Discharge of Surety in Contract of Guarantee

In this blog, we have discussed the various modes of discharge of surety under a contract of guarantee. Creditor, principal debtor, and surety are the three parties in a contract of guarantee. When all the three parties agree, a contract of guarantee is formed. Consider the following scenario: A and B walk into a store, and A places an order for certain goods to be delivered to B on credit. “I may give products on credit if A provides a guarantee for the payment,” the merchant says. A guarantee is an assurance that the payment will be made. As A promises to guarantee the payment, B is the principal debtor, A is the surety, and the merchant is the creditor in this scenario, and the transaction represents a contract of guarantee.

Now, there may be some circumstances in which the surety, i.e., A may be relieved from his liability towards this contract. Let’s find out the cases where the surety can be discharged from his liability.

Discharge of surety from liability

Under a contract of guarantee, a surety may be discharged from his liability in the following circumstances:

1) By notice of revocation in case of a continuing guarantee:

In the case of a continuing guarantee, the surety’s liability extends to all transactions contemplated until the guarantee is revoked. Here, it is important to mention that a continuing guarantee is one that extends to a series of transactions, unlike a specific guarantee which is for a single debt.

A continuing guarantee is revoked and the surety is discharged from liability when a notice of revocation is given by the surety (Section 130 of the Indian Contract Act, 1872). Such notice operates to revoke the surety’s liability with regard to future transactions. However, he continues to be accountable for transactions that are entered into before the issue of notice.

For example, “A” guarantees to “B”, to the extent of Rupees 10,000, that “C” will pay all bills drawn on him by B. B draws a bill on C, and C accepts the bill. Thereafter, A issues notice of revocation, and later C dishonours the bill at maturity. A is obligated due to his guarantee because the concerned bill in question was drawn prior to the issue of notice of revocation.

2) By the death of the surety in case of a continuing guarantee:

In the absence of a contract to the contrary, the death of the surety acts as a ground for revoking a continuing guarantee as far as future transactions are concerned (Section 131 of the Contract Act). However, the surety’s estate will be held accountable for all transactions done prior to his death.

3) Discharge of surety by Variation in the terms of the contract:

The surety is discharged from his liability if any variation is made in the terms of the contract between the creditor and principal debtor without the surety’s consent (Section 133 of the Contract Act). In such a case, the surety is discharged with regard to all transactions taking place after the variation.

For example, A becomes C’s surety to guarantee the conduct of B as a manager in C’s bank. Following that, B and C agree, without A’s approval, to enhance B’s salary and also make him liable for one-fourth of the losses suffered on overdrafts. Thereafter, B enables a customer to overdraw, causing the bank to lose money. A is released from his suretyship as a result of the variation made without his assent, and he is not obligated to make good this loss.

To take another example, suppose C agrees to lend Rs. 5,000 to B on March 1st, and A guarantees the repayment of the same. On January 1st, C pays the money to B. Now, A is released from liability because the contract has been amended such that C may sue B for the money before March 1st.

4) When the creditor releases the principal debtor:

A surety will be released if the creditor releases the principal debtor, or if the creditor acts or fails to act in a way that causes the principal debtor to be released (Section 134 of the Indian Contract Act). However, the surety is not discharged if the creditor fails to sue the principal debtor within the limitation period.

For example, X agrees to build a house for B at a given price and within a specified time frame, with B supplying the necessary timber. X’s performance is guaranteed by Z. But B fails to provide the timber. Hence, Z is no longer held liable.

5) Composition without the consent of the surety:

The surety will be released from liability if the creditor reaches a composition agreement with the principal debtor without the surety’s assent, or if the creditor pledges to give time or not to sue the principal debtor without the surety’s consent (Section 135 of the Indian Contract Act).

6) Violation of rights of the surety:

If the creditor performs an act that violates the surety’s rights or fails to perform an act that his obligation to the surety requires him to perform, and the eventual remedy of the surety against the principal debtor is affected as a result, the surety is discharged (Section 139 of the Indian Contract Act).

To understand this with the help of an example, assume B agrees to build a ship for C for a specific price, which will be paid in installments as the project progresses. A takes up the role of surety for C in the event that B fails to fulfill his contractual obligations. C prepays B the last two installments without A’s knowledge. This prepayment relieves A of his obligation.

7) Loss of security by the creditor:

Where the creditor loses or parts with any security that the principal debtor had given in favour of the creditor at the time of the contract, the surety is discharged to the extent of the value of the security, unless the surety consented to the release of such security by the creditor in favour of the debtor. It makes no difference whether the surety was or was not aware of the security (Section 141 of the Indian Contract Act).

8) Discharge of surety when Guarantee is obtained by misrepresentation:

When a misrepresentation relating to a significant fact in the contract of guarantee is made by the creditor or with his knowledge or consent, the contract is void (Section 142). Hence, the contract may be avoided by the surety to discharge himself from liability.

9) Discharge of surety when Guarantee is obtained by concealment:

Similar to the previous point, if a guarantee is obtained by the creditor by being silent about some important aspect of circumstances relating to the contract, the contract is null and void (Section 143). Thus, the surety will be discharged.

10) Failure of co-surety to join a surety:

When a contract of guarantee states that a creditor may not act on it until the time another person joins as a co-surety, the guarantee is void if that other person does not join (Section 144).

Conclusion

A surety is extremely important in a contract of guarantee because the guarantee under this contract is only provided by the surety to pay for the debts of the principal debtor if he defaults on payments. With a view to preserving the interests of a surety under a contract of guarantee, the Indian Contract Act, 1872 allows the surety’s liability to be discharged in a variety of circumstances. Further, a surety must be safeguarded from any alterations made to the terms of the contract that he did not consent to. Because a surety’s obligation is co-extensive with that of the principal debtor, he is not accountable for anything that has not been agreed to.

To sum up, the surety is discharged from liability: (i) by notice in case of continuing guarantee only, (ii) by surety’s death (in case of continuing guarantee only), (iii) by variance in terms of the contract, (iv) by release or discharge of the principal debtor, (v) by arrangement between the creditor and the principal debtor, (vi) by impairing the eventual remedy of the surety, (vii) by loss of security by the creditor, and (viii) by the invalidation of the contract of guarantee.


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Ruchi Gandhi

The author enjoys to write informational content in the domain of company law and allied laws. She takes interest in doing thorough and analytical research on legal topics. She is a CA along with MBA (Fin) and M. Com.

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