Introduction to Special Contract

• Man is a social animal – Legendry Greek Philosopher Aristotle

• In civilised society interaction with other is inevitable e.g. attend class
• While interacting you have to follow code of conduct – expected results
• Indian Contract Act – Sections 1 to 75 – General principles
• Section 2(h)
• What is agreement?
• Social agreements
• When an agreement becomes contract?
Essentials of Valid Contract Sec. 10

• Two parties
• Intention to create legal relationship
• Consideration
• Capacity to contract
• Free and genuine consent
• Legality of object
• Agreement not declared as void
• Legal formalities
• Possibility of performance
• Free from ambiguities
 Special Contracts
(Reference books; Law of Contract by Avthar Singh/GCV Subba Rao,ND Kapoor)

• All the general principles given under section 10 of Indian Contract

Act 1872 are applicable to Special contracts but we see some
peculiarity in nature
Contract of Indemnity & Guarantee (Sec. 124-147)
Contract of Indemnity
• It is a contract to provide protection against loss, or contract to make
good loss
• Sec. 124 of Indian Contract Act defined mean;
- one party promises the other to save him from the loss caused, by
the conduct of promisor himself or by the conduct of other person
- E.g. Mr. A contracts to indemnify Mr. B from the consequences of legal
proceedings initiated by Mr. C against B in respect of certain sum of ₹ 2000/-
( Pending suit between B&C now A promises pay is he looses the case)
- E.g. A and B both claims the goods from the railway Co. supplied by a company,
A executes the indemnity bond in favour of railways and takes the delivery, if
tomorrow it is proved that B is the owner A is liable to indemnify Railway Co.,
- Parties 1. Promisor/ Indemnifier/ Indemnitor
2. Promisee/ Indemnified/ /indemnity holder
• In English Law – contract of indemnity covers the loss caused by promisor,
third party and accidental loss.
• But Sec. 124 is narrower doesn’t cover accidental loss
• In Gajanan v. Moreshwar case, J Chagla observes that Sec. 124 is not
exhaustive as it covers liability to indemnify the loss caused by indemnifier or
third party only
• It doesn’t cover implied promise to indemnify, and loss caused by
accident
• E.g., Defendant ‘A’ requests plaintiff ‘B’ to execute a mortgage in
favour bank, and plaintiff does so, now defendant must discharge
mortgage, on his failure banker will recover it from plaintiff, then the
defendant should indemnify the plaintiff, here is implied indemnity
A-----(need of loan)---------B----(mortgage)---------Banker
Contract of Insurance
- Contract of insurance is contract of indemnity except life insurance
- But not U/S 124 as it doesn’t cover accidental loss
- Promise under English law of indemnity covers all the losses like
accidents, which do not depend upon conduct of promisor or any
other person
Rights of Indemnity holder Sec. 125
• The promisee is entitled to recover loss provided, he must have acted
within the scope of authority and in prudent manner...
- Sec 125(1) all damages which he is compelled to pay in a suit which is
subject matter of contract of indemnity
- (2) All costs which incurs in bringing or defending the suit, provided
acted in prudent manner and within the scope of authority
- (3) All sums which he may have paid under the terms of compromise,
provided it is not against the orders of the indemnifier and done it in
prudent manner
Time at which liability of indemnifier commences
• Language of Sec. 124 and 125 are not exhaustive regarding time at
which it commences – relay upon court rulings to understand when
liability of indemnifier commences
• Settled law
- Osman Jamal & Sons v. Gopal – indemnified can compel the
indemnifier before he makes the payment(loss)
- Richardson’s case – indemnity is not given by repayment after
payment, but requires the party to be indemnified shall not be called
upon to pay
• Above rulings are based on equity principles; indemnity doesn’t mean
reimbursement of money paid by the indemnified, but it is to save
him from liability to pay
Gajanan Moreshwar v. Moreshwar Madan(1942)
• P was a lease holder of Municipal plot – transfers it to D – same was approved by MC but not
separate lease deed was executed in favour of D, hence, lease continued to stand in the name of P
- In the meanwhile, D borrowed ₹ 5000/- from C by giving his leasehold interest as security
- As lease was in the name of P, D requested him to execute mortgage deed in favour of C, though D
was interested and liable to pay
- Terms of mortgage deed said P being lease holder may be made to pay
- D fails to pay back loan- now P files a suit and claims that (i) he shall be entitled to be indemnified (ii)
an order directing the D to release P from the mortgage liability
- Now D defends saying suit is premature as he has not yet paid (loss)
- But Chagla J said as per equity principle once the P incurs liability, and it becomes absolute, he can
call upon the indemnifier to save him from the liability and pay off – need not wait till he suffers the
loss(pay)
- P lease holder - transfers D – approved by MC – but did not execute separate deed – borrowed 5000
from C – P executed mortgage deed – term say P may be made to pay – D fails to repay loan- P sues
D to be indemnified – defends premature – equity – once P incurs liability and absolute –
indemnified can claim the remedy
• Adamson v Jarvis
- The plaintiff an auctioneer sold certain cattle on the instruction of the
defendant, later it was realised that those cattle were not belonging to
defendant but somebody else, who sued the auctioneer for wrongful
conversion of cattle. The auctioneer in his term sued the defendant for
the indemnifying the loss as he acted at the instance of the defendant
- The court held that as plaintiff having acted on the instruction of the
defendant, he can assume that behind the instruction of the
defendant there was an implied promise to indemnify the loss if
something goes wrong
- Thus in English law indemnity means promise to save a person from
the harmful act of the promiser
- Further it was stated that in English law promise to indemnify may be
express or implied from the circumstances of the case
• Dugdale v Lovering – Plaintiff was in possession of some trucks, and
they were claimed by two defendants X Co., and KP Co., the
defendant X Co., demanded the delivery but plaintiff demanded for
the indemnity bond, but it was not executed nevertheless trucks were
delivered to X Co.,
- Later the KP Co., successfully sued the plaintiff for conversion of their
truck, the plaintiff was allowed to recover indemnity from the
defendant as plaintiff made his intention clear that for delivery of truck
indemnity bond should be executed
 Contract of Guarantee
• Contract to perform somebody else's promise or discharge the liability of
third party in case of his default Sec 126
• Three parties (tripartite)
- Person who gives guarantee is – Surety, guarantor, co obligant
- Person in respect of whose default surety is given is – Principal Debtor(PD)
- Person to whom guarantee is given – Creditor
- E.g., S requests C to lend ₹ 500/- to PD and promises C that if PD fails to repay
I (S) will pay
- S and P goes into shop, where S requests shop keeper C to sell some goods to
P on credit basis, and promises C that if P doesn’t pay, I will pay
- Tripartite contract between C&PD, S&C and S&PD
- It can be oral or written in nature
• Economic functions of contract of guarantee are it enables the a person loan or
goods on credit or an employment
- Some one comes forward and tells the lender, supplier of goods or employer that
a person is in need of money, goods, or employment if he doesn’t perform his
contractual obligations I will be held responsible for the same
• Independent liability different from guarantee
- Promise made by the surety is conditional i.e., only on the default of the principal
debtor, if the promise is independent of principal debtors default it is not a
contract of guarantee
- E.g. X&Y goes to a shop and Y tells the shop keeper Z that let X have the goods
and I am liable to pay for them/ I am the pay master – no contract of guarantee
because liability is independent of default of X (this was a original promise not
collateral)
- Taylor v Lee – Landlord and tenant went to the plaintiffs shop and landlord said
Mr. Parker is my tenant and living on my land for this year, and you will sell
whatever he wants and I will see it paid
Essentials of contract of Guarantee
1. Concurrence among the three parties
- P borrowed ₹ 5000/ from C; later S undertakes liability pay in case of P’s default without
the knowledge of P – no contract of guarantee
2. Primary liability should be on principal debtor and enforceable debt
- Purpose of guarantee is to secure repayment of debt, hence there should be existence
of valid recoverable debt
- e.g., Surety to pay time barred debt - P borrowed money from C and S gives guarantee
to C after it is barred by law of limitation
- However, there is an exceptions, where a company director stands as guarantee to the
company’s debt, and which was void and ultra vires, however directors were held liable,
voidness is not by the express and emphatic language of the statue
- But surety against minors' debt is enforceable –In Coutte & Co. v Browne Lecky case
bank lent the loan to an infant by way of overdraft was void u/s 1 of Infants’ Relief Act.
Status of infancy was known to all the parties – statue was also express and emphatic
that loan was void, hence, it was held that action against surety was not maintainable
• Oliver J also observes that when statute emphatically declares that infant incurs no
liability, you see no default or omission on the part of infant, when there is no
obligation on the part of Principal debtor how can you attach the liability on the
part of surety
- However, in India in Narasappa Nikade v Narashiv Shripat, the Bombay HC observes;
minor executed a bond and borrowed a loan for the purpose of litigation, this bond
was guaranteed by surety, the court held that surety is liable because contract of
guarantee is a promise to perform third parties' obligations. Just because of duty of
the third party is imperfect it doesn’t mean that surety’s liability is absent
- If the debt is void the contract of so-called surety is not collateral but principal
contract
3. Consideration
- Contract of guarantee also should have the support of consideration otherwise it is
void
- Sec 127 – anything done or promises to do for the benefit of principal debtor
constitute consideration
- E.g. PD requests the seller C to sell the goods on credit basis, seller C agrees to sell
provided S gives guarantee for the price, S gives guarantee and C agrees to sell goods
to PD – sufficient consideration
- C sells goods to PD on credit basis, later S requests C forbear to sue for the price for
one year, if C does so, S is liable for the debt if PD commits defaults in payment of price
– forbearance to sue is consideration
- C sells the goods to PD, afterwards S promises to pay for them without consideration –
contract of surety is void – but this example is criticized saying past consideration valid
consideration in India
- Failure of consideration is different situation – e.g., a person agreed to cut and remove
the timber from the forest, payment was assured by bank guarantee, but forest
department never permitted to do so, neither bank guarantee is liable, nor contractors
earnest money is subjected to forfeiture, it is an instance of failure of consideration
- Guarantee for the past debt - is it valid contract of guarantee? Technically speaking it
is invalid. Sec 127 says any thing done for the benefit of Principal Debtor is a good
consideration
- Is surety contract for past debt valid?
- Oudh HC in M Gulam Husain Khan v M Faiaz Ali Khan (1940) answers positively –
Lessee of a piece of land agreed to pay royalty due under the lease in certain
instalments and a few days after a surety executed a surety bond binding himself
to pay royalty in case of default of lessee – the court held it was a valid surety
bond because section 127 indicates consideration includes both executory and
executed contract
- In SICOM Ltd., v Padmashri Mahipatri Shah (2005) in this case guarantee was
given subsequent to release of loan amount to PD – held surety was liable
because consideration includes past consideration also
- Past and future debt – A guarantee for the past and future debt is enforceable
provided further debt is borrowed after guarantee and the surety undertakes the
liability if PD fails to repay he would repay both past and present debt
- Some benefit to the PD is sufficient to constitute consideration, it is of
no consequence that PD never requested the surety to stand as
guarantor or surety was given without his knowledge
- Counter guarantee – is a guarantee for the protection of original
guarantor, when the original guarantor is called upon to pay and he
pays, in his term he can call upon counter guarantor to pay him
4. Misrepresentation and Concealment
- Contract of Guarantee is not a contract of Uberrimae fides (utmost
good faith)
- Contract of uberrimae fides require to disclose all the material facts
by the parties to the contract E.g.,Insurance
- Fraud on the part of debtor alone doesn’t vitiates the contract, unless
creditor or agents are party to such fraud
• When guarantee is given to the banker, the banker doesn’t have any
obligation to disclose the matter which is prejudicial to the interest of
the surety
• E.g., P raised loan for establishing a factory from a Bank for which S
stood as surety, and sanctioned loan amount was credited to SB A/C
of P in the same bank, later entire amount was withdrawn to pay off a
loan in some other bank, it was known to Banker, but it was not
communicated to S, held nondisclosure of this information doesn’t
discharge surety (National Provincial Bank of Englan v. Glanusk)
Contract of Fidelity Guarantee, fraud or concealment fact renders it
invalid
• Fidelity guarantee - guarantee of loyalty/ faithfulness
- Sec 142 any guarantee obtained by misrepresentation of material fact by the creditor or
with his knowledge or assent of creditor renders the contract of surety invalid
- Sec 143 any guarantee obtained by the creditor by means of silence (concealment) as to
material fact renders the surety contract invalid
• In contract of Fidelity Guarantee, the party must disclose all the material facts otherwise
contract of guarantee can be avoided
- In London General Omnibus Co. v Holloway - C appointed P as his clerk to collect money
from his client, P misappropriated the receipts, later P’s relative made good the loss,
subsequently C decided to retain P in service based on fidelity guarantee given by S, But C
did not disclose P’s previous dishonesty – Held guarantee could not be enforced against S
as C did not disclose the P’s dishonesty
- C supplied 200 tons of iron to PD and S stood as surety for the payment price by PD. But
there was a secret agreement between C and PD that PD should pay 5% more than the
market price and this excess 5% will be adjusted towards old debt from PD, but this was
not disclosed to S – it renders the surety contract invalid, because C and PD collectively
concealed the material fact relating to surety contract
5. Writing not necessary –
- Sec 126 expressly declares that contract of surety may be oral or in writing, but in
English law it must be in writing and signed by the contracting party
 Distinction – Contract of indemnity and guarantee
Contract of Indemnity
1. Two parties viz., Indemnifier and Indemnified
2. Liability of indemnifier to the indemnified is primary and
independent
3. Only one set of contract between Indemnifier &
Indemnified
4. It is not necessary for the indemnifier to act at the
request of the indemnified
5. Liability of the indemnifier arises only on the happening
of the future contingency
6. Indemnifier can’t sue third party in his own name
because there is no privity of contract (Unless it is assigned
in his favour)
Contract of Guarantee
- Three parties viz., Creditor, Principal Debtor & Surety
- Liability of Surety to the Creditor is collateral (secondary),
primary liability is on principal debtor
- Tripartite contract; (i) Principal Debtor & Creditor (ii)
Creditor and Surety (iii) Surety and Principal Debtor
- It is necessary that the surety should give guarantee at
the request of principal debtor
- Liability of surety arises on default of PD or
nonperformance of duty which is guaranteed
- Surety after discharging the debt due by the principal
debtor he can step into the shoes of creditor – can sue
principal debtor for the recovery of paid amount of loan
 Extent of surety’s liability Sec 128
1. Nature of Surety’s liability is co-extensive with that of Principal
Debtor unless contrary is provided i.e., surety may limit his liability
by the terms of agreement
- E.g., PD borrowed Rs 50,000 from Creditor and S stood as surety as to
its repayment. On default of PD Surety is held liable not only for the
principal amount but also interest and any other sum due
- The maximum extent of surety’s liability is equivalent to that of
liability of PD or it can be less than that provided terms are there for
reduction of liability – but liability of surety can’t be more than
liability of PD
- E.g., Creditor advanced Rs. 50,000 loan to PD and this loan was
guaranteed by the Surety. PD fails to repay the loan on the agreed
day. The Creditor immediately attached the goods belong to PD and
realized Rs. 25,000/- now the liability of the Surety also will get
reduced to that extent
- Condition Precedent – where there is condition precedent on the liability of
Surety, he is not liable unless such condition precedent is fulfilled
- E.g., Surety gives guarantee to a loan borrowed by PD, the condition precedent is
that unless another person joins him as co-surety Creditor shall not act upon the
debt for recovery. Held contract of guarantee is not valid unless the other person
joins him as co-surety
- National Provincial Bank of England v Brackenburry – PD borrowed loan from the
Bank and S signed the surety bond in which he expressed his intention was to
have two more co-guarantors. It turns out that out of two one fails to sign the
surety bond. Though Surety no 1 signs the surety bond it was not binding on the
surety because conditions precedent were not fulfilled.
- If one of the co-guarantor’s signature is forged the effect is same i.e., surety bond
is not binding
• James Graham Co., Ltd. v South Gate Sands (1986) – Plaintiff (C) supplied timber
to a Company (PD) in which defendant (S) was a director. The Company fails to
pay for the supplied timber. The plaintiff agreed to suspend the claim for the
period of 1 year on the basis of assurance that 3 directors of the company
becomes joint guarantors. A surety bond appeared to have signed by all the three
handed over to the plaintiff. Subsequently the company went into liquidation.
The plaintiff filed a suit for the enforcement of surety bond against 3 sureties
liable jointly and severally. While hearing it was discovered that one of the joint
sureties signature was forged. Held no contract of surety and non of them will be
held liable
- Only remedy is invoking criminal law punishing the sureties who pretended to be
guarantor
Proceeding against Surety without Exhausting Remedies against PD
- Liability of surety is unconditional, the court can’t introduce the condition for to
enforce the liability of the surety
- Bank of Bihar ltd. V Damodar Pradad – PD borrowed loan from a Bank (Cr) for
which S stood as surety. The PD failed to repay. The Cr approached trial court -
held the Cr can enforce the guarantee only after exhaust the remedy against PD.
On appeal the Patna HC confirmed the stand of trial court but Supreme court
overruled it. It was of the opinion that, if the Cr is asked to postpone the
remedies against the Surety, very purpose of the Surety contract will be defeated.

- The justification given by the trial court was that PD was solvent hence, the
banker should exhaust the remedy against him
- But the SC was of the opinion that solvency of the PD is not sufficient ground to
postpone the execution of decree against surety.
- In a contract of guarantee it has been the duty of surety to pay and then
subrogate the rights the Creditor
- Thus the Surety doesn’t have the right to dictate terms on Cr that you first
exhaust the remedy against PD
- SBI v Index Port Registered – In this case a composite decree was passed against
PD, his mortgaged property and the Surety. The SC held just because it was
composite in nature, it doesn’t mean its execution should be postponed. Decree
is simultaneous and joint and several passed against all the defendants. Now it is
up to the creditor, he can proceed to execute it as he likes.
- In SBI v Sakasaria Sugar Mills ltd., (1986) Venkatachallaiah J observed that Sec 128
of Indian Contract Act 1872 clearly provides that the liability of the surety is
coextensive with the liability of PD. Thus the surety is liable to pay entire debt. His
liability is immediate and it was not deferred until the creditor exhausted his
remedies against the PD
Action against PD alone
- The Cr can sue against PD alone, such suit can’t be rejected on the ground that
surety was not impleaded as defendant. If at all suit against the PD is dismissed
this dismissal will not absolve the liability of the surety
Suit against Surety alone
- Suit against the surety without impleading PD is maintainable. The terms of
contract of guarantee is enforceable against guarantor jointly and severally with
that of the PD
- Held it was left to the option of the creditor to sue PD along with the Surety or
Surety alone
- Thus the position of the surety is vulnerable. The court may save him from the
vulnerability only on the ground of absence of free consent
- The position of the surety can be described as vulnerable where there is a
relationship of trust and confidence between the surety and the PD
- E.g. the wife stood as surety for the loan borrowed by her husband (fiduciary).
Where wife received no independent advise. The court freed her from the
suretyship on the ground that it was due to undue influence or misrepresentation
- This vulnerability is not limited to spouses only but with other cohabitants in the
family like elderly parents etc.
Proceedings against mortgagors mortgaged property
- The creditor can’t take the possession of surety’s mortgaged property without
notice to him, neither he can put surety’s mortgaged property for auction sale
without notice to the surety and aid of the court
- The reason is liability of the surety secondary and arises only when the borrower
fails to repay. However, surety is bound by his separate agreement for which PD is
not a party
- The LIC policy deposited with the creditor in support of his surety is available to
the creditor to the extent of amount due under the policy
- In a situation where whereabouts of the PD is not known even to the surety, the
Cr can proceed against the property of the surety which is given as security even
without exhausting remedy against PD
- The surety can’t take the defence of his ignorance as to consequences of giving
his property as security against loan borrowed by the PD
Agreement to be bound by any acknowledgement etc by the PD about
indebtedness
- If the guarantor agrees to be bound by any admission, acknowledgement or part
payment by the PD, later sureties are not allowed to disown the their liability
saying it is contrary to law or opposed to public policy
Prosecution of guarantor for bouncing his cheque
- If the guarantor has issued a cheque to the creditor as security for repayment of
loan and if such cheque is bounced he is subjected to prosecution u/s 138 of NI Act.
He can’t take the defence that he has not issued the cheque for discharging of
personal liability
Death of PD
- Creditor can file a suit against PD and Surety. If the PD dies after filing of suit, suit
holds good against Surety. But the creditor in the interest of surety can implead
the legal heirs of the deceased PD under Order 1 and Rule 10 of CPC because if
the suit is decreed the surety can subrogate the rights of the creditor and
proceed against Legal representatives of deceased PD
Winding up of PD company
- When the PD company wound-up without repayment of loan the creditor
becomes part of the winding up proceedings and he is entitled to get only
proportionate dividends from the sale of company assets
2. Surety’s right to limit his liability or make it conditional
- It is open to the surety to place limit upon his liability. He may expressly declare
that his liability as guarantor is limited to the extent of fixed amount
- e.g., surety declares that his liability shall not at any time exceed Rs 25,000/- In
such cases whatever may be owning of PD the liability of surety can’t go beyond
the amount specified.
- In Yarlagadda Bapanna v Devata China – clause in the surety bond provides that
liability of surety is up to Rs 15,000/- further it declared that he would be liable
for any amount that might be decreed. The AP HC held that it should be
construed as meaning not exceeding Rs 15,000/
- The surety can put the condition precedent that on the default of PD demand has
to be made up on the surety, where an independent and separate demand
should be made, sending mere carbon copy of demand notice sent to PD is not
sufficient
Guarantor’s Insistence upon Collateral Security
- Whether guarantor’s liability in contract of guarantee depends upon third parties'
collateral security obtained by the lender? Depends upon the nature of
contractual relationship between lender and the guarantor
- The guarantor must establish the fact that his liability is depending upon the
collateral security given by the third party – failure to obtain collateral security by
the creditor relieves the guarantor from his liability
Impossibility of Main Contract
- Florance Mabel v State of Kerala (2001)- PD borrowed money from the bank for
apiculture. This loan was guaranteed by the surety. In surety bond it was
undertaken that on the failure of PD to repay the surety would repay. Honey bees
died because of viral infection and business failed totally. PD was not able to
repay because of business failure. Held though main object of the contract failed
the surety can’t escape from the liability on the ground of impossibility of
performance.
- The liability of surety doesn’t depend on the possibility of surety being able to
realise the amount from the PD
- Industrial finance Corporation of India ltd. V Cannanore Spg Mills ltd. (2002) The
SC observes that the right of the creditor to recover the amount of loan from the
guarantor arises out of terms of surety bond which is not in any way superseded
merely because the creditor or guarantor unable to receive anything from the PD
Novation of Main Contract
- Son borrowed loan for commencing business and father stood as surety. Later
this business was converted into a Company and with due consent of the bank
this loan was treated as Company loan. Bank accepted son and his companions as
surety for the Company loan. Held under the new arrangement of loan father was
dropped out and he was not made liable for repayment of loan 
3. Liability under continuing guarantee
- Liability extends to a series of transactions- liability of surety extends to all
transactions contemplated until the revocation of guarantee
- E.g., S says to C that if you appoint D as an employee to collect your rent from the
tenants’ I will stand as a surety of P’s prompt collection and payment of collected
rent
- C is a supplier of tea powder and PD is a Hotelier, S stands as a surety to C for the
supply of tea power worth ₹ 10,000/ in total- but C supplies tea powder worth
20,000/ and fails to pay, S is liable only to the extent of contemplated Rs 10,000/-
- Whether guarantee is continuing or not depends up on language, subject matter,
and circumstances 
- E.g., I(S) agree to be answerable to C (supplier) for 5 sacks of flour to be delivered
to P, payable in one month – held not continuing
- Thus the continuing guarantee is intended to cover series of transactions over a
period of time. The surety undertakes the liability to answer the creditor for all
his dealings with the PD for certain period of time
- The essence of continuing guarantee is that it applies not to a specific number of
transactions and makes the surety liable for unpaid transactions
Revocation of Continuing guarantee
1. By notice – whatever liability incurred up to date of notice surety is liable not
for subsequent transaction
- E.g., S stands as a surety for loan of ₹ 10,000/- during next 12 months – in the
first quarters advanced ₹ 3000/ S gives notice of revocation – liable for ₹ 3000/
only
2. By death of surety – it stands revoked by operation of law – unless contrary
is provided- however, previous liability continues, on his property or his legal
heirs
3. Other modes of revocation -
(1) Novation Sec. 62.-(i) substitution of new contract in the place of existing
contract between the same parties or otherwise with different terms
- P owes C ₹ 10,000/-subject to 10% interest, S stands as surety – later rate of
interest is increased to 12%, P&C mutually agreed – S is relieved as surety
(ii) Contract between the existing parties rescinded and new contract is
formed with a third party
- P owes C ₹10,000/ under a contract, S is a surety - now PCZ mutually
agreed, where C accepts Z as his debtor- S will be relieved
- Novation should take place before expiry of time given for performance,
- otherwise it amounts to breach- it obligates the surety to perform
(2) Variance in terms of contract-
- Surety is liable for whatever he has undertaken – but terms of contract
is varied between C&P without consent of S, he is discharged from the
subsequent transactions
- E.g., C appoints P as his salesman for fixed salary, S stands as surety,
later C&P mutually agreed, where P gets commission on sales- S is not
responsible for subsequent P’s dishonesty
- E.g., P contracts to construct a house for C, terms says payment must
be made stage by stage, S stands as surety, C makes advance payment
for which S is not liable
- However, surety is given for distinct debts, duties, or obligations -
variance in terms of one contract will not discharge the surety from
other contracts
- E.g., Contract between C&P where P agreed to construct house,
construct compound, interlock floor, garden under different contract,
S stands as surety, variance in terms of one contract will not discharge
S from the rest of the contracts
- Lord Westbury in Blest v. Brown observes “you bind surety to the
letters of his engagement; beyond proper interpretation of
engagement, you have no hold on him
• If the terms of engagement is varied without the consent of surety- no
matter whether it is for the benefit of surety, innocently, surety has
right to say, contract for which I engaged to be surety exists no longer
• It is immaterial whether alteration prejudiced the interest of surety, or
loss is nominal, or no loss, creditor is liable to forfeit the whole remedy
(3) By release or discharge of principal debtor
- A contract between C&P releases P from contractual obligation, in turn
release the surety also
- E.g., C employs P as his employee in one place, for which S stands as
surety- this employment is terminated- C employs P afresh in some
other stations for which somebody else stands as surety in the place of
S- Surety S will get discharged from obligations
- Acts or omission of creditor discharges the PD, in turn discharges the surety as well
- E.g., P contracts to constructs a building for C within the specified period, for which
C must supply materials- S stands as surety for the performance of Ps obligation – C
fails to supply materials – which discharges both P and S
- E.g., P contracts with C to grow Indigo crop and supply to C at fixed price S stands
as surety for the performance contract, C diverts a stream which was necessary for
irrigation and growing indigo crop and prevents P from growing crops – it
discharges both P and S
(4) Composition, Extension of Time & Promise not to Sue Sec.135
- Mutual settlement, composition, understanding to grant more time to perform,
forbear to sue without the assent of Surety - it discharges surety
- E.g., P purchases car from C on hire purchase agreement, S stands as surety for the
payment of instalments, C extends time for payment of last instalment for valid
consideration without the consent of S, - held S is relieved from the liability
(Midland Motors Showrooms ltd., v. Newman)
Composition
- The creditor makes composition of debt with the PD without consulting Surety
discharges the surety because it results in inevitable variance in original terms of
contract.
- A settlement agreement was entered between PD and the banker where they
mutually agreed to go for one time settlement without referring it to surety –
discharges surety because this arrangement of onetime settlement amounted to
novation in exclusion of surety, it ceases the liability of surety
- However, a compromise in terms of a court decree is different from private
composition, it does not relieve the surety unless the decree is collusive to trap surety
Promise to give Time
- When the debt is time bound, and time expires the surety has the right to require the
PD to pay off the debt, and one of the duties of the creditor towards the surety is not
to give more time to repay the debt
- Though manifestly extension of time is for the benefit of surety, or extension to time
might not have caused any loss, or caused nominal loss to the surety – relieves surety
- Midland Motors Showrooms ltd. v Newman – PD purchased a motor car from the
Midland Motors on instalment payment, which was guaranteed by S. The PD fails
to pay couple of instalments. The seller Midland motors struck a deal with the PD
where it was agreed that PD has to pay certain amount immediately and balance
he can pay at the end of the month, this was done without the knowledge of
surety – Surety is relieved
- Amrithlal GL v. State Bank of Travencore - The bank give time to the PD to make
up the quantity of goods pledged before the due date for the repayment of loan
doesn’t amount to extension of time for repayment under Sec 135
However, Surety is not discharged in the following cases
(i) The creditor enters into contract with third party and promises him that he
would give time to the PD for the repayment, for which PD and the Surety were
not parties – Surety is not discharged
- E.g., S draws a Bill on PD and given to C, C being a holder enter into contract with
Z and agreed to give time to PD for the payment – Surety is not discharged
Promise not to sue
- If the creditor under an agreement with PD promises not to sue him relieves the
surety, because surety is entitled at any time require the Cr to call upon the PD to
pay off debt when it is due, this positive right will be violated when Cr promises
the PD not to sue him
(ii) Mere creditors forbearance to sue principal debtor or forbear to enforce any
other remedy against principal debtor will not discharge surety unless contrary
term in contract of surety, (Sec. 137)
- E.g., P owes C for which S is a surety. Debt becomes payable, nevertheless C
doesn’t claim and sue for the recovery for reasonable period- doesn’t relieve S
from his liability
- If such forbearance to sue is beyond law of limitation discharges surety because
guilty of acts and omission discharges both PD and surety Sec 134
- But Sec 137 says mere forbearance to sue doesn’t discharge surety
- This conflict between the sections resolved by Privy Council in Mahanth Singh v U
Ba Yi – held failure to sue PD until the recovery of debt is barred by law of
limitation doesn’t operate as discharge of surety in England, same view prevails
in India
Reserving right against Surety
- Creditors promise not to sue PD or giving time to pay by reserving his right
against surety would not discharge the Surety
- In Mahanth Singh case – builder was engaged by the trustee of a temple for
construction work, payment by the trustee was guaranteed by a Surety. The
trustees defaulted in payment and builder sued both trustees and Surety, but
beneficiary of trust replaced trustees and thereby action against trustees were
dropped but suit against surety was maintained
- (iii) In case of co-sureties, release of one of the sureties will not discharge
others; neither such discharged is free from his liability towards other
sureties(Sec. 138)
(5) Creditor’s acts or omission impairing surety’s eventual remedy (Sec 139)
- When a Creditor does something which is inconsistent with rights of Surety, or omits
to do his duty towards Surety which impairs his remedy available against PD -
discharges surety from his liability
- E.g., payment for house construction stage by stage, pays last instalment in advance
- E.g., S puts P as apprentice in C’s office and guarantee fidelity of P. C promises to
check the accounts at least once in month, fails to do so, at the year end it is found P
embezzled- held S is not liable (Hewison v. Rickets)
- S guarantee fidelity of Bank Manager to the Directors, manager indulged in
malpractice, Directors kept quite though it came to their knowledge- relieved surety
from his liability
(6) Loss of Security Sec 141
- If the Cr. loses or part with security given on the date of guarantee- surety is
discharged from the liability to the extent of value of security
- However, if there are two or more debts, loss of security given to one debt will not
relieve surety from other debts liability
- E.g., C advances loan to P, S stands as surety also accepts gold as pledge from P, C
later cancels pledge and returns gold, P becomes insolvent and sue S for the debt-
surety is not liable to the extent of value of the security (debt is 1 lakh and gold is
worth 1 lakh- 0 liability)
Kinds of Guarantee
• Guarantee for repayment of loan
• Guarantee for payment of price of goods sold on credit
• Guarantee of fidelity
• Specific or Simple guarantee – if Surety pays, he will step into shoes of
Creditor
• Continuing guarantee
Rights of Surety
I. Against Principal Debtor
(1) Right of Subrogation Sec 140
- When deb becomes due, or PD fails to perform the duty guaranteed by the surety
and Surety pays the debt or performs the duty which he is liable to perform will
step into the shoes of Cr against the PD and avail all the remedies which were
available to Cr.
- When liability of the surety is coextensive with that of the PD, rights of the Surety
is also no less than the right of Cr after Surety satisfies the debt of Cr.
- Thus, the surety may sue the PD in the name of the Cr
- Limplugh Iron Ore Co., Case – A director of a company in liquidation guarantee
and paid the rent due from the company before the date of liquidation – held
Director is entitled to place himself in the place of the Cr and avail all the
remedies available to the Cr viz. to obtain the indemnification from the company
(PD) for the loss sustained
- This right of the surety not only stands on the basis of contract but also upon the
natural justice and equity
- But this right may not be at the advantage of the surety always particularly in the
event of insolvency of the PD – though rights of the Cr vests with the surety he
may not have any indemnification
Rights before Payment
- Under right of subrogation surety may get certain right before he makes the
payment- The Calcutta HC has examined such situation, where the debt for which
Surety stood as guarantor becomes due, the PD stated selling his property one
after another leaving the Surety in fear that nothing is left after he makes the
repayment of debt if at all.
- general understanding is that Surety can’t bring injunction before he repays the
debt – however, the Calcutta HC said if Surety in his suit proved by affidavit or
otherwise that the PD threatens by disposing his property with the intent of
defrauding creditor the court may grant temporary injunction restraining him
from disposal of property
(2) Right to indemnity Sec 145
- Implied promise to indemnify surety – in every contract of guarantee there is a implied
promise by the PD to indemnify the surety
- Thus, Surety is entitled to recover from the PD whatever the amount rightfully paid under
the contract of guarantee, not wrongful payments
- E.g., PD borrowed Rs 10,000 from the Cr and S stood as guarantor, on the due date of
debt the Cr demands repayment from S, but S defend the case on some reasonable
grounds – but court held S is liable to pay, now S can recover the debt amount paid + cost
of the defense before the court of law
- But surety is not entitled to recover wrongful payment – E.g., Surety guaranteed the
payment for the payment of 4 motor car sold on hire purchase agreement, hire purchaser
defaulted, the Surety sold one of the cars and paid Rs 4000/ as hire purchase instalments
and claimed for the indemnity – held he is not entitled because he has not given the
account for realized amount on the sale of car – hence he was not allowed to recover
indemnity – paid amount of Rs 4000/- was regarded as wrongful payment
II. Rights of Surety Against Creditor
(1) Right to securities Sec 141
- Surety has the right to get the benefit of securities held by the Cr against PD at
the time of contract of suretyship
- The surety may or may not have the knowledge of existence of such security but
he is entitled to get the advantage of security
- If the Cr releases or parts with the security without the concurrence of the surety,
surety will be discharged to the extent of value of the security which is released
- Eg The Cr has advanced some loan to his tenant (PD) for which S stood as surety,
further the Cr had taken the some furniture of PD as security (pledge). Later the
Cr cancelled the pledge and tenant becomes insolvent. Cr sues Surety – held
Surety is discharged to the extent of value of the furniture released
- Sec 141 recognises and incorporates the general rule of equity as expounded in
Crythorne v. Swinbarne – the surety has every remedy which the creditor has
against PD including enforcement of security
- After paying off the debt to the Cr the Surety will step into the shoes of Cr and
right to have securities if any the Cr has against PD
- It is the duty of the Surety to keep the security intact or not to give up or not to
further burden with the further advances
- Wuff & Billing v Jay – where Cr lent Rs 30 lakhs to X&Y who were traders, S stood
as surety for the loan. X&Y mortgaged their business premises and Plant &
Machineries as security. The Cr had the right to sell off the security on default of
PD. Default happened but Cr did not enter the possession of the property. Cr
received the notice of PD’s insolvency, but allowed PD to continue in the
possession of the property mortgaged, Consequently the assets mortgaged were
seized by the receiver – held the Cr by omission to seize the property mortgaged
on default deprived himself from the power to assign the security in favour of
Surety. Therefore the Surety is discharged from the debt liability to the extent
equal to the worth of property mortgaged – (i.e. the Cr gave up the security)
- According to English law the Surety has the right to securities what Cr holds
against the PD whether the Surety know of them or not, whether they were
received before or after the guarantee
- State of MP v Kaluram – the State (Cr) sold lot of felled timber to a person (PD)
for a fixed price, payable in 4 equal instalments, the payment of which is
guaranteed by the Surety(S). The contract further provided that if the default
committed by the PD the state will get the power to stop PD from the removal of
timber and sell them for the realisation of price. The PD defaulted, however the
state allowed him to remove the timber. Then the Surety was sued for the loss.
Held surety was not liable as security was given up by the state by allowing the
PD for removing the timber – to that extent Surety is relieved from the liability
(2) Right to share reduction
- C supplies goods to PD on credit basis and S stands as surety. As per terms of
surety contract the surety is liable only the extent of goods supplied worth Rs 2.5
lakh. C supplied goods worth 3 lakh and PD became insolvent. C proved whole
amount (3 lakh) in insolvency proceedings and demanded and received 2.5 lakh
from S. Afterwards C received proportionate dividend from the insolvency
proceedings – held out of dividend received by C, Surety is also entitled to receive
his proportionate dividend
(3) Right to Set-off
- When Cr sues the Surety for the due amount of debt from the Dr, the Surety may claim
the benefit of set-off from the Cr
- E.g., Dr borrowed from Cr Rs 20,000/, S stands as surety for repayment and in another
transaction the Cr owes Rs 10,000/ to Dr. After set-off liability of Dr is only 10,000/, here
the Surety is also entitle to get the benefit of set off, hence liability of Surety is also Rs
10,000/
- The Surety can claim the benefit of set-ff not only from the Cr but also from the third
party who derived their title from the Cr. E.g., Seller sold the goods on credit basis to a
purchaser and S stood as surety, on default of purchaser the S is liable to pay. Held - S
having paid the price entitled to avail unpaid sellers right of lien against purchaser and
any other who derives title from the purchaser
III. Rights against Co-sureties
- Where the debt has been guaranteed by more than one sureties they are called Co-
sureties
- There are two rights against each other;
(1) Effect of releasing Surety Sec 138
- Release of one of the co-sureties doesn’t release other co-sureties from their obligations
towards Creditor, neither the released Surety is relieved from his obligations towards
other co-sureties. The released Surety is liable to contribute on the default of Debtor
(2) Right to Contribution Sec 146-147
- When more than one sureties guarantee same debt or duty, either jointly or severally,
under same contract or different contract and it may be with or without knowledge each
other, in the absence of contract to contract they are liable to contribute to the unpaid
portion of debt equally
- E.g., S1, S2, S3, stands as guarantor for the loan amount of Rs 3 lakh advanced by a Cr to a
Dr, on default of Dr liability of S1,S2, S3 will be 1 lakh each
- S1,S2,S3 guarantees the conduct of D in the establishment of C, by executing separate
bond. As per bond S1 Rs 10,000/- S2 Rs 20,000/- S3 Rs 40,000/-, D commits default and S1
is asked to pay Rs 10,000/- and S2 & S3 are asked to contribute Rs 15,000/- subject to
their maximum limit equally
- S1, S2, S3, by executing separate surety bond stood as guarantor of
D’s conduct in C’s establishment. As per surety bond they agreed to
contribute the following amounts respectively - S1 Rs 10,000/ S2 Rs
20,000/- and S3 Rs 40,000/. D commits default to the extent of Rs
70,000/- S1 S2 and S3 are liable to pay full amount subject to their
maximum limit
- If any one of the sureties is compelled to pay more than his share, he
can recover contribution from other surety so that loss will be equal
among the sureties
- Same principle applies irrespective of the fact that whether their
liabilities is joint or several under the same or different contract and
with or without the knowledge of surety to each other
• Indemnity v. guarantee
- Common factor in both is that it is a device for protection against a probable loss
- In either case loss may arise due to human conduct – accidental loss excluded
1. Liability under a contract of indemnity is contingent in nature it may or may not
arise
- In case of guarantee liability of surety is in existence i.e., once the guarantee (Cr)
acts up on the promise the liability of Surety automatically arises though it was in
dormant till Debtor commits default
2. Liability in contract of indemnity is primary/original, whereas liability in case of
guarantee is collateral
- The purpose of guarantee is to support the primary liability of third party (Dr).
Whereas in contract of indemnity there being no third party indemnifiers liability
itself is primary
3. In a contract of indemnity there are only 2 parties namely indemnifier and
indemnified/indemnity holder
- But there are three parties and tripartite agreement
- Agreement between Cr and Dr loan agreement
- Agreement between Surety and Cr contract of guarantee
- Agreement between Dr and Surety implied contract of indemnity