EXCEPTIONS TO COEXTENSIVE LIABILITY OF A SURETY

INTRODUCTION

Section 134 of the Indian Contract Act 1872 [hereinafter ICA], talks about the discharge of surety when the principal debtor is discharged; It states that if by a contract between the creditor and principal debtor or by any act of the former, the principal debtor is released, the surety’s liability would automatically stand discharged. However, under some circumstances, the release of the principal debtor does not amount to the surety’s discharge and the creditor will still have a right of action against him. The article seeks to expound upon these exceptional circumstances.

SECTION 137 OF ICA

One exception to the provision of section 134 is Section 137 of ICA which states that mere forbearance on the creditor’s part to sue the principal debtor or enforce remedy against him, doesn’t discharge the surety unless it has been stated in the contract. This was upheld in the Privy Council decision of Mahanth Singh v. U Ba Yi (1939), where the facts were as follows:

Four trustees had employed the appellant who was a building contractor, to carry out certain repair and maintenance work. They owed him an amount of Rs. 26000, while the respondent was the surety. As the amount fell into arrears, the appellant filed a suit of recovery. The original four trustees had died in the meantime and were replaced by eight new trustees. The appellant wanted to substitute the original trustees with the new ones and bring a claim against them. However, it was held that the nature of the liability of the trustees was personal and hence, if a claim would arise after their deaths, it would be against their legal heirs and not the new trustees. So, the appellant accordingly filed another application for substitution to bring an action against the legal heirs of the old four trustees, but the court didn’t admit the application under Order 1 rule 10 of the Civil Procedure Code 1908 [hereinafter CPC]. The court held that the appellant couldn’t be allowed to change his mind in the middle of the proceeding and only the respondent could be held liable as the surety.

When the matter was brought before the privy council, the respondent made two contentions.

  • Since the original trustees (principal debtors) had been discharged, the surety also stood discharged (section 134 read with section 128 of ICA).
  • According to section 2(j) of the ICA, a contract becomes void when it ceases to be enforceable by the law. Hence, the respondent stands discharged as the limitation period had expired.

The Privy council held that there should be a rectification to the particular position of law adopted by the High Court where it applied order 1 rule 10 of CPC; it said that was an incorrect provision, and the correct provision was, order 23 rule 1 of CPC which in these kinds of situations allowed the court to exercise discretion and allow fresh suit by the appellant.

It further stated that in such a situation, not filing the lawsuit within the time stipulated by the law of limitation can’t amount to discharge under section 134, because section 134 can’t be read in isolation. It must be read with section 137 which talks about how when the creditor fails to pursue a remedy against the principal debtor due to some procedural difficulties, it doesn’t amount to discharge of the surety. A claim still lies against the latter unless it has been contractually stated that a claim against surety would not lie.

The court further dealt with the second contention made by the respondent that the contract stands void under section 2(j) of the contract act by interpreting the law of limitation to mean a substantive and not procedural law. The crux of the judgment is that due to any procedural hurdles if the creditor is not able to pursue a remedy against the principal debtor, the surety wouldn’t stand automatically discharged. The release of the principal debtor under this condition was temporary and not under section 134.

RESERVING RIGHT AGAINST THE SURETY BY MEANS OF A CONTRACTUAL CLAUSE

Another way by which the creditor can ensure that his rights against the surety remain intact even when the principal debtor has been released is by making the arrangement a part of the contract of guarantee.

In Annadana Jadaya Goundar v. Konammal (1933), the Madras High Court held that under normal circumstances, it would be a breach of contract if the creditor decided to release the principal debtor but held the surety liable. However, if a provision for the same has been incorporated into the agreement, a claim could still arise against the surety.

In another case- Lalit Kumar Jain v. Union of India (2021), where the petitioners were the promotors or directors of their respective companies. The companies had been advanced loans by government banks and the petitioners had agreed to become the surety. When the proceedings were underway, the companies were undergoing insolvency under Insolvency and Bankruptcy Code 2016 [hereinafter IBC] and were not able to repay.  The Union of India representing the government banks issued a notification against the petitioners under section 1(3) of IBC. The Petitioners contended that the notification was impugned and this was against section 134 of ICA as the discharge of the principal debtor by initiating an insolvency resolution against them should automatically discharge the surety.

The Supreme Court in the case relied on a number of cases including, Industrial Finance Corp of India ltd v. Cannanore spinning and weaving mills limited and PNB v. state of UP (2002) where the issue was whether the surety could still be held liable when the principal debtor is discharged under the Insolvency law or company law. While approving another Supreme Court judgment in Maharashtra state electricity board v. official liquidator (Ernakulam), the court observed that as the nature of the guarantee was unequivocal, the liability of the surety would continue even when the principal debtor could not be held liable and the creditor could raise a claim against the surety under section 128. There was no discharge under section 134. The approval of the resolution plan didn’t ipso facto didn’t discharge the surety of its liability.

Further, the court held that under the contract of guarantee, the release or discharge of the principal borrower from the debt by an involuntary process that is by operation of law or due to liquidation or insolvency proceedings doesn’t amount to discharge under sections 134 and hence, doesn’t absolve the surety of his/her liability which arises out of an independent Contract. Accordingly, the apex court concluded in the current case that the notification issued by the Union of India was legal and valid. The approval of a resolution plan relating to a corporate debtor didn’t discharge the liability of the petitioners who were personal guarantors to the corporate debtors.

CONCLUSION AND ANALYSIS

Hence, to conclude, it can be said that the liability of the surety is coextensive to that of the principal debtor. However, there are circumstances under which even when the principal debtor has been discharged, the surety will still be held liable. This could happen when the creditor forbears to sue the principal debtor- this act in itself doesn’t absolve the surety. Similarly, when a clause has been included in the agreement, and for some reason, the creditor is unable to pursue his remedy against the principal debtor, the surety could still be held liable. Also, if in a situation the creditor, due to certain involuntary process i.e., by operation of law or due to liquidation or insolvency proceedings, is unable to hold the principal debtor liable, he would still have a claim against the surety as the latter would not be automatically discharged. Such provisions are not contrary to section 134 of ICA, instead, they carve out an exception to the conditions stated in section 134 to uphold the right of the creditor against the surety, in situations he is unable to hold the principal debtor accountable.

Author(s) Name: Anandita Anand (National Law University, Jodhpur)