Contract of guarantee is a tripartite agreement between the creditor, principal debtor and surety. A contract of guarantee means a contract to enforce third party’s promise or discharge liability if the default made by the second party. In a contract of guarantee, the creditor means a person whom the guarantee was given to another person, the principal debtor means the person who receives the guarantee or who defaults that guarantee and the surety means the person who gives a guarantee to certain contract on behalf of the principal debtor. There were three contracts between the creditor, principal debtor and surety that is an original contract between the creditor and principal debtor, a contract of guarantee between creditor and surety, a contract indemnity between surety and principal debtor. There are some rights against creditors where the surety will enjoy the rights that are Right to securities under Section 141 of the Indian contract Act, 1872, Right to set off and Right to share reduction.
These are the surety’s right to benefits against the creditor. The main element of a contract of guarantee is to make assurance for the payment of the amount which was taken by the principal debtor from the creditor. In a contract of guarantee, there will be surety when the principal debtor made a contract with the creditor; the creditor has security with him and for this contract and when the principal debtor does not pay the amount then surety should pay that amount to the creditor and the security will be given to the surety, that the right was given to the surety to claims the security. Surety has benefits to recover security.
Section 141 of The Indian Contract Act, 1872
Section 141 of the Indian Contract Act, 1872 deals with the right against a creditor. The surety enjoys some rights against the creditor: Right to securities, Right to share reduction, Right to set off. It states that “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 entered into, whether the surety knows of the existence of such security or not; and if the creditor loses, or without the consent of the existence of such security or not; and if the creditor loses, or without the consent of the surety, parts with such security, the surety, the surety is discharged to the extent of the value of the security.”[1]
Examples:
- A advances rupees 5000 to B, on the guarantee of C. A also had additional security which covered rupees 5000 by mortgage of B’s valuable things. B has a default to pay the amount and A does not accept or the Mortgaged and A sues C based on the guarantee. C discharged from the liability to the value of those things.
- K wants to secure a loan from M and L was surety for K. However, M obtained further security from K for that debt. Later, K gives up further security. Here L is not discharged from the liability.
Rights against the creditor to take back the securities for surety which was deposited by the principal debtor, after making the dues the surety has all the rights which are available to the creditor against the principal debtor under section 141 of the Indian Contract Act, 1872. He is entitled to the benefit of every security which creditor has against the principal debtor. The right exists irrespective of the fact whether the surety knows of the existence of such security or not.
In Wuff & Billing v. Jay,[2] the plaintiff gave £ 300 to A and B and the defendant was the surety for that amount which was lent to A and B by the plaintiff. During the time of loan A and B is given by an accomplishment as security for the amount taken from the plaintiff. The plaintiff was given a right to sell the security when the A and B is a default by the notice. The debtors’ insolvency occurred and default took and the defendant did not enter into ownership. The plaintiff knew about insolvency and allowed it to continue in possession. The court held that “the plaintiffs, by their omission to seize the property assigned on default, had deprived themselves of the power to assign the security to the surety. He was, consequently, discharged to the quantity that the products were really worth.”
According to English law, the surety has a right to securities which the creditor in fact has against the principal debtor, whether the surety knew of them or not and whether they were received before or after the guarantee. In Scotland, The Mercantile Law Amendment (Scotland) Act, 1856 (U.K.), states that “From and after the passing of this Act, all Guarantees, Securities, or Cautionary Obligations made or granted by any Person for any other Person, and all Representations and Assurances as to the Character, Conduct, Credit, Ability, Trade, or Dealings of any Person, made or granted to the effector for the purpose of enabling such Person to obtain Credit, Money, Goods, or Postponement of Payment of Debt, or of any other Obligation demandable from him, shall be in writing and shall be subscribed by the Person undertaking such Guarantee, Security, or Cautionary Obligation, or making such Representations and Assurances, or by some person duly authorized by him or them, otherwise the same shall have no effect”[3].
Right to securities
When the surety has fulfilled all the liabilities which made defaults by the principal debtor to the creditor, the surety was a person who can entitle to take all the securities which belonged principal debtor but which was with the creditor. Surety has all the rights on all the securities given by the principal debtor to the creditor. It is also not more important if the surety knows about those securities or not. If the securities are burdened with further advances it will not affect the right of the surety. In the case, Forbes v. Jackson[4], the principal debtor borrowed £200 on mortgaging his leasehold premises and a policy of life insurance, the defendant joined as a surety. The principal debtor lent further sums from the creditor on the securities; the surety does not know anything about it. The principal debtor failed to pay that sum. The surety paid off £ 200 and interest then he claimed both the securities. The creditor demanded payment of the further advances also. But the court held that “The surety’s right to the securities was not affected by the further advances and, therefore, the surety entitled to both the securities.”
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Right to Share Reduction
The protection is entitled to claim the proportionate reduction of its liability by the amount of dividend received by the creditor (from the main debtor’s official receiver) on the debtor’s insolvency. Similarly, the law reduces the debt responsibility of the debtor; the creditor is entitled to claim a proportionate reduction of his liability. The reduction here leads to insolvency. For example, A lends to B, the guarantor is C. Later B becomes insolvent. B’s property is attached to recover a loan which he had taken by A. In this case, the official receiver that is principal debtor must create a list of creditors and pay them proportionate to the sum lent by them. The surety can ask the principal debtor about the amount given to A. The amount received by A through this method can be deduced by surety.
Right to set off
If the creditor owes money to the debtor, the sum due can be balanced against the protection in the creditor’s argument. If the creditor needs to pay the debtor back, the surety may charge the amount to be paid to the creditor. In case the creditor made a breach of contract against the debtor in that situation the principal debtor is released from his duties, the surety also is released. However, the creditor does not have any chance to sue the surety if the creditor is not able to sue the principal debtor because he did not carry out his duties in that contract. If the creditor made a breach of contract there won’t be discharge on the debtor’s part but it gives a right to counterclaim for damages to the debtor, if the creditor sues the surety, the surety can avail himself of any defence that the principal debtor might have had which discharge him completely or partly from the creditor.[5]
Right of set-off is the bank’s rights to merge the same person’s two accounts where one account is in credit balance and the other account is in debit balance to cover a defaulted loan. The lender can only exercise the right to set-off if the money owed to him is a certain amount, which is due and if there is no agreement, express or implied to the contrary. For example, A lending setoff clause is also included in a borrower’s loan agreement with the bank where they keep other collateral, such as money in a check, savings or money markets account, or a deposit certificate. In the case of default, the creditor decides to make those assets available to the lender. If the assets are kept at that lender, the lender can access them more easily to cover a defaulted payment. But a set-off provision may also require asset rights retained at other institutions. Although such assets rights are retained available to the lender, if a borrower defaults, the setoff provision will grant the lender statutory permission to seize them.
Case laws
Amrit Lal Goverdhan Lalan v. State Bank of Travancore
In this case[6], the contract of guarantee entered into by the partnership firm and they entered into an agreement to open a cash credit account to the extent of Rs. 1,00,000. The appellant became surety for the agreement and allowed to recover from the bank, the bank can hold the contract without any taking other security. The Supreme court held that under section 141 of the Indian contract Act, 1872, the creditor without the consent surety loses the part of security, the liability of A was released to the extent of the value of the security so lost.
State of M.P v. Kaluram
In this case[7], Jagatram was awarded the sale of trees on payment of security and frequently the payment was made in instalments. This contract was performed in favour of the M.P’s governor, Kaluram and Nathuram are both sureties for the Jagatram. He reduced the quantity of the trees and paid the first instalment but did not pay the other instalment. In this case, the court held that the word “security” in Section 141 and this word is not used in any technical sense and it also includes the creditor’s all rights towards the property at the time of contract. “The surety is entitled to payment of the debt or performance of all that he is liable for, to the benefit of the rights of the creditor against the principal debtor which arises out of the transaction which gives rise to the right or liability.”
State Bank of Saurastra v. Chitranjan Ranganath Raja
In this case[8], the creditor allowed cash credit which was limited to Rs 75,000 to the principal debtor on his pledging 5,000 tins of groundnut oil and respondent was surety for this contract. Afterwards, when the Bank lost the pledged tins and sued the legal representative of Principal debtor and the Surety to repay the debt, Surety contested discharge of his liability. The court held that under “Section 141 of the Indian Contract Act, 1872” states that the creditor had taken the multiple security from the debtor when the contract of guarantee was performed by them and it is not important that surety has knowledge of that security which offered by the debtor, if the creditor without consent of surety loses the security, the surety would be released or discharged to the value of the security.
Suggestions
- Surety must know about the securities which were given by the principal debtor to the creditor.
- Surety should know that he has all rights on securities as a creditor if the surety pays the default of the principal debtor.
- Surety has a chance to discharge if they change terms in contract mutually but surety does know about that.
Conclusion
A surety is a person who, if the principal debtor refuses to pay the amount, who comes forward to pay the debt. In case of a judgment against the principal debtor in favour of the creditor, the wings of the judgment can also be applied against the securities as their liability is coinciding with the principal debtor. The liability of surety is coincident with that of the principal debtor unless otherwise provided for in the contract. A surety has certain rights against the creditor, the principal debtor and co sureties. If the principal debtor defaulted to the creditor but principal debtor kept some securities with the creditor and they will be surety to contract and surety pays the default amount done by the principal debtor, the surety had all rights on securities and that securities are owed by the surety and principal debtor should take from the surety by paying the amount. This states that in Section 141 of the Indian Contract Act, 1872.
REFERENCES
[1] The Indian Contract Act, 1872 (Act 9 of 1872),s.141.
[2] (1872) 7 QB 756.
[3] Trevor c. Hartley, “The law of suretyship and indemnity in the United Kingdom of Great Britain and Northern Ireland”, available at:
https://op.europa.eu/en/publication-detail/-/publication/dfe66c6f-5568-4f8d-be69-da15528beb11 (last accessed on 12th December, 2020).
[4] (1882) 19 Ch D 615.
[5] Avtar Singh, Contract and Specific Relief 665(Eastern book company, 12th ed., 2019).
[6] AIR 1968 SC 1432.
[7] 1967 SCR (1) 266.
[8] 1980 AIR 1528, 1980 SCR (3) 915.
BY BANOTH MYTHILY MEERA NAIK | SYMBIOSIS LAW SCHOOL, HYDERABAD