The Judicial Debate on Discharge of Surety

The Judicial Debate on Discharge of Surety.

[Debanga Goswami]

The author is a 4th year student of B.A.LLB (Hons.) of NUJS, Kolkata.

Introduction

According to Section 126 of the Indian Contract Act, 1872, (hereinafter referred to as “the Act”) a surety is a person who provides a guarantee in a contract of guarantee.[1] The same section defines a contract of guarantee as a contract to “perform the promise, or discharge the liability of a third person in case of his default”.[2] A contract of guarantee consists of three parties- the creditor, the principal debtor (hereinafter referred to as the “PD”) and the surety, (or the guarantor) and there is a privity of contract between all of them.[3] The liability of the surety is co-extensive with that of the PD.[4] Since a surety guarantees the performance of the obligations of a third party, the laws related to him are interpreted by the Court in his favour. The legislature has made provisions to discharge the surety in circumstances under which it would be inequitable to hold him responsible for the failure of the PD. Here, the author is making an attempt to critically examine the judicial debate pertaining to the circumstances which lead to the discharge of the surety.

Issue 1

The Rule

Any variance made in the terms of the contract between the PD and the creditor, without the consent of the surety, discharges him as to the transactions subsequent to the variance.[5] But, Section 133 only applies to the concept of continuing guarantee, which is clear from the phrase ‘transactions subsequent to the variance’, present in the provision.[6] This implies that the surety would be liable only for the transactions that are precedent to the variance in the contract between the creditor and the PD, without his consent.[7] He would be discharged for all the subsequent transactions.[8]

The Debate

Section 133 is based on the premise that the surety can’t be bound to do something which he hasn’t contracted to.[9] The Indian courts have interpreted this section to mean that in order for the surety to be discharged, the variance has to be a substantial one.[10] The test to ascertain substantial variance is that whether the variance materially affects the position of the surety or not.[11] But, the courts have not been able to reach at a uniform opinion pertaining to a peculiar situation. The situation arises when the variance is of a beneficial nature for the surety. In an English case[12], it was ruled that the though the surety was not prejudiced by the variance, yet he stood discharged. The same was reiterated in an Indian case.[13] Here, the creditor and the PD contracted to reduce the mortgage amount. The Court discharged the surety by stating that in such cases, the surety is the sole judge to decide whether he wants to continue with the contract or not.

However, in another Indian case[14] the debt amount was decreased from Rs. 25,000 to Rs. 20,000 through a variance in the terms of the contract. But, the Court held that the change was unsubstantial and was for the benefit of the surety. Hence, he was not discharged.

The guarantee of the protection of the assets of the creditor is crucial for the commercial world to thrive. Thus, the author opines that the surety should be discharged by the courts only in cases where there is a material alteration which goes against his interests.

Issue 2

The Rule

Section 134 inter alia states that the surety is discharged by any act or omission of the creditor, the legal consequence of which is the discharge of the PD.[15] The omission of the creditor, the legal consequence of which is the discharge of the PD also includes failure to sue PD within the limitation period.

The Debate

The issue on which courts have differed is that whether failure of the creditor to sue the PD within the limitation period discharges the surety or not. The judges who believe that the surety is discharged in such a situation have a three-pronged argument. First, liability of the surety is co-extensive with that of the PD[16] and thus his discharge should lead to the discharge of the surety. Second, the liability of the surety being a secondary one, when the PD with a primary obligation is discharged, then there is no reason to hold the surety liable.[17] Third, discharge of the PD and consequent lack of a debt on his part can be used by him as a defense to not indemnify the surety after the surety fulfills his contractual obligations.[18]Viewing the same from PD’s perspective, if he remains liable to indemnify the surety even after he is discharged from his liability towards the creditor, then the effect would be to render his discharge of little or no consequence.[19]

But, courts have also come up with a counter view. When Section 134 is read along with Section 137 of the Act, the phrase ‘mere forbearance’[20] implies that except express contracts, the surety is not discharged. The Madras High Court has made a distinction between barring of the remedy and complete extinction of the debt.[21]It said that when the suit of the creditor becomes time-barred against the PD, his remedy against the latter is gone. It means that he cannot approach the Court to get an order for the PD to repay his debt. But, it doesn’t mean that his right over the debt is non-existent. The debt as well as his right over it are very much existent. So, after the surety had paid off the debt to the creditor, he can get indemnified by the PD. [22] This was re-affirmed in the case of Mahant v U Ba Yi.[23]

The author also supports the above-mentioned line of reasoning. Even after the suit gets time-barred against the PD, the debt and the creditor’s right over it are not extinguished. Thus, the surety should be directed to pay the creditor and later get indemnified by the PD. This would also justify the legislative intention implicit in Section 137 of the Act.

Exception

But in a case,[24] the Court developed an interpretation which applies to the contracts of continuing guarantee where there is a provision of repayment on demand. In such cases, limitation period against the PD would start only when a demand is made by the creditor within a particular period of time and either the time period lapses or the PD expressly refuses to perform within that time. Thus, the liability to pay may arise on the PD and the surety at the same time or at different points in time.[25] In such cases, the creditor can make a demand to the surety for payment only within the limitation period of the PD. This exception was made because the right of the creditor to demand payment couldn’t be made indefinite and had to be curtailed.

Conclusion

The above discussion is a testament to the importance of the surety in the world of commercial transactions. Thus, the surety should be protected from any variance in the contract without his consent, which goes against his interests. At the same time, the courts shouldn’t allow a surety to evade his or her responsibility by taking advantage of the circumstances[26] and/or on whimsical grounds.[27] Doing otherwise may lead to two unwanted consequences. First, citing it as precedent, sureties may try to claim discharge on fraudulent and whimsical grounds. Second, this would result in creditors losing their faith on the concept of guarantee, which will have a cataclysmic effect on the world of commercial transactions.

[1] S. 126, The Indian Contract Act, 1872

[2] Ibid

[3] Parker v Lewis 8 LR Ch 1035 (1873)

[4] S. 128, The Indian Contract Act, 1872

[5] S. 133, The Indian Contract Act, 1872

[6] Pollock and Mulla The Indian Contract and Specific Relief Act, 1414 (Nilima Bhadbhade, 14 ed, 2012)

[7] Mulla The Indian Contract Act, 306 (Rahul S Sahay, 14ed., 2015)

[8] Ibid

[9] Supra 6, at 1411

[10] Keshavlal Harilal Setalvad v Pratapsing Moholalbhai Seth AIR1932Bom168

[11] Supra 6, at 1414

[12] Holmes v Brunskill 3 QBD 495 (CA) (1878)

[13] Supra 10

[14] M.S Anirudhan v Thomco’s Ltd 1963 AIR 746

[15] S. 134, The Indian Contract Act, 1872

[16] S. 128, The Indian Contract Act, 1872

[17] Chitty on contracts ,44-070 (Sweet & Maxwell, 13ed., 2008),

[18] ibid

[19] ibid

[20] S. 137 The Indian Contract Act, 1872

[21] Supra 8, at1426

[22] Carter v White (1883) 25 Ch 666

[23] 1939(41)BOMLR742

[24] Syndicate Bank v Channaverappa Beleri and Ors. AIR 2006 SC 1874

[25] Supra 21, at 44-070

[26] Suresh Narain Sinha v Akhauri Balbhadra Prasad and Ors. AIR 1957 Pat

[27] Kalicharan v Abdul Rahman- AIR 1918 PC 226