B.A. LL.B. (Five Years) Sem 5 Contract II 2012 Jun Question Paper with Solutions

The three parties. The same section names them. The person who gives the guarantee is the surety. The person whose default is guaranteed is the principal debtor. The person to whom the guarantee is given is the creditor. For example, a bank lends Rs 5 lakh to a shopkeeper, and the shopkeeper's brother promises to repay if the shopkeeper does not. The bank is the creditor, the shopkeeper the principal debtor and the brother the surety.

The nature of the surety's promise. The principal debtor is primarily liable for his own debt. The surety's promise is collateral. He answers only "in case of his default", that is, if the principal debtor fails to pay. So there must be a debt or duty of the principal debtor that can be enforced, now or in the future.

Consideration. The surety usually gets nothing for himself. Section 127 meets this. "Anything done, or any promise made, for the benefit of the principal debtor" may be enough consideration for the surety. In the example, the bank's loan to the shopkeeper supports the brother's promise. But illustration (c) shows the limit. A promise to pay for goods already delivered, given without anything in return, is void.

A. Rights against the principal debtor

1. Right of subrogation (section 140). Once the guaranteed debt has become due, the surety may pay "all that he is liable for". He is then "invested with all the rights which the creditor had against the principal debtor". This is subrogation, which means stepping into the creditor's shoes. The surety may sue the debtor as the creditor could have, and enforce any security the creditor held.

Bank of Bihar explains the place of this right. The Court said it is the surety's duty to pay the decree. On paying, he is subrogated under section 140 and may then recover from the principal debtor. So the surety cannot block the creditor, but he does not lose his money either.

2. Right to indemnity (section 145). "In every contract of guarantee there is an implied promise by the principal debtor to indemnify the surety." The surety may recover "whatever sum he has rightfully paid", but no sum paid wrongfully. The illustrations draw the line.

• In illustration (a), the surety defends a suit on reasonable grounds but loses. He may recover the debt and the costs.

The illustrations mark the limits. In illustration (a), the creditor cancels a mortgage of the debtor's furniture, and the surety is discharged to the value of the furniture. In illustration (c), the creditor gives up a security he obtained after the guarantee was given. The surety is not discharged, because he never relied on it.

Amrit Lal Goverdhan Lalan v. State Bank of Travancore, AIR 1968 SC 1432, applied the section. A firm had a cash credit account secured by goods pledged with the bank. On verification, goods worth Rs 35,690 were found missing, and the bank could not explain the shortage. The Supreme Court held that the bank had lost the security through its own negligence. The surety was discharged to the extent of Rs 35,690.

State Bank of Saurashtra v. Chitranjan Rangnath Raja, AIR 1980 SC 1528, went further. A bank held 5,000 tins of groundnut oil under its own lock and key, as security for a cash credit loan. The tins were lost through its negligence. The bank argued that the guarantee was an independent contract. The Supreme Court rejected this and held the surety discharged under sections 139 and 141 read together.

5. Right to be discharged by the creditor's conduct. The surety may resist the creditor's claim where the creditor has done something the Act treats as releasing him.

C. Rights against co-sureties

7. Right to contribution (section 146). Where two or more persons guarantee the same debt, they share it equally as between themselves, unless they agreed otherwise. This applies whether they are bound jointly or severally, and whether or not they knew of each other. A surety who pays more than his share may recover the excess from the others. In illustration (a), A, B and C guarantee Rs 3,000 and the debtor defaults. As between themselves, each must pay Rs 1,000.

8. Sureties bound in different sums (section 147). Such sureties pay equally, but only "as far as the limits of their respective obligations permit". A surety whose equal share would exceed his limit pays his limit, and the others share the rest equally.

9. Release of one co-surety (section 138). If the creditor releases one co-surety, the others are not discharged. The released surety also remains liable to contribute to them. So the creditor cannot shift one surety's share onto the rest by releasing him.

Summary

Conclusion. A contract of guarantee under section 126 is a promise to answer for a third person's default. It is supported by anything done for the principal debtor (section 127). The surety's liability is co-extensive with the debtor's, and Bank of Bihar lets the creditor proceed against him first. The law balances this with his rights. Against the debtor, he is subrogated on payment (section 140) and indemnified for what he rightly paid (section 145). Against the creditor, he is entitled to every security held when he became surety, and is discharged if it is lost (section 141). Amrit Lal Goverdhan Lalan and State Bank of Saurashtra apply this. Co-sureties must share the burden with him (sections 146 and 147).