Discharge of Surety’s Liability
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This article is written by Arushi Chopra, a student of Symbiosis Law School, Noida. This article deals with the discharge of surety’s liability. 

Introduction

A contract of guarantee is considered to be of huge commercial viability and has been greatly in use in case of any commercial transactions. This is because a contract of guarantee acts as a second pocket to repay the amount if the first pocket or the person to whom the loan is advanced fails to pay.

In a contract of guarantee, a surety undertakes to pay the amount to the creditor in case the principal debtor is not able to pay the amount. The Indian Contract Act, 1872 through its different provisions ensures that it protects the interest of all the parties in a contract of guarantee, especially the interests of the surety. It may happen that initially when the contract of guarantee had been entered into, the contract was not entirely based on good faith. However, after entering into such a contract, our legal system makes it a point that good faith is imposed on the creditor. [1] It also ensures that there is no ambiguity related to the rights and liabilities of the surety.

Discharge of surety

The Indian Contract Act, 1872 provides for the discharge of the liability of surety, in case of certain given circumstances. A surety is said to discharge from his liability if his liability to perform the promise, in case of a default by the principal debtor, comes to an end. 

The situations under which a surety is discharged from his liability is listed as follows:

  • Discharge by Revocation
  1. Revocation of guarantee by giving notice (Section 130);
  2. Revocation by death (Section 131).
  • Discharge by the conduct of the parties
  1. Variance in terms of the contract (Section 133);
  2. Release or discharge of the principal debtor (Section 134);
  3. Compounding by Creditor with the principal debtor (Section 135);
  4. Creditors act/omission impairing surety’s eventual remedy (Section 139);
  5. Loss of security (Section 141).
  • Discharge by the invalidation of the contract
  1. Guarantee obtained by misrepresentation (Section 142);
  2. Guarantee obtained by concealment (Section 143);
  3. Failure of a co-surety to join a surety (Section 144).

Revocation of surety by giving notice

Section 130 of the Indian Contract Act, 1872 states that a continuing guarantee, i.e., a guarantee for a series of transactions can be revoked if a notice is served to the creditor. However, revocation in case of a specific guarantee is not possible if the contract entered into has been already acted upon.

Interpretation of the relevant section

On analysis of Section 130 of the Indian Contract Act, 1872, it can be inferred that a continuing guarantee can be revoked by serving a notice only for any future transactions. The surety is liable for the transactions which are already entered into. This is the reason, why the section does not include revocation of specific guarantee, as there are no future transactions which have not yet been entered into in case of a specific guarantee. It can also be inferred that the notice should be given to the creditor at any time. This notice should be clear and specific and it should state that the surety is intending to terminate his liability as to the future transactions. Also, there should not be any existence of the contract stating the contrary. 

Case Law and Analysis

Case law, in this effect, is the case of Sita Ram Gupta v Punjab National Bank. [2] The facts of this case as identified were that the appellant revoked the guarantee given by him before the amount was advanced to the principal debtor. However, there was a clause in the contract of guarantee entered into, which provided that the guarantee is of continuing nature and will not be cancelled or revoked. The court held that the appellant was himself responsible for waiving off his own rights and hence, cannot revoke the contract. 

Revocation by death

Section 131 of the Indian Contract Act, 1872 provides that in case of death of the surety, the liability of the surety is discharged.

Interpretation of the relevant section

From the interpretation of Section 131, it can be inferred that the death of the surety will lead to a discharge of the surety. The surety will be discharged from the future transactions which are entered into. However, the legal heirs of the deceased surety have the obligation towards the transactions, for which the surety has given the guarantee, in case the transactions have already been entered into. They are liable only to the extent of the property that they have inherited [3] and they cannot be made personally liable for the obligations of the surety. Also, there should be no separate provision in the contract which states that the contrary to this provision.

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Discharge by variance in terms of the contract

Section 133 of the Indian Contract Act, 1872 provides for the discharge of the liability of the surety, in case of material alteration or variance in the terms of the contract. 

Interpretation of the relevant section

Through the literal interpretation of the provision, it can be determined that a surety can be discharged from his liability if there is a variance that has been made without the consent of the surety, in case of a continuing contract of guarantee. The essential factor which determines if the liability of the surety is discharged is the concept of substantiality and materiality of the variance. The court has to decide, keeping the entire facts into consideration, whether a given variance is material or not. In case the variance in the contract leads to a benefit of the surety, the surety may not be discharged of his liability as it is within the discretion of the court with regards to the materiality of the fact.

Case Law and analysis

A relevant case law, to this effect, is the case of Bonar v Macdonald [4] which is summarised as follows:

  • Facts

The defendants entered into a contract of guarantee for the conduct of the manager of a bank. The bank raised his salary and he was made liable to one-fourth of the loss, without the consent of the surety. The manager allowed a customer to overdraw his amount and this lead to loss.

  • Issues

Whether the surety is bound to pay the amount of loss or is it a material variation?

  • Judgement

It was held that the variation in the terms of the contract was made without taking the surety into consideration and the variation is obviously material. Hence, the surety is discharged from his liability.

Therefore, it can be inferred that any material changes in the contract can discharge the duty of the surety, as is evident from the above case law. The manager was made liable for one- fourth of the loss of the firm which was to be paid by the surety, in case of a default by the manager.

Release or discharge of the principal debtor

Section 134 of the Indian Contract Act provides for the discharge of the liability of the surety, in case the principal debtor is released from his liability to repay the amount. 

Interpretation of the relevant section

Therefore, Section 134 deals with the discharge of the secondary liability of the surety in case the primary liability of the principal debtor is discharged. However, the converse is not true. This means that if there is a discharge of the liability of the surety, it will not automatically discharge the liability of the principal debtor. The section provides two situations which would result in the release of the principal debtor. These are elucidated as follows:

  • Existence of a contract or laws

In case, the liability of the principal debtor gets discharged, the surety who has the secondary liability is also discharged from his liability.

However, a distinction must be made by the court in relation to the time when the surety is discharged from his liability and when it is not. For instance, in the case where the amount of the principal debtor gets reduced to the application of the debt relief act, the surety will be liable only for the reduced amount. However, in case the principal debtor is discharged from the liability in case of insolvency, the surety is not discharged. 

  • Act or omission

The second case is where there is an act or omission on part of the creditor that discharged the liability of the principal debtor. In this case, the surety will be discharged. This can happen when the creditor fails to perform his part of the promise which discharges the liability of the debtor.

Compounding by Creditor with Principal Debtor

According to Section 135 of the Indian Contract Act, 1872, a surety can be discharged of his liability if there is any composition or a new agreement between the creditor and the principal debtor. Through analysing Section 135 of the Indian Contract Act, it can be concluded that a surety can be discharged from his liability in case of three prevailing circumstances. These are:

  • Composition

Composition refers to variation in the original contract and adding something up which was not present in the original contract. In case there is a composition in the contract between the debtor and the creditor without surety’s consent, it would discharge his liability.

  • Promise to give time

The surety is entitled to ask the principal debtor to pay off the debt when it is the time for repayment. However, if there is a contract between the principal debtor and the creditor whereby the creditor has agreed to give some more time to pay off the debt without keeping the surety into consideration, the surety will be discharged.

However, Section 136 of the Indian Contract Act, 1872 provides that, if the creditor enters into an agreement to give time with a third party, it does not discharge the surety from his liability.

  • Promise not to sue

If there is an explicit contract which provides that the creditor will not sue in the event of default, it would result in the discharge of liability of the surety. However, mere forbearance to sue will not discharge the liability as provided under Section 137.

If the surety has agreed to such conditions, he will not be discharged from the contract as is evident from the phrase “unless the surety assents” in Section 135.

Creditor’s act/omission impairing surety’s eventual remedy

It is the duty of the creditor not to do any act which is inconsistent with the contract which would result in the impairment of the remedy of the surety to recover the amount from the principal debtor after repayment. This right of the surety to discharge his liability is provided in Section 139 of the Indian Contract Act, 1872.

Interpretation of the relevant section

The above rule is in close proximity to the right of subrogation with the surety after he repays the loan. The surety takes place of the creditor after repayment and he can exercise all the rights that the creditor has and if any of the rights are impaired or the remedy against the principal debtor is impaired due to any act or omission by the creditor, it would discharge the surety.

Loss of security

Section 141 of the Indian Contract Act, 1872 gives surety the right to claim all the security which had been kept with the creditor after paying the amount to the creditor. If the security is lost and the surety does not get the security for any reason, the surety can be discharged from his liability. 

Interpretation of the relevant section

Through Section 141, it can be inferred that it is immaterial whether the security that was earlier held by the creditor was known to the surety or not. In case the surety does not receive the security after repayment, he can be discharged of his liability. However, this discharge of liability will be to the extent of the value of the security which had not been duly delivered to the surety. Thus, if the value of the lost security is less than the liability of the surety, the surety will be discharged to the extent of his liability. However, if the value of the security is more than the liability, the surety will be discharged from the whole of his liability. 

This provision arises due to the Right of Subrogation with the surety, according to which the surety is entitled to all the rights of the creditor and takes the position of the creditor after paying the amount to the original creditor. Hence, the surety also has the right to the security of exercising the right of subrogation.

Different courts have different views regarding the treatment of a contract which states the contrary to the provisions laid down in the act. In one case, it has been ruled that Section 133, 134, 135, 139 and 141 can be struck down in case of an existence of a clause to the contrary. However, a ruling has also been given stating that Section 133 cannot be struck down in any circumstance. [5]

Discharge by invalidation

A surety can be discharged of his liability if the contract of guarantee is invalidated. The Indian Contract Act provides for three circumstances under which a contract of guarantee can become invalidated. These are elucidated as follows:

  • Guarantee by misrepresentation (Section 142)

Section 142 provides that if a contract of guarantee has been entered into owing to the misrepresentation of a material fact which was known to the creditor, it would invalidate the contract.

  • Guarantee by concealment (Section 143)

According to Section 143, if a contract of guarantee is obtained due to concealment of a material fact by a creditor, the contract would be invalid.

  • Failure of a co-surety to join a surety (Section 144)

If the surety has put forth a condition that the creditor shall not act upon the contract in the absence of another co-surety and this condition is not fulfilled, it would lead to invalidation of contract.

Conclusion

The Indian Contract Act, 1872 provides for the discharge of the liability of surety in case of certain given circumstances with the objective of securing the interests of the surety, who guarantees payment of the debt in case of a default.

The situation under which the surety can be discharged from his liability can be categorised into three different heads i.e. by revocation, the conduct of the parties and invalidation of the contract.

References

Books Referred

  1. Singh Avtar (2017). Contract and Specific Relief (12th ed). Lucknow: Eastern Book Company
  2. Meena R.L (2008). Textbook on Law of Contracts including Specific Relief. Delhi: Universal Law Publishing
  3. Pollock and Sir Dinshaw Fardunji Mulla (2017) The Indian Contract Act and Specific Relief Acts (15th Ed) Vol. 2. Gurgaon, Haryana: LexisNexis 

Websites and Journals Referred

  1. Goswami D. (2018). The Judicial Debate on Discharge of Surety- The CBCL Blog. Retrieved January 17, 2020, from https://cbcl.nliu.ac.in/contemporary-issues/the-judicial-debate-on-discharge-of-surety/
  2. Columbia Law Review (1924). Suretyship- Extension of time- Discharge of Surety Vol.24, No. 2 pp. 211-212. Retrieved January 20, 2020, from https://www.jstor.org/stable/1112874/
  3. Kanwar J. (2019). Surety. Retrieved January 17, 2020, from http://lawtimesjournal.in/surety/

Endnotes

[1] Kay LJ in Rouse v Bradford Banking Co. Ltd, 1894 AC 586

[2] AIR 2008 SC 2416

[3] RK Dewan v State of UP, 2005 All LJ 2067

[4] (1850) 3 HL Cas 226

[5] Union of India v Pearl Hosiery Mills, AIR 1961 Punj 281


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