CONTRACTS-I

Chanakya National Law University

Submitted to-
Dr. Vijay Kr. Vimal
Faculty of Contract-I

Submitted By-
ANSHIKA SINGH
Roll no. 1610
BBA LL.B.
2ND year 3RD semester
Contents
Topic Page No.
1. Introduction
2. Rights of Guarantee
3. Rights of Surety
A) Right against Principal Debtor
i) Right of Subrogation
ii) Right of Indemnity against the principal debtor
B) Right against Creditor
i) Right to Securities with the creditor
C) Right against the Co-Surities
i) Right of Contribution Against co-surities
ii) Co-surities bound in different sums
4. Case Laws
5. Conclusion
6. Bibliography
 ACKNOWLEDGEMENT

I would like to thank my faculty Dr. Vijay Kr. Vimal, whose assignment of such a relevant
and current topic made me work towards knowing the subject with a greater interest and
enthusiasm and moreover he guided me throughout the project.

I owe the present accomplishment of my project to my friends, who helped me immensely

with sources of research materials throughout the project and without whom I couldn’t have
completed it in the present way.

I would also like to extend my gratitude to my parents and all those unseen hands who helped
me out at every stage of my project.
Introduction
Guarantee is an undertaking to answer for another’s liability and collateral thereto. It is a
collateral undertaking to pay the debt of another in case he does not pay it. It is a provision to
answer for the payment of some debt, or the performance of some duty in the case of failure
of some person who, in the first instance, is liable for such payment or performance.
Bouvier’s Law Dictionary gives the meaning of guarantee as a promise to answer for the
debt, default, or miscarriage of another person. Guarantee is an. undertaking to be collaterally
responsible for the debt, default or miscarriage of another. In a banking context it is an
undertaking given by the guarantor to the banker accepting responsibility for the debt of the
principal debtor, the customer, should he or she default. The guarantor may or may not be a
customer.
A Guarantee is a promise by one person, who is called the ‘guarantor’ or ‘surety’ to answer
for the present or future debt of another person who is called the ‘principal debtor’, such
promise being made to the party to whom the principal debtor is, or will become, liable3. In
Lord Halsbury’s Laws of England a guarantee is defined as "an accessary contract whereby
the promisor undertakesto be answerable to the promisee for the debt, default or miscarriage
of another person whose primary liability to the promisee must exist or be contemplated. The
words surety and guarantor are used as synonymous terms in Indian law and English Law. In
American law, guarantee is distinguished from suretyship in being a secondary, while
suretyship is a primary, obligation; or, as sometimes defined, guarantee is an undertaking that
the debtor shall pay; suretyship, that the debt shall be paid. A surety differs from a guarantor,
who is liable to the creditor only if the debtor does not meet the duties owed to the creditor;
the surety is directly liable. While a surety’s liability begins with that of the principal, a
guarantor’s liability does not begin until the principal debtor is in default. In India, Contract
of Guarantee is included in the Indian Contract Act, 1872 and is defined under section 126 as
follows :
A "Contract of Guarantee" is a contract to perform the promise, or discharge the liability, of a
third person in case of his default. The person who gives the guarantee is called the "Surety";
the person in respect of whose default the guarantee is given is called the "Principal debtor",
and the person to whom the guarantee is given is called the "Creditor". A guarantee may be
either oral or written.
Though a contract of guarantee may be oral or in writing in India it must be required to be in
writing only in England.
Oral Guarantee
In P.J. Rajappan v Associated Industries (P) Ltd ,
the guarantor, having not signed the contract of guarantee, wanted to wriggle out of the
situation. He contended that he did not stand surety for the performance of the contract.
Evidence showed involvement of the guarantor in the deal, having promised to sign the
instrument later. The Kerala High Court held that a contract of guarantee is a tripartite
agreement, involving the principal debtor, surety and the creditor. In a case where there is an
evidence of involvement of the guarantor, the mere failure on his part in not signing the
agreement is not sufficient to demolish otherwise acceptable evidence of his involvement in
the transaction leading to the conclusion that he guaranteed the due performance of the
contract by the principal debtor. When a court has to decide whether a person has actually
guaranteed the due performance of the contract by the principal debtor all the circumstances
concerning the transactions will have to be necessarily considered. Court cannot adopt a
hyper technical attitude that the guarantor has not signed the agreement and so he cannot be
saddled with the liability. Due regard has to be given to the relative position of the
contracting parties and to the entire circumstances which led to the contract. Under Section
126 of the Contract Act, a contract of guarantee need not necessarily be in writing; it may be
express by words of mouth, or it may be tacit or implied and may be inferred from the course
of the conduct of the parties concerned. Contracts of guarantee have to be interpreted taking
into account the relative position of the contracting parties in the backdrop of the contract.
The court has to consider all the surrounding circumstances and evidence to come to a
finding when the guarantor refutes his liability.
Essentials of a Guarantee
To a layman a guarantee is a baffling document. The main obligation, namely to pay ifthe
borrower does not pay, is expressed in two or three lines. Why then does there have to be a
long document bristling with curious legalese? In fact many of the technical provisions are
vital to the protection of a lender. Some are so fundamental that, ifthey are not there, the
lender could find himself with a useless guarantee by reason of some seemingly trivial action
on his part. Guarantees are encrusted with law. This is no doubt attributable to the fact that
guarantors have, historically, sought 98 every available legal means to avoid a liability which,
human nature being what it is, they did not expect to have to meet when they gave the
guarantee. Guarantors have, therefore, become darlings of the courts. As a result lawyers
have drafted provisions into guarantees to counter vulnerability of the obligation and to
redress the balance. The business side of the contract of guarantee is concerned with solvency
of the surety, the legal side with the provision of an effective contract which will in
conceivable circumstances give the banker a good legal remedy against the surety. The best
banking approach to the subject of guarantees is to recognise the following essentials : 1. The
value of the guarantee, which must be maintained throughout the period of the advance to the
customer 2. The validity of the guarantee, which means in general that the guarantor’s mind
must run with his pen at the time he signs his guarantee and that nothing shall happen to
enable the guarantor later to avoid liability on the grounds of mistake, duress, or undue
influence. 3. The form of guarantee which must cover all possibilities, limiting the common
law rights of the guarantor and permitting wide freedom to the banker in dealing with the
borrower. Each bank has its own form ofguarantee printed for 99 general use. At first sight it
is a verbose (using more words than are needed) and unduly lengthy document, but every
phrase and condition is essential. 4. The greatest care is necessary when obtaining the
signature _ of the guarantor to the guarantee. The endless legal phraseology of the document
itselfwill be of little value ifthe guarantor’s mind does not run with his pen. As many
guarantors will seek some loophole to try to wriggle out of the liability, patience and close
attention is always necessary at the outset to ensure that the guarantee is valid. It is not a
routine task but one demanding skill and knowledge and any attempt to rush the completion
is fraught with danger. The trouble arises when the security needs to be realised and
carelessness can jeopardise the bank’s cause of action against the guarantor. The law leans in
favour of the guarantor, with the result that ifthe creditor oversteps in any way the letter of his
contract he will usually find that his security has vanished.
RIGHTS OF SURETY
When we were discussing the contract of indemnity we discussed the meaning of the contract
of indemnity and the essentials of the contract of indemnity, along with the rights of the
indemnity holder. Then we moved on to discuss the concept of the contract of indemnity
along with the definition of the contract given in the Indian Contract Act. Then we went on to
discuss the essentials of the contract of guarantee. Today we are going to discuss the
remaining part of the contract of guarantee. It includes the rights of the surety against the
principal debtor, against principal creditor and against co sureties. Nature and extent of the
surety, liability and then under what circumstances the surety will be free from the
responsibilities.
Rights of Surety against the Principal Debtor
1. Right of Subrogation
After the payment of the debt to the creditor, the surety is subrogated to the rights of the
creditor i.e., he has the same rights as those of the creditors. Therefore, he can sue the
principal debtor to exercise those rights. Thus if the surety has performed his promise
towards the creditor, all the rights of the principal debtor against the creditor devolve upon
him.
According to Bouvier’s Law Dictionary50, "Subrogation is the substitution of another person
in the place of the creditor, to whose rights he succeeds in relation to the debt. That change
which puts another person in the place of the creditor, and which makes the right, the
mortgage, or the security which the creditor has pass to the person who is subrogated to him -
that is to say, who enters into his right". It is the substitution of another person in place of the
creditor, so that the person substituted will succeed to all the rights of the creditor, having
reference to a debt due him. It is independent of any mere contractual relations between the
parties to be affected by it, and is broad enough to cover every instance in which one party is
required to pay a debt for which another is primarily answerable, and which in equity, and
conscience ought to be discharged by the latter. The surety’s right to be placed in the
creditor’s position on the discharge of the principal debtor’s obligation, to the extent that the
surety’s property has been used to satisfy the creditor’s claim and to effect such discharge, is
called the surety’s "right of subrogation".
In India, the right of subrogation has been enunciated in Sections 140 and 141 of the Indian
Contract Act, 1872. Section 140 provides for the right of subrogation as under : "Rights of
surety on payment or performance Where a guaranteed debt has become due, or default of the
principal debtor to perform a guaranteed 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 principal debtor". When the surety has paid all that he is liable for he is invested
with all the rights which the creditor had against the principal debtor. The surety steps into
the shoes of the creditor. The creditor had the right to sue the principal debtor. The surety
may, therefore, sue the principal debtor in the rights of the creditor.
The Supreme Court has laid down in Amrit Lai Goverdhan Lalan v State Bank of
Travancore that the surety will be entitled to every remedy which the creditor had against
the principal debtor; to enforce every security and all means of payment; to stand in the place
of the creditor; to have the securities transferred to him, 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. The language of Section 140 which
employs the words "is invested with all the rights which the creditor had against the principal
debtor" makes it plain that even "without the necessity of transfer, the law vests those rights
in the surety".
In Kadamba Sugar Industries (P) Ltd v Devro Ganapathi Hegde, the Corporation Bank
advanced a loan to Appellant No.l and a mortgage was created by depositing the title deeds
towards security for the loan. The loan was not paid and a suit had to be filed. During the
pendency of the suit, the Respondents 1 to 5 paid the amount as they were sureties to the
loan. It was held by the court that the sureties had the right of subrogation provided under
Section 140 of the Indian Contract Act, 1872. A question arose as to whether the surety,
impleaded as defendant in the suit can apply for attachment before judgment and temporary
injunction in respect of the property of the principal debtor. It was held by Bombay High
Court in Jugalkishore Ram Pratap and Rathi v Brijmohan Ram Pratap and Rathi and Another
that a surety is so entitled to protect his interests. It was decided by the Bombay High Court
in State Bank ofIndia v Fravina Dyes Intermediate57 that the guarantor by invoking the
doctrine of subrogation can apply for a temporary injunction against the debtor even before
making payment to the creditor if he apprehends that the debtor threatens or is about to
remove or dispose of his property with intent to defraud the creditor. That is, the guarantor is
entitled to a grant of Quia Timet injunction against the principal debtor under certain
circumstances.
2. Right of Indemnity
In every contract of guarantee, there is an implied promise by the principal debtor to
indemnify the surety i.e., to compensate the surety. Therefore, upon the payment of debt of
the principal debtor, the surety becomes entitled to recover from the principal debtor, all the
amount including interest plus costs rightly paid to the creditor under the guarantee. The
reason is that the surety is entitled to full indemnification.
Bombay High Court in Jugalkishore Ram Pratap and Rathi v Brijmohan Ram Pratap
and Rathi and Another that a surety is so entitled to protect his interests. It was decided by
the Bombay High Court in State Bank of India v Fravina Dyes Intermediate that the
guarantor by invoking the doctrine of subrogation can apply for a temporary injunction
against the debtor even before making payment to the creditor if he apprehends that the
debtor threatens or is about to remove or dispose of his property with intent to defraud the
creditor. That is, the guarantor is entitled to a grant of Quia Timet injunction against the
principal debtor under certain circumstances.
Right against Creditor
1. Right to get Securities: If Surety makes payment to creditor, surety can get all
securities into his possession from creditor.

Surety’s right to benefit of creditor’s securities.—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 of the existence of such security 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. —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 of the existence of such
security 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
(a) C, advances to B, his tenant, 2,000 rupees on the guarantee of A. C has also a further
security for the 2,000 rupees by a mortgage of B’s furniture. C, cancels the mortgage. B
becomes insolvent and C sues A on his guarantee. A is discharged from liability to the
amount of the value of the furniture. (a) C, advances to B, his tenant, 2,000 rupees on the
guarantee of A. C has also a further security for the 2,000 rupees by a mortgage of B’s
furniture. C, cancels the mortgage. B becomes insolvent and C sues A on his guarantee. A
is discharged from liability to the amount of the value of the furniture."
(b) C, a creditor, whose advance to B is secured by a decree, receives also a guarantee for
that advance 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. (b) C, a creditor,
whose advance to B is secured by a decree, receives also a guarantee for that advance 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."
(c) 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. (c) 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."
Rights of Surety against Co-sureties
When two or more persons give a guarantee for the same debt, they are called as co-sureties.
All of them are equally liable to the creditor for the payment of the debt to the creditor. The
rights of one co-surety against the other co-sureties are as follows:
1. Right to Contribution against co-surities
If two or more persons are co-sureties for the same debt either jointly or severally, or whether
under the same or different contracts and whether with or without the knowledge of each
other, the co-sureties in the absence of any contract to the contrary, are liable as between
themselves, to pay each, an equal shares of the whole debt, or that part of it which remains
unpaid by the principal debtor.
Sometimes, one co-surety discharges the entire obligations. In such cases, he can obtain equal
contribution from the other co-sureties.
Now we move on to discuss the right of the surety against co sureties. When we say co
sureties it means in a contract of guarantee there are more than one surety.
Sometime in the contract, it happens that one person does not want to take the complete
liability in terms of the surety in a contract. There has to be a more than or sometime there are
more than one surety in that case what are rights available with the surety. Right of the surety
in this case will be that he has got a right to contribute. Rights of contribution stands for that
suppose on the due date or in a contract of guarantee one surety is making the complete
payment on behalf of the other co sureties. Then,he has got a right to claim the contribution
from the other co sureties.
Let us take an example. A is a person and he has been sanction the loan by the B
of rupees 10,000/- the guarantee was given by the C and D. They have decided to share the
equal amount of rupees 5,000/-each. If the A become a defaulter on a due date, let us extend
this example and presume that A on a due date becomes a defaulter and he doesn’t make the
payment to the B of rupees 10,000/- and suppose in this case C makes the full payment to the
B and that is of rupees 10,000/- than C has got a right against the D to recover the 5,000/-
rupees. Here the D has to give the contribution which he agreed to give in the contract of
guarantee and that is rupees 5,000/-will be given by the D to the C because C has made the
full payment so C has got a right against another co surety that is D. Another right of surety is
right to share the benefit of securities as we mention when we were having, we were
discussing the rights of the surety against creditor, we mention that sometime the securities
were kept by the debtor with creditor

2. Liability of Co-sureties bound in Different Sums

If the co-sureties are bound in different sums, they are liable to pay equally but not more than
the maximum amount guaranteed by each one of them.
Example: A, B and C are sureties for D, enter into three several bonds, each in a different
penalty, such as A in the penalty of Rs.5,000, B in that of Rs.10,000, C in that of Rs.20,000,
conditioned for D’s duly accounting to E. D failed to the extent of Rs.15,000, A, B and C are
each liable to pay Rs.5,000 each.
CASE LAWS
Radha Thiagarajan v South Indian Bank Ltd30 was decided by the Kerala High Court. In
that case, the appellant and her husband executed a continuing guarantee in favour of the
respondent bank for grant ofan over draft account to a textile company, the terms of which
provided that the liabilities of the sureties would remain unaffected, notwithstanding any
indulgence or release granted to the company. The bank instituted a suit against the company
and the sureties for recovery of money under the overdraft account. The company was,
meanwhile, taken over under section 18A of the Industries (Development and Regulation)
Act, 1951 and subsequently nationalised under the Sick Textile Undertakings
(Nationalisation) Act, 1974. The suit was dismissed as against the company on the ground of
availability of alternative remedy under the Nationalisation Act, but decreed as against the
appellant. The appellant contended that since the liability of the principal debtor was
extinguished under the Nationalisation Act, the liability of the sureties was also extinguished.
It was held that under Section 5 of the Nationalisation Act, every liability of the textile
undertaking, other than a liability arising from loans advanced by Government after it had
been taken over under the Industries (Development and Regulation)Act, 1951 was the
exclusive liability of the owner and enforceable against him only. Under Section 24 of the
Nationalisation Act, the liability of the owner stood discharged in respect of a claim only to
the extent the claim was admitted in terms of Section 23(4) of the Act. The discharge under
the section had, therefore, no effect upon any claim which had been rejected in part or whole,
and in regard to any such claim, the remedy against the owner had to be pursued outside the
statute. The liability of the surety remained unimpaired in respect of the undischarged debt.
This case clearly points out that the discharge of the principal debtor is not discharge of the
surety where it is not brought about by the voluntary act of the creditor, but by operation of
law.
State Bank of India v G.J.Herman and others following the Supreme Court decision made
the following observations while dwelling on the liabilities of the co - surety :
"The Principle laid down by the Supreme Court is that the liability of the sureties is co -
extensive with that of the principle debtor. Consequently creditor can proceed against the
principal debtor or against the sureties, unless it is otherwise provided in the contract. The
same should be principle with regard to the rights and liabilities between the co - sureties as
well. A co - surety cannot insist that the creditor should proceed either against principal
debtor or against other sureties before proceeding against him, since the liability of a surety is
joint and several. To the extent to which they stood guarantee, they are liable to be proceeded
against by the creditor. The option is entirely that of the creditor to decide against whom he
could proceed either against principal debtor or against any of the sureties. Court for that
matter, or a co - surety cannot insist that creditor should proceed against other sureties before
proceeding against him. Such a direction is directly against the principle of co -
extensiveness. It is heartening to note that Indian Courts have thoroughly recognised the
principle of co - extensiveness even before the enactment of the Indian Contract Act, 1872.
In State Bank of Saurashtra v Chitranjan Rangnath Raja and another, the bank granted
a cash credit facility to the customer against pledge of goods by the principal debtor and the
personal guarantee of the surety. Goods pledged under the custody of the bank were lost by
the negligence of the bank. The Supreme Court held that the surety is discharged to the extent
of the security of the goods lost. The Court observed that even if the surety of the personal
guarantee is not aware of the security offered by the principal debtor, yet once the right of the
surety against the principal debtor is impaired by any action or inaction, which implies
negligence appearing from lack of supervision undertaken in the contract, the surety would be
discharged to the extent of the value of the securities so impaired.
In State Bank of India v Quality Bread Factory, cash credit was given by the bank on open
cash credit system. Hypothecated goods were lost by the negligence of the bank. Based on
the aforesaid decision of the Supreme Court, Punjab and Haryana High Court held that it has
not been laid down in the Contract Act that this principle applies only to pledges and not the
hypothecation. Therefore the law applies equally to open credit system. The bank should, as a
pledgee, keep requisite vigilance on the debtor both in the "lock and key" system and "Open
Credit System" in order to protect himself and the security against the illegal actions of the
debtor. Any negligence or inaction on the part of the bank by which he loses the security
absolves the surety from his liability.
In Bank of India v Yogeshwar Kant Wadhera, the Punjab and Haryana High Court held
that where the delivery of goods is not given to the creditors as in the case of hypothecate
(bank), the surety was not entitled to claim protection of Section 141 of the Indian Contract
Act, 1872. As in hypothecation the possession of the goods is with the borrower, it will be
wrong to say that the goods are in constructive possession of the creditor - bank because it
has no effective control over them. By hypothecation, only an equitable charge is created and
nothing more and therefore the Section 141 is not applicable to hypothecation. The Punjab
and Haryana High court has, by this decision, overruled its earlier decision in State Bank of
India v Quality Bread Factory.
In Mohiribibi v Dharmodas, the Privy Council held in respect of section 11 of the Contract
Act as under : "Looking at Section 11 their Lordships are satisfied that the Act makes it
essential that all contracting parties should be competent to contract and especially provides
that a person who by reason of infancy is incompetent to contract cannot make a contract
within the meaning of the Act. The question whether a contract is void or voidable
presupposes the existence of a contract within the meaning of the Act, and cannot arise in the
case of an infant". Ever since this decision it has not been doubted that a minor’s agreement
is absolutely void. The ruling of the Privy Council in the Mohiribibi Case has been generally
followed by courts in India and applied both to the advantage and disadvantage of minors.
Section 128 of the Indian Contract Act, 1872 provides that the liability of the surety is co -
extensive with that of the principal debtor. When Section 128 is read with section 11, the
minor’s obligation under the contract is void and hence the surety for the minor’s obligation
is not liable. The principle of co - extensiveness does not make the surety for a minor liable
due to the principal obligation of the minor being void. The dictum is that guarantee being a
collateral or secondary obligation cannot be enforced when the principal obligation is void.
Conclusion
Guarantee is an undertaking to answer for another’s liability and collateral thereto. It is a
collateral undertaking to pay the debt of another in case he does not pay it. It is a provision to
answer for the payment of some debt, or the performance of some duty in the case of failure
of some person who, in the first instance, is liable for such payment or performance.
Bouvier’s Law Dictionary gives the meaning of guarantee as a promise to answer for the
debt, default, or miscarriage of another person. Guarantee is an. undertaking to be collaterally
responsible for the debt, default or miscarriage of another. In a banking context it is an
undertaking given by the guarantor to the banker accepting responsibility for the debt of the
principal debtor, the customer, should he or she default. The guarantor may or may not be a
customer.
When we were discussing the contract of indemnity we discussed the meaning of the contract
of indemnity and the essentials of the contract of indemnity, along with the rights of the
indemnity holder. Then we moved on to discuss the concept of the contract of indemnity
along with the definition of the contract given in the Indian Contract Act. Then we went on to
discuss the essentials of the contract of guarantee. Today we are going to discuss the
remaining part of the contract of guarantee. It includes the rights of the surety against the
principal debtor, against principal creditor and against co sureties. Nature and extent of the
surety, liability and then under what circumstances the surety will be free from the
responsibilities.
After the payment of the debt to the creditor, the surety is subrogated to the rights of the
creditor i.e., he has the same rights as those of the creditors. Therefore, he can sue the
principal debtor to exercise those rights. Thus if the surety has performed his promise
towards the creditor, all the rights of the principal debtor against the creditor devolve upon
him.
In every contract of guarantee, there is an implied promise by the principal debtor to
indemnify the surety i.e., to compensate the surety. Therefore, upon the payment of debt of
the principal debtor, the surety becomes entitled to recover from the principal debtor, all the
amount including interest plus costs rightly paid to the creditor under the guarantee. The
reason is that the surety is entitled to full indemnification.
If two or more persons are co-sureties for the same debt either jointly or severally, or whether
under the same or different contracts and whether with or without the knowledge of each
other, the co-sureties in the absence of any contract to the contrary, are liable as between
themselves, to pay each, an equal shares of the whole debt, or that part of it which remains
unpaid by the principal debtor.
Sometimes, one co-surety discharges the entire obligations. In such cases, he can obtain equal
contribution from the other co-sureties.
 BIBLIOGRAPHY

• Books Referred:
– The Law of Contracts-I : R.K. BANGIA

–Ratanlal Dheerajlal, Contract Law-I

-Indian Contract Act: Bare Act

Websites:-
www.indiankanoon.org
www.googlebooks.co.in

www.legalserviceindia.com