did not stop him from removing further timber. The surety was then sued for the loss but he was not held liable.

It is important to note that the right to securities arises only after the creditor is paid in full. If the surety has guaranteed only part of the debt, he cannot claim a propertional part of the securities after paying part of the debt. This was held in the case of Goverdhan Das vs Bank of Bengal 1891.

2. Right of set off If the creditor sues the surety, the surety may have the benefit of the set off, if any, that the principal debtor had against the creditor. He is entitled to use the defences that the principal debtor has against the creditor. For example, if the creditor owes the principal debtor something, for which the principal debtor could have counter claimed, then the surety can also put up that counter claim.

Rights against co-sureties

1. Effect of releasing a surety As per section 138, Where there are co-sureties, a release by the creditor of one of them does not discharge the others; neither does it free the surety so released from his responsibilty to the other surities. A creditor can release a co-surety at his will. However, as held in the case of Sri Chand vs Jagdish Prashad 1966, the released co-surety is still liable to the others for contribution upon default.

2. Right to contribution As per section 146, where two or more persons are co-surities for the same debt jointly or severally, with or without the knowledge of each other, under same or different contractx, in the absernce of any contract to the contrary, they are liable to pay an equal share of the debt or any part of it that is unpaid by the principal debtor.

Illustrations -

  1. A, B, and C are surities to D for a sum of 3000Rs lent to E. E fails to pay. A, B, and C are liable to pay 1000Rs each.
  2. A, B, and C are surities to D for a sum of 1000Rs lent to E and there is a contract among A B and C that A and B will be liable for a quarter and C will be liable for half the amount upon E’s default. E fails to pay. A and B are liable for 250Rs each and C is liable for 500Rs.

As per section 147, co-sureties who are bound in different sums are liable to pay equally as fas as the limits of their respective obligations permit.

Illustrations -

  1. A, B and C as surities to D, enter into three several bonds, each in different penalty, namely A for 10000Rs, B for 20000 Rs, and C for 30000Rs with E. D makes a default on 30000Rs. All of them are liable for 10000Rs each.
  2. A, B and C as surities to D, enter into three several bonds, each in different penalty, namely A for 10000Rs, B for 20000 Rs, and C for 40000Rs with E. D makes a default on 40000Rs. A is liable for 10000Rs while B and C are liable for 15000Rs each.
  3. A, B and C as surities to D, enter into three several bonds, each in different penalty, namely A for 10000Rs, B for 20000 Rs, and C for 40000Rs with E. D makes a default on 70000Rs. A, B and C are liable for the full amount of their bonds.

Discharge of Surety

A surety is said to be discharged from liability when his liability comes to an end. Indian Contract Act 1872 specifies the following conditions in which a surety is discharged of his liability -

1. Section 130 - By a notice of revocation - discussed above.

2. Section 131 - By death of surety - discussed above.

3. Section 133 - By variance in terms of contract - A variance made without the consent of the surety in terms of the contract between the principal debtor and the creditor, discharges the surety as to the transactions after the variance.

Illustrations -

  1. A becomes a surety to C for B’s conduct as manager in C’s bank. Afterwards, B and C contract without A’s consent that B’s salary shall be raised and that B shall be liable for 1/4th of the losses on overdrafts. B allows a customer to overdraft and the bank loses money. A is not liable for the loss.
  2. A guarantees C against the misconduct of B in an office to which B is appointed by C. The conditions of employment are defined in an act of legislature. In a subsequent act, the nature of the office is materially altered. B misconducts. A discharged by the change from the future liablity of his guarantee even though B’s misconduct is on duty that is not affected by the act.
  3. B appoints C as a salesperson on a fixed yearly salary upon A’s guarantee on due account of sales by C. Later on, without A’s consent, B and C contract that C will be paid on commission basis. A is not liable for C’s misconduct after the change.
  4. C promises to lends 5000Rs to B on 1st March. A guarantee the repayment. C gives the money to B on 1st January. A is discharged of his liability because of the variance in as much as C may decide to sue B before 1st march.

4. Section 134 - By discharge of principal debtor - The surety is discharged by any contract between the creditor and the principal debtor by which the principal debtor is discharged; or by any action of the creditor the legal consequence of which is the discharge of the principal debtor.

Illustrations

  1. A gives a guarantee to C for goods to be delivered to B. Later on, B contracts with C to assign his property to C in lieu of the debt. B is discharged of his liability and A is discharged of his liability.
  2. A contracts with B to grow indigo on A’s land and deliver it to B at a fixed price. C guarantees A’s performance. B diverts a stream of water that is necessary for A to grow indigo. This action of B causes A to be discharged of the liability. Consequenty C is discharged of his suretyship as well.
  3. A contracts with B to build a house for B. B is to supply timber. C guarantees A’s performance. B fails to supply timber. C is discharged of his liability.

If the principal debtor is released by a compromise with the creditor, the surety is discharged but if the principal debtor is discharged by the operation of insolvancy laws, the surety is not discharged. This was held in the case of Maharashtra SEB vs Official Liquidator 1982.

5. Section 135 - By composition, extension of time, or promise not to sue - A contract between the principal debtor and the creditor by which the creditor makes a composition with, or promises to give time to, or promises to not sue the principal debtor, discharges the surety unless the surety assents to such a contract.

It should be noted that as per section 136, if a contract is made by the creditor with a third person to give more time to the principal debtor, the surety is not discharged. However, in the case of Wandoor Jupitor Chits vs K P Mathew AIR 1980, it was held that the surety was not discharged when the period of limitation got extended due to acknowledgement of debt by the principal debtor.

Further, as per section 137, mere forbearance to sue or to not make use of any remedy that is available to the creditor against the principal debtor, does not automatically discharge the surety. Illustration -

  1. B owes C a debt guarateed by A. The debt becomes payable. However, C does not sue B for an year. This does not discharge A from his suretyship.

It must be noted that forbearing to sue until the expiry of the period of limitation has the legal consequence of discharge of the principal debtor and thus as per section 134, will cause the surety to be discharged as well. If section 134 stood alone, this inference was correct. However, section 137 explicitly says that mere forbearance to sue does not discharge the surety. This contradiction was removed in the case of Mahanth Singh vs U B Yi by Privy Council. It held that failure to sue the principal debtor until recovery is banned by period of limitation does not discharge the surety.

6. Section 139 - By imparing surety’s remedy - If the creditor does any act that is inconsistent with the rights of the surety or omits to do an act which his duty to surety requires him to do, and the eventual remedy of the surety himself against the principal debtor is thereby impaired, the surety is dischared.

Illustrations -

  1. C contracts with B to build a ship the payment of which is to be made in installments at various stages of completion. A guarantee’s C’s performance. B prepays last two installments. A is discharged of his liability.
  2. A appoints M as an apprentice upon getting a guarantee of M’s fidelity by B. A also promises that he will at least once a month see M make up the cash. A fails to do this. M embezzeles. B is discharged of his suretyship.
  3. A lends money to B with C as surety. A also gets as a security the mortgate to B’s furniture. B defaults and A sells his furniture. However, due to A’s carelessness very small amount is received by sale of the furniture. C is discharged of the liability.

State of MP vs Kaluram - Discussed above.

In the case of State Bank of Saurashtra vs Chitranjan Ranganath Raja 1980, the bank failed to properly take care of the contents of a godown pledged to it against a loan and the contents were lost. The court held that the surety was not liable for the amount of the goods lost.

Creditor’s duty is not only to take care of the security well but also to realize it proper value. Also, before disposing of the security, the surety must be informed on the account of natural justice so that he can have the option to take over the security by paying off the debt. In the case of Hiranyaprava vs Orissa State Financial Corp AIR 1995, it was held that if such a notice of disposing off of the security is not given, the surety cannot be held liable for the shortfall.

However, when the goods are merely hypothecated and are in the custody of the debtor, and if their loss is not because of the creditor, the suerty is not discharged of his liability.

Extent of Surety’s Liability

As per section 128, the liability of a surety is co-extensive with that of the principal debtor, unless it is otherwise provided in the contract.
Illustration

  1. A guaratees the payment of a bill by B to C. The bill becomes due and B fails to pay. A is liable to C not only for the amount of the bill but also for the interest.

This basically means that although the liability of the surety is co-extensive with that of the principal debtor, he may place a limit on it in the contract. Co-extensive implies the maximum extent possible. He is liable for the whole of the amount of the debt or the promises. However, when part of a debt was recovered by disposing off certain goods, the liability of the surety is also reduced by the same amount. This was held in the case of Harigopal Agarwal vs State Bank of India AIR 1956.

The surety can also place conditions on his guarantee. Section 144 says that where a person gives guarantee upon a contract that the creditor shall not act upon it untill another person has joined it as co-surety, the guarantee is not valid if the co-surety does not join. In the case of National Provincial Bank of England vs Brakenbury 1906, the defendant signed a guarantee which was supposed to be signed by three other co-surities. One of them did not sign and so the defendant was not held liable.

Similarly, a surety may specify in the contract that his liability cannot exceed a certain amount.

However, where the liability is unconditional, the court cannot introduce any conditions. Thus, in the case of Bank of Bihar Ltd. vs Damodar Prasad AIR 1969, SC overruled trial court’s and high court’s order that the creditor must first exhaust all remedies against the principal debtor before suing the surety.


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Created on 2020/10/19 23:13 by • Last modified on 2020/11/07 18:32 (external edit)