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Nature and extent of surety’s liability: Judicial interpretation


Authored by Aprajita Priyadarshini


Keywords: Guarantee, Surety, Liability, Principal Debtor, Creditor, Contract.


Abstract

The Indian Contract Act, 1872 provides for the specific performance contract of Guarantee. Guarantees have been among the earliest forms of contractual obligations. A guarantee arises when a person called the surety, assures to discharge the duties or liabilities of a third party in case of his failure to do so. The guarantee contracts do not have the usual legal remedy of compensation for damages but instead has either a substitutional remedy or a specific remedy as the recourse. This article deals with the nature and extent of the liability that a surety has in cases of contracts of guarantee. It is an attempt to provide an overview of when a surety may be released from his or her obligations under a guarantee following a material variation to the principal lending contract.


Introduction

The Contract of guarantee has been defined under Sec-126 of the Indian Contract Act, 1872. The contract of guarantee plays an important role in cases a loan is being sought or goods are taken on credit. A third person ensures the lender of the loan or the supplier of the goods that the person availing the loan can be trusted and given the loan. In case of any default on the side of the debtor to repay the loan or remit the price of the goods, this person can be held responsible to comply with the requisites of the contract.


Thus, the contract of guarantee is a tripartite agreement, involving the creditor, the principal debtor and the guarantor or surety.[1]

The Principal Debtor is the person availing the loan or credit in whose favour the guarantee is given. The Surety is the person who makes such guarantee in the favour of Principal Debtor and the Creditor is the person who is giving the loan or credit to whom the guarantee is made.


Surety’ Liability

The Act under Sec-128 defines the extent to which a surety can be made liable in the contracts of guarantee.


Nature of Liability: The surety’s liability is co-extensive with that of the principle debtor under the Principle of Co-Extensiveness unless the contract itself provides otherwise. 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.[2] The term co-extensive here means that the surety will be liable to the same extent to which the principal-debtor is liable. It was held in the case of E. G. Bankruptcy: Jagannath vs. Shivnarayan[3] that the discharge of the principal debtor by law does not discharge the surety.


Although the liability of a surety is co-extensive with that of the principal debtor, the liability can be limited by the surety by means of a special contract. He can expressly declare his liability to be limited to a certain fixed amount. Also unless the contract so provides, the creditor cannot sue the surety for the enforcement of his liability before there has been a default made by the principal debtor. Thus, the liability of the surety is secondary and not primary in nature and arises immediately on default by the principal debtor. The creditor nonetheless is not bound to proceed against the principal debtor first before suing the surety for the default in contract performance unless such has been expressly provided in the contract.


Extent of the Liability: As regards the extent of the liability of the surety, it shall be decided as per the terms of the contract of guarantee. The liability of the guarantor cannot go beyond the terms of the guarantee.[4] If the limit of liability has been pre-mentioned in the terms of contract, then the liability of the surety may not be co-extensive with that of the principal debtor which otherwise shall be co-extensive.


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. Also, the surety can be made liable not only for the principal amount but also for the interest due under the contract.


The principle of co-extensiveness is not an immutable rule. The precise extent of the liability of the surety will always be governed by the provisions of guarantee on their true construction of the document, and the parties remain free to provide for limitations of the liabilities of the surety without detracting from the nature of the contract as guarantee. The court has not always regarded itself as bound to treat the surety as co-extensively liable with the principal, and there are circumstances where the surety will remain liable notwithstanding the fact that the principal is not, or is no longer, liable for the principal obligations.[6]


Discharge of Surety’s Liability: The liability of the surety can be discharged by Revocation of Guarantee (S.130) or by the death of the surety (S.131). These discharge the surety from all future transactions. If there has been any change in the terms and conditions of the contract between the creditor and principal debtor, without the consent of the surety, the surety gets discharged of all transactions taking place after such changes have been made (S.133). If extra time has been provided to the principal debtor for the payment of debt, the surety is discharged of his liability in such situations (S.135). Also, if any act has been done by the creditor that goes against the rights of the surety, he is discharged of his liability towards the contract of guarantee.


Conclusion

The liability of the Surety under the Contract Act, 1872 is co-extensive with that of the principal debtor under Section 128. This has been brought under judicial interpretation time and again which has laid important principles regarding the liability of the surety. The liability of surety under Sec 128 has been given the status of not being a hard and fast rule. The exceptional situation to the liability is brought by the terms of the contract of guarantee itself. The extent of liability can be limited by the terms of the guarantee itself. The surety’s liability in contract of guarantee has always been and shall always be interpreted on the terms of the contract and the facts of the case and thus a great scope of interpretation of this section of the Indian Contract Act is available.


References:

· https://shodhganga.inflibnet.ac.in/bitstream/10603/131970/12/12_chapter%204.pdf

· https://blog.ipleaders.in/a-guide-to-contract-of-guarantee/

· https://www.toppr.com/guides/business-laws-cs/indian-contract-act-1872/contract-of-guarantee/

· https://www.srdlawnotes.com/2017/07/when-is-surety-discharged-from-his.html

[1] P.J. Rajappan v Associated Industries (P) Ltd [1990 (1) All India Bkg Law Judgments 321] [2] Central Bank of India vs. C.L. Vimla, (2015) 7 SCC 337 [3] AIR 1940 Bombay 387 [4] Central Bank of India v. Virudhunagar Steel Rolling Mills Ltd., (2016) 3 SCC (Civ) 664 [5] AIR 1967 SC 1634 [6] Moschi vs. Lep Air Services Ltd., (1973) AC 331