In this article we will discuss the nature and extent of liability of surety in detail and try to measure the maximum extent of surety’s liability.
Contract of guarantee
A contract of guarantee is precisely stated under Section 126 of the Indian Contract Act, 1872. According to this section, a contract of guarantee can be understood as a contract that requires an individual or a group of individuals to perform a promise made or to discharge their liability under the contract when the third party to the contract failed to fulfill their part of the promise. This guarantee can be oral or written.
A contract of guarantee requires three parties: the principal debtor, the creditor, and the surety. The individual on whose non-payment the guarantee has to be given is the principal debtor or the borrower, the creditor is the individual who is given the guarantee and the surety is the individual who gives the guarantee.
Surety makes a promise to the creditor that on the principal debtor’s default, they will discharge the third party’s liability or fulfill the promise which was made by the principal debtor. Therefore, the surety gives assurance to the creditor for the principal debtor’s act.
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Liability of guarantor coextensive with that of principal debtor
According to Section 128, “The liability of the surety is coextensive with that of the principal debtor, unless it is otherwise provided by the contract.”
The provision that the surety’s liability is coextensive with that of the principal debtor means that his liability is exactly the same as that of the principal debtor. It means that on a default having been made by the principal debtor, the creditor can recover from the surety all what he could have recovered from the principal debtor. For instance, the principal debtor makes a default in the payment of a debt of Rs. 10,000/-. The creditor may recover from the surety the sum of Rs. 10,000/- plus interest becoming due thereon as well as the amount spent by him in recovering that amount. This may be further explained by the following example. A guaranteed to B the payment of a bill of exchange by C, the acceptor. The bill is dishonoured by C, the acceptor. A is liable not only for the amount of the bill but also for any interest and charges which may have become due on it.
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 surety is also reduced accordingly. In Narayan Singh v. Chattarsingh A.I.R. 1973 Raj. 347., it has been held that if the principal debtor’s liability is scaled down in an amended decree or otherwise extinguished in whole or in part by a statute, the liability of the surety would also pro tanto be reduced or extinguished. In this case, the liability of an agriculturist, who was the principal debtor, was scaled down under the Rajasthan Relief of Agricultural Indebtedness Act, 1957. It was held that the effect of scaling down the principal debtor’s liability was that the surety’s liability had also been reduced accordingly. The surety’s liability was considered to be reduced for another reason also, and that was that if the surety is made liable for the full amount, he in his turn will become entitled to recover the same from the principal debtor, and this will eventually negative the benefit conferred upon the agriculturist principal debtor under the statute.
If the principal debtor’s liability is affected by illegality, so is also that of the surety. Therefore, where the liability of the principal is held to be not enforceable on the ground of the contract being illegal, there is no question of surety being made liable.( Varadarajulu v. Thavsi Nadar, A.I.R. 1963 Mad. 413, at 419)
If the principal debtor happens to be a minor and the agreement made by him is void, the surety too cannot be made liable in respect of the same because the liability of the surety is coextensive with that of the principal debtor.( Kelappan Nambiar v. Kunhi Raman, A.I.R. 1957 Mad. 164) It has been held in an English case(Coutts & Co. v. Browne Lecky, (1947) K.B. 104), that the guarantee of the loan or an overdraft to an infant is void, because the loan to the infant itself is void.
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Surety’s liability for loan transaction
The loan was advanced by Bank to principal borrower under certain scheme with a clause in the scheme that bank shall not ask for borrower’s contribution in the form of margin money or seek collateral security or third party guarantee. There was execution of document by borrower and surety for repayment of loan. In the instant case as surety had voluntarily agreed to repay the loan, therefore, he was liable to repay such loan jointly and severally with borrower as clause in scheme did not mean that if anybody voluntarily agreed to repay loan, it should be refused.(Syndicate Bank v. K. Manohara, A.I.R. 2003 Ker. 284.)
Cash Credit Facility-Liability of surety coextensive with that of principal debtor
Presiding Officer had unduly placed reliance upon statement by bank’s witness in cross-examination, that bank was not knowing hypothecation goods and they were not shown in Schedule of application. Presiding Officer sought to give benefit of Section 139, Contract Act to defendant No. 6 relying on this statement.
Proceedings revealed that Bank had sold hypothecated goods and secured Rs. 25 lacs. There was no question of any negligence. In view of provision of Section 128 of Contract Act, Presiding Officer was not correct in giving direction to Bank to proceed against ‘C’ Schedule property of defendant No. 6 only as ‘last resort’. Property of defendant No. 6 was also liable and accessible and available for execution of decree against defendant Nos. 1 to 5 and decree ought to have been joint and several against all defendants including defendant No.6.( State Bank of India v. V.N. Anantha Krishnan, (2005) (2) BC 173 (DRAT Chennai)
Creditor can sue the surety without exhausting remedies against the principal debtor
The liability of the surety is joint and several with the principal debtor. It has already been noted that according to Section 128, “the liability of the surety is coextensive with that of the principal debtor, unless it is otherwise provided by the contract.” It means that if the principal debtor makes a default, i.e., he fails to perform his obligation, the creditor can sue either the principal debtor, or the surety or both of them. The creditor can sue the surety even though he has not exhausted his remedies against the principal debtor. Unless the parties, expressly or impliedly so agree, the contract should not be construed as “imposing any condition precedent upon the decree-holder to exhaust all his remedies against the principal debtor before proceeding against the surety for realizing the decretal amount.”
The position on this point was thus explained by the Supreme Court in Bank of Bihar v. Damodar Prasad (A.I.R. 1969 S.C. 297) Bachawat, J. :
Before payment, the surety has no right to dictate terms to the creditor and ask him to pursue his remedies against the principal in the first instance. In the absence of some special equity, the surety has no right to restrain an action against him by the creditor on the ground that the principal is solvent or that the creditor may have relief against the principal in some other proceedings. Likewise, where the creditor has obtained a decree against the surety and the principal, the surety has no right to restrain execution against him until the creditor has exhausted his remedies against the principal.
In Bank of Bihar v. Damodar Prasad, the plaintiff bank lent money to Damodar Prasad, on the guarantee of Paras Nath Sinha. In spite of demands by the bank, the loan was neither repaid by Damodar Prasad (principal debtor), nor by Paras Nath Sinha (the surety). The bank then filed a suit against both the principal debtor and the surety. A decree was passed in favour of the bank but with the condition that the plaintiff bank shall be at liberty to enforce its dues against the surety only after having exhausted its remedies against the principal debtor. In its appeal before the Supreme Court, the plaintiff bank challenged the validity of the condition in the decree that the bank should enforce the decree against the surety only after having exhausted the remedies against the principal debtor.
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Prior action against principal debtor not necessary
In Ram Bahadur Singh v. Tehsildar Bisli A.I.R. 2002 All. 344, the decision of the Supreme Court in State Bank of India v. Indexport Registered(A.I.R. 1992 S.C. 1740.) was followed and it was held that the guarantors cannot insist that creditor must first proceed against the principal borrower and not the guarantor. In other words, it is open to the creditor to proceed for making recovery against the guarantors without first proceeding against the principal borrower.
In Mukesh Gupta v. SICOM Ltd., Mumbai A.I.R. 2004 Bom.104, the terms of contract had enabled creditor to institute a suit against guarantor without instituting suit against principal debtor. The guarantor had waived his right under Sections 133, 140 and 141 regarding discharge of surety under the terms of contract. The Bombay High Court held that guarantor could not contend that surety stood discharged because of alleged failure of creditor to take timely steps to preserve security to call for additional security.
Prior action against pledged goods not necessary
It has been held in State Bank of India v. Gautmi Devi Gupta A.I.R. 2002 M.P. 81, that if there is a decree in favour of the creditor bank in his favour, certain goods have been hypothecated, it is not necessary that the decree holder bank should proceed to recover the decretal amount first from the hypothecated goods and then proceed against the surety. Even without proceeding against the hypothecated property, the bank can proceed against the surety.
The liability of the principal debtor and the surety is joint and several. The creditor can, therefore, sue either both of them together or either of them individually. If after an action against both, the creditor obtains a decree against both of them, he is free to enforce the decree in the first instance against the surety. When the creditor files a suit against both the principal debtor and the surety, and the suit against the principal debtor is dismissed, that would not automatically discharge the surety from liability, and the suit can proceed against the surety.
In Union Bank of India v. Manku Narayan(A.I.R. 1987 S.C. 1078.), it has 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.
Limit on surety’s liability by contract
It has already been noted that Section 128 declares that the liability of the surety is coextensive with that of the principal debtor, unless it is otherwise provided by the contract. It means that if the contract between the parties so provides, surety’s liability may not be there to the full extent as that of the principal debtor but smaller than that. Similarly, in Yarlagadda v. Devata China Yerakayya A.I.R. 1966 A.P. 151, the bond executed by the surety limited his liability to the tune of Rs. 15,000 with a stipulation that he might be liable to any amount that might be finally decreed. It was held that the responsdent (surety) “had undertaken the liability only to the tune of Rs. 15,000 and the clause rendering himself liable to any amount that might be finally decreed should be constructed as meaning not exceeding Rs. 15,000.”
In Aditya Narayan Chauresia v. Bank of India A.I.R. 2000 Pat. 222, it has been held by the Patna High Court that if the guarantors bind themselves up to a certain maximum limit, their liability cannot go beyond that. In the instant case, the guarantors undertook to be liable up to a maximum of Rs. 25,000 plus interest payable thereon. It was held that their maximum liability could not extend beyond that limit. They were, therefore, held liable for the part of the debt only.
Likewise, in Vyasya Bank Ltd. v. Deputy Director, D.G.F.T. A.I.R. 2004 A.P. 10., the amount of interest on principal amount was not agreed by the parties. Since, “the liability of guarantor mainly flows from the terms and conditions of the guarantee bond”, the Andhra Pradesh High Court held that the guarantor could not be made liable to pay the interest.
Condition that there shall be a co-surety
Sometimes, there may be a condition in a contract of guarantee that there shall be a co-surety also. Where a person gives a guarantee upon a contract that the creditor shall not act upon it until another person has joined in it as co-surety, the guarantee is not valid if that other person does not join (Section 144). It means that in such a contract, liability of the surety is dependent on the condition precedent that a co-surety will join. The surety can be made liable under such a contract only if the co-surety joins, otherwise not.
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Liability of co-surety
It has been noted above that the liability of sureties is coextensive with that of the principal debtor. It implies that the creditor can proceed against the principal debtor or the surety, at his discretion, unless it is otherwise provided in the contract. The same principle is applicable with regard to the rights and liabilities of the co-sureties. Since the liability of the co-sureties is joint and several, a co-surety cannot insist that the creditor should proceed either against the principal debtor or against any other surety before proceeding against him.
In State Bank of India v. G.J. Herman A.I.R. 1998 Ker. 161, it has been held that when there is a composite decree against the principal debtor and the sureties, the creditor has the discretion to decide against whom he wants to proceed. Neither the court nor a co-surety can insist that the creditor should first proceed against another surety before proceeding against him. Such a direction would go against the coextensiveness of the liability of the sureties with that of the principal debtor.
Conclusion
We can conclude from the above discussion that the coextensiveness concept cannot be categorised as a rigorous principle. The clauses in the guarantee on the actual created document will determine the precise scope and extent of the surety’s obligation, although the parties are able to set further limitations without departing from the guarantee contract’s original intent.
The parties are free to put restrictions, if any, to the surety’s obligation, and the surety’s exact and precise extent will always be governed by the requirements of the guarantee on how the instrument has been formed.