CENTRAL UNIVERSITY OF SOUTH BIHAR

SCHOOL OF LAW & GOVERNANCE

Akash kumar

B.A.LL.B (Hons.)

3rd Semester (2018-2023)

Enrolment-CUSB1813125009 (Sec-A)

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Introduction

Contract of Guarantee means a contract to perform the promises made or discharge the
liabilities of the third person in case of his failure to discharge such liabilities.
As per section 126 of Indian Contract Act, 1872, a contract of guarantee has three parties: –
Surety: “A surety is a person giving a guarantee in a contract of guarantee. A person who
takes responsibility to pay a sum of money, perform any duty for another person in case that
person fails to perform such work.” (Bangia, 2017: 6)

Principal Debtor: “A principal debtor is a person for whom the guarantee is given in a
contract of guarantee.” (Bangia, 2017: 6)

Creditor: “The person to whom the guarantee is given is known as the creditor.” (Bangia,
2017: 6)
For example, Mr. X advances a loan of Rs 25,000 to Mr. Y and Mr. Z promise that in case
Mr. Y fails to repay the loan, then he will repay the same. In this case of a contract of
guarantee, Mr. X is a Creditor, Mr. Y is a principal debtor and Mr. Z is a Surety.

Contract of Indemnity
”It is a contract in which one party promises to save the other from the loss caused to him by
the acts of promisor or by any other person.
In a contract of indemnity, there are two parties namely indemnifier (promisor) and
indemnified (promisee).” (Bangia, 2017: 1)
Differentiation between contract of indemnity and contract of guarantee
There is a difference between the two special types of contracts, contract of indemnity and
contract of guarantee which is as follows: –

“In a contract of guarantee, there are three parties to a contract namely surety, principal
debtor and creditor whereas in case of indemnity there are only two parties to a contract,
promisor, and promisee.

In case of the contract of guarantee, the liability of the surety is secondary whereas in a
contract of indemnity the liability of promisor is primary.
Surety provides guarantee only when requested by the principal debtor in a contract of
guarantee. Indemnifier is not required to act at the request of the debtor, in a contract of
indemnity.

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In a contract of guarantee, there is an existing liability for debt or duty, surety guarantees the
performance of such liability. In a contract of indemnity, the possibility of incurring a loss is
contingent against which indemnifier undertakes to indemnify.
Surety is eligible to proceed against the principal debtor on payment of debt, in case principal
debtor fails to pay the debt. Indemnifier cannot sue third parties in his own name.”i

Surety’s Liability
According to section 128 of Indian Contract Act, 1872, the liability of a surety is co-
extensive with that of principal debtor’s unless the contract provides.

Liability of surety is same as that of the principal debtor. A creditor can directly proceed
against the surety. A creditor can sue the surety directly without sue principal debtor. Surety
becomes liable to make payment immediately when the principal debtor makes default in
such payment.
However, primary liability to make payment is of the principal debtor, surety’s liability is
secondary. Also, where the principal debtor cannot be held liable for any payment due to any
defect in documents, then surety is also not responsible for such payment.

Discharge of a Surety (Sec.130 – 141)

Notice of Revocation (Section 130)

Ordinarily a guarantee cannot be revoked if the liability has already been accrued. But
Section 130 provides for revocation of continuing guarantee. For example, if A has stood
surety for a Rs. 50,000 home loan of B from a bank, and the money has been disbursed, A
cannot revoke the guarantee, as the liability has accrued. Accordingly, “where a guarantee is

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a continuing one and extends to a series of transactions, the surety as to future transactions
may revoke it, by giving notice to the creditor. However, the surety shall remain liable for the
acts already acted upon, i.e., prior to the notice of revocation.” (Bangia, 2017: 19)

1) Sita Ram Gupta v. Punjab National Bankii

“The appellant having entered into an agreement of guarantee with the respondent bank
revoked by a letter written to the Manager of the Bank, before the loan was in fact advanced
by the bank. Referring to the manner in which the agreement was entered into, it was held
that it was not open to the appellant to revoke the guarantee. The apex court said that the
agreement not being unlawful, would override the statutory provision contained in section
130 of the contract act, 1872 since he had waived the benefit of section 130 by entering into
agreement of guarantee with the bank. The appellant was thus held not entitled to deny
liability to pay the debt advanced by the bank.” (Bangia, 2017: 20)

Death of Surety (Section 131)

“In case of a continuing guarantee, the death of the surety, in the absence of any contract to
the contrary, discharges him from liability as regards future transactions (i.e., transactions
after his death).” (Bangia, 2017:21) In other words, the surety’s survivors or legal
representatives would not be liable unless expressly mentioned in the contract.

Novation

Novation, i.e., entering into a fresh contract, either between the same parties or between other
parties, constitutes another mode of discharging a surety from the liability. If the parties to a
contract (of guarantee) agree to substitute it with a new contract, the original contract need
not be performed and so the surety stands discharged with regard to the old contract. For the
surety, too, a fresh contract would have to be drafted.

1) Satish Chandra Jain v. National Small Scale Industries Corpn. Ltd.iii

“The appellant stood as guarantor on funding done to his son’s property venture. Later on, the
son converted his proprietary business into private limited company. The respondent-creditor
gave his consent to such change and fresh agreement was entered into under which the
company became hirer and appellant’s son with one another became guarantors. On default
by company, suit for recovery was filed against it and the two guarantors under the
subsequent agreement but appellant was not made a party to the suit. The apex court held that

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inclusion of property of appellant recovery certificate issued was not proper because
subsequent agreement amounted to novation of contract by which the guarantee of appellants
stood discharged. Again, where the liability of the guarantor was limited to cash credit
facility in favour of the principal debtor up to extent of Rs. 2,50,000 and overdraw were made
by the principal debtor beyond that limit. It was held that the guarantor was not bound by
overdraw allowed by the bank. The plea that guarantee was extended to series of transaction
and therefore, the guarantor being liable was held not tenable.” (Bangia, 2017: 24)

Variance In Terms of Contract (Section 133)

“Any variance or alteration in the terms of the contract made between the principal debtor
and the creditor, without the surety’s consent, discharges the surety as to the transactions
taking place subsequent to the variance.” (Bangia, 2017: 21)
The following are some of the examples in this regard.

Example 1

A becomes surety to C for payment of rent by B under a lease. Afterwards B and C contract
to hike the rent, without informing A. A would hence, be discharged from his liability as a
surety for accruing subsequent to the variance in terms of the contract without his consent.

Example 2

C contracts to lend B Rs 5,000 on March 1. A guarantees repayment. C pays Rs 5,000 to B on

1) Amrit Lal v. State of Travancoreiv

“In this case, the credit limit of the debtor, which had been fixed at Rs 1,00,000 was first
reduced to Rs. 50,000 and then again raised to Rs. 1,00,000 without consulting the surety.
This was done by oral instruction to the cashier only. It was held that in this case there was no
variation in the terms of the contract within the meaning of sec. 133, and, therefore, the surety
had not been discharged thereby.” (Bangia, 2017: 23)

2) Anirudhan v. Thomco’s Bankv

“The appellant agreed to stand as surety to the tune of Rs. 25,000 for an overdraft to be
allowed by the respondent bank to the principal debtor, Shankran. The bank agreed to allow

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the overdraft only for Rs. 20,000 and not for Rs. 25,000. The principal debtor altered the
amount of guarantee from Rs. 25,000 to Rs 20,000. The alteration in this case, which was
made by the principal debtor, was not to the prejudice of the surety. The question before the
Supreme Court was whether such an alteration, which was to the benefit of the surety, had
discharged the surety. The majority decision (2:1) was that when the alteration is
unsubstantial and that does not discharge the surety from liability.” (Bangia, 2017: 23)

Release or Discharge of Principal Debtor (Section 134)

“The surety is discharged by any contract between the creditor and the principal debtor, by
which the principal debtor is released, or by any act or omission of the creditor, the legal
consequence of which is the discharge of the principal debtor.” (Bangia, 2017: 25) The
following example explains the point.
Example: A contracts with B to build a house for B for a fixed price within a stipulated time,
B supplying the necessary timber. C guarantees A’s performance of the contract. B fails to
supply the timber. C is thus discharged from his surety.

1) Charan Singh v. Security Finance Pvt. Ltd.vi

“In this case, the creditor obtained a decree for Rs. 30,155 jointly against the two principal
debtor and the surety. After that, the creditor entered into an agreement with one of the
principal debtors that if he paid the sum of Rs. 10,000, the creditor will not proceed further
against him. After this amount had been paid, the creditor sought to recover the balance from
the surety. It was held that such a compromise after the decree had been passed did not
discharge the surety and, therefore, the creditor was held entitled to recover the balance of the
amount from the surety.” (Bangia, 2017: 26)

Arrangement between Principal Debtor And Creditor (Section 135)

“Where the creditor, without the consent of the surety arrives at a settlement with the
principal debtor, or promises to give him more time, or promises not to sue him by a contract
between the creditor and the principal debtor, the surety is absolved from the liability, unless
the surety assents to such contract.” (Bangia, 2017: 27)
Where, however, a contract to give time to the principal debtor is made by the creditor with a
third person, and not with the principal debtor, the surety is not discharged. For instance, C,
the holder of an overdue bill of exchange drawn by A as surety for B, and accepted by B,
contracts with M to give time to B. A is not discharged.

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1) Kurian v. The Alleppey C.C.M.S. Societyvii

“The creditor filed a suit against the debtor for the recovery of some money due from the
debtor. Then there was a compromise between the two parties to the suit according to which
the debtor was allowed to pay the decretal money within nine months from the date of
compromise. This happened without the knowledge or consent of the surety. It was held that
this arrangement meant giving time to the debtor within the meaning of section 135, and the
surety was, therefore, discharged from his liability.” (Bangia, 2017: 28)

Impairing Surety’s Remedy (Section 139)

“If the creditor commits any act, which is inconsistent with the rights of the surety, or fails to
perform any act that his duty to the surety requires him to do, such that the eventual remedy
of the surety himself against the principal debtor is impaired; the surety is discharged.
The following are some of the illustrations in this regard.” (Bangia, 2017: 30)

Example 1

B contracts to build a ship for C for a given sum, to be paid in installments as the work
reaches certain stages. A becomes surety to C for B’s due performance of the contract. C,
without the knowledge of A, prepays the last two installments to B. A is discharged by the
prepayment.

Example 2

C lends money to B on the security of a joint and several promissory note made in C’s favour by B,
and by A as surety for B, together with a bill of sale of B’s furniture, which gives power to C to sell
the furniture. Owing to his (C’s) misconduct and wilful negligence, only a small price is realized. A is
discharged from liability on the note.

Example 3
A puts N as an apprentice to B, and gives a guarantee to B for N’s fidelity. B, on his part,
promises that he will, at least once a month, see N deposit the cash collected by him on B’s
behalf. B, however, fails to check up the books as promised, and M embezzles. A is not liable
to B on his guarantee.

1) Nirmal Singh Kukreja v. Suraj Guptaviii

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“The plaintiff stood guarantor to funding defendant son-in-law proprietary business. The
defendant having committed serious defaults in payment of debt due to various financial
institutions, the plaintiff negotiated with the bank, the creditor, for one time settlement.
Pursuant to the same, the plaintiff paid amounts claimed for in suit by the bank. After
discharging liability towards the creditor bank, the plaintiff filed the suit against the
defendant claiming the amount he paid to his creditor along with interest of 18% per annum
on payments so made. The plaintiff was held entitled to recover the amount so claimed along
with interest.” (Bangia, 2017: 31)

2) M.R Chakrapani v. Canara Bankix

“The property hypothecated to the bank was sold by the principal debtor. The surety
immediately furnished the particulars of the sale to the bank, but the bank took no steps either
to trace and seize the property or failed to take any action against the principal debtor by
lodging a complaint with the police or filing a case in a criminal court for tracing and
attachment of property and recovering the dues. It was held that the surety was discharged
due to inaction of the bank.” (Bangia, 2017: 32)

Loss of Security (Section 141)

“If the creditor loses, or without the consent of the surety, parts with such security, the surety
is discharged to the extent of the value of the security.” (Bangia, 2017: 32) It is immaterial
whether the surety was or is aware of such security or not. For instance, C advances to B, his
tenant, Rs 2,000 on the guarantee of A. C has also a further security for Rs 2,000 by a
mortgage of B’s furniture. C, however cancels the mortgage. B becomes insolvent and C sues
A on his guarantee. A is discharged from liability to the amount of the value of the furniture.

1) I.F.C.I. Ltd. V. Cannanore Spg. And Weaving Mills Ltdx

“In this case, a contract for the supply of textile goods to be manufactured by a certain textile
unit. The said textile unit was nationalized and the assets vested in the Government.

The question arose if impossibility of performance of contract by the principal debtor

It was held that the surety was not discharged even though the principal was discharged
because the discharged of principal debtor was not due to the voluntary act of the creditor. It
was observed that the contract of guarantee has no co-relation with the Nationalization Act. It

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is an independent contract and it is not covered under Section 141 of the contract act. The
surety continues to be liable in this case.” (Bangia, 2017: 33)

2) H.P.S.I.D.C V. M/S Manson India Pvt. Ltd.xi

“The defendant company and its promoters had taken loan from the appellant corporation.
The promoters unilaterally without waiting for prior written approval from the corporation as
was required under the agreement entered into between them, transferred their interest in the
company to new Direction and charged management of the company. It was held that the
Promoters were not absolved of their personal liability under the deed of guarantee with the
corporation.” (Bangia, 2017: 33)

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CONCLUSION

The ways in which a surety is discharged from his surety ship are exceedingly numerous, for
a surety is a favoured debtor. Speaking generally, however, under the law of principal and
surety, a creditor must not either act in a manner inconsistent with the contract of guarantee
itself, or do anything to prejudice the right of contribution between the co-surety as for should
he do so, the surety will be released, either wholly or protanto. A guarantor may be
discharged or released from his liability under the guarantee by a subsequent release or
agreement, by operation of law, by payment or by performance of the principal debtor
obligation or by a breach of the contract of guarantee and it may be stated as a general rule
that any act or omission on the part of the creditor in breach of his duty under the guarantee,
that increases the guarantor's risk or otherwise injures his rights and remedies, discharges the
guarantor from his liability under the guarantee, at least to the extent of the injury so
occasioned. The real value of any guarantee depends entirely on the financial ability or
solvency of the guarantor to meet the liability with reasonable promptitute when called upon
to do so. The undoubted standing of the guarantor must apply not only when the contract is
signed, but throughout the subsistence of the contract of guarantee. The very object of the
guarantee will be defeated if the creditor is asked to postpone his remedies against the surety.

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REFERENCE
1) Bangia, R.K. (2017). The Indian Contract Act. Allahabad law Agency

END NOTE

i
Darshan Kadu, www.Seven important distinction between a contract of indemnity and a contract of guarantee.
Last accessed on 12-11-2019 at 12:30 PM
ii
A.I.R 2008 S.C. 2416
iii
A.I.R 2003 S.C. 623
iv
A.I.R 1968 S.C 1432
v
A.I.R 1963 S.C 746
vi
A.I.R 1988 Delhi 130
vii
A.I.R 1975 Kerala 44
viii
A.I.R 2013 H.P 23
ix
A.I.R 1997 Kant. 216
x
A.I.R 2002 S.C 1841
xi
A.I.R 2009 (NOC) 490 (H.P)

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