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negotiable-instruments:principal-and-surety

Principal and surety relationship between parties to a negotiable instrument

Sections 37 to 39 of the Negotiable Instruments Act should be read together to determine the relationship of all the parties to a negotiable instrument whether a promissory note or a cheque or a bill of exchange.

Maker, drawer and acceptor principals

The maker of a promissory note or cheque, the drawer of a bill of exchange until acceptance, and the acceptor are, in the absence of a contract to the contrary, respectively liable thereon as principal debtors, and the other parties thereto are liable thereon as sureties for the maker, drawer or acceptor, as the case may be.1)

Prior party a principal in respect of each subsequent party.

As between the parties so liable as sureties, each prior party is, in the absence of a contract to the contrary, also liable thereon as a principal debtor in respect of each subsequent party.2)

Illustration: A draws a bill payable to his own order on B, who accepts, A afterwards indorses the bill to C, C to D, and D to E. As between E and B, B is the principal debtor, and A, C and D are his sureties. As between E and A, A is the principal debtor, and C and D are his sureties. As between E and C, C is the principal debtor and D is his surety.

Principal and surety

A party to a negotiable instrument is liable to the holder either as a principal debtor or as a surely In the case of a promissory note or a cheque the original maker of the instruments, and, in the case of a bill of exchange, the drawer and after acceptance, the acceptor, ordinarily occupy the positions of the principal debtors unless there is a contract to the contrary and other parties to the instruments are liable as their sureties. The relationship inter se between such sureties is that every prior party is a principal debtor to every succeeding party. The executant of a promissory note should be regarded as the principal debtor and not as surety. But when there are two executants of a note and one executant signed it as a surety for the other to the knowledge of the promisee evidence is admissible to prove that fact. But a different view has been held by the other High Courts. The latter view, it is submitted, seems to be the better one as it is consistent with the illustration in section 132 of the Indian Contract Act and Sec 92 of the Indian Evidence Act. When, however, money is realised from one of the executants, in a suit for contribution by him against the other, the latter is competent to resist the claim on the ground that he was a surety. The maker of a promissory note cannot escape from his liability under this section on the plea that the note was attested by witnesses and the purchaser of the note being a holder thereof can recover the amount although initially the note was without consideration.

As stated before, the drawer of a Bill of Exchange is the principal debtor so long as the bill is not accepted. The drawer of a hundi made payable after a specified period after date, who is also the drawee, is liable thereupon as a principal debtor and presentment for acceptance or for payment is unnecessary. But the moment the bill is accepted the acceptor becomes the principal debtor and the drawer becomes only a surety. The position of the sureties inter se is not that of co-sureties but that of a principal debtor and surety, every prior party being the principal debtor of every subsequent party although all are sureties in respect of the acceptor.The drawer or indorser stands in a position sufficiently analogous to that of a surety to entitle him to all the equities of the surety after dishonour and not before and is entitled to the benefit of the set off in favour of the principal debtor. The relationship of principal and surety arises not because of any contract but because of the provisions of these two sections.

Successive endorsers

Where several persons successively endorse a negotiable instrument each prior party is individually liable to the succeeding party in the order of their indorsement and the liability of these indorsers is not joint but several. Where after one full indorsement there were two blank indorsements the presumption is capable of being rebutted by evidence of any special agreement, as where the directors of a company agreeing with each other to become sureties to the bank for the same debt of the company made three promissory notes by the company and successively endorsed them, it was held that the directors were co-sureties and not sureties in succession. In the case of co-sureties there can be contribution between themselves in spite of their respective relationship with reference to the holder. The contract of the drawer, acceptor or the intervening endorser of a bill is distinct from each other and the liability of each to pay the same sum of money arises wholly out of his contract made severally subject to different conditions. Therefore, if a decree is obtained against any of the parties and the amount cannot be realised from him the plaintiff may proceed to institute a fresh suit against any other, and his election to proceed against one party is no bar to his proceeding against others, if need be. A bill may be time-barred against an acceptor but this may not discharge the liability of the drawer if the suit against him is in time. A creditor is not bound to exhaust his remedies against the principal debtor before proceeding against surety. He may sue either or both in one action. He may execute the decree against one or both but under exceptional circumstances court may direct the creditor to proceed against the principal debtor first.

Agreement to the contrary

The ordinary rule of law laid down in these two sections regulating the relationship of the parties to the instrument is liable to variation by any special contract to the contrary between the parties. Thus, in the case of two joint makers of a note the presumption is that each took a moiety of the amount and so are jointly liable and not as surety unless there is a special contract to the effect. In the case of accommodation bills or notes the contrary contract is implied as between the party accommodating and the party accommodated but no such special contract to alter the liability will be implied or presumed as between those parties and subsequent parties. Where a note is executed by the maker to accommodate the payee and the note is endorsed, the maker is liable to the indorsee as the principal debtor and the payee as his surety in the absence of a special agreement to the contrary. But where a person is induced to execute a promissory note in favour of a bank by its director to conceal an unauthorised loan to him on the express condition that the maker will not be liable on the note, the maker cannot escape liability to the bank as the director cannot represent the bank to enter into the special agreement.

Position of surety

When the principal debtor defaults and the amount is realised by the holder from the surety the latter acquires all the rights and equities of the creditor against the principal debtor and becomes entitled to the benefit of the securities furnished by the maker although he may not he aware of the existence of such security. If the holder parts with such security without his consent the surety is proportionately discharged. The surety may be discharged by a contract or by any act or omission of the creditor. Where an indorsee of an accommodation note takes mortgage from the payee for the amount and grants him time to make the payment the maker is discharged from the liability. Mere knowledge that the maker is an accommodation party does not deprive the creditor of his right to treat him as a principal debtor. For discharge of surety, see Indian Contract Act sections 134-141.

Suretyship

Section 39 of the Negotiable Instruments Act,1881

When the holder of an accepted bill of exchange enters into any contract with the acceptor which, under section 134 or 135 of the Indian Contract Act, 1872 (9 of 1872), would discharge the other parties, the holder may expressly reserve his right to charge the other parties, and in such case they are not discharged.

This section is an exception to the general law that if the principal debtor is discharged by the creditor the surety is also discharged along with him, under the provisions of sections 134 and 135 of the Indian Contract Act. It is not permissible under that Act to keep the liability of the surety intact after the discharge of the principal debtor or after any sort of composition with him. But a different view has been expressed in other cases.

Granting time

But drawer and the indorser of the bill are discharged if the holder agrees to give time for payment to the acceptor. But they won’t be discharged if the holder enters into a contract with a third person to give time to the principal debtor. A mere promise to grant time without any consideration does not discharge the sureties. A surety is not discharged if the holder waits till the expiry of the period of limitation to proceed against the principal debtor. But according to the Allahabad High Court by such forbearance he is discharged.3) The section being an exception to the general rule of discharge of sureties should be confined to contracts only with the acceptor.

A surety cannot get his discharge by giving a notice to the creditor that the principal debtor is selling away his properties and the creditor should take steps to realise the money. But if the creditor assents to a transfer of the property by the principal debtor or does any act by which the remedy of the surety against the principal debtor is impaired the surety is discharged. So also where a creditor accepts interest in advance from the principal debtor on condition that he will not sue the debtor during the time for which the interest is paid the surety will be discharged but where the interest is accepted without any such condition the surety will not be discharged.

An act which may extend the time and privileges to the creditor but confers no benefit to the debtor nor affects the surety will not discharge the latter.

Reservation of right

The reservation of right by the holder against the parties mentioned in the section must be express and clear. In a suit instituted by the creditor on a promissory note against the maker and the two sureties, when the plaintiff withdraw the claim against the maker, it was held that he could proceed only against the sureties as there was express reservation of his right against the sureties. A surety was not held to be discharged if in a similar case the suit was dismissed against the maker for non-service of summons.4) But where a creditor allowed the case to abate against the principal debtor by omission to substitute his legal representatives in time, or where in appeal the creditor appellant failed to add the principal debtor as a respondent the surety was held to be discharged.

An accommodation acceptor is to prove that he is not, as appears on the face of it, the principal debtor but is only a surety and on such proof he will be entitled to the rights of a surety. A person who was originally a principal debtor but by a subsequent arrangement converted himself to a surety as where a retiring partner by a deed covenanted that the continuing partners should pay the debts and indemnify him and become a surety for the debts of such creditors as had notice was allowed to prove that he was a surety and had the rights and privileges of the surety and neither section 132 of the Contract Act nor section 92 of Indian Evidence Act was held to be any bar to such proof.

1)
Section 37
2)
Section 38
3)
Sahgram v Lachman, 60 All 211
4)
Ali v Mahammad, 14 Bom 257