Discharge of Surety’s Liability

The Indian Contract Act, 1872 enumerates a ‘contract of guarantee’ which is considered as the most important aspect of the said act. A contract of guarantee involves three parties that are principal debtor, creditor, and a surety. A surety is a person who gives a guarantee to the creditor that he would make the debt payment if the principal debtor makes a default. A surety is thereby liable to the creditor for the debt repayment. This liability of the surety can be discharged or released in certain circumstances that are expressly provided under the said act. Also, certain rights against the creditor, principal debtor, or co-sureties are available to a surety. Hence, a contract of guarantee is incomplete without a surety.

Introduction

Section 126[1] of the Indian Contract Act, 1872 (ICA) provides that ‘A ‘contract of guarantee’ is a contract to perform the promise, or discharge the liability, of a third person in case of his default.’ The section also defines the term ‘surety’. The person who gives a guarantee to pay the amount advanced or perform any duty is called a surety while the person to whom the guarantee is given is called a creditor. The person on behalf of whom the guarantee is given is called a principal debtor. Also, a guarantee can either be oral or written. Hence, we can say that in a contract of guarantee, a surety is responsible to pay the creditor, an amount that the principal debtor is unable to pay.

A contract of guarantee acts as a second resource if the first resource i.e. the person to whom the money is advanced, fails to pay. According to Section 127[2] of ICA, there is enough consideration for a surety to give a guarantee to the creditor when the principal debtor does or promises something to the creditor. Surety plays a very vital role in a contract of guarantee as he is the ultimate person who will be liable to pay the sum of money to the creditor in case the principal debtor makes a default.

Section 128[3] of ICA provides for surety’s liability which is co-extensive with the principal debtor’s liability. It means that the surety has the same liabilities as the principal debtor. Hence, a surety is liable to pay the amount owed to the principal debtor, if he makes a default in payment to the creditor. Also, a creditor can directly sue the surety without suing the principal debtor. It is, however, significant to note that a principal debtor will not be held liable where there is a defect in documents and the same applies to the surety. The discharge of surety’s liability means when his liabilities under the contract of guarantee comes to an end. Sections 130-144 of ICA provide certain circumstances under which the liability of the surety is discharged which include revocation by the death of the surety, revocation by giving notice, etc.

Who is a Surety?

A surety is a person or an organization that guarantees to pay the sum of money to the creditor in an instance where the principal debtor makes a default or is not able to pay. A surety is also called the ‘guarantor’. When the principal debtor fails to pay his debts, a surety assumes upon himself, the responsibility to pay the debts of the principal debtor. Section 126 of ICA, also defines the term ‘surety’ while defining the contract of guarantee. In a contract between two parties, where one party questions the ability of the other party to satisfy the requirements of the contract, a presence of surety is very common. A lender, in order to reduce risk, may require the debtor with a surety while entering into a contract. Therefore, a surety takes all the responsibility to pay the debts of the principal debtor if he is unable to pay them.

Surety’s Liability

Section 128 of ICA talks about the liability of the surety. Under the contract of guarantee, the surety’s liability is co-extensive with the principal debtor unless otherwise provided. A surety immediately becomes liable for the payment if the principal debtor makes a default. It was also held in Central Bank of India v. C.L. Vimla[4]that, “the liability of the guarantor is co-extensive with that of the debtor. 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”.Also, Section 146[5] of ICA provides that if there is more than one surety for the same debt, then they are required to repay the debt in equal amounts.

A surety and the principal debtor have the same liabilities and therefore a surety will not be held liable for something for which the principal debtor himself is not liable, however, the primary liability stays with the principal debtor only. The surety has only secondary liability. A creditor can also directly sue the surety. In Maharaja of Benaras v. Har Narain Singh[6], the principal was laid out that the surety is not liable for the interest on the principal amount as the principal debtor, himself, was not liable for it. The surety will be liable for the principal amount only unless otherwise mentioned in the contract.

·         The extent of Surety’s Liability

The terms of a contract of guarantee determine the extent of a surety’s liability. As per Section 128 of ICA, the liability of a surety is ‘co-extensive’ with that of the principal debtor, which shows the extent of the surety’s liability. An amount to which the principal debtor is liable, a surety would also be liable, no more or less. However, the liability of a surety is only co-extensive with the principal debtor when there is no limit on the extent of the liability. Also, the liability of a surety cannot go past the terms of the contract of guarantee or more than what he has undertaken. Therefore a guarantor cannot be made liable beyond the terms that are agreed upon. In the case of Zakir Hussain v. Deputy Commissioner of Gonda[7], it was laid down that a surety will not be liable to the interest of the principal amount under the contract of guarantee, he would only be liable for the principal amount.

The commencement of a surety’s liability will also depend upon the terms of the contract of guarantee that is entered into by the principal debtor and the creditor. An agreement between the parties can be made that the surety’s liability would arise on the occasion of the principal debtor’s default in payment. The liability of a surety is secondary and it is also immediate in a case where the principal debtor makes a default. A notice of default is not required to be provided by the creditor to the surety unless otherwise agreed in the contract of guarantee.

·         Limitations of Surety’s Liability

A surety can place a limit on his liability by virtue of a phrase in Section 128 of ICA that says, ‘unless it is otherwise provided by the contract’. This provides an opportunity to limit the liability of the surety. A surety can limit his liability to a certain amount or fixed amount but it is vital to note that the liability of a surety cannot be greater than the liability of the principal debtor himself. This principle was also laid down in the case of Aditya Narayan Chouresia v. Bank of India[8] where it was said that guarantors or the sureties are only bound to the amount which they decided and not beyond that.

Rights of a Surety

A surety can avail of certain rights against the principal debtor, creditor, and co-sureties. These rights are as follows:-

·         Rights against the Principal Debtor

A surety can avail two rights against the principal debtor that are right of subrogation, and the right of indemnity. When the surety fulfills his liability towards the creditor in case the principal debtor fails, the rights of a creditor are ‘subrogated’ upon him which means that the surety will now have the same rights as the creditor. This is called the right of subrogation against the principal debtor. The surety becomes the creditor of the principal debtor and all the rights of the principal debtor against the creditor will now be delegated upon the surety. Section 140[9] of ICA also recognizes the right of subrogation.

The right of indemnity is when the surety pays the debt of the principal debtor and in turn, he becomes entitled to redeem the amount from the principal debtor. A contract of guarantee encompasses an ‘implied promise’ of compensation to the surety i.e. to indemnify the surety by the principal debtor when he makes a debt payment. The ICA also recognizes the right to indemnity under Section 145[10].

·         Rights against the Creditor

A surety can avail three rights against the creditor which are right to securities, right to equities, and right to set-off. A right to claim securities from the creditor is available to the surety. The securities which the creditor has with the principal debtor before or after the contract of guarantee can be recovered by the surety on the payment of the debt by him. These securities are entitled to the surety even if he doesn’t have any knowledge about their existence. Similarly,  a surety can avail the right to equities, after the repayment of debt to the creditor, and claim the equities which the creditor had against the principal debtor. The right to set-off can be availed by the surety in a case where the creditor owes something to the principal debtor. The owed amount can be charged by the surety from the amount that has to be paid to the creditor.

·         Rights against the Co-Sureties

A surety can avail three rights against the fellow sureties for the same debt that are right to contribution, and the effect of releasing a surety. A right to contribution as per Section 146 of ICA is that when there is more than one surety for the same debt, each of the surety has to pay the debt in equal amounts unless it is provided otherwise. As per Section 138[11] of ICA, if one of the surety is released from its liabilities then it does not mean that the other sureties are also discharged from their liabilities. However, the discharged surety will be responsible for any default on the part of other sureties.

Discharge of Surety’s Liability

Section 126 of ICA defines a contract of guarantee which also includes that a surety is someone who provides a guarantee of the debt payment in a case where the principal debtor makes a default. A surety, therefore, has a liability to pay the debts of the principal debtor if he fails to make a payment. A surety acts as an assurance for the creditor in case the principal debtor fails to perform his act.

A surety is considered as a ‘favored debtor’ and the liability of a surety can be discharged or released. Discharge of surety’s liability means that the liabilities of the surety have come to an end and he is no longer under any obligation. A surety may be discharged or released from his liabilities by any agreement, operation of law, the performance of the principal debtor’s act, payment of principal debtor’s debt, or by any breach on the part of the creditor in the contract of guarantee. The ICA incorporates certain circumstances under which the surety is discharged from its liabilities. These circumstances are provided under Sections 130-144. They can be enclosed under the following heads:-

·         Discharge by Revocation

Revocation by Notice: Section 130[12] of ICA provides for the revocation of a continuing guarantee for future transactions by the surety. It says that the surety, by giving notice to the creditor, can revoke a continuing guarantee for future transactions. The notice should clearly state that the surety is discontinuing his liability for future transactions. However, a specific guarantee for the liability that has already been arisen cannot be revoked by the surety. A surety is still liable for the transactions already entered into.

Revocation by Death: Section 131[13] of ICA provides for the revocation of continuing guarantee for the continuing transactions. In case of the surety’s death, he is released from his liability and his legal heirs will not be liable for the transactions, either continuing or in future. However, they will be liable if so is provided in the contract of guarantee.

·         Discharge by Conduct

Variation in terms of the Contract: Section 133[14] of ICA provides for the discharge of surety’s liability by any variation in the terms of the contract of guarantee entered upon by the creditor and principal debtor. A surety is only liable for the terms agreed upon by him thus if the creditor and the principal debtor make any changes in the terms of the contract without informing or consulting the surety, he will be immediately released from his liability. This principle was also laid down in the case of Bonar v. Mcdonald[15] where the court held that the surety will be discharged from his liabilities because the variance in terms of the contract was material.

Discharge or Release of Principal debtor: Section 134[16] of ICA incorporates a discharge of surety’s secondary liability in a case where the primary liability of the principal debtor is released or discharged. The liability of the principal debtor can be discharged either by entering into a contract with the creditor or by any act or omission on the part of the creditor. Thus, in these cases, where the principal debtor itself is released from his liabilities, the surety’s liability is also discharged.

Compounding by Creditor with Principal Debtor: Section 135[17] of ICA provides for the discharge of surety’s liability when the creditor compounds with or promises the principal debtor that he will not sue the principal debtor on the occurrence of default in performance. In such a scenario, the liability of the surety is released unless he consents to such a contract.

Impairing surety’s remedies: Section 139[18] of ICA discharges the surety from its liabilities if the creditor has done any act or omission which is inconsistent with the rights of the surety. Also, if the said act or omission impairs the eventual remedies of the surety against the principal debtor, the surety’s liabilities are said to be discharged.

Loss of Security: Section 141[19] of ICA provides that if the creditor losses or parts with any security without the consent of the surety, then the surety will be discharged from his liability for the value of the security so parted with or lost. It is immaterial that surety knew of the securities or not.

·         Discharge by Invalidation of a Contract

Guarantee obtained by Misrepresentation: As per Section 142[20] of ICA, a guarantee obtained by the means of misrepresentation on the part of the creditor that concerns a material fact is invalid. Hence, the surety’s liability will be discharged.

Guarantee obtained by Concealment: As per Section 143[21] of ICA, a guarantee obtained by concealing a material fact of a contract on the part of the creditor is constituted as invalid and as a result, the liability of the surety will be discharged.

Default on the part of Co-Sureties: As per Section 144[22] of ICA, when a condition is proposed by a surety that the creditor will not act upon the contract unless another co-surety has joined. The non-fulfillment of this condition will result in the invalidation of the contract and thus the surety will be discharged from his liability.

Conclusion

A surety plays a very vital role in a contract of guarantee as the guarantee under this contract is provided only by the surety to pay the debts of a principal debtor in case he makes a default in payment. The Indian Contract Act, in order to protect the interests of a surety under a contract of guarantee, provides for the discharge of the surety’s liability under various circumstances. A surety must be protected from any change in the terms of a contract for which he didn’t give his assent. A surety’s liability is co-extensive with the principal debtor and hence, he is not liable for anything which is not agreed upon.

Frequently Asked Question (FAQs)

  1. Who is a surety?
  2. What are the rights of a surety?
  3. What is surety’s liability?
  4. What is the extent of surety’s liability?
  5. How is surety’s liability discharged?

References


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