Law of Contracts - II (Indemnity, Guarantee, Bailment, Pledge, Agency, and Partnership

Act)

Q. 1 Define a contract of Indemnity. What are the essential elements of a contract of Indemnity?
What are the rights of Indemnity holder?

Q. 2 Define a contract of guarantee. What are the rights of surety? When is surety discharged of
guarantee? What is a continuing guarantee and what are its modes of revokation? Distinguish
between Guarantee and Indemnity with Illustrations.

Q. 3 Define Bailment. What are the rights, duties, and liabilities of a bailee? When is he not
responsible for loss, destruction, or deterioration of the things bailed? What are the various kinds
of lien held by the bailee. Explain the rights of finder of goods.

Q. 4 What is pledge? What are the essentials of pledge. Can a pledge be made by a person who is
not the owner of goods? What is the difference between bailment and pledge? Explain Pawner's
right to redeem.

Q. 5 Define partnership. Is sharing of profit conclusive proof of partnership? Explain "partners

are agents of each other". What are the mutual rights and liabilities of the partnenrs? What are
the liabilities of the partners after dissolution? Retirement of a partner. Can minor be admitted to
the benefits of partnership? If yes, what are the rights and liabilities of such a minor after
attaining majority? What is implied authority of a partner? Can it be restricted? Can a partner be
expelled? If so, when? Is the registration of a partnership firm compulsary? What are the
consequences of non-registration? What is the procedure for registration? Can a partner of an
unregistered firm bring a suit against a third party to release the property of the dissolved firm?
Explain various modes of dissolution of the Firm.

Q. 6 Define Agency. Is a notice to agent notice to principal? Explain vicarious liability of the
principal. What are the various ways an agency can be created? Describe the rights and duties of
an agent towards his principal. An agent cannot delegate his auhority. Explain. Describe modes
of termination. What are theeffects of termination?
Q. Define a contract of Indemnity. What are the essential
elements of a contract of Indemnity? What are the rights of
Indemnity holder?
In the old English law, Indemnity was defined as a promise to save a person harmless from the
consequences of an act. Such a promise can be express or implied from the curcumstances of the
case. This view was illustrated in the case of Adamson vs Jarvis 1872. In this case, the plaintiff,
an auctioneer, sold certain goods upon the instructions of a person. It turned out that the goods
did not belong to the person and the true owner held the autioneer liable for the goods. The
auctioneer, in turn, sued the defendant for indemnity for the loss suffered by him by acting on his
instructions. It was held that since the auctioneer acted on the instructions of the defendant, he
was entitled to assume that if, what he did was wrongful, he would be idemnified by the
defendant.

This gave a very broad scope to the meaning of Indemnity and it included promise of indemnity
due to loss caused by any cause whatsoever. Thus, any type of insurance except life insurance
was a contract of Indemnity. However, Indian contract Act 1872 makes the scope narrower by
defining the contract of indemnity as follows:

Section 124 - A contract by which one party promises to save the other from loss caused to
him by the conduct of the promisor himself or by the conduct of any other person is a "contract
of Indemnity".

Illustration - A contracts to indemnify B against the consequences of any proceedings which C

may take against B in respect of a certain sum of Rs 200. This is a contract of indemnity.

This definition provides the following essential elements -

1. There must be a loss.

2. The loss must be caused either by the promisor or by any other person.

3. Indemnifier is liable only for the loss.

Thus, it is clear that this contract is contingent in nature and is enforceable only when the loss
occurs.

Rights of the indemnity holder

Section 125, defines the rights of an indemnity holder. These are as follows -

The promisee in a contract of indemnity, acting within the scope of his authority, is entitled to
recover from the promisor -
 i. Right of recovering Damages - all damages that he is compelled to pay in a suit in respect
of any matter to which the promise of indemnity applies.

ii. Right of recovering Costs -all costs that he is compelled to pay in any such suit if, in
bringing or defending it, he did not contravene the orders of the promisor and has acted as it
would have been prudent for him to act in the absence of the contract of indemnity, or if the
promisor authorized him in bringing or defending the suit.

iii. Right of recovering Sums -all sums which he may have paid under the terms of a
compromize in any such suite, if the compromize was not contrary to the orders of the promisor
and was one which would have been prudent for the promisee to make in the absence of the
contract of indemnity, or if the promisor authorized him to compromize the suit.

As per this section, the rights of the indemnity holder are not absolute or unfettered. He must act
within the authority given to him by the promisor and must not contravene the orders of the
promisor. Further, he must act with normal intelligence, caution, and care with which he would
act if there were no contract of indemnity.

At the same time, if he has followed all the conditions of the contract, he is entitled to the
benefits. This was held in the case of United Commercial Bank vs Bank of India AIR 1981.
In this case, Supreme Court held that the courts should not grant injunctions restraining the
performance of contractual obligations arising out of a letter of credit or bank guarantee if the
terms of the conditions have been fulfilled. It held that such LoCs or bank guarantees impose on
the banker an absolute obligation to pay.

In the case of Mohit Kumar Saha vs New India Assurance Co AIR 1997, Calcutta HC held
that the indemnifier must pay the full amount of the value of the vehicle lost to theft as given by
the surveyor. Any settlement at lesser value is arbitrary and unfair and violates art 14 of the
constitution.

Commencement of liability
In general, as per the definition given in section 124, it looks like an idemnity holder cannot hold
the indemnifier liable untill he has suffered an actual loss. This is a great disadvantage to the
indemnity holder in cases where the loss is imminent and he is not in the position to bear the
loss. In the case of Gajanan Moreshwar vs Moreshwar Madan, AIR 1942, Bombay high court
observed that the contract of indemnity held very little value if the indemnity holder could not
enforce his indemnity untill he actually paid the loss. If a suit was filed against him, he had to
wait till the judgement and pay the damages upfront before suing the indemnifier. He may not be
able to pay the judement and could not sue the indemnifier. Thus, it was held that if his liability
has become absolute, he was entitled to get the indemnifier to pay the amount.

Q. Define a contract of Guarantee. What are the essential

elements of a contract of Guarantee? What is a continuing
Guarantee and what are its modes of revocation. What are
the rights of Surety? When is Surety discharged of
Guarantee? What is the extent of Surety's liability?
Section 126 of Indian Contract Act 1872 defines a contract of guarantee as follows :
"A contract of guarantee is a contract to perform the promise, or to discharge the liabilities of a
third person in case of his default. The person who gives the guarantee is called Surety, the
person in respect of whose default the guarantee is given is called Principal Debtor, and the
person to whom the guarantee is given is called Creditor. A Guarantee may be either oral or
written."

For example, when A promises to a shopkeeper C that A will pay for the items being bought by B
if B does not pay, this is a contract of guarantee. In this case, if B fails to pay, C can sue A to
recover the balance. The same was held in the case of Birkmyr vs Darnell 1704, where the
court held that when two persons come to a shop, one person buys, and to give him credit, the
other person promises, "If he does not pay, I will", this type of a collateral undertaking to be
liable for the default of another is called a contract of guarantee.

A contract of guarantee has the following essential elements -

1. Existance of Creditor, Surety, and Principal Debtor - The economic function of a guarantee
is to enable a credit-less person to get a loan or employment or something else. Thus, there must
exist a principal debtor for a recoverable debt for which the surety is liable in case of the default
of the principal debtor.

In the case of Swan vs Bank of Scotland 1836, it was held that a contract of guarantee is a
tripartite agreement between the creditor, the principal debtor, and the surety.

2. Distinct promise of surety - There must be a distinct promise by the surety to be answerable
for the liability of the Principal Debtor.

3. Liability must be legally enforceable - Only if the liability of the principal debtor is legally
enforceable, the surety can be made liable. For example, a surety cannot be made liable for a
debt barred by statute of limitation.

4. Consideration - As with any valid contract, the contract of guarantee also must have a
consideration. The consideration in such contract is nothing but any thing done or the promise to
do something for the benefit of the principal debor. Section 127 clarifies this as follows :
"Any thing done or any promise made for the benefit of the principal debtor may be sufficient
consideration to the surety for giving the guarantee."

Illustrations:
1. A agrees to sell to B certain goods if C guarantees the payment of the price of the goods. C
promises to guarantee the payment in consideration of A's promise to deliver goods to B. This is
a sufficient consideration for C's promise.
2. A sells and delivers goods to B. C, afterwards, requests A to forbear to sue B for an year
and promises that if A does so, he will guarantee the payment if B does not pay. A forbears to sue
B for one year. This is sufficient consideration for C's guarantee.
3. A sells and delivers goods to B. Later on, C, without any consideration, promises to pay A if
B fails to pay. The agreement is void for lack of consideration.

However, there is no uniformity on the issue of past consideration. In the case of Allahabad
Bank vs S M Engineering Industries 1992 Cal HC, the bank was not allowed to sue the surety
in absence of any advance payment made after the date of guarantee. But in the case of Union
Bank of India vs A P Bhonsle 1991 Mah HC, past debts were also held to be recoverable under
the wide language of this section. In general, if the principal debtor is benefitted as a result of the
guarantee, it is sufficient consideration for the sustenance of the guarantee.

5. It should be without mispresentation or concealment - Section 142 specifies that a

guarantee obtained by misrepresenting facts that are material to the agreement is invalid, and
section 143 specifies that a guarantee obtained by concealing a material fact is invalid as well.

Illustrations -
1. A appoints B for collecting bills. B fails to account for some of the bills. A asks B to get a
guarantor for further employment. C guarantees B's conduct but C is not made aware of B
previous mis-accounting by A. B, afterwards, defaults. C cannot be held liable.

2. A promises to sell Iron to B if C guarantees payment. C guarantees payment however, C is

not made aware of the fact that A and B had contracted that B will pay 5 Rs higher that the
market prices. B defaults. C cannot be held liable.

In the case of London General Omnibus vs Holloway 1912, a person was invited to
guarantee an employee, who was previously dismissed for dishonesty by the same employer.
This fact was not told to the surety. Later on, the employee embezzled funds but the surety was
not held liable.

Continuing Guarantee
As per section 129, a guarantee which extends to a series of transactions is called a continuing
guarantee.
Illustrations -
1. A, in consideration that B will employ C for the collection of rents of B's zamindari, promises
B to be responsible to the amount of 5000/- for due collection and payment by C of those rents.
This is a continuing guarantee.

2. A guarantees payment to B, a tea-dealer, for any tea that C may buy from him from time to
time to the amount of Rs 100. Afterwards, B supplies C tea for the amount of 200/- and C fails to
pay. A's guarantee is a continuing guarantee and so A is liable for Rs 100.

3. A guarantees payment to B for 5 sacks of rice to be delivered by B to C over the period of one
month. B delivers 5 sacks to C and C pays for it. Later on B delivers 4 more sacks but C fails to
pay. A's guarantee is not a continuing guarantee and so he is not liable to pay for the 4 sacks.
Thus, it can be seen that a continuing guarantee is given to allow multiple transactions without
having to create a new guarantee for each transaction. In the case of Nottingham Hide Co vs
Bottrill 1873, it was held that the facts, circumstances, and intention of each case has to be
looked into for determining if it is a case of continuing guarantee or not.

Revocation of Continuing Guarantee

1. As per section 130, a continuing guarantee can be revoked at any time by the surety by notice
to the creditor.
Once the guarantee is revoked, the surety is not liable for any future transaction however he is
liable for all the transactions that happened before the notice was given.

Illustrations -
1. A promises to pay B for all groceries bought by C for a period of 12 months if C fails to pay.
In the next three months, C buys 2000/- worth of groceries. After 3 months, A revokes the
guarantee by giving a notice to B. C further purchases 1000 Rs of groceries. C fails to pay. A is
not liable for 1000/- rs of purchase that was made after the notice but he is liable for 2000/- of
purchase made before the notice.

This illustration is based on the old English case of Oxford vs Davies.

In the case of Lloyd's vs Harper 1880, it was held that employment of a servant is one
transaction. The guarantee for a servant is thus not a continuing guarantee and cannot be revoked
as long as the servant is in the same employment. However, in the case of Wingfield vs De St
Cron 1919, it was held that a person who guarateed the rent payment for his servant but revoked
it after the servant left his employment was not liable for the rents after revocation.

2. A guarantees to B, to the amount of 10000 Rs, that C shall pay for the bills that B may draw
upon him. B draws upon C and C accepts the bill. Now, A revokes the guarantee. C fails to pay
the bill upon its maturity. A is liable for the amount upto 10000Rs.

2. As per section 131, the death of the surety acts as a revocation of a continuing guarantee with
regards to future transactions, if there is no contract to the contrary.

It is important to note that there must not be any contract that keeps the guarantee alive even
after the death. In the case of Durga Priya vs Durga Pada AIR 1928, Cal HC held that in each
case the contract of guarantee between the parties must be looked into to determine whether the
contract has been revoked due to the death of the surety or not. If there is a provision that says
death does not cause the revocation then the constract of guarantee must be held to continue even
after the death of the surety.

Rights of the Surety

A contract of guarantee being a contract, all rights that are available to the parties of a contract
are available to a surety as well. The following are the rights specific to a contract of guarantee
that are available to the surety.
Rights against principal debtor

1. Right of Subrogation
As per section 140, where a guaranteed debt has become due or default of the principal debtor to
perform a duty has taken place, the surety, upon payment or performance of all that he is liable
for, is invested with all the rights which the creditor had against the princpal debtor. This means
that the surety steps into the shoes of the creditor. Whatever rights the creditor had, are now
available to the surety after paying the debt.

In the case of Lampleigh Iron Ore Co Ltd, Re 1927, the court has laid down that the surety will
be entitled, to every remedy which the creditor has against the principal debtor; to enforce every
security and all means of payment; to stand in place of the creditor to have the securities
transfered in his name, though there was no stipulation for that; and to avail himself of all those
securities against the debtor. This right of surety stands not merely upon contract but also upon
natural justice.

In the case of Kadamba Sugar Industries Pvt Ltd vs Devru Ganapathi AIR 1993, Kar HC
held that surety is entitled to the benefits of the securities even if he is not aware of theire
existence.

In the case of Mamata Ghose vs United Industrial Bank AIR 1987, Cal HC held that under the
right of subrogation, the surety may get certain rights even before payment. In this case, the
principal debtor was disposing off his personal properties one after another lest the surety, after
paying the debt, seize them. The surety sought for temporary injunction, which was granted.

2. Right to Indemnity
As per section 145, in every contract of guarantee there is an implied promise by the principal
debtor to indemnify the surety; and the surety is entitled to recover from the the principal debtor
whatever sum he has rightfully paid under the guarantee but no sums which he has paid wrong
fully.

Illustrations -
B is indebted to C and A is surety for the debt. Upon default, C sues A. A defends the suit on
reasonable grounds but is compelled to pay the amount. A is entitled to recover from B the cost
as well as the principal debt.

In the same case above, if A did not have reasonable grounds for defence, A would still be
entitled to recover principal debt from B but not any other costs.

A guarantees to C, to the extent of 2000 Rs, payment of rice to be supplied by C to B. C

supplies rice to a less amount than 2000/- but obtains from A a payment of 2000/- for the rice. A
cannot recover from B more than the price of the rice actually suppied.

This right enables the surety to recover from the principal debtor any amount that he has paid
rightfully. The concept of rightfully is illustrated in the case of Chekkara Ponnamma vs A S
Thammayya AIR 1983. In this case, the principal debtor died after hire-purchasing four motor
vehicles. The surety was sued and he paid over. The surety then sued the legal representatives of
the principal debtor. The court required the surety to show how much amount was realized by
selling the vehicles, which he could not show. Thus, it was held that the payment made by the
surety was not proper.

Rights against creditor

1. Right to securities
As per section 141, a surety is entitled to the benefit of every security which the creditor has
against the principal debtor at the time when the contract of suretyship is entered into whether
the surety knows about the existance of such securty or not; and 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.

Illustrations -
C advances to B, his tenant, 2000/- on the guarantee of A. C also has a further security for
2000/- by a mortgage of B's furniture. C cancels the mortgage. B becomes insolvent and C sues
A on his guarantee. A is discharged of his liability to the amount of the value of the furniture.

C, a creditor, whose advance to B is secured by a decree, also receives a guaratee from A. C

afterwards takes B's goods in execution under the decree and then without the knowledge of A,
withdraws the execution. A is discharged.

A as surety for B makes a bond jointly with B to C to secure a loan from C to B. Afterwards, C
obtains from B a further security for the same debt. Subsequently, C gives up the further security.
A is not discharged.

This section recognizes and incorporates the general rule of equity as expounded in the case of
Craythorne vs Swinburne 1807 that the surety is entitled to every remedy which the creditor
has agains the principal debtor including enforcement of every security.

The expression "security" in section 141 means all rights which the creditor had against property
at the date of the contract. This was held by the SC in the case of State of MP vs Kaluram AIR
1967. In this case, the state had sold a lot of felled trees for a fixed price in four equal
installments, the payment of which was guaranteed by the defendent. The contract further
provided that if a default was made in the payment of an installment, the State would get the
right to prevent further removal of timber and the sell the timber for the the realization of the
price. The buyer defaulted but the State still did not stop him from removing further timber.
The surety was then sued for the loss but he was not held liable.

It is important to note that the right to securities arises only after the creditor is paid in full. If the
surety has guaranteed only part of the debt, he cannot claim a propertional part of the securities
after paying part of the debt. This was held in the case of Goverdhan Das vs Bank of Bengal
1891.

2. Right of set off

If the creditor sues the surety, the surety may have the benefit of the set off, if any, that the
principal debtor had against the creditor. He is entitled to use the defences that the principal
debtor has against the creditor. For example, if the creditor owes the principal debtor something,
for which the principal debtor could have counter claimed, then the surety can also put up that
counter claim.

Rights against co-sureties

1. Effect of releasing a surety

As per section 138, Where there are co-sureties, a release by the creditor of one of them does not
discharge the others; neither does it free the surety so released from his responsibilty to the other
surities.
A creditor can release a co-surety at his will. However, as held in the case of Sri Chand vs
Jagdish Prashad 1966, the released co-surety is still liable to the others for contribution upon
default.

2. Right to contribution
As per section 146, where two or more persons are co-surities for the same debt jointly or
severally, with or without the knowledge of each other, under same or different contractx, in the
absernce of any contract to the contrary, they are liable to pay an equal share of the debt or any
part of it that is unpaid by the principal debtor.

Illustrations -
A, B, and C are surities to D for a sum of 3000Rs lent to E. E fails to pay. A, B, and C are
liable to pay 1000Rs each.

A, B, and C are surities to D for a sum of 1000Rs lent to E and there is a contract among A B
and C that A and B will be liable for a quarter and C will be liable for half the amount upon E's
default. E fails to pay. A and B are liable for 250Rs each and C is liable for 500Rs.

As per section 147, co-sureties who are bound in different sums are liable to pay equally as fas
as the limits of their respective obligations permit.

Illustrations -
A, B and C as surities to D, enter into three several bonds, each in different penalty, namely A
for 10000Rs, B for 20000 Rs, and C for 30000Rs with E. D makes a default on 30000Rs. All of
them are liable for 10000Rs each.

A, B and C as surities to D, enter into three several bonds, each in different penalty, namely A
for 10000Rs, B for 20000 Rs, and C for 40000Rs with E. D makes a default on 40000Rs. A is
liable for 10000Rs while B and C are liable for 15000Rs each.

A, B and C as surities to D, enter into three several bonds, each in different penalty, namely A
for 10000Rs, B for 20000 Rs, and C for 40000Rs with E. D makes a default on 70000Rs. A, B
and C are liable for the full amount of their bonds.
Discharge of Surety
A surety is said to be discharged from liability when his liability comes to an end. Indian
Contract Act 1872 specifies the following conditions in which a surety is discharged of his
liability -

1. Section 130 - By a notice of revocation - discussed above.

2. Section 131 - By death of surety - discussed above.

3. Section 133 - By variance in terms of contract - A variance made without the consent of the
surety in terms of the contract between the principal debtor and the creditor, discharges the surety
as to the transactions after the variance.

Illustrations -
A becomes a surety to C for B's conduct as manager in C's bank. Afterwards, B and C contract
without A's consent that B's salary shall be raised and that B shall be liable for 1/4th of the losses
on overdrafts. B allows a customer to overdraft and the bank loses money. A is not liable for the
loss.

A guarantees C against the misconduct of B in an office to which B is appointed by C. The

conditions of employment are defined in an act of legislature. In a subsequent act, the nature of
the office is materially altered. B misconducts. A discharged by the change from the future
liablity of his guarantee even though B's misconduct is on duty that is not affected by the act.

B appoints C as a salesperson on a fixed yearly salary upon A's guarantee on due account of
sales by C. Later on, without A's consent, B and C contract that C will be paid on commission
basis. A is not liable for C's misconduct after the change.

C promises to lends 5000Rs to B on 1st March. A guarantee the repayment. C gives the money
to B on 1st January. A is discharged of his liability because of the variance in as much as C may
decide to sue B before 1st march.

4. Section 134 - By discharge of principal debtor - The surety is discharged by any contract
between the creditor and the principal debtor by which the principal debtor is discharged; or by
any action of the creditor the legal consequence of which is the discharge of the principal debtor.

Illustrations
A gives a guarantee to C for goods to be delivered to B. Later on, B contracts with C to assign
his property to C in lieu of the debt. B is discharged of his liability and A is discharged of his
liability.

A contracts with B to grow indigo on A's land and deliver it to B at a fixed price. C guarantees
A's performance. B diverts a stream of water that is necessary for A to grow indigo. This action
of B causes A to be discharged of the liability. Consequenty C is discharged of his suretyship as
well.

A contracts with B to build a house for B. B is to supply timber. C guarantees A's performance.
B fails to supply timber. C is discharged of his liability.

If the principal debtor is released by a compromise with the creditor, the surety is discharged but
if the principal debtor is discharged by the operation of insolvancy laws, the surety is not
discharged. This was held in the case of Maharashtra SEB vs Official Liquidator 1982.

5. Section 135 - By composition, extension of time, or promise not to sue - A contract between
the principal debtor and the creditor by which the creditor makes a composition with, or
promises to give time to, or promises to not sue the principal debtor, discharges the surety unless
the surety assents to such a contract.

It should be noted that as per section 136, if a contract is made by the creditor with a third person
to give more time to the principal debtor, the surety is not discharged. However, in the case of
Wandoor Jupitor Chits vs K P Mathew AIR 1980, it was held that the surety was not
discharged when the period of limitation got extended due to acknowledgement of debt by the
principal debtor.

Further, as per section 137, mere forbearance to sue or to not make use of any remedy that is
available to the creditor against the principal debtor, does not automatically discharge the surety.
Illustration -
B owes C a debt guarateed by A. The debt becomes payable. However, C does not sue B for an
year. This does not discharge A from his suretyship.

It must be noted that forbearing to sue until the expiry of the period of limitation has the legal
consequence of discharge of the principal debtor and thus as per section 134, will cause the
surety to be discharged as well. If section 134 stood alone, this inference was correct.
However, section 137 explicitly says that mere forbearance to sue does not discharge the surety.
This contradiction was removed in the case of Mahanth Singh vs U B Yi by Privy Council. It
held that failure to sue the principal debtor until recovery is banned by period of limitation does
not discharge the surety.

6. Section 139 - By imparing surety's remedy - If the creditor does any act that is inconsistent
with the rights of the surety or omits to do an act which his duty to surety requires him to do, and
the eventual remedy of the surety himself against the principal debtor is thereby impaired, the
surety is dischared.

Illustrations -
C contracts with B to build a ship the payment of which is to be made in installments at
various stages of completion. A guarantee's C's performance. B prepays last two installments. A
is discharged of his liability.

A appoints M as an apprentice upon getting a guarantee of M's fidelity by B. A also promises

that he will at least once a month see M make up the cash. A fails to do this. M embezzeles. B is
discharged of his suretyship.

A lends money to B with C as surety. A also gets as a security the mortgate to B's furniture. B
defaults and A sells his furniture. However, due to A's carelessness very small amount is received
by sale of the furniture. C is discharged of the liability.

State of MP vs Kaluram - Discussed above.

In the case of State Bank of Saurashtra vs Chitranjan Ranganath Raja 1980, the bank failed
to properly take care of the contents of a godown pledged to it against a loan and the contents
were lost. The court held that the surety was not liable for the amount of the goods lost.

Creditor's duty is not only to take care of the security well but also to realize it proper value.
Also, before disposing of the security, the surety must be informed on the account of natural
justice so that he can have the option to take over the security by paying off the debt. In the case
of Hiranyaprava vs Orissa State Financial Corp AIR 1995, it was held that if such a notice of
disposing off of the security is not given, the surety cannot be held liable for the shortfall.

However, when the goods are merely hypothecated and are in the custody of the debtor, and if
their loss is not because of the creditor, the suerty is not discharged of his liability.

Extent of Surety's Liability

As per section 128, the liability of a surety is co-extensive with that of the principal debtor,
unless it is otherwise provided in the contract.
Illustration - A guaratees the payment of a bill by B to C. The bill becomes due and B fails to
pay. A is liable to C not only for the amount of the bill but also for the interest.

This basically means that although the liability of the surety is co-extensive with that of the
principal debtor, he may place a limit on it in the contract. Co-extensive implies the maximum
extent possible. He is liable for the whole of the amount of the debt or the promises. However,
when part of a debt was recovered by disposing off certain goods, the liability of the surety is
also reduced by the same amount. This was held in the case of Harigopal Agarwal vs State
Bank of India AIR 1956.

The surety can also place conditions on his guarantee. Section 144 says that where a person gives
guarantee upon a contract that the creditor shall not act upon it untill another person has joined it
as co-surety, the guarantee is not valid if the co-surety does not join. In the case of National
Provincial Bank of England vs Brakenbury 1906, the defendant signed a guarantee which was
supposed to be signed by three other co-surities. One of them did not sign and so the defendant
was not held liable.

Similarly, a surety may specify in the contract that his liability cannot exceed a certain amount.

However, where the liability is unconditional, the court cannot introduce any conditions. Thus, in
the case of Bank of Bihar Ltd. vs Damodar Prasad AIR 1969, SC overruled trial court's and
high court's order that the creditor must first exhaust all remedies against the principal debtor
before suing the surety.

Q. Differentiate between a contract of Indemnity and a

contract of Guarantee.
Contract of Indemnity
Contract of Guarantee (Section 126)
(Section 124)
It is a bipartite agreement between
It is a tripartite agreement between the Creditor, Principal
the indemnifier and indemnity-
Debtor, and Surety.
holder.
Liability of the indemnifier is
Liability of the surety is not contingent upon any loss.
contingent upon the loss.
Liability of the surety is co-extensive with that of the
principal debtor although it remains in suspended
Liability of the indemnifier is
animation until the principal debtor defaults. Thus, it is
primary to the contract.
secondary to the contract and consequenty if the principal
debtor is not liable, the surety will also not be liable.
The undertaking in indemnity is The undertaking in a guarantee is collateral to the original
original. contract between the creditor and the principal debtor.
There are three contracts in a contract of guaratee - an
There is only one contract in a
original contract between Creditor and Principal Debtor, a
contract of indemnity - between the
contract of guarantee between creditor and surety, and an
indemnifier and the indemnity
implied contract of indemnity between the surety and the
holder.
principal debtor.
The reason for a contract of
The reason for a contract of guarantee is to enable a third
indemnity is to make good on a loss
person get credit.
if there is any.
Once the indemnifier fulfills his
Once the guarantor fulfills his liabilty by paying any debt
liability, he does not get any right
to the creditor, he steps into the shoes of the creditor and
over any third party. He can only
gets all the rights that the creditor had over the principal
sue the indemnity-holder in his own
debtor.
name.
Q. Define a contract of Indemnity. What are the essential
elements of a contract of Indemnity? What are the rights of
Indemnity holder?
In the old English law, Indemnity was defined as a promise to save a person harmless from the
consequences of an act. Such a promise can be express or implied from the curcumstances of the
case. This view was illustrated in the case of Adamson vs Jarvis 1872. In this case, the plaintiff,
an auctioneer, sold certain goods upon the instructions of a person. It turned out that the goods
did not belong to the person and the true owner held the autioneer liable for the goods. The
auctioneer, in turn, sued the defendant for indemnity for the loss suffered by him by acting on his
instructions. It was held that since the auctioneer acted on the instructions of the defendant, he
was entitled to assume that if, what he did was wrongful, he would be idemnified by the
defendant.

This gave a very broad scope to the meaning of Indemnity and it included promise of indemnity
due to loss caused by any cause whatsoever. Thus, any type of insurance except life insurance
was a contract of Indemnity. However, Indian contract Act 1872 makes the scope narrower by
defining the contract of indemnity as follows:

Section 124 - A contract by which one party promises to save the other from loss caused to
him by the conduct of the promisor himself or by the conduct of any other person is a "contract
of Indemnity".

Illustration - A contracts to indemnify B against the consequences of any proceedings which C

may take against B in respect of a certain sum of Rs 200. This is a contract of indemnity.

This definition provides the following essential elements -

1. There must be a loss.

2. The loss must be caused either by the promisor or by any other person.

3. Indemnifier is liable only for the loss.

Thus, it is clear that this contract is contingent in nature and is enforceable only when the loss
occurs.

Rights of the indemnity holder

Section 125, defines the rights of an indemnity holder. These are as follows -

The promisee in a contract of indemnity, acting within the scope of his authority, is entitled to
recover from the promisor -
i. Right of recovering Damages - all damages that he is compelled to pay in a suit in respect
of any matter to which the promise of indemnity applies.
 ii. Right of recovering Costs -all costs that he is compelled to pay in any such suit if, in
bringing or defending it, he did not contravene the orders of the promisor and has acted as it
would have been prudent for him to act in the absence of the contract of indemnity, or if the
promisor authorized him in bringing or defending the suit.

iii. Right of recovering Sums -all sums which he may have paid under the terms of a
compromize in any such suite, if the compromize was not contrary to the orders of the promisor
and was one which would have been prudent for the promisee to make in the absence of the
contract of indemnity, or if the promisor authorized him to compromize the suit.

As per this section, the rights of the indemnity holder are not absolute or unfettered. He must act
within the authority given to him by the promisor and must not contravene the orders of the
promisor. Further, he must act with normal intelligence, caution, and care with which he would
act if there were no contract of indemnity.

At the same time, if he has followed all the conditions of the contract, he is entitled to the
benefits. This was held in the case of United Commercial Bank vs Bank of India AIR 1981.
In this case, Supreme Court held that the courts should not grant injunctions restraining the
performance of contractual obligations arising out of a letter of credit or bank guarantee if the
terms of the conditions have been fulfilled. It held that such LoCs or bank guarantees impose on
the banker an absolute obligation to pay.

In the case of Mohit Kumar Saha vs New India Assurance Co AIR 1997, Calcutta HC held
that the indemnifier must pay the full amount of the value of the vehicle lost to theft as given by
the surveyor. Any settlement at lesser value is arbitrary and unfair and violates art 14 of the
constitution.

Commencement of liability
In general, as per the definition given in section 124, it looks like an idemnity holder cannot hold
the indemnifier liable untill he has suffered an actual loss. This is a great disadvantage to the
indemnity holder in cases where the loss is imminent and he is not in the position to bear the
loss. In the case of Gajanan Moreshwar vs Moreshwar Madan, AIR 1942, Bombay high court
observed that the contract of indemnity held very little value if the indemnity holder could not
enforce his indemnity untill he actually paid the loss. If a suit was filed against him, he had to
wait till the judgement and pay the damages upfront before suing the indemnifier. He may not be
able to pay the judement and could not sue the indemnifier. Thus, it was held that if his liability
has become absolute, he was entitled to get the indemnifier to pay the amount.

Q. Define a contract of Guarantee. What are the essential

elements of a contract of Guarantee? What is a continuing
Guarantee and what are its modes of revocation. What are
the rights of Surety? When is Surety discharged of
Guarantee? What is the extent of Surety's liability?
Section 126 of Indian Contract Act 1872 defines a contract of guarantee as follows :
"A contract of guarantee is a contract to perform the promise, or to discharge the liabilities of a
third person in case of his default. The person who gives the guarantee is called Surety, the
person in respect of whose default the guarantee is given is called Principal Debtor, and the
person to whom the guarantee is given is called Creditor. A Guarantee may be either oral or
written."

For example, when A promises to a shopkeeper C that A will pay for the items being bought by B
if B does not pay, this is a contract of guarantee. In this case, if B fails to pay, C can sue A to
recover the balance. The same was held in the case of Birkmyr vs Darnell 1704, where the
court held that when two persons come to a shop, one person buys, and to give him credit, the
other person promises, "If he does not pay, I will", this type of a collateral undertaking to be
liable for the default of another is called a contract of guarantee.

A contract of guarantee has the following essential elements -

1. Existance of Creditor, Surety, and Principal Debtor - The economic function of a guarantee
is to enable a credit-less person to get a loan or employment or something else. Thus, there must
exist a principal debtor for a recoverable debt for which the surety is liable in case of the default
of the principal debtor.

In the case of Swan vs Bank of Scotland 1836, it was held that a contract of guarantee is a
tripartite agreement between the creditor, the principal debtor, and the surety.

2. Distinct promise of surety - There must be a distinct promise by the surety to be answerable
for the liability of the Principal Debtor.

3. Liability must be legally enforceable - Only if the liability of the principal debtor is legally
enforceable, the surety can be made liable. For example, a surety cannot be made liable for a
debt barred by statute of limitation.

4. Consideration - As with any valid contract, the contract of guarantee also must have a
consideration. The consideration in such contract is nothing but any thing done or the promise to
do something for the benefit of the principal debor. Section 127 clarifies this as follows :
"Any thing done or any promise made for the benefit of the principal debtor may be sufficient
consideration to the surety for giving the guarantee."

Illustrations:
1. A agrees to sell to B certain goods if C guarantees the payment of the price of the goods. C
promises to guarantee the payment in consideration of A's promise to deliver goods to B. This is
a sufficient consideration for C's promise.
2. A sells and delivers goods to B. C, afterwards, requests A to forbear to sue B for an year
and promises that if A does so, he will guarantee the payment if B does not pay. A forbears to sue
B for one year. This is sufficient consideration for C's guarantee.
 3. A sells and delivers goods to B. Later on, C, without any consideration, promises to pay A if
B fails to pay. The agreement is void for lack of consideration.

However, there is no uniformity on the issue of past consideration. In the case of Allahabad
Bank vs S M Engineering Industries 1992 Cal HC, the bank was not allowed to sue the surety
in absence of any advance payment made after the date of guarantee. But in the case of Union
Bank of India vs A P Bhonsle 1991 Mah HC, past debts were also held to be recoverable under
the wide language of this section. In general, if the principal debtor is benefitted as a result of the
guarantee, it is sufficient consideration for the sustenance of the guarantee.

5. It should be without mispresentation or concealment - Section 142 specifies that a

guarantee obtained by misrepresenting facts that are material to the agreement is invalid, and
section 143 specifies that a guarantee obtained by concealing a material fact is invalid as well.

Illustrations -
1. A appoints B for collecting bills. B fails to account for some of the bills. A asks B to get a
guarantor for further employment. C guarantees B's conduct but C is not made aware of B
previous mis-accounting by A. B, afterwards, defaults. C cannot be held liable.

2. A promises to sell Iron to B if C guarantees payment. C guarantees payment however, C is

not made aware of the fact that A and B had contracted that B will pay 5 Rs higher that the
market prices. B defaults. C cannot be held liable.

In the case of London General Omnibus vs Holloway 1912, a person was invited to
guarantee an employee, who was previously dismissed for dishonesty by the same employer.
This fact was not told to the surety. Later on, the employee embezzled funds but the surety was
not held liable.

Continuing Guarantee
As per section 129, a guarantee which extends to a series of transactions is called a continuing
guarantee.
Illustrations -
1. A, in consideration that B will employ C for the collection of rents of B's zamindari, promises
B to be responsible to the amount of 5000/- for due collection and payment by C of those rents.
This is a continuing guarantee.

2. A guarantees payment to B, a tea-dealer, for any tea that C may buy from him from time to
time to the amount of Rs 100. Afterwards, B supplies C tea for the amount of 200/- and C fails to
pay. A's guarantee is a continuing guarantee and so A is liable for Rs 100.

3. A guarantees payment to B for 5 sacks of rice to be delivered by B to C over the period of one
month. B delivers 5 sacks to C and C pays for it. Later on B delivers 4 more sacks but C fails to
pay. A's guarantee is not a continuing guarantee and so he is not liable to pay for the 4 sacks.

Thus, it can be seen that a continuing guarantee is given to allow multiple transactions without
having to create a new guarantee for each transaction. In the case of Nottingham Hide Co vs
Bottrill 1873, it was held that the facts, circumstances, and intention of each case has to be
looked into for determining if it is a case of continuing guarantee or not.

Revocation of Continuing Guarantee

1. As per section 130, a continuing guarantee can be revoked at any time by the surety by notice
to the creditor.
Once the guarantee is revoked, the surety is not liable for any future transaction however he is
liable for all the transactions that happened before the notice was given.

Illustrations -
1. A promises to pay B for all groceries bought by C for a period of 12 months if C fails to pay.
In the next three months, C buys 2000/- worth of groceries. After 3 months, A revokes the
guarantee by giving a notice to B. C further purchases 1000 Rs of groceries. C fails to pay. A is
not liable for 1000/- rs of purchase that was made after the notice but he is liable for 2000/- of
purchase made before the notice.

This illustration is based on the old English case of Oxford vs Davies.

In the case of Lloyd's vs Harper 1880, it was held that employment of a servant is one
transaction. The guarantee for a servant is thus not a continuing guarantee and cannot be revoked
as long as the servant is in the same employment. However, in the case of Wingfield vs De St
Cron 1919, it was held that a person who guarateed the rent payment for his servant but revoked
it after the servant left his employment was not liable for the rents after revocation.

2. A guarantees to B, to the amount of 10000 Rs, that C shall pay for the bills that B may draw
upon him. B draws upon C and C accepts the bill. Now, A revokes the guarantee. C fails to pay
the bill upon its maturity. A is liable for the amount upto 10000Rs.

2. As per section 131, the death of the surety acts as a revocation of a continuing guarantee with
regards to future transactions, if there is no contract to the contrary.

It is important to note that there must not be any contract that keeps the guarantee alive even
after the death. In the case of Durga Priya vs Durga Pada AIR 1928, Cal HC held that in each
case the contract of guarantee between the parties must be looked into to determine whether the
contract has been revoked due to the death of the surety or not. If there is a provision that says
death does not cause the revocation then the constract of guarantee must be held to continue even
after the death of the surety.

Rights of the Surety

A contract of guarantee being a contract, all rights that are available to the parties of a contract
are available to a surety as well. The following are the rights specific to a contract of guarantee
that are available to the surety.

Rights against principal debtor

1. Right of Subrogation
As per section 140, where a guaranteed debt has become due or default of the principal debtor to
perform a duty has taken place, the surety, upon payment or performance of all that he is liable
for, is invested with all the rights which the creditor had against the princpal debtor. This means
that the surety steps into the shoes of the creditor. Whatever rights the creditor had, are now
available to the surety after paying the debt.

In the case of Lampleigh Iron Ore Co Ltd, Re 1927, the court has laid down that the surety will
be entitled, to every remedy which the creditor has against the principal debtor; to enforce every
security and all means of payment; to stand in place of the creditor to have the securities
transfered in his name, though there was no stipulation for that; and to avail himself of all those
securities against the debtor. This right of surety stands not merely upon contract but also upon
natural justice.

In the case of Kadamba Sugar Industries Pvt Ltd vs Devru Ganapathi AIR 1993, Kar HC
held that surety is entitled to the benefits of the securities even if he is not aware of theire
existence.

In the case of Mamata Ghose vs United Industrial Bank AIR 1987, Cal HC held that under the
right of subrogation, the surety may get certain rights even before payment. In this case, the
principal debtor was disposing off his personal properties one after another lest the surety, after
paying the debt, seize them. The surety sought for temporary injunction, which was granted.

2. Right to Indemnity
As per section 145, in every contract of guarantee there is an implied promise by the principal
debtor to indemnify the surety; and the surety is entitled to recover from the the principal debtor
whatever sum he has rightfully paid under the guarantee but no sums which he has paid wrong
fully.

Illustrations -
B is indebted to C and A is surety for the debt. Upon default, C sues A. A defends the suit on
reasonable grounds but is compelled to pay the amount. A is entitled to recover from B the cost
as well as the principal debt.

In the same case above, if A did not have reasonable grounds for defence, A would still be
entitled to recover principal debt from B but not any other costs.

A guarantees to C, to the extent of 2000 Rs, payment of rice to be supplied by C to B. C

supplies rice to a less amount than 2000/- but obtains from A a payment of 2000/- for the rice. A
cannot recover from B more than the price of the rice actually suppied.

This right enables the surety to recover from the principal debtor any amount that he has paid
rightfully. The concept of rightfully is illustrated in the case of Chekkara Ponnamma vs A S
Thammayya AIR 1983. In this case, the principal debtor died after hire-purchasing four motor
vehicles. The surety was sued and he paid over. The surety then sued the legal representatives of
the principal debtor. The court required the surety to show how much amount was realized by
selling the vehicles, which he could not show. Thus, it was held that the payment made by the
surety was not proper.

Rights against creditor

1. Right to securities
As per section 141, a surety is entitled to the benefit of every security which the creditor has
against the principal debtor at the time when the contract of suretyship is entered into whether
the surety knows about the existance of such securty or not; and 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.

Illustrations -
C advances to B, his tenant, 2000/- on the guarantee of A. C also has a further security for
2000/- by a mortgage of B's furniture. C cancels the mortgage. B becomes insolvent and C sues
A on his guarantee. A is discharged of his liability to the amount of the value of the furniture.

C, a creditor, whose advance to B is secured by a decree, also receives a guaratee from A. C

afterwards takes B's goods in execution under the decree and then without the knowledge of A,
withdraws the execution. A is discharged.

A as surety for B makes a bond jointly with B to C to secure a loan from C to B. Afterwards, C
obtains from B a further security for the same debt. Subsequently, C gives up the further security.
A is not discharged.

This section recognizes and incorporates the general rule of equity as expounded in the case of
Craythorne vs Swinburne 1807 that the surety is entitled to every remedy which the creditor
has agains the principal debtor including enforcement of every security.

The expression "security" in section 141 means all rights which the creditor had against property
at the date of the contract. This was held by the SC in the case of State of MP vs Kaluram AIR
1967. In this case, the state had sold a lot of felled trees for a fixed price in four equal
installments, the payment of which was guaranteed by the defendent. The contract further
provided that if a default was made in the payment of an installment, the State would get the
right to prevent further removal of timber and the sell the timber for the the realization of the
price. The buyer defaulted but the State still did not stop him from removing further timber.
The surety was then sued for the loss but he was not held liable.

It is important to note that the right to securities arises only after the creditor is paid in full. If the
surety has guaranteed only part of the debt, he cannot claim a propertional part of the securities
after paying part of the debt. This was held in the case of Goverdhan Das vs Bank of Bengal
1891.

2. Right of set off

If the creditor sues the surety, the surety may have the benefit of the set off, if any, that the
principal debtor had against the creditor. He is entitled to use the defences that the principal
debtor has against the creditor. For example, if the creditor owes the principal debtor something,
for which the principal debtor could have counter claimed, then the surety can also put up that
counter claim.

Rights against co-sureties

1. Effect of releasing a surety

As per section 138, Where there are co-sureties, a release by the creditor of one of them does not
discharge the others; neither does it free the surety so released from his responsibilty to the other
surities.
A creditor can release a co-surety at his will. However, as held in the case of Sri Chand vs
Jagdish Prashad 1966, the released co-surety is still liable to the others for contribution upon
default.

2. Right to contribution
As per section 146, where two or more persons are co-surities for the same debt jointly or
severally, with or without the knowledge of each other, under same or different contractx, in the
absernce of any contract to the contrary, they are liable to pay an equal share of the debt or any
part of it that is unpaid by the principal debtor.

Illustrations -
A, B, and C are surities to D for a sum of 3000Rs lent to E. E fails to pay. A, B, and C are
liable to pay 1000Rs each.

A, B, and C are surities to D for a sum of 1000Rs lent to E and there is a contract among A B
and C that A and B will be liable for a quarter and C will be liable for half the amount upon E's
default. E fails to pay. A and B are liable for 250Rs each and C is liable for 500Rs.

As per section 147, co-sureties who are bound in different sums are liable to pay equally as fas
as the limits of their respective obligations permit.

Illustrations -
A, B and C as surities to D, enter into three several bonds, each in different penalty, namely A
for 10000Rs, B for 20000 Rs, and C for 30000Rs with E. D makes a default on 30000Rs. All of
them are liable for 10000Rs each.

A, B and C as surities to D, enter into three several bonds, each in different penalty, namely A
for 10000Rs, B for 20000 Rs, and C for 40000Rs with E. D makes a default on 40000Rs. A is
liable for 10000Rs while B and C are liable for 15000Rs each.

A, B and C as surities to D, enter into three several bonds, each in different penalty, namely A
for 10000Rs, B for 20000 Rs, and C for 40000Rs with E. D makes a default on 70000Rs. A, B
and C are liable for the full amount of their bonds.

Discharge of Surety
A surety is said to be discharged from liability when his liability comes to an end. Indian
Contract Act 1872 specifies the following conditions in which a surety is discharged of his
liability -

1. Section 130 - By a notice of revocation - discussed above.

2. Section 131 - By death of surety - discussed above.

3. Section 133 - By variance in terms of contract - A variance made without the consent of the
surety in terms of the contract between the principal debtor and the creditor, discharges the surety
as to the transactions after the variance.

Illustrations -
A becomes a surety to C for B's conduct as manager in C's bank. Afterwards, B and C contract
without A's consent that B's salary shall be raised and that B shall be liable for 1/4th of the losses
on overdrafts. B allows a customer to overdraft and the bank loses money. A is not liable for the
loss.

A guarantees C against the misconduct of B in an office to which B is appointed by C. The

conditions of employment are defined in an act of legislature. In a subsequent act, the nature of
the office is materially altered. B misconducts. A discharged by the change from the future
liablity of his guarantee even though B's misconduct is on duty that is not affected by the act.

B appoints C as a salesperson on a fixed yearly salary upon A's guarantee on due account of
sales by C. Later on, without A's consent, B and C contract that C will be paid on commission
basis. A is not liable for C's misconduct after the change.

C promises to lends 5000Rs to B on 1st March. A guarantee the repayment. C gives the money
to B on 1st January. A is discharged of his liability because of the variance in as much as C may
decide to sue B before 1st march.

4. Section 134 - By discharge of principal debtor - The surety is discharged by any contract
between the creditor and the principal debtor by which the principal debtor is discharged; or by
any action of the creditor the legal consequence of which is the discharge of the principal debtor.

Illustrations
A gives a guarantee to C for goods to be delivered to B. Later on, B contracts with C to assign
his property to C in lieu of the debt. B is discharged of his liability and A is discharged of his
liability.

A contracts with B to grow indigo on A's land and deliver it to B at a fixed price. C guarantees
A's performance. B diverts a stream of water that is necessary for A to grow indigo. This action
of B causes A to be discharged of the liability. Consequenty C is discharged of his suretyship as
well.
 A contracts with B to build a house for B. B is to supply timber. C guarantees A's performance.
B fails to supply timber. C is discharged of his liability.

If the principal debtor is released by a compromise with the creditor, the surety is discharged but
if the principal debtor is discharged by the operation of insolvancy laws, the surety is not
discharged. This was held in the case of Maharashtra SEB vs Official Liquidator 1982.

5. Section 135 - By composition, extension of time, or promise not to sue - A contract between
the principal debtor and the creditor by which the creditor makes a composition with, or
promises to give time to, or promises to not sue the principal debtor, discharges the surety unless
the surety assents to such a contract.

It should be noted that as per section 136, if a contract is made by the creditor with a third person
to give more time to the principal debtor, the surety is not discharged. However, in the case of
Wandoor Jupitor Chits vs K P Mathew AIR 1980, it was held that the surety was not
discharged when the period of limitation got extended due to acknowledgement of debt by the
principal debtor.

Further, as per section 137, mere forbearance to sue or to not make use of any remedy that is
available to the creditor against the principal debtor, does not automatically discharge the surety.
Illustration -
B owes C a debt guarateed by A. The debt becomes payable. However, C does not sue B for an
year. This does not discharge A from his suretyship.

It must be noted that forbearing to sue until the expiry of the period of limitation has the legal
consequence of discharge of the principal debtor and thus as per section 134, will cause the
surety to be discharged as well. If section 134 stood alone, this inference was correct.
However, section 137 explicitly says that mere forbearance to sue does not discharge the surety.
This contradiction was removed in the case of Mahanth Singh vs U B Yi by Privy Council. It
held that failure to sue the principal debtor until recovery is banned by period of limitation does
not discharge the surety.

6. Section 139 - By imparing surety's remedy - If the creditor does any act that is inconsistent
with the rights of the surety or omits to do an act which his duty to surety requires him to do, and
the eventual remedy of the surety himself against the principal debtor is thereby impaired, the
surety is dischared.

Illustrations -
C contracts with B to build a ship the payment of which is to be made in installments at
various stages of completion. A guarantee's C's performance. B prepays last two installments. A
is discharged of his liability.

A appoints M as an apprentice upon getting a guarantee of M's fidelity by B. A also promises

that he will at least once a month see M make up the cash. A fails to do this. M embezzeles. B is
discharged of his suretyship.
 A lends money to B with C as surety. A also gets as a security the mortgate to B's furniture. B
defaults and A sells his furniture. However, due to A's carelessness very small amount is received
by sale of the furniture. C is discharged of the liability.

State of MP vs Kaluram - Discussed above.

In the case of State Bank of Saurashtra vs Chitranjan Ranganath Raja 1980, the bank failed
to properly take care of the contents of a godown pledged to it against a loan and the contents
were lost. The court held that the surety was not liable for the amount of the goods lost.

Creditor's duty is not only to take care of the security well but also to realize it proper value.
Also, before disposing of the security, the surety must be informed on the account of natural
justice so that he can have the option to take over the security by paying off the debt. In the case
of Hiranyaprava vs Orissa State Financial Corp AIR 1995, it was held that if such a notice of
disposing off of the security is not given, the surety cannot be held liable for the shortfall.

However, when the goods are merely hypothecated and are in the custody of the debtor, and if
their loss is not because of the creditor, the suerty is not discharged of his liability.

Extent of Surety's Liability

As per section 128, the liability of a surety is co-extensive with that of the principal debtor,
unless it is otherwise provided in the contract.
Illustration - A guaratees the payment of a bill by B to C. The bill becomes due and B fails to
pay. A is liable to C not only for the amount of the bill but also for the interest.

This basically means that although the liability of the surety is co-extensive with that of the
principal debtor, he may place a limit on it in the contract. Co-extensive implies the maximum
extent possible. He is liable for the whole of the amount of the debt or the promises. However,
when part of a debt was recovered by disposing off certain goods, the liability of the surety is
also reduced by the same amount. This was held in the case of Harigopal Agarwal vs State
Bank of India AIR 1956.

The surety can also place conditions on his guarantee. Section 144 says that where a person gives
guarantee upon a contract that the creditor shall not act upon it untill another person has joined it
as co-surety, the guarantee is not valid if the co-surety does not join. In the case of National
Provincial Bank of England vs Brakenbury 1906, the defendant signed a guarantee which was
supposed to be signed by three other co-surities. One of them did not sign and so the defendant
was not held liable.

Similarly, a surety may specify in the contract that his liability cannot exceed a certain amount.

However, where the liability is unconditional, the court cannot introduce any conditions. Thus, in
the case of Bank of Bihar Ltd. vs Damodar Prasad AIR 1969, SC overruled trial court's and
high court's order that the creditor must first exhaust all remedies against the principal debtor
before suing the surety.
Q. Differentiate between a contract of Indemnity and a
contract of Guarantee.
Contract of Indemnity
Contract of Guarantee (Section 126)
(Section 124)
It is a bipartite agreement between
It is a tripartite agreement between the Creditor, Principal
the indemnifier and indemnity-
Debtor, and Surety.
holder.
Liability of the indemnifier is
Liability of the surety is not contingent upon any loss.
contingent upon the loss.
Liability of the surety is co-extensive with that of the
principal debtor although it remains in suspended
Liability of the indemnifier is
animation until the principal debtor defaults. Thus, it is
primary to the contract.
secondary to the contract and consequenty if the principal
debtor is not liable, the surety will also not be liable.
The undertaking in indemnity is The undertaking in a guarantee is collateral to the original
original. contract between the creditor and the principal debtor.
There are three contracts in a contract of guaratee - an
There is only one contract in a
original contract between Creditor and Principal Debtor, a
contract of indemnity - between the
contract of guarantee between creditor and surety, and an
indemnifier and the indemnity
implied contract of indemnity between the surety and the
holder.
principal debtor.
The reason for a contract of
The reason for a contract of guarantee is to enable a third
indemnity is to make good on a loss
person get credit.
if there is any.
Once the indemnifier fulfills his
Once the guarantor fulfills his liabilty by paying any debt
liability, he does not get any right
to the creditor, he steps into the shoes of the creditor and
over any third party. He can only
gets all the rights that the creditor had over the principal
sue the indemnity-holder in his own
debtor.
name.
Q. Define Bailment. What are the rights, duties, and
liabilities of a bailee? When is he not responsible for loss,
destruction, or deterioration of the things bailed? What are
the various kinds of lien held by the bailee. Explain the
rights of finder of goods.
Bailment is a kind of activity in which the property of one person temporarily goes into the
possession of another. The ownership of the property remains with the giver, while only the
possession goes to another. Several situations in day to day life such as giving a vehicle for
repair, or parking a scooter in a parking lot, giving a cloth to a tailor for stitching, are examples
of bailment. Section 148 of Indian Contract Act 1872, defines bailment as follows -

Section 148 - A bailment is the delivery of goods by one person to another for some purpose,
upon a contract that they shall, when the purpose is accomplished, be returned or otherwise
disposed of according to the directions of the person delivering them. The person delivering the
goods is called the bailor and the person to whom they are delivered is called the bailee.
Explanation - If a person is already in possession of the goods of another contracts to hold them
as a baliee, he thereby becomes the bailee and the bailor becomes the bailor of such goods
although they may not have been delivered by way of bailment.

According to this definition the following are the essential elements of bailment -

1. Delivery of goods
The possession of goods must transfer from one person to another. Delivery is not same as
custody. For example, a servant holding his master's umbrella is not a bailee but only a
custodian. The goods must be handed over to the bailee for whatever is the purpose of the
bailment.

In Ultzen vs Nicols 1894, the plaintiff went to a restaurant for dining. When he entered the room,
the waiter took his coat and hung it on a hook behind him. When the plaintiff arose to leave, the
coat was gone. It was held that the waiter voluntarily took the responsibility of keeping the coat
while the customer was dining and was thus a bailee. Therefore, he was liable to return it.

Contrasting this case with Kaliaperumal Pillai vs Visalakshmi AIR 1938, we can see the
meaning of delivery. In this case, a woman gave some gold to a jeweler to make jewelery. Every
evening she used to take the unfinished jewels, put it in a box, lock the box and take the keys of
the box with her while leaving the box at the goldsmith. One morning, when the opened the box
the gold was gone. It was held that, in the night, the possession of the gold was not with the
jeweler but with the plaintiff because she locked the box and kept the keys with her.

As the explanation to section 148 says, even if a person already has the possession of goods that
he does not own, he can become a bailee by entering into a contract with the bailor. In such a
case, the actual act of delivery is not done but is considered to be valid for bailment.
Types of Delivery - As per section 149, the delivery to the bailee may be made by doing
anything which has the effect of putting the goods in the possession of the intended bailee or of
any person authorized to hold them on his behalf. This means that the delivery can be made to
either the bailee or to any other person whom the baliee authorizes. This person can be the bailor
himself. This gives us two types of delivery - Actual and Constructive. In actual delivery, the
physical possession of the goods is handed over to the bailee while in constructive delivery the
possession of the goods remains with the bailor upon authorization of the bailee. In other words,
the bailee authorizes the person to keep possession of the goods.
In Bank of Chittor vs Narsimbulu AIR 1966, a person pledged cinema projector with the bank
but the bank allowed him to keep the projector so as to keep the cinema hall running. AP HC
held that this was constructive delivery because something was done that changed the legal
possession of the projector. Even though the physical possession was with the person, the legal
possession was with the bank.

2. Delivery upon contract

For a valid bailment, the delivery must be done upon a contract that the goods will be returned
when the purpose is accomplished. If the goods are given without any contract, there is no
bailment. In Ram Gulam vs Govt. of UP AIR 1950, plaintiffs ornaments were seized by police
on the suspicion that they were stolen. The ornaments were later on stolen from the custody or
police and the plaintiff sued the govt. for returning the ornaments. It was held that the goods
were not given to the police under any contract and thus there was no bailment.

However, this decision was criticized and finally, in State of Gujarat vs Menon Mohammad
AIR 1967, SC held that bailment can happen even without an explicit contract. In this case,
certain motor vehicles were seized by the State under Sea Customs Act, which were then
damaged. SC held that the govt. was indeed the bailee and the State was responsible for proper
care of the goods.

3. Conditional Delivery
The delivery of goods is not permanent. The possession is given to the bailee only on the
condition that he will either return the goods or dispose them according to the wishes of the
bailer after the purpose for which the goods were given. For example, when the stitching is
complete, the tailor is supposed to return the garment to the bailor. If the bailee is not bound to
return the goods to the bailor, then the relationship between them is not of bailment. This is a key
feature of bailment that distinguishes it from other type of relations such as agency. J Shetty of
SC in U Co. Bank vs Hem Chandra Sarkar 1990, observed that the distinguishing feature
between a bailment and an agency is that the bailee does not represent the bailor. He merely
exercises some rights of the bailor over the bailed property. The bailee cannot bind the bailor by
his acts. Thus, a banker who was holding the goods on behalf of its account holder for the
purpose of delivering them to his customers against payment, was only a bailee and not an agent.

Duties of a Bailor
A bailor may give his property to the bailee either without any consideration or reward or for a
consideration or reward. In the former case, he is called a gratuitous bailor, while in the latter, a
bailor for reward. The duties in both the cases are slightly different. Section 150 specifies the
duties for both kinds of bailor. It says that the bailor is bound to disclose any faults in the goods
bailed that the bailor is aware of, and which materially interfere with the use of them or which
expose the bailee to extraordinary risk. This means that if there is a fault with the goods which
may cause harm to the bailee, the bailor must tell it to the bailee. For example, if a person bails
his scooter to his friend and if the person knows that the brakes are loose, then he must tell this to
the friend. Otherwise, the bailor will be responsible for damages arising directly out of the faults
to the bailee. But the bailor is not bound to tell the bailee about the fault if the bailor himself
does not know about it.

Section 150 imposes a bigger responsibility to the non-gratuitous bailor since he is making a
profit out of the bailment. A non gratuitous bailor is responsible for any damage that happens to
the bailee directly because of the fault of the goods irrespective of whether the bailor knew about
it or not.
In Hyman and Wife vs Nye & Sons 1881, the plaintiff hired a carriage from the defendant.
During the journey, a bolt in the under part of carriage broke, causing an accident in which the
plaintiff was injured. The defendants were held liable even though they did not know about the
condition of the bolt.

Duties/Responsibilities of a Bailee
1. Duty to take reasonable care
In English law the duties of a gratuitous and non-gratuitous bailee are different. However, in
Indian law, Section 151 treats all kinds of bailees the same with respect to the duty. It says that in
all cases of bailment, the bailee is bound to take as much care of the goods bailed to him as a
man of ordinary prudence would, under similar circumstances take, of his own goods of the same
bulk, quality, and value as the goods bailed. The bailee must treat the goods as his own in terms
of care. However, this does not mean that if the bailor is generally careless about his own goods,
he can be careless about the bailed goods as well. He must take care of the goods as any person
of ordinary prudence would of his things.

In Blount vs War Office 1953, a house belonging to the plaintiff was requisitioned by the War
Office. He was allowed to keep his certain articles in a room of the house, which he locked. The
troops who occupied the house were not well controlled and broke into the room causing damage
and theft of the articles. It was held that War office did not take care of the house as an owner
would and held the War Office liable for the loss.

Bailee, when not liable for loss etc. for thing bailed -
As per section 152, in absence of a special contract, the bailee is not responsible for loss,
destruction, or deterioration of the thing bailed, if he has taken the amount of care as described in
section 151. This means that if the bailee has taken as much care of the goods as any owner of
ordinary prudence would take of his goods, then the bailee will not be liable for the loss,
destruction, or deterioration of the goods. No fixed rule regarding how much care is sufficient
can be laid down and the nature, quality, and bulk of goods will be taken into consideration to
find out if proper care was taken or not. In Gopal Singh vs Punjab National Bank, AIR 1976,
Delhi HC held that on the account of partition of the country, when a bank had to flee along with
mass exodus from Pakistan to India, the bank was not liable for the goods bailed to it in Pakistan.
If the bailee has taken sufficient care in the security of the goods, then he will not be liable if
they are stolen. However, negligence in security, for example leaving a bicycle unlocked on the
street, would cause the bailee to be liable. In Join & Son vs Comeron 1922, the plaintiff stayed
in a hotel and kept his belonging in his room, which were stolen. The hotel was held liable
because they did not take care of its security as an owner would.

If loss is caused due to the servant of the bailee, the bailee would be liable if the servant's act is
within the scope of his employment.

Special Contract
The extent of this responsibility can be changed by a contract between the bailor and the bailee.
However, it is still debatable whether the responsibility can be reduce or it can be increased by a
contract. Section 152 opens with, "In absence of special contract", which is interpreted by
Punjab and Haryana HC, as the bailee can escape his responsibility by way of a contract with the
bailor. However, in another case Gujarat HC held that the bank was liable for loss of bales of
cotton kept in its custody irrespective of the clause that absolved the bank of all liability. This
seems to be fair because no one can get a license to be negligent and a minimum standard of care
is expected from everybody.

2. Duty not to make unauthorized use (Section 154)

Section 154 says that if the bailee makes any use of the goods bailed which is not according to
the conditions of the bailment, he is liable to make compensation to the bailor for any damage
arising to the goods from or during such use of them.
Illustration - A lends horse to B for his own riding only. B allows C, a member of his family, to
ride the horse. C rides with care but the horse is injured. B is liable to compensate A for the
injury to the horse.
A hires a horse in Calcutta from B expressly to march to Benares. A rides with care but marches
to Cuttack instead. The horse accidentally falls and is injured. A is liable to make compensation
to B.

Thus, we can see that bailee is supposed to use the goods only as per the purpose of the bailment.
If the bailee makes any unauthorized use of the goods, he will be held absolutely liable for any
damages.

3. Duty not to mix (Section 155-157)

The bailee should maintain the separate identity of the bailor's goods. He should not mix his
goods with bailor's good without bailor's consent. If he does so, and if the goods are separable,
he is responsible for separating them and if they are not separable, he will be liable to
compensate the bailor for his loss. For example, A bails 100 bales of cotton with a particular
mark to B. B, without A's consent, mixes them with his own. A is entitled to have his 100 bales
returned and B is bound to bear all expenses for separation. But if A bails a barrel of Cape flour
worth Rs 45 to B and B mixes it with country flour worth Rs 25, B is liable to A for the loss of
his flour.

4. Duty to return (Section 160)

Section 160 - It is the duty of the bailee to return or deliver according to the bailor's directions,
the goods bailed, without demand, as soon as the time for which they were bailed has expired or
the purpose for which they were bailed has been accomplished.

If the bailee keeps the goods after the expiry of the time for which they were bailed or after the
purpose for which they were bailed has been accomplished, it will be at bailee's risk and he will
be responsible for any loss or damage to the goods arising howsoever.
In Shaw & Co vs Symmons & Sons 1971, the plaintiff gave certain books to the defendant to be
bound. The defendant bound them but did not return them within reasonable time. Subsequently,
the books were burnt in an accidental file. The defendants were held liable for the loss of books.

5. Duty to return increase (Section 163)

As per Section 163, in absence of any contract to the contrary, the bailee is bound to deliver to
the bailor, or according to his directions, any increase of profit which may have accrued from the
goods bailed.
Illustration - A leaves a cow in the custody of B to be taken care of. The cow has a calf. B is
bound to deliver the calf as well as the cow to B.

6. Duty not to set up jus tertii (Section 166)

As per Section 166 if the bailor has no title and the bailee, in good faith returns the goods back
to the bailor or as per the directions of the bailor, he is not responsible to the owner in respect of
such delivery. Thus, once the bailee takes the goods from the bailor, he agrees that the goods
belong to the bailor and he must return them only to the bailor. He cannot deny redelivery to the
bailor on the ground that the bailor is not the owner.

If there is true owner of the goods, he can apply to the court to stop the delivery of the goods
from the bailee to the bailor. This right is given to the true owner in section 167.

Rights of a Bailee
1. Right to necessary expenses (Section 158)
The bailee is entitled to lawful charges for providing his service. As per Section 158 says that
where by conditions of the bailment, the goods are to be kept or to be carried or to have work
done upon them by the bailee for the bailor and the bailee is to receive no remuneration, the
bailor shall repay to the bailee the necessary expenses incurred by him for the purpose of
bailment. Thus, a bailee is entitled to recover the charges as agreed upon, or if there is no such
agreement, the bailee is entitled to all lawful expenses according to this section.

In Surya Investment Co vs STC AIR 1987, STC hired a storage tank from the plaintiff. On
account of a dispute, STC appointed a special officer to take charge of the tank, who delivered
the contents as per directions of STC. Thus, the plaintiff lost his possession and with it, his right
of lien. SC held that the plaintiff is entitled to the charges even if he loses his right of lien
because the bailor has enjoyed bailee's services.

2. Right to compensation (Section 164)

As per section 164, the bailor is responsible to the bailee for any loss which the bailee may
sustain by reason that the bailor was not entitled to make the bailment, or to receive back the
goods, or to give directions respecting them. This means that if the bailor had no right to bail the
goods and if still bails them, he will be responsible for any loss that the bailee may incur because
of this.

3. Right of Lien (Section 170-171)

In general, Lien means the right to keep the possession of the property of a person until that
person clear the debts. In case of bailment, the bailee has the right to keep the possession of the
property of the bailor until the bailor pays lawful charges to the bailee. Thus, right of Lien is
probably the most important of rights of a bailee because it gives the bailee the power to get paid
for his services.

Lien is of two kinds - Particular and General.

Particular Lien
This means that the lien holder has a right to keep possession of only that particular property for
which the charges are owed. For example, A gives a horse and a bicycle to B. A agrees to pay B
charges for training the horse and no charges for keeping the bicycle. Now, if A fails to pay
charges for the horse, B is entitled to keep possession only of the horse and not of the bicycle. He
must return the bicycle.
Section 170 gives this right to the bailee. It says that where the bailee has, in accordance with the
purpose of the bailment, rendered any service involving the exercise of labor or skill in respect of
the goods bailed, he has, in absense of a contract to the contrary, a right to retain such goods until
he receives due remuneration for the services he has rendered in respect of them.

Illustrations - A delivers a rough diamond to B to be cut and polished, which is accordingly done.
B is entitled to keep the diamond until charges for his services are paid.
A gives cloth to B, a tailor, to make into a cloth. B promises to deliver the coat as soon as it is
done and also to give 3 months credit for the price. B is not entitled to keep the coat until he is
paid.

Conditions for Particular Lien -

1. Exercise of labor or skill - This right is subject to the condition that the bailee has
exercised labor or skill in respect of the goods. Further, it has been frequently pointed out
that the labor or skill must be such as improves the goods. This, in Hutton vs Car
Maintenance Co 1915, it was held that a job master has no lien for feeding and keeping
the horse in his stable but a horse trainer does get a lien upon the horse.

2. Labor or skill exercised must be for the purpose of the bailment - Any services rendered
that are beyond the purpose of the bailment do not give a right of lien. For example, A
bails his car to B to repair Engine. But B repairs tires instead. B will not get the right of
lien.
 3. Labor or skill exercised must be in respect of the goods - As mentioned before, the bailee
gets a right of lien only upon the goods upon which the service was performed.

General Lien -
As opposed to Particular Lien, General Lien gives a right to the bailee to keep the possession of
any goods for any amount due in respect of any goods. Section 171 says that, bankers, factors,
wharfingers, attorneys of a High Court, and policy brokers may, in the absence of a contract to
the contrary, retain as a security for a general balance of account, any goods bailed to them; but
no other persons have a right to retain, as a security for such balance, goods bailed to them,
unless there is an express contract to that effect.
Thus, this right is only available to bankers, factors, wharfingers, attorneys of high court, and
policy brokers. However, this right can be given to the bailee by making an express contract
between the bailor and the bailee.

4. Right to Sue (Section 180-181)

Section 180 enables a bailee to sue any person who has wrongfully deprived him of the use or
possession of the goods bailed or has done them any injury. The bailee's rights and remedies
against the wrong doer are same as those of the owner. An action may be brought either by the
bailor or the bailee.

Thus, in Umarani Sen vs Sudhir Kumar AIR 1984, a firm which had consigned the goods, of
which it was a bailee, with a carrier, was allowed to sue the carrier for loss of the goods.

Rights of finder of goods

If a person finds something, he does not automatically become the owner of that thing. He, in
fact, becomes a special kind of a baliee in the sense that he has to keep the thing until the owner
is found. He should take care of the thing just like a bailee. Section 168 and 169 describe the
rights of such finder of goods.

Section 168 - The finder of goods has no right to sue the owner for compensation for trouble
and expense voluntarily incurred by him to preserve the goods and to find out the owner; but he
may retain the goods against the owner until he receives such compensation; and where the
owner has offered a specific reward for the return of goods lost, the finder may sue for such
reward, and may retain the goods until he receives it.

Thus, if the finder has incurred expenses in finding the owner and/or in maintaining the goods
voluntarily, he can retain the possession of the goods until the owner pays the expense to him,
though the finder cannot sue the owner for the expense. His only remedy is to keep the goods.
Further, if the owner has promised a reward for the return of the goods, the finder is entitled to
the rewards, and he can even sue the owner for the reward. He can retain the goods as well until
the reward is received.

As per Section 169, the finder of the goods can even sell the goods if they are of common
objects of sale, in the following conditions -
 1. the finder of goods was not able to find the owner after good faith efforts.

2. the owner is found but the owner refuses to pay lawful expenses and

1. either the goods are in danger of perishing or of losing greater part of the value

2. or the lawful charges of the finder amount to two third of the value of the goods.

What is pledge? What are the essentials of pledge? Can a

pledge be made by a person who is not the owner of goods?
What is the difference between bailment and pledge?
Explain Pawner's right to redeem.
Pledge is a special kind of bailment in which a person transfers the possession of his property to
another for securing the loan taken from the other. It only differs from bailment in the matter of
purpose. When the purpose of the bailment is to secure a loan or a promise, it is called a pledge.
Section 172 of Indian Contract Act 1872 defines Pledge as follows -
Section 172 - The bailment of goods as a security for the payment of a debt or performance of a
promise is called Pledge. The bailor in this case is called a Pawnor and the bailee is called
Pawnee.

J Shelat in Lallan Prasad vs Rahmat Ali AIR 1967 observed that Pawn or pledge is a bailment
of personal property as a security for some debt or engagement.

The following are essential ingredients of a pledge -

1. Delivery of possession - As in bailment, the delivery of possession is essential in a pledge.

Thus, in Revenue Authority vs Sudarsanam Pictures, AIR 1968, a film producer borrowed a
sum of money from a financier and agreed to deliver the final prints of the film when ready. This
was held not to be a pledge because there was no delivery of possession at the time of the
agreement.
It is possible to do delivery by atonement in which case a third person who has the possession of
the property agrees to hold it on behalf of the pledgee upon direction of the pledger.

Hypothecation - It is also possible to let the pawner keep the physical goods even though the
legal possession is transfered to the pawner. Thus, in Bank of Chittor vs Narsimbulu AIR
1966, a cinema hall equipment was pledged to the bank but the bank allowed the hall owner to
keep the equipment to show the movies. The hall owner then sold the equipment to another party.
It was held that the sale was subject to the pledge.
In Bank of India vs Binod Steel AIR 1977, MP HC held that in such cases where goods are
hypothecated, other creditors cannot claim right on them until the claim of the pledgee is
satisfied.

2. In return of a loan or a promise - The delivery must be in return of a loan or of acceptance

of a promise to perform something. Thus, if A gives his bicycle to B in friendship, it is not a
pledge but a simple bailment. However, if A gives his bicycle to B as a security for a debt of
100Rs it will be a pledge.

3. In pursuance of a contract - The delivery must be done under a contract though it is not
necessary that the delivery and the payment of loan be at the same time. Delivery can be made
even after the loan is received.

Rights of a Pawnee
1. Right of retainer (Section 173- 174) - As per section 173, the pawnee may retain the
goods pledged, not only for a payment of a debt or the performance of the promise, but also for
the interest of the debt, and all necessary expenses incurred by him in respect of the possession
or for the preservation of the goods pledged. Further, as per section 174, in absence of any
contract to the contrary, the pawner shall not retain the goods pledged for debt or promise other
than the debt or promise for which they have been pledged. However, such contract shall be
presumed in absence of any contract to the contrary with respect to any subsequent advances
made by the pawnee.
This means that if A pledges his gold watch with B for 1000 Rs and later on he promises to teach
B's son for a month and takes for 500Rs for this promise , and if he does not teach B's son, B
cannot retain A's gold watch after A pays 1000Rs. Thus, the right of retainer is a sort of
particular lien. The difference was pointed out in Bank of Bihar vs State of Bihar 1972 by SC.
It observed that a pawnee obtains a special interest in the pledged goods in the sense that he can
transfer or pledge that special interest to somebody else. The lien only gives the right to detain
the goods but not transfer. Thus, a pledgee get the first right to claim the goods before any other
creditor can get them. The pledgee's loan is secured by the goods.

2. Right to extra ordinary expenses (Section 175) - As per section 175, the pawnee is
entitled to receive from the pawner extra ordinary expenses incurred by him for the preservation
of the goods pledged. For such expenses, however, he does not have right to detain the goods.
Section 175 says that the pawnee is entitled to receive from the pawner extraordinary expenses
incurred by him for the preservation of the goods pledged.

3. Right of sale (Section 176) - As per section 176 (Pawnee's right where pawnor makes
default) - If the pawnor makes default in payment of the debt or performance at the stipulated
time, of the promise, in respect of which the goods were pledged, the pawnee may bring a suit
against the pawnor upon the debt or the promise and retain the goods pledged as a collateral
security; or he may sell the thing pledged, on giving the pawnor reasonable notice of the sale.
This right secures the debt for the pawnee up to the value of the goods pledged because it allows
the pawnee to either sue the pawnor for recovering the debt or perform the promise or sell the
goods pledged. If the value received after selling the goods, the pawner is still liable for the
difference and if the value of the sale is more than the amount of debt, the pawnee is supposed to
give the difference to the pawnor. However, if the pawnee has sold the goods, he cannot sue for
the debt.
In Lallan Prasad vs Rahmat Ali AIR 1967the defendant borrowed 20000Rs from the plaintiff
on a promissory note and gave him aeroscrapes worth about 35000Rs, as a security for the loan.
The plaintiff sued for repayment of the loan but was unable to produce the security, having sold
it. SC rejected his action. It held that pledgee cannot maintain a suit for recovery of debt as well
as retain the pledged property.

The pawner is required to give a reasonable notice to the pawnee about the sale. The notice is not
a mere notice but reasonable notice. In Prabhat Bank vs Babu Ram AIR 1966, the terms of an
agreement of a loan enabled the bank to sell the securities upon default without notice. The
pawnor defaulted in payment. The bank sent a reminder upon which the pawnor asked for more
time. The bank sold the securities. SC held that this was bad in law. The bank is required to give
a clear and specific notice of the impending sale. Pawner's request for more time cannot be
interpreted as a notice of sale.

When the goods are lost due to pawnee's negligence, the liability of the pawnor is reduced to the
extent of value of the goods.

Pawnor's Right to Redeem (Section 177)

Section 177 provides a very important right to the pawnor. It allows the pawnor to redeem his
property even if he has defaulted. It says that if a time is stipulated for the payment of a debt or
performance of the promise for which the pledge is made, and the pawnor make default in
payment of the debt or performance of the promise at the stipulated time, he may redeem the
goods pledged at any subsequent time before the actual sale of them; but he must, in that case,
pay, in addition, any expense which have arisen from his default.

J Shelat in Lallan Prasad vs Rahmat Ali AIR 1967, observed that the pawnor has as absolute
right to redeem his property upon satisfaction or the debt or the promise. This right is not
extinguished by the expiry of the stipulated time for repayment of debt or performance of the
promise but only by the actual sale of the goods. If the pawnor redeems his goods after the
expiry of the stipulated time, he is bound to pay the expenses as have arisen on account of his
default.

The pawnor also has a right to take back any increase in the property. In M R Dhawan vs
Madan Mohan AIR 1969, certain shares of a company were pledged. During the period of the
pledge, the company issued bonus and rights shares. Delhi HC held that the pawnor was entitled
to those at the time of redemption.

Pledge made by non-owner of the goods

Ordinarily goods may be pledged by the owner or by any person with the consent of the owner. A
pledge made by any other person is not valid. Thus, in Biddomoy Dabee vs Sittaram, it was
held that a pledge made by the servant who was holding the goods of his master was not valid.
Similarly, in Purushottam Das vs Union of India AIR 1967, a railway company delivered
goods on a forged railway receipt. The goods were then pledged with the defendants. In a suit by
the railways to recover the goods it was held that the pledge was invalid.
This is important to protect the interests of the owners. However, in many situations it is equally
important to allow trade and commerces and so there are some situations where a person having
the possession of the goods by owner's consent, is entitled to pledge those goods even without
owner's consent for the pledge. These situations are discussed below -

1. Pledge by Mercantile agent (Section 178)

When a mercantile agent is in possession of the goods with consent of the owner, any pledge
made by him in ordinary course of business will be valid, provided that the pawnee acts in good
faith and that he has no notice of the fact that the pawnor is not authorized to pawn the goods.
The essential conditions of this rule are - he must be a mercantile agent, he must have possession
of the goods by consent of the owner, and it must be done in ordinary course of business. Further,
the pawnee should act in good faith and he must not have notice that the pawnor has no authority
to pledge.

2. Pledge by a person in possession under voidable contract (Section 178 A)

When the goods are obtained by a person under a contract that is voidable under section 19 or 19
A, he can pledge the goods if the contract is not avoided at the time of the pledge. Thus, in
Phillips vs Brooks Ltd 1919, a fraudulent person pretending to be a man of credit induced the
plaintiff to give him a valuable ring in return for his cheque which proved worthless. Before the
fraud could be discovered, he pledged the ring with the defendants. The pledge was held to be
valid.

3. Pledge by person with limited interest (Section 179)

Section 179 says that where a person pledges goods in which he has only a limited interest, the
pledge is valid to the extent of that interest. Thus, when a car worth 100,000Rs is owned jointly
by A and B both having 50% interest in the car, and if A pledges the car for 60000Rs, the value
of the pledge that the pledgee can receive upon default is only 50% of the value received by
sale.
Thus, if a pledgee further pledges the goods, his interest is only the amount for which the first
pledger pledged the goods. For example, if A pledged his car worth 100000Rs for 20000Rs to B.
B's interest in the car is only 20000 Rs. He can further pledge it but if he pledges it for more than
20000Rs, A will be liable only for 20000Rs.

In Jaswantrai Manilal Akhney vs State of Bombay 1956, a cooperative bank had an overdraft
account with the Exchange Bank, which was secured by the deposit of certain securities. After
many dealing and adjustments the last position of the account was that the overdraft limit was set
at Rs 66150 and the securities under the pledge of the bank were worth Rs 75000. The
cooperative bank did not make use of this overdraft for a long time and when it attempted to use
it, the Exchange Bank was itself in financial crisis and had pledged the securities first with
Canara Bank and then after having redeemed them, pledged them again with a private financier.
The SC held that the pledge was invalid.

Difference between Bailment and Pledge -

Pledge is a special kind of Bailment. Thus, all Pledges are Bailments but the reverse is not true.
 Bailment
Bailment can be for many reasons ranging for
reward to gratuitous.
The bailee does not get a right to sell the
goods.
The bailee only get a right of lien over the
goods.
The bailee can use the goods bailed.
The bailee is not responsible for the loss,
destruction, or deterioration if he uses the
goods with reasonable care.
Pledge
A pledge is bailment done for a specific type of
purpose, which is to secure a loan or
performance of a promise.
A pawnee has a right to sell the goods in case
of default.
A pawnee gets a right of retainer and a special
interest in the goods, which is more that just
the lien.
The pawnee has no right to use the goods.
The pawnee is absolutely liable for the upkeep
of the goods.

Q. Define Partnership. Is sharing of profit conclusive proof

of partnership? Explain - "partners are agents of each
other". What are the mutual rights and liabilities of the
partners? What is implied authority of a partner? Can it be
restricted? Can a partner retire? What are its consequences?
Can a partner be expelled? If so, when? Can minor be
admitted to the benefits of partnership? If yes, what are the
rights and liabilities of such a minor after attaining
majority?

Is the registration of a partnership firm compulsory? What

are the consequences of non-registration? Can a partner of
an unregistered firm bring a suit against a third party to
release the property of the dissolved firm? What is the
procedure for registration? Explain various modes of
dissolution of the Firm. What are the liabilities of the
partners after dissolution?
In common parlance, partnership is a business owned and managed by two or more people. To
form a partnership, each partner normally contributes money, valuable property or labor in
exchange for a partnership share, which reflects the amount contributed. Section 4 of Indian
Partnership Act 1932 defines Partnership as follows -

Section 4 - Partnership is the relationship between persons who have agreed to share the profits
of a business carried on by all or any of them acting for all. Persons who have entered into
partnership with one another are individually called partners and collectively called a firm and
the name under which their business is carried on is called firm name.

Examples -

1. A and B buy 100 bales of cotton to sell later on profit which they agree to share equally.
A and B are partners in respect of such cotton.

2. A and B buy 100 bales of cotton together for personal use. There is no partnership
between A and B.

3. A, a goldsmith, agrees with B to buy and provide gold to B to work on an ornament and
to sell and that they shall share the profit. A and B are partners.

4. A and B are carpenters working together. They agree that A will keep all the profits and
will pay B a wage. They are not partners.

5. A and B jointly own a ship. This circumstance does not make them partners.

Section 5 of IPA 1932 says that the relation of partnership arises from contract and not from
status. Thus, if there is no specific contract, there can be no partnership. As per Section 6, to
determine whether a partnership exists between a group of persons, we have to look at the real
relation between them as shown by all relevant facts taken together. It further says that sharing of
profits or of gross returns arising from a property owned jointly by them does not by itself makes
them partners.

Based on these definitions, in Helper Girdharbhai vs Saiyed M Kadri and others AIR 1987, J
Sabyasachi of SC identified that the following elements must be there in order to establish a
partnership - there must be an agreement entered into by all the parties concerned, the agreement
must be to share profits of the business, and the business must be carried on by all or any of the
person concerned for all. These three aspects can be discussed under four heads -

1. Agreement - There has to be an agreement between two or more people to enter into
partnership. The agreement is the source of the partnership. It is not necessary that the
agreement be formal or written. An agreement can be express or implied. Further, such
agreement must follow all the requirements of a valid contract given by Indian Contract
 Act 1872. This includes the parties must be competent to contract and the object of the
agreement should be legal.

2. Business - They must intend to start or do a business. A business is a very wide term and
includes any trade, occupation, or profession. Business may not be of long duration or
permanent and even a single activity may be considered a business. Thus, if two persons
are not partners, they can engage is a transaction with an intention to share profits and
can become partners in respect of that transaction. For example, if two advocates are
appointed to jointly plead a case and if they agree to divide the profits, they are partners
in respect to that case. Section 8 also mentions that a person may become partner with
another in particular adventures of undertaking.
It is however necessary that a business exists. If a business is simply contemplated and
has not been started, the partnership is not considered to be in existence. In Ram Priya
Saran vs Ghanshyam Das AIR 1981 All, two persons agreed that after their tender is
passed they will construct the dam in partnership. In order to deposit earnest money, the
plaintiff gave 2000 Rs. The tender was not accepted. It was held that since a business was
only contemplated and not started, there was no partnership and so the plaintiff was
entitled to get 2000 Rs from the defendant.
However, in Khan vs Miah 2000 WLR, two persons obtained loan from the bank to start
a restaurant. They also entered into a contract to purchase equipement and laundary for
the restaurant. But their relationship terminated before the opening of the restaurant. It
was held that there is no rule of law that parties to a joint venture do not become partners
untill they actually embark on the activity in question. It is necessary to identify the
venture in order to decide whether the parties have actually embarked upon it but it is not
necessary to attach any name to it. Many business require a lot of investment and
activities before the actual trading begins. This does not mean that the business has not
started until the trading begins. It was held that in this case the activity of the business
had begun and so the partnership was in existence.

3. Sharing of profits - Normally, an activity is done in partnership with a goal to make

profits. Thus, for a valid partnership to exist, the partners must agree to share the profits
according to their investment. Here, profits include losses as well.

4. Mutual Agency - The firm must be managed by the partners and thus when any partner
acts, he acts on behalf of the firm and thus on behalf of other partners. Therefore, a
partner is considered an agent of others. In absence of such mutual right of agency, a
partnership cannot exist. This was held in Cox vs Hickman 1860. In this case, two
person carried on business in partnership. Due to financial crisis they obtained loans.
Having unable to repay the loans they executed a trust deed of properties in favor of the
creditors. Some of the creditors were made trustees of the business. This included Cox
and Wheatcroft. They were empowered to enter into contracts and execute instruments to
carry on business and to divide the profits among the creditors. After the recovery of
debts, the property was to be restored to the two original partners. Cox never acted as
trustee and retired, while Wheatcroft acted as a trustee for some time and retired. Other
trustee then became indebted to Hickman and executed a bill of exchange, which was not
accepted and paid. Hickman sued the trustees for recovery of the money for materials
 supplied. The trustees could be held liable if they were partners. However, it was held
that they were not partners. They observed that in partnership every partner is an agent of
another and in this case this element was absent.

As we can see, a partnership requires all the above ingredients to have legal validity, and so a
mere sharing of profits is not a conclusive proof of a partnership. It must have the other three
elements also. As mentioned in Section 6, merely sharing of profits arising out of a jointly owned
property does not necessarily create a partnership. For example, if two persons own a house and
give it on rent, the sharing of the rent does not create a partnership. Similarly, a payment to a
person contingent upon profits also does not necessarily create a partnership until the element of
mutual agency is not present. This is the case when profits is shared with the lender of money for
business. In case of Mollow March Co vs The Court of Wards 1872, a Hindu Raja loaned
some money to Watson & Co. In return, he was to get a % of profit and was to exercise control
on some aspects of the business. He was not empowered to direct the transactions of the
company. It was held that although sharing of profits is a very strong test, yet whether a relation
of partnership exists depends on the real intention and conduct of the parties.

Duty/Liabilities of the partners

GIC, BEN, APC
91011, 121313, 151616

1. General Duties - According to section 9, every partner is liable to carry on the business
in the best interest of the firm, to be just and faithful to each other, and to render true
accounts and full information affecting the firm to any partner or his legal representative.
During the course of business no partner can do any act which may be against his duty to
work to greatest common advantage.
In Bentlay vs Craven 1853, it was held that if a partner was authorized to purchase
goods for the firm and if he supplies the goods from his own stock and makes a profit, he
is liable to give the profit to the firm. This matter is further clarified in section 16 which
says that subject to contract between the partners, if a partner derives any profit for
himself from any transaction of the firm or from the use of the property or business
connection of the firm, he shall pay that profit to the firm. Further, if a partner carries on
any business of the same nature as and competing with that of the firm, he shall pay all
such profit to the firm. Subject to contract means, partners can choose to modify this rule
while entering into partnership. For example, the partnership contract may specify that a
partner may be allowed to use firm's property for personal use.

2. Duty to indemnify for loss caused by fraud - According to section 10, every partner
shall indemnify the firm for any loss caused to it by his fraud in the conduct of the
business of the firm. For example, a firm of A and B enter into a contract with the
government. Later on, due to B's conduct, the govt. cancels the contract and gives it to B.
Here, the contract obtained by B in his own name will be for the benefit of the
partnership. Further, if the second contract is of the lesser value, B is personally liable to
the firm for the difference.
 3. Duties imposed by contract - As per Section11 any special rights and duties may be
given or imposed by the contract between the partners.

4. Duty relating to the conduct of business - According to section 12, every partner is
bound to attend to his duties diligently. Thus, if a partner is assigned some task, he must
do it to the best of his abilities. Further, if any difference arises in respect of ordinary
business matter, it may be decided by majority. However, no change in the nature of
business can be made without the consent of all the partners.
In Suresh Kumar vs Amrit Kumar AIR 1982, Delhi HC held that majority cannot
trample on the opinion of minority in the key matters of the partnership. Thus, majority
cannot replace the managing director of the firm because it is a key business decision. It
can be done only with the consent of all the partners.

5. Duty to contribute equally to the losses - According to section 13(b), partners shall
contribute equally to the losses sustained by the firm.

6. Duty to indemnify for loss caused by his willful neglect - According to section 13 (f),
if a partner neglects the business activity willfully, he must compensate the firm for the
loss caused. It has been long held that if a partner during the course of business commits
breach of duty, or fraud, or culpable negligence and causes harm to the firm, even if he is
not liable in law, he must be held liable to indemnify the firm in equity. This does not
mean that a partner, when acting in good faith, makes an error in judgment and causes
loss to the firm, is liable. However, this is subject to the contract among the partners. This
means that the contract may specify that a partner is a sleeping partner and may excuse
him from doing any work.

7. Duty in respect of application of property of the firm - According to section 15, the
property of the firm shall be held and used exclusively for the purposes of the business. If
a partner uses it for personal benefits, he shall account for and pay such profits to the
firm.

8. Duty in respect of personal profits - According to section 16(a), if a partner derives any
profit for himself from any transaction of the firm or from any property or business
connection of the firm, he shall account for that profit and pay it to the firm, subject to the
contract.

9. Duty not to compete with the firm - According to section 16(b), if a partner engages in
a business in competition of the firm, he should pay the profits to the firm. But if a
partner does a private act, which is not in the scope of the business of the firm, he is not
liable to the firm for the profits.

Rights of the partners

The partners of the firm have following rights -
CBI,PII
111212,131313
 1. Rights given by contract - As per Section11 any special rights, such as right to
remunerationmay be given by the contract between the partners.

2. Right to take part in the conduct of business - As per section 12(a), subject to the
contract between them, a partner has a right to take part in the conduct of business. Only
way to restrain a partner from getting involved in the business is to specify it in the
contract of partnership. Even courts cannot, through an injunction, restrain a partner.

3. Right to have access to and inspect and copy books of the firm - As per section 12,
every partner has a right to inspect the books and make a copy if he wants.

4. Right to share in profit - As per section 13, subject to contract, a partner is entitled to an
equal share of the profit.

5. Right to receive interest on the capital subscribed - As per section 13, subject to
contract, where a partner is entitled to interest on the capital subscribed by him, such
interest shall be payable only out of profits. Further, if a partner pays any money to the
firm, beyond the amount of capital, he is entitled to 6% interest.

6. Right to indemnity in respect of payments made and liabilities incurred - According

to section 13, the firm shall indemnify a partner in respect of payments made and
liabilities incurred by him in the ordinary and proper conduct of business or in doing such
act, in an emergency, for the purposes of protecting firm from loss as would be done by a
person of ordinary prudence in his own case under similar circumstance.

Implied authority of a partner

As held in Cox vs Hickman 1860, if two or more agree to carry on a business, each of them is a
principal and each is an agent for the other. Further, each is bound by the other's contract in
carrying on the trade as much as a single principal would be bound by the act of an agent. This
principle has been incorporated in section 18 of IPA 1932. It says that a partner is the agent of
the firm for the purposes of the firm. Its complimentary principle is incorporated in section 25
which says that every partner is liable jointly with all other partners and also severally for all acts
of the firm done while he is a partner.

This brings us to the implied authority of the partners. Since, a partner is an agent of the firm, his
act binds every other partner and the firm. For example, if a partner A gives a check in the firm's
name to a creditor and if the check is unpaid, partner B is equally liable even though B's
signature does not appear on the check. This authority to bind the firm is called "implied
authority". It has been incorporated in section 19 of IPA 1932, which says that the act of the
partner which is done to carry on, in the usual way, business of the kind carried on by the firm,
binds the firm.

The following essential conditions are required for the exercise of Implied Authority to bind the
firm -
 1. Usual way - The act must be done to carry on the business in the usual way. Any drastic
action, which is out of ordinary, requires the consent of all the partners. For example, if a
firm deals in coal, a partner has the implied authority to enter into a contract to buy and
sell coal, but not gold. The implied authority of partners is limited to only those acts
which are done in usual way and related to the business of the kind carried on by the
firm.

2. Mode of doing act to bind firm - Section 22 specifies that in order to bind the firm, the
act must be done in firm's name or in any manner expressing or implying the intention to
bind the firm. For example, if a partner A obtains a loan in his name without mentioning
anything about the firm, it will not bind the firm. It must be clear from the action that it is
intended as being done by the firm.
In Devji vs Magan Lal AIR 1965, a partner had taken a sublease in his own name
instead of the firm's name. Further, there did not seem to be any intention to bind the
firm. SC held that the firm was not bound by the lease as the parties did not intend to bind
the firm by this transaction.

Power of implied authority also has the following restrictions -

There are two kinds of restrictions - Statutory restrictions, as imposed by section 19 (2) and
Restrictions imposed by partnership deed and those imposed by the agreement between the
partners. Statutory restrictions are binding upon all the partners whether they know them or not,
while the second type of restrictions are applicable only when the partners have knowledge about
them.

Statutory restrictions - In the absence of any usage or custom of trade to the contrary, a partner
is not allowed to -

1. Refer a dispute to arbitration.

2. open a banking account on behalf of the firm in his own name.

3. compromise or relinquish any claim or portion of the claim by the firm.

4. withdraw a suit or proceeding filed on behalf of the firm.

5. admit any liability in a suit or proceeding against the firm.

6. acquire immovable property on behalf of the firm.

7. transfer immovable property belonging to the firm.

8. enter into partnership on behalf of the firm.

Contractual Restrictions - As per section 20, Partners may, by contract, put additional
restrictions or give additional powers to the partners. However, any act which falls under the
implied authority but is restricted by the contract, will bind the firm unless certain conditions are
satisfied. A firm can avoid its liability in such case, if the person dealing with the partner knows
the restriction or the person dealing with the partner does not know or does not believe that the
partner is a partner in the firm.

In Sanganer Dal & Flour Mill vs F C I AIR 1982, a partner of the firm, who had the implied
authority to enter the contract with FCI to purchase goods, entered in to a contract with FCI to
purchase Dal. The contract had an arbitration clause. In this case, the question was whether the
partner had the power to enter into such a contract? It was held by SC that the partner was
within his implied authority to enter into a contract to purchase goods from the corporation
because it was normal for their business and the contract was done in the usual way. Thus, the
contract was valid even if it contained an arbitration clause.

Admission of Partners (Section 23)

Since a partner is an agent of the firm and can bind the firm by his acts, an admission or
representation by him concerning the affairs of the firm, is evidence against the firm. This is
incorporated in section 23, which says that an admission or representation made by a partner
concerning the affairs of the firm is evidence against the firm if it is made in ordinary course of
business.
The key factor in this is that the admission or representation must be made in ordinary course of
business. This will also not include the representation by which a partner increases his scope of
authority. For example, if a partner executes a bill of exchange for payment of his personal debts
and on inquiry he makes a false statement that the other partners have authorized him, the said
bill of exchange will not bind the firm.

Incoming partners
The mutual relations of the partners is based on the principle that they have to be just and fair to
each other and are bound to carry on the business of the firm to the greatest common advantage.
Thus, it is important for each partner to have trust in each other. Therefore, section 31 lays down
a general principle that a partner cannot be introduced into a firm without the consent of all the
existing partners. However, the existing partners may, by contract, authorize a partner to
introduce a new partner. A contract may also be made that upon death of a partner, a new partner
may be nominated in his place. If there are only two partners and one of them dies, there is no
question of nominating a new partner because the partnership ends as soon as the partner dies.
Also, a new partner is not liable for any act of the firm done before he became a partner.

Outgoing partners
In many situations, a partner may have to leave the partnership. A partner may leave in the
following ways -
CANEID
323232333442

1. With the consent of all other partners - According to section 32(1) (a), a partner may
retire with he consent of all the other partners.
2. With an express agreement by partners - Section 32 (1)(b) provides that a partner may
retire with an express agreement by partners. This means that if there is a provision in the
contract deed of partnership that allows a partner to retire, a partner can retire using that
agreement.
In Vishnu Chandra vs Chandrika Prasad Agarwal AIR 1983, the question before SC
was whether a partner was entitled to retire on the basis of partnership deed. The deed
provided that a partner may retire by giving one month notice and that a partner cannot
retire within one year of commencement of business and if he does so, his capital will not
be returned. SC held that it is consistent with the provisions of section 31(1)(b) and the
partner can retire according to the deed.

3. By giving notice to all other partners in case of partnership at will - According to

section 32(1)(c), a partner may retire where the partnership is at will, by giving notice in
writing to all the other partners of his intention to retire.

4. By Expulsion (Can a partner be removed? How?) - According to section 33 (1) a

partner may not be expelled by any majority of the partners, save in exercise of good
faith of powers conferred by contract between the partners. Thus, to expel a partner by
majority of the partners, the following two conditions must be satisfied -

1. Such a power must be conferred by contract between the partners. This means, the
contract of partnership must clearly give this power to the partners otherwise, a
partner cannot be expelled.

2. The power to expel a partner conferred under the contract must be exercised in
good faith. Thus, if majority of the partners try to expel a partner with evil
intention and without any reasonable cause, it is not possible.

In Carmichael vs Evans 1904, a partner was caught traveling without ticket and was
convicted on this charge. He was expelled by the majority of the partners. It was held that
the expulsion was justified.
In Blisset vs Daniel 1953, a partner was expelled by the majority of the partners because
he opposed the appointment of the son of a partner on the post of manager. It was held
that the expulsion was invalid.

5. On insolvency of a partner - According to section 34(1), where a partner in a firm is

adjudicated an insolvent he ceases to be a partner on the date on which the order of
adjudication is made, whether or not firm is thereby dissolved.

6. By Death - Upon death of a partner, his association with the firm ends and he ceases to
be a partner. His estate will not be liable for the acts of the firm after his death. According
to section 42(c), subject to the contract between the partners, a firm is dissolved by the
death of a partner. This means that partners may by contract that by death of a partner the
firm will not be dissolved but if there is no such contract, the firm will be dissolved.
Liability of a retired partner
The liability of a retired partner may be of two types - For acts done before retirement and for
acts done after retirement.

1. Acts before retirement - The general rule is that a partner is liable for all acts done
before retirement even after he is retired. However, a retiring partner may be discharged
of his liabilities for act before retirement by an agreement between the retiring partner
and the remaining partners. The agreement should specify that all such liabilities will be
borne by the remaining partners. A notice to this effect must also be given to the
creditors.

2. Acts after retirement - The general principle is that a retired partner is not liable for the
acts of the firm done after his retirement. However, he must give a public notice of his
retirement to escape liabilities.

Partnership with a minor

By virtue of section 10 and 11 of Indian Contract Act 1872, a minor is not considered capable of
giving consent and thus any contract with a minor is void ab initio. Therefore, a contract of
partnership with a minor is also void. In other words, a partnership cannot be done with a minor
and a minor cannot become a partner of a firm. However, a minor can be admitted to the benefits
of the partnership as per section 30 (1), by the consent of all the partners. In Venkatarama Iyer
vs Balayya AIR 1936, it was held that there must be some positive act of the partners so that the
court may infer that the minors have been admitted to the benefits of the partnership. Merely
assuming that the minors were admitted would be an error in law and is not sufficient.
Further, in Addl Commr. of Income Tax vs Uttam Kumar Pramod Kumar 1975, a
partnership deed was not signed by minor or anybody on his behalf. It was held that to admit the
minor to the benefits of partnership it is necessary to have an agreement between the partners and
the minor. Since the property and money of the minor can be used for the firm, an agreement is
necessary between the partners and someone on behalf of the minor.

Rights and Liabilities of a minor

He has the following rights -

1. to such share of the property and of the profits of the the firm as may be agreed upon.

2. to access, copy, and inspect the records of the firm.

3. his share is liable for the acts of the firm but he is not personally liable for them.

4. may sue the partners for his share of profits of the firms when severing his connection
with the firm.

5. As per Section 30(5), he has a right of election to become or not to become the partner of
the firm after becoming a major. Upon attaining the age of majority, the minor can, within
 six months , give public notice that he has elected to become or not to become a partner
of the firm. If he fails to give such notice, he will be become partner of the firm at the
expiry of six months.

Illustration - In Shivganda R Patil vs Chandrakanth Neelkanth Sadalge AIR 1965, C

a minor was admitted to the benefits of the partnership between A and B. The partnership
became indebted and was dissolved while C was still a minor. Upon majority, C did not
exercise the option of election. Later on, the creditor started insolvency proceedings
against the partners and impleaded C as well in the proceedings. It was held that a minor
cannot be impleaded in insolvency proceedings against the firm on the ground that he had
become a major after dissolution of the firm. At the time of his majority the firm had
ceased to exist and thus there was no question of electing to become or not to become a
partner.

Registration of a firm
Chapter 7 of IPA 1932 deals with the registration of firms. Under this act, registration of firms is
not compulsory. There is no penalty for not registering. However, the effects of non-registration
are so severe that usually firms opt to register.
Consequences of not registering

1. Suits between partners and Firm - A per Section 69 (1) unless a firm is registered and
the party is shown as a partner, no suit can be filed by or on behalf of any partner against
the firm. In Loonkaran Sethia vs Mr Ivan E John AIR 1977, the firm was not
registered and the plaintiff filed the suit to enforce an agreement entered into by a partner
of the firm. The suit was filed on behalf of the firm and was for its benefit. SC observed
that a partner of an unregistered firm cannot bring a suit to enforce a right arising out of a
contract falling within the ambit of section 69. It held that the suit was unmaintainable.

2. Suit between firm and third parties - Until the firm is registered, no suit can be filed by
the firm against third parties. In Ram Adhar vs Rama Kirat Tiwary AIR 1981, the
plaintiff sold bricks to the defendant. The defendant did not pay the price to the
partnership firm and so the firm filed the suit. It was held that since the firm was not
registered the suit was unmaintainable.

3. Bar to claim set off and other proceedings - According to section 69(3), suit cannot be
filed for claim of set off or other proceedings to enforce a right arising from a contract.

Exception
According to section 69(3)(a), the provisions of section 61(1) and (2) shall not affect the
enforcement of any right to sue for the dissolution of the firm, or for accounts of the dissolved
firm or any right or power to realize the property of dissolved firm. Thus, a partner of a
dissolved firm can sue a third party for releasing the property of the firm.

Procedure for registration

As per section 58, registration of a firm can be done any time by sending a statement in
prescribed form by post or delivering to the registrar of the area in which any place of business
of the firm is situated or proposed to be situated. The form should also be accompanied with the
prescribed fee. The form must contain -

1. the firm name

2. place or principal place of the business of the firm.

3. the names of any places where the firm carries on business.

4. the date when each partner joined the firm.

5. the names in full and permanent address of the partners.

6. the duration of the firm.

The statement must be signed by all of the partners or by their agents specially authorized in this
behalf. Each person signing the statement shall also verify it in the manner prescribed. There is a
restriction on the name of the firm that it cannot contain certain words such as Crown, Emperor,
Empress, King etc. that give an impression that the firm is associated with the govt.

When the registrar is satisfied that the provisions of section 58 have been fulfilled, he shall
record an entry in the Register of Firms and shall file the statement.

Dissolution of the firm

As per section 39, the dissolution of the partnership between all the partners of a firm is called
the dissolution of the firm. The firm is dissolved when all the partners stop carrying on the
partnership business. It is possible that some partners may decide to disassociate from the firm
while others carry on the business. In this case the partnership is not dissolved.
After dissolution of the firm, the partnership between the partners does not completely end. It
continues for the purpose of realization of assets or properties of the firm. Also, after the
dissolution, the right and power of the partners of the firm to bind the firm exists as is necessary
to wind up the operation and for the acts that started before the dissolution but have not yet
ended.

Modes of dissolution
1. Dissolution by agreement - According to section 40, a firm may be dissolved either with
the consent of all the partners or in accordance with a contract between the partners.

2. Compulsory Dissolution - According to section 41, a firm will be compulsorily

dissolved if

1. all the partners or all but one of the partners become insolvent - This happens
because if a partner becomes insolvent, he becomes incompetent to contract and
so he ceases to be a partner as per section 34(1). Thus, if all or all but one partners
become insolvent the firm will compulsorily dissolved because for a partnership,
at least two partners are required.

2. If the business of the firm becomes unlawful - It is possible that due to legislation,
the business may become unlawful. For example, liquor sales may become
unlawful in a particular state. In such a case, a partnership that sells liquor will be
dissolved.

3. Dissolution upon contingencies - According to section 42, subject to the contract, a

firm is dissolved on the happening of following contingencies -

1. By Expiry of fixed term - A firm is dissolved, if it is constituted for a fixed term,

which that term expires.

2. On completion of adventures or undertakings - In many cases, a partnership is

started with a specific goal to accomplish or for a particular task. Upon
completion of such task, the partnership gets dissolved.
 3. By the death of a partner - Subject to the contract between the partners,a
partnership gets dissolved if a partner dies.

4. By the adjudication of a partner as an insolvent - If a partner becomes

insolvent and if there is no provision in the contract to keep the partnership alive
in such case between the solvent partners, the partnership is dissolved.

4. Dissolution by notice of partnership at will - According to section 43, a partnership at

will can be dissolved any time by any partner by giving a notice of such intention to other
partners.

5. Dissolution by court - According to section 44, the court may dissolve a partnership if -

1. a partner becomes of unsound mind - In such a case, the next friend of the
person with unsound mind may request the court to dissolve the firm.

2. a partner becomes permanently incapable - At the suit of a partner, the court

may dissolve the firm on the ground that a partner other than the one suing has
become permanently incapable of performing the duties of partnership.

3. a partner is guilty of conduct likely to affect prejudicially the carrying on of

business - At the suit of a partner the court may dissolve a firm on the ground that
a partner other than the one suing, is guilty of conduct which is likely to affect the
business prejudicially. For example, in partnership of doctors, if one doctor is
guilty of immorality towards some patients, it is possible for the court to dissolve
the partnership upon suit of other partners.
In Carmichael vs Evans 1856, a partner was convicted of traveling without ticket
and the court dissolved the firm on this ground.

4. willful or persistent breach of agreements relating to the business or

management of the affairs of the firm - If a partner willfully or persistently
commits breach of the agreements related to the firm, or the conduct of its
business, or conducts such that it is not reasonably practical for other partners to
carry on the business, the court may dissolve the firm upon suit by other partners.

5. transfer of the whole interest in the firm by a partner to a third party - At the
suit of a partner the court may dissolve a firm on the ground that a partner other
than the one suing, has in any way transferred the whole of his interest in the firm
to a third party.

6. perpetual loss - At the suit of a partner, the court may dissolve the firm on the
ground that the business of a firm cannot be carried on without incurring loss. It is
indeed impractical to run a business that is continuously going in the loss. Thus, if
a partner of such a business desires, he can request the court to dissolve the firm.
 7. Just and Equitable cause - As per section 44(g), the court may dissolve the firm
on any just and equitable ground upon request by a partner. This gives very wide
powers to the court because the court has to decide whether there is a just and
equitable ground for dissolving a firm.

Consequences of Dissolution

1. Liabilities of the partners for acts done after dissolution - As per section 45, until
public notice is given of the dissolution, partners remain liable for their acts as they were
before dissolution. It is therefore essential to give notice of dissolution if the partners
want to escape liability for the acts of the firm.

2. Right of partners to have business wound up after dissolutions - Upon dissolution of

the firm, every partner is entitled, as against other partners, to have the property of the
firm applied in payments of debts and other liabilities of the firm and to have the surplus
distributed to the partners as per the contract.

3. Continuing authority of partners for purpose of winding - Each partner continues to

enjoy implied authority but for the acts done in the process of winding up of the business.

4. Settlement of accounts - Upon dissolution, the accounts of the firm will be settled as
per the agreement of the partners.

5. Payment of debts - where there are any joint debts, the property of the firm will be first
applied to clear those debts and then it will be applied to any separate debts due to a
partner.

6. Restrain the use of name of the firm - Every partner has a right to restrain another from
using the name of the firm, subject to any contract between them. However, if the
goodwill of the firm is sold, the buyer may use the name of the firm for his business.

7. Restrain in trade - Subject to contract, the partners of the firm may be restrained from
doing the same business as the firm after the dissolution as long as the conditions of the
restrain do not violate section 27 of ICA 1872.