This article has been written by Albinita Pradhan pursuing a Diploma in Advanced Contract Drafting, Negotiation and Dispute Resolution, and has been edited by Shashwat Kaushik.
This article has been published by Sneha Mahawar.
Table of Contents
Introduction
Chapter VIII, Sections 126 to 147 of the Indian Contract of 1872, explains the ‘contract of guarantee.’ A contract of guarantee is a contract that is entered into to perform the promise to be liable for a debt or discharge the liability of a third person when he or she is in default. It has three parties, i.e., the surety, the principal debtor, and the creditor, and the obligation arises only on the default of the principal debtor. However, in a contract of guarantee, the right of subrogation arises out of a contractual agreement between the insurer and the insured to avoid any sort of dispute. This is embodied in Section 140 and Section 141 of the Act.
Origin of subrogation
The word subrogation has its origin in two Latin words, “sub,” which means in place of another, and “rogare,” which means ask; thus, “subrogare” means choose as a substitute. In Morgan v. Seymore, it is stated that the surety can stand in the shoes of the creditors and also have the same rights as the creditor against the principal debtor, provided the guarantor has repaid the debt or dues.
Subrogation under the Indian Contract Act, 1872
In India, the surety’s rights of subrogation have been explained under Section 140 and Section 141 of the Indian Contract Act of 1872.
Section 140 of the ICA
Section 140 of the Indian Contract Act of 1872 explains the rights of surety on payment or performance. It says that on default on the part of the principal debtor to pay the guaranteed debt, the surety pays the guaranteed debt and is invested with all the rights or remedies that the creditor had against the principal debtor, although he is not a creditor.
Lalit Kumar Jain vs. Union of India (2021)
In Lalit Kumar Jain vs. UOI, it was held that as per Section 140 of the Indian Contract Act, 1872, the guarantor is invested with all the rights of the creditor that the creditor had against the principal debtor after the payment or performance that he had promised to do with the principal debtor, including the right to file a resolution plan against the corporate debtor.
State Bank of India vs. Indexport Registered & Ors. (1992)
In State Bank of India vs. Indexport Registered & Ors., the Supreme Court held that it is the obligation of the guarantor or surety to pay the debt, and on payment of the debt by the guarantor or surety, the guarantor or surety is subrogated to all the rights of the creditor and can remove the debt amount from the principal debtor.
Section 141 of the ICA
Section 141 talks about the surety’s right to benefit from the creditor’s securities as entered in the contract of suretyship and states that the surety is entitled to all the benefits of the security with whatever security is held by the creditor against the principal debtor, whether the surety knows of its existence or not. If the security is lost, parted with, or sold without the consent of the creditor, then the surety is discharged to the extent of the value of the security.
State Bank of Saurashtra vs. Chitranjan Rangnath Raja and Anr (1980)
In State Bank of Saurashtra vs. Chitranjan Rangnath Raja and Anr, it was held that the General Manager of the Bank had asked for two securities that had to be deposited with the bank for a cash credit facility. One was the pledge of goods, which was deposited by the principal debtor, and the other was the personal guarantee, which the surety himself gave with full understanding and knowledge and entered into a contract of guarantee. The goods pledged by the principal debtor were lost due to the negligence of the bank. The Supreme Court of India held that the surety was discharged because of the wrongful partying of goods without the consent of the surety. Since the bank negligently mishandled the pledged goods, which were supposed to be kept under the lock and key of the bank and supervised by an employee of the Bank, the surety stands discharged.
Illustrations:
- X advances an amount of Rs.10000/- to Y on the guarantee of Z. X also has security for recovering the amount of Rs. 10000/- by mortgaging Y’s 6-seater dining table. X cancels the mortgage, and Y becomes unable to pay the debt owed by X. X sues Z on Y’s guarantee. Z is discharged from liability for the value of the 6-seater dining table.
- S wanted to purchase a car and he wanted a loan of Rs. 200000/- from N and C was the guarantee of S. N also has further securities for the same debt. Later, S gives up further securities. Here, C is not discharged from liability.
Surety’s right of subrogation
A surety’s right of subrogation in a contract must meet the following conditions in order to be legally valid:
Lawful object
Subrogation in a contract must be for a legal purpose. It is not lawful if it is forbidden by law, if it is fraudulent, immoral, or opposed to public policy, or if it would defeat the provisions of any law.
Capacity
The requirements of capacity to contract for an individual obtaining insurance must be according to Section 11 of the Indian Contract Act, 1872. An individual obtaining insurance must be of sound mind or insane and disqualified under any law.
Intention to create legal relationship
The requirement is met when an offer is made by the insurer and accepted by the insured on a written application for a contract of insurance. The offer should not be for illegal ventures.
Set-off or counterclaim
In the case of default by the principal debtor, if the surety is called upon to make the payment to the creditor, he is entitled to exercise the right of set-off or counterclaim that the principal debtor had against the creditor.
Representation and warranties
The surety, principal debtor, and creditor make certain representations and warranties, and such representations and warranties must not be false.
Indemnification
The indemnity provisions in the contract of guarantee enable an implied promise by the principal debtor to indemnify the surety. Accordingly, the surety has a legal right to recover from the principal debtor whatever he has paid on his behalf.
Principle of subrogation
The principle of subrogation is explained by the Hon’ble Supreme Court in the landmark judgement of Economic Transport Organisation v. Charan Spinning Mills, Pvt. Ltd. (2010) and is summarised as follows:
- The doctrine of subrogation applies to contracts or insurance policies.
- In terms of the principles of subrogation, it neither terminates nor puts an end to the rights of the assured. The insurer will receive back all the benefits given to the assured for indemnifying the losses.
- It arises when the insured’s claim is settled by the insurer for the loss.
- When the subrogation letter is executed by the insured on reduced terms, the rights of both the insurer and the insured will be governed by its terms.
- It also enables the rights of the insured against third parties to be exercised by the insurer in the name of the assured.
Discharge of surety
The surety is discharged from his liability under the following conditions:
Revocation by serving notice to the creditor: The surety can revoke the continuing guarantee as to future transactions by serving a notice to the creditor.
Surety’s death: In view of Section 131 of the Indian Contract Act of 1872, the death of a surety terminates the continuing guarantee and discharges the surety from liability.
Variance made without the surety’s consent: When a contract is entered into between the creditor and the principal debtor and any variance is made in the contract between them without the consent of the surety, the surety is discharged from its liability.
Release of principal debtor: The surety is discharged from its liability when the principal debtor is also discharged. If the creditor fails to do an act or does some unlawful act and the legal consequences discharge the principal debtor, then the surety is also discharged.
Loss of securities: When the contract of suretyship is entered into with the creditor, if the creditor loses all the securities due to its negligent act or parts of such security without its consent, then the surety is discharged from its liability.
Conclusion
In view of the above, I conclude that subrogation is substituting one party for another in the payment of a debt. Subrogation in a contract is evidenced by an instrument to avoid any sort of dispute regarding the claim for reimbursement. It is automatic. It applies to contracts and insurance policies, and it is one of the legal rights of the surety against the principal debtor.
References
- https://www.lawyersclubindia.com/articles/doctrine-of-subrogation-in-insurance-14987
- https://www.juscorpus.com/analysis-of-right-of-subrogation-under-ibc-regime/
- AIR 1980 SC 1528
- Singhal’s Law of Contract Part-II
- 2010 (4) SCC 114:2010 (2) JT 271
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