In this blog, we throw light on the nature and extent of surety’s liability in case of a contract of guarantee. But before that, let us understand what a contract of guarantee is.
In a contract of guarantee, there is an agreement to perform a promise or to settle the liability of a third party in the event of his default. The individual who provides the guarantee is known as the Surety, the person in respect of whom the guarantee is given is known as the Principal Debtor, and the person to whom the guarantee is issued is known as the Creditor (Section 126 of the Indian Contract Act, 1872). Also, such a contract of guarantee can be either oral or in writing. Although according to English law, it has to be in writing.
To illustrate with an example, suppose A makes a loan of Rs. 15,000 to B, and C promises to repay the amount if B fails to do so. This is a contract of guarantee. B, here is the principal debtor, A is the creditor, and C is the surety or guarantor in this case.
The extent of surety’s liability
According to Section 128 of the Indian Contract Act, the liability of the surety is said to be co-extensive with that of the principal debtor (i.e., similar to that of the principal debtor), unless the contract states otherwise. By no means is the creditor bound to sue or proceed against the principal debtor. Indeed, he can sue the surety even without suing the principal debtor. As soon as the principal debtor makes a default in the payment of the debt, the surety becomes immediately liable.
Liability arises when a default is made
But here a point must be noted. Until a default is made by the principal debtor, the surety cannot be called upon by the creditor to pay. Hence, in a way, the nature of the surety’s liability is secondary and the primary liability is that of the principal debtor. It is only when the principal debtor fails to pay, that the liability of the surety will arise. And as stated earlier, the creditor can sue the surety even before suing the principal debtor.
For example, “A” guarantees to “B” that the acceptor, C, will pay a bill of exchange. Later, C does not honour the bill. Now, A is responsible not only for the total amount of the bill but also for any interest and charges that may have accrued on it.
The extent of surety’s liability for a specified sum
By virtue of the above, it is true that the surety is liable to the same extent to which the principal debtor is liable. However, if the surety has issued the guarantee for a specified amount at the time of giving the guarantee, the surety’s liability can never exceed the specified amount. For example, A lends Rs. 5,000 to B, and C only provides a guarantee for Rs. 3,000. Now, if B fails to meet his dues, C is only accountable for Rs. 3,000.
Liability in case of co-surety
Further, if there is a condition precedent for the surety’s liability in a contract, the surety will only be liable if that condition is met first. Section 144 of the Indian Contract Act states that if a person provides a guarantee on a contract that the creditor would not act on it until another person joins in as co-surety, the guarantee is null and void if that other person does not join in.
Your friend A, for example, needs a bank loan of Rs. 10,000. You and two of your friends, C and D, agree to ensure that the loan is paid back. C refuses to sign the documents that are required of him. Here, because it is a condition precedent to your guarantee that the repayment of the loan must be guaranteed by all three, you and your friend D are also not accountable for this guarantee.
Relevant case laws on the nature and extent of surety’s liability
Kashiba vs. Shripat (1894) I.L.R. 19 Bom. 697 (Principal debtor is a minor)
By reference to the case of Kashiba vs. Shripat (1894), it was observed that Section 128 solely defines the amount of a surety’s liability when the provisions of the contract do not limit it. It does not imply, however, that the surety can never be held liable if the principal debtor cannot be held liable. Therefore, a surety is not released from liability simply because the contract between the principal debtor and creditor was voidable at the choice of the former and was avoided by him.
Where the agreement between the principal debtor and creditor is void, for instance, because the principal debtor is a minor, the surety is still held to be liable. This is so because in such cases, the contract of the so-called surety is not considered to be collateral, but a principal contract.
Swaminatha Pillai V. Lakshman Ayya – AIR 1935 Mad 748 (Can the creditor sue the surety?)
In the case of Swaminatha Pillai V. Lakshman Ayya (1935), it was held that the surety cannot even ask the creditor to first exhaust all the remedies open to him against the principal debtor, before taking action against the surety.
It is stated that the surety’s liability is co-extensive with that of the principal debtor, but that does not indicate that if the principal debtor cannot be held responsible for whatever reason, the surety will likewise not be held liable. This is due to the fact that the contract between the surety and the creditor is an independent contract rather than a collateral one.
The surety, for example, is responsible when the principal debtor is a minor. Furthermore, if the liability of the principal debtor is reduced or terminated as a result of any act, the surety remains liable. Also, the surety is still liable even if the creditor does not sue the principal debtor and the obligation becomes time-barred.
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