Contract of Guarantee (Sec.126)

Introduction

Section 126 of the Indian contract Act, 1872 states that a contract of guarantee is that contract which perform the promise or the discharge of the liabilities of the third person  in the case of default of that third person.

This contract usually contains two parties. But on the other hand a contract of gurantee contains three parties and three contract forms in the contract of guarantee ,so it is also called as tripartite agreement. This includes the principal debtor ,surety  and the creditor. These parties have their own respective duties and liabilities towards each other. 

Contract of Suretyship is also a term used for the contract of guarantee.  The gurantee contract contains three parties that are as stated below:

Surety:

Surety is basically the person who provides with the gurantee of  principal debtor to the creditor.

Principal debtor : 

Principal debtor is basically  the person in whose respect the guarantee is given .The person for whom the guarantee is given is the principal debtor.

Creditor : 

Creditor is the person to whom the guarantee is given. Principle debtor, creditor and surety are bound by various contracts together.

Types of contract

1.Principal Contract

The contract that is made between the principal debtor and the creditor is known as principal contract .

2.Secondary Contract

The contract that is made between the creditor and the surety is known as a secondary contract.

3.Implied Contract

The contract that is made between the principal debtor and surety is called as implied contract.

Section 128 of the Indian contract act 1872 states that the liability of  surety is co-extensive with that of the principal debtor, unless and until it is otherwise provided by the contract. It means that the liability of surety would  be equal to the principal debtor till the principal debtor discharge from his liabilities and otherwise any terms or conditions mentioned in the contract.

This means that if the principal debtor fails to fulfill his liabilities then the surety is liable to pay the liabilities of the principal debtor and the creditors can recover from the surety all that he could have to recover from the principal debtor. 

There are several rights of surety which are stated below:

1.The Rights of surety on  payment or on performance : 

 Under Section 140 of the Indian Contract Act 1872, it is stated that where a guaranteed debt had become due, or default of the principal debtor to perform a guaranteed duty has taken place, the surety on payment or on performance of all that it is liable for, is invested with all the rights which the creditor has against the principal debtor.

In Tarun Shrma V. Ali Zulfikar Ahmed it was stated that section 140 of the Indian Contract Act 1872 provides that where a guaranteed debt has become due, or default of the principal debtor to perform a guaranteed duty has taken place, the surety, upon payment or performance of all that he is liable for, is invested with all the rights which the creditor has against the principle debtor.

2) The right of surety to benefit of the creditor's securities (Under Section 141of the Indian Contract Act 1872 ) :

 Section 141 of the Indian Contract Act 1872 states that a surety is entitle to benefit of each and every security that the creditor has against the principal debtor at the time when the contract of suretyship was entered into. Whether the surety is aware of the existence of that security or not, and if the creditor loses, or without that consent of the existence of that security or not, and if the creditor loses, or without the consent of surety, parts with such security, the surety, the surety will get discharged to the extent of that value of the security.

Z, advances to Y, his tenant, 500 rupees on the guarantee of X. Z had also a further security for the 500 rupees by the mortgage of Y’s furniture. Afterwards Z, cancels the mortgage. Y becomes insolvent and Z sues X on his guarantee. X is discharged from the liability to that amount of the value of the furniture.

3) The Right of Indemnity : 

Section 145 of the Indian Contract Act,1872 states that in each and every contract of guarantee there is an implied promise made by the principal debtor to indemnify  surety, and  surety is entitled to recover from the principal debtor all the sum that he has rightfully paid under the guarantee, but not the sums which he had paid wrongfully.

Z lends Y a sum of money, and X, at the request of Y, accepts a bill of exchange drawn by Y upon X to secure the amount. Z, the holder of the bill, demands payment of it from X, and, on X’s refusal to pay, sues him upon the bill. X, not having reasonable grounds for so doing, defends the suit, and has to pay the amount of the bill and costs. He can recover from Y the amount of the bill, but not the sum paid for costs, as there was no real ground for defending the action.

4) Right against Co-Sureties (Under Section 146 of the Indian Contract Act 1872): 

 When there are more than one surety in a contract of gurantee, they are referred as co sureties. Co-sureties are considered equally liable as creditor can sue one or all. If only one surety is sued and he had to pay the debt then he can demand the co-sureties for the contribution.

Section 146 of Indian Contract Act 1872 also states that the co-sureties are liable for contributing equally.

When there are two or more persons as  co-sureties for the same debt or duty, jointly or may be severally, and whether under the same or different contract, and whether with or without the knowledge of each other the co-sureties, in the absence of any of the contract to the contrary, are liable, as between themselves, to pay each other an equal share of  whole debt, or of that part of it which remains unpaid by the principal debtor.

(b) X, Y and Z are sureties to M for the sum of 10000 rupees lent to N, and there is a contract between X, Y and Z that X is to be responsible to the extent of one-quarter, Y to the extent of one-quarter, and Z to the extent of one-half. N makes default in payment. As between the sureties, X is liable to pay 2500 rupees, Y 2500 rupees, and Z 5000 rupees.

5) Right to Request :

Surety has a right to request a creditor to choose the principal debtor to sue before he is called upon to pay the debt in the contract of guarantee surety.

Rights against Creditor and Principal Debtor

1.Rights against the Creditor

Section 141of the Indian Contracts Act 1872 states that the surety is eligible to the benefit of each and every security that the creditor had against the principal debtor. This even holds true if at the time of entering in the contract of guarantee the surety was unaware of the existence of such a security. And, when the creditor loses or parts with that security without the consent of the surety, this gets the surety discharged to the extent of the value of such security.

2. Rights against the Principal Debtor

Once the surety discharges the debt, he obtains the rights of a creditor against the principal debtor. He can now sue the principal debtor for the amount of debt paid by him to the creditor due to the default of the principal debtor. In such kind of case where the principal debtor on discovering that the debt had become due, starts disposing of his properties in order to prevent seizure by the surety, the surety can compel the debtor to pay the debt and discharge him from his liability to pay.

3.Rights of Surety against the co-sureties

When more is paid than his share by the surety to the creditor, he gets the right of contribution from the co-sureties, that are equally liable to pay. For example, X, Y, and Z are the co-sureties to M for a sum of ₹300 lent to N who made default in payment. Thus, X, Y, and Z are liable to pay ₹100 each as between them. So, in this case, if anyone of them pays more than ₹100, he can claim the excess from the other two co-sureties so as to reduce his payment to ₹100 only. However, if one of the co-sureties becomes insolvent, the other co-sureties should contribute their share in equal amount.

Surety’s Liability

Section 128 of Indian Contract Act, 1872 states that the liability of the surety is co-extensive with that of principal debtor’s unless the contract provides. The Liability of the surety is same as it is of the principal debtor. The creditor can directly proceed against a surety. The creditor can sue a surety directly without sueing the principal debtor.A Surety becomes liable to make a payment immediately when the principal debtor makes default in such kind of payment.

However  the principal debtor holds the primary liability to make payment , The liability of the surety is secondary. And, when the principal debtor cannot be held liable for any payment due to any defect in the documents, then the surety is also not responsible for such payment.

Bank of Bihar Ltd vs Dr Damodar Prasad (AIR1969SC297)

The plaintiff bank lent Money to Damodar Prasad ,on the guarantee of Paras Nath Sinha. Despite of such demands by the bank, the loan was neither repaid by Damodar Prasad (principal debtor),nor by Paras Nath Sinha .The bank then filed a suit against both of them (the principal debtor and the surety).

A decree was passed in the favour of the bank but with the condition that the plaintiff bank shall be at liberty to enforce its dues against the principal debtor. In its appeal before the Supreme Court ,the Plaintiff bank challenged the validity of the condition In the decree against the surety only after Having exhausted there  against the principal debtor. The plaintiff's appeal was allowed And the above stated condition in the decree was set a side.The bank ,therefore, was held Entitled to enforce its claim against the principal debtor.

Union Bank of India vs Mukku Narayan (AIR 1987 SC 1078)

It was been held by the Supreme Court that when there is a decree against the principal debtor, the guarantor and also against the mortgaged property, the decree- holder bank should first proceed against the mortgaged property and then against the guarantor.

If the principal debtor's liability is reduced e.g., after the creditor has recovered a part of the sum due from him out of his property, the liability of the decree or otherwise extinguished in whole or in part by the statute, the liability of the surety would also pro tanto be reduced or extinguished.

The Extent of a Surety's Liability (Under Section 128 of the Indian Contract Act 1872) :

The Nature of Liability of a surety:

 The nature of liability of a surety is co- extensive. The fundamental principle laid down for the surety's liability in section 128  is that the liability of a surety is co- extensive with that of the principal debtor. The surety, however, by an agreement places a limit on its liability.

Liability of surety: 

The liability of the surety is co- extensive with that of the principal debtor, unless it is otherwise provided by the contract. It means that the quantum of obligation of the surety is the same as that of the principal debtor unless there is a contract to the contrary. 

For Example:

X guarantees to Y the payment of a bill of exchange by  Z, the acceptor. The bill is dishonoured by Z. X is liable not only for the amount of the bill but also for any interest and charges which may have become due on it.

KT Sutochana Vs Orissa SFC AIR 1992 

It was held that if the payment of a  bond of loan is guaranteed then surety is not only liable for forth amount of the loan, but it is also liable for any interest or charges which might have become due on it. Where the overdrafts of a company were guaranteed from the company's directors and a part of the loan was recovered by the banker by disposing of various goods belonging to the company, the High Court of Madras held that the liability of the surety have gone down . Sureties are necessary parties for the proceeding against the principal debtor.

V. Somanath Raju And Anr. Vs Konchada Ramamurty Subudhi

It was stated that it is clear that though the liability of the principal debtor and his surety arises under the same transaction, still they are distinct, because the liability of the surety does not in all cases arise simultaneously. The question depends upon the terms of the guarantee by which the surety binds himself. That being the clear position of law, I have no doubt that the defendants 3 and ,4 are equally liable. The decree passed by the learned Subordinate Judge is quite correct and should be affirmed.