Week 2-5 - Guarantee

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Law of Contract II - Week 2 to 5
By: Nitin Gomber Esq.

+ WHAT IS GUARANTEE?
Section 126 of the ICA
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’
The person to whom the guarantee is given is called the ‘creditor’
**A guarantee may be either oral or written.

+
WHAT IS GUARANTEE?
n  Summarily speaking, a guarantee is a promise to answer for

the payment of some debt, or the performance of some duty,
in case of the failure of another party, who is in the first
instance liable to such payment or performance.
n  Therefore, in case of a contract of guarantee, the primary

liability is that of the principal debtor! Surety’s liability is only
secondary i.e. it arises only when the principal debtor fails!
n  Therefore, it can be said that a guarantee is an undertaking to

indemnify if some other person does not fulfill his promise.
[Please understand that the word ‘indemnify’ in this sentence is
used casually, rather than being used as a term defined under
the ICA]
+ DIFFERENCE BETWEEN ‘A CONTRACT OF
INDEMNITY’ & ‘A CONTRACT OF GUARANTEE’
Number of parties to a contract – Three v. Two
n  A contract of guarantee involves three parties: (1) A Creditor,

(2) A Principal-Debtor, and (3) A Surety.
n  A contract of indemnity involves two parties: (1) An

Indemnifier, and (2) An Indemnity Holder.
Note: A contract of guarantee must, therefore, involve a contract

to which all three parties are privy! Their express participation
or implied assent to have such a contract must be proved by
the person who wants to rely on it.
Number of Contracts: Three* v. One
n  In a contract of guarantee, there ought to be three contracts

ideally. First, between the creditor and the principal debtor,
second, between creditor and the surety, and third, between
the principal debtor and the surety.
n  In a contract of indemnity, there’s only one contract –

between the indemnifier and the indemnity holder.
Note*: There need not be three separate agreements between

these parties. A single agreement will also do. The whole idea
stating the number of contracts is that all these three should be
privy of the whole transaction expressly or in an implied
manner.
Nature of Liability – Secondary v. Primary
n  In a contract of guarantee, the obligation of the surety

depends substantially on the principal debtor’s default.
Therefore, the nature of liability of the surety is secondary.
This liability will only arise if the principal debtor fails.
n  Under a contract of indemnity, the indemnifier undertakes an

independent obligation which does not depend upon the
existence of any other obligation of any other obligor.
Therefore, the nature of liability of the indemnifier is
primary.
Note: The liability of the surety presupposes the existence of a

principal-debtor and the surety’s liability is thus secondary.
Example: A and B have entered into a contract whereby A

agrees to supply to B, 100 tons of olive oil at his factory on 25th
February, 2016, for a consideration of Rs. 10 Lakh. C, is a friend
of B. When B tells C of his contract with A, C makes an oral
promise to B that if A does not deliver as per the contract, he
will pay Rs. 10 Lakh to B. Identify who is the Creditor, the
Principal Debtor and the Surety.
In this example, C makes an oral promise to B to compensate him

for A’s default. The problem here is that A is not privy to this
conversation between B and C. Therefore, C is a total stranger to
this contract. This is not a contract of guarantee. This may be
construed as a contract of indemnity between A and C,
depending on other facts.
Example: A (principal-debtor) takes a loan from B (creditor),

with C (surety) taking up the liability for repaying the loan in
case A fails to pay back. All three were privy to the contract
and it constituted a valid contract of guarantee. After A failed to
pay to B, C executed a promissory note in favour of B (creditor)
promising him to pay the amount owed by A by March 01, 2016.
What do you think of C’s arrangement with B now?
In this example, the surety (C) has now become primarily liable
to B by way of the promissory note. According to this new
arrangement between the two, the surety can be said to have
undertaken to pay the amount of debt unconditionally. This is not
a contract of guarantee (even though this new arrangement has in
fact come to the fore because of a contract of guarantee).
Example: A (principal-debtor) takes a loan from B (creditor),

with C (surety) taking up the liability for repaying the loan in
case A fails to pay back. All three were privy to the contract
and it constituted a valid contract of guarantee. Now,
unfortunately, C dies. Given that one of the party is no more,
does this still remain a contract of guarantee?
The legal representatives / heirs of a surety continue to be liable

for the amount to the creditor even after the death of the surety.
However, their liability is limited to the extent of the estate
inherited by them from the surety. Therefore, the contract of
guarantee continues to live on.
n  Note: Whether a particular transaction is a contract of

guarantee is a question of construction, especially in light of
extrinsic evidence (circumstances / context etc.) available.
+ Consideration in a ‘Contract of Guarantee’
Section 127
Anything done, or any promise made, for the benefit of the principal
debtor, may be sufficient consideration to the surety for giving the
guarantee.
n  This section is nothing but an application of the wider principle

that in all cases of contract, the really necessary element of
consideration is the legal detriment incurred by the promisee at
the promisor’s request, and it is immaterial whether there is, any
apparent benefit to the promisor.
n  The consideration for the Surety’s promise may move from either
the Creditor or the Principal Debtor.
n  The consideration may benefit the Surety, but, it is not necessary
that the Surety should receive any benefit under the contract.
n  The benefit may consist wholly of some advantage given to

the Principal Debtor by the Creditor at the Surety’s request.
n  The word ‘done’ in the section indicates that past benefit to
the Principal Debtor can be good consideration for a bond of
guarantee.
n  Where the surety bond has been made after the original
borrowing by the Principal Debtor, the Creditor must prove
that in consideration of the contract of guarantee, he did
something, or refrained from doing something.
Note: A contract of guarantee, without consideration, is void.

Illustration: B requests A to sell and deliver him goods on

credit. A agrees to do so, provided C will guarantee the
payment of the price of the goods. C promises to guarantee the
payment in consideration of A’s promise to deliver the goods.
Agrees to sell to B on credit
A C
Gives the guarantee
Illustration: A sells and delivers goods to B. C afterwards

requests A to forbear to sue B for the debt for a year, and
promises that, if he does so, C will pay for them in default of
payment by B. A agrees to forbear as requested.
Agrees to not sue B for debt, for 1 year
A C
Gives the guarantee
Illustration: A sells and delivers goods to B. C afterwards,

agrees to pay for them in default of B.
A C
Gives the guarantee
+
Surety’s liability
Section 128
The liability of the surety is co-extensive with that of the principal-

debtor, unless it is otherwise provided by the contract.
n  Meaning of co-extensive: The word ‘co-extensive’ is an adjective

for the word ‘extent’ and relates to the quantum of the principal
debt. This section indicates that a surety is liable to the same
extent as the principal debtor.
n  So, for example, if the principal debtor is not liable on the
principal debt for some reason, the surety is also not liable. Also,
if the principal debtor is discharged of his debt by the creditor
for some reason, the surety is also discharged.
n  This section only explains the quantum of surety’s obligation

when the terms of the contract do not limit it, as they often do.
+
n  Therefore, a surety’s liability depends upon the terms of his contract
and cannot be made liable for more than he has undertaken.
n  A surety is not entitled to any kind of notice of default of the principal
debtor, unless the terms of the guarantee so require.
n  It is not necessary for the creditor, before proceeding against the
surety, to first call upon the principal-debtor to pay, unless such a
demand is necessary under the contract.
n  Note: The contract of guarantee may provide for conditions precedent
to the surety’s liability. It may provide, for instance, that the creditor
shall first take proceedings against the principal debtor. Any such
express or implied conditions precedent to the surety’s liability must
be fulfilled before recourse may be had to him.
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Note: The liability of the surety is joint and several with the
principal debtor. It is not affected by the death of the principal
debtor. It is the choice of the creditor to recover the amount
either from the principal debtor after his default, or from the
surety. He may file a suit against both the principal debtor and
the surety, or at his option, only against the surety, or only against
the debtor, or against any one of the co-sureties.
Note: The Courts are at loggerheads when it comes to figuring

the liability of sureties in cases where the contracts are void /
voidable to begin with. If a surety knowingly guarantees the debt
of a minor, it is possible that the surety is off the hook as his
liability is co-extensive with that of the minor. However, there are
cases whereby it was held that a surety remains liable.
+ CASES WRT. CONTRACT OF GUARANTEE
Bank of Bihar v. Damodar Prasad AIR 1969 SC 297
Facts:
n  The Plaintiff Bank lent moneys to Dr. Damodar Prasad

(Defendant No. 1) on the guarantee of Mr. Paras Sinha
(Defendant No. 2).
n  In spite of repeated reminders, neither Defendant No. 1 nor

Defendant No. 2 paid up their dues of Rs. 14500 (approx.)
n  Interestingly, the Surety (Defendant No. 2) had agreed to pay

and satisfy the liabilities of the principal debtor up to Rs.
12,000 and interest thereon, two days after demand.
n  The bond also provided that the Plaintiff would be at liberty to
enforce and to recover upon the guarantee notwithstanding any
other guarantee, security or remedy which the Bank might hold or
be entitled to in respect of the amount secured. (Therefore, the
only condition for enforcement of the guarantee bond was a
demand for payment by the Plaintiff)
n  Now, given the Defendant’s non payment, the Plaintiff Bank sued
both the Defendant’s in Court. The Court while passing the decree
held, “plaintiff bank shall be at liberty to enforce its dues in
question against Defendant No. 2 (surety) only after having
exhausted its remedies against Defendant No. 1 (principal debtor)”
n  The Plaintiff challenged the legality of this direction in this High
Court. The Plaintiff’s appeal was rejected by the High Court. The
Plaintiff is now challenging this direction in the Supreme Court.
n  The argument of the Plaintiff is that the surety has no right to
dictate terms to the creditor and ask him to pursue his remedies
against the principal-debtor in the first place. The surety, in fact,
is the guarantee!
n  The Plaintiff also argues that the direction of the court is very
vague, as it does not state how and when the creditor would
exhaust his remedies.
n  The Defendant argues that given that the Principal-Debtor was
solvent at the time and therefore, the Court utilized its power
under Order 20 Rule 11 (1) and Section 151 of the Code of Civil
Procedure, 1908 to impose such a condition.
Note: Section 151 of CPC says that the Court has an inherent power
to make such orders as may be necessary for the ends of justice or
to prevent the abuse of the process of the Court.
Note: Order 20 Rule 11 (1) talks about the power of the Court to
postpone the payment of the amount so decreed by giving
sufficient reasons that are clear and specific.
Issue:
Whether or not the court was justified in issuing the following

direction to the Plaintiff “plaintiff bank shall be at liberty to enforce
its dues in question against Defendant No. 2 only after having
exhausted its remedies against Defendant No. 1”?
Decision:
n  The Court ruled in favor of the Plaintiff.
Rationale:
n  Solvency of the principal-debtor is not a sufficient ground for

restraining execution of the decree against the surety. It is the
duty of the Surety to pay to the Creditor.
n  The very object of guarantee is defeated if the creditor is

asked to postpone his remedies against the surety. The
liability of the surety is immediate!
n  The Creditor is not bound to exhaust his remedy against the
principal, before suing the surety and a suit may be
maintained against the surety even though the principal has
not been sued.
n  Ideally, the Creditor should have been allowed to go against

the Surety. The Surety could have then claimed the said
amount from the principal-debtor.
n  Even though the Court had the inherent power to postpone
the execution of the decree under Section 151, the ends of
justice did not require such postponement.
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BANK GUARANTEES
(Very briefly)
n  Bank Guarantees are performance guarantees given by

banks to pay or to repay, a specified sum in the event of any
default in performance by the principal-debtor.
n  In simple words, a bank guarantee is a promise from a bank

or other lending institution that if a particular borrower
defaults on a loan, the bank will cover the loss.
How it works?
n  Lets assume Company ABC is a small, relatively unknown

restaurant (new company) that wants to purchase a Rs. 20 lakh
kitchen equipment. Here, the equipment vendor may require
Company ABC to provide a bank guarantee in order to feel
more confident that it will receive payment for the equipment
it ships to Company ABC.
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BANK GUARANTEES
(Very briefly)
n  … To obtain this bank guarantee, Company ABC requests one

from its preferred lender (usually the bank with which it keeps
its cash accounts). The lender provides the guarantee in
writing, which is then passed on to Company ABC and its
vendor. Company ABC’s lender essentially becomes a co-
signer on the purchase contract with the vendor.
Why it matters?
A bank guarantee enables companies to make purchases that

they would otherwise not be able to make; these guarantees
thus serve to heighten business activity and expand
entrepreneurial activity.
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BANK GUARANTEES
(Very briefly)
n  Bank guarantees are of two kinds: (a) Unconditional, and (b)
Conditional.
n  An unconditional bank guarantee is one where the surety

becomes liable to the party without proof of breach. As
soon as a demand of the amount is made in accordance with
the guarantee document, the surety becomes liable to pay.
n  A conditional bank guarantee is one where the surety

becomes liable to the party only upon proof of breach of
terms underlying the contract or upon proof of loss occurring
from breach.
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CASES WRT. CONTRACT OF GUARANTEE
Centax (India) Ltd. v. Vinmar Impex Inc. (1986) 4 SCC 136
Facts:
n  The Appellant (the buyer) covenanted to purchase and

Respondent No. 1 (the seller) agreed to sell and supply 100MT
of High Density Polythene Powder (HDPE) @ $565 per MT, on
an irrevocable letter of credit opened by the appellant in favor
of the respondent.
n  One of the terms of this contract was that both parties agreed
that the Bills of lading should mention shipping mark 5202.
n  Now, at the request of the Appellant, the Allahabad Bank

opened a letter of credit for $56,500 valid up to June 30, 1985
in favor of Respondent No. 1.
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n  The goods were dispatched by Respondent No. 1 in

containers and they reached shore by June 05, 1985.
n  Respondent No. 1 failed to forward, through Bank, the

original bills of lading, marine insurance policy, signed
invoices etc. to enable the Appellant to take delivery.
n  Since the shipping company was refusing to release the

cargo for want of the aforesaid documents, Respondent No. 1
instructed them to release the goods for a bank guarantee.
n  After taking delivery of the goods, the Appellant sold them in
the market and realized proceeds of Rs. 17,50,000
+
n  The Shipping company thereafter made a demand upon

Allahabad Bank to honor its letter of guarantees.
n  On getting to know this, the Appellant brought this suit

seeking an injunction on the encashment of bank guarantees,
alleging that there was breach of contract on the part of
Respondent No. 1 as the goods were not of grade 5202 and
also because they failed to forward the documents which
would have enabled the Appellant to take delivery of the
consignment.
n  The argument of the Respondent is that the Appellant anyway

took delivery of the goods and sold the consignment.
Unclean hands!
+
n  The High Court disallowed Appellant’s application for grant

of temporary injunction holding that requirements of Order
39 Rule 1 of CPC are not met (prima facie case, balance of
convenience, irreparable injury).
Issue:
Whether or not an injunction can be granted against the

encashment of absolute bank guarantees at the instance of the
person who in fact sought them from the bank?
Decision:
n  The Court ruled in favor of Respondent No. 1

+
Rationale:
n  The shipping company on the faith and assurance of the

letters of guarantee gave delivery of the goods to the
Appellants. Accordingly, there is no prima facie case made
out for the grant of temporary injunction in this case.
n  Except possibly in clear cases of fraud, of which the banks

have notice, the courts will leave merchants to settle their
disputes under the contract themselves.
+
Hindustan Steel Works v. Tarapore & Co. (1996) 5 SCC 34
Facts:
n  Hindustan Steel awarded a contract to M/s Tarapore for

construction of civil works in its Vishakhapatnam Steel Plant.
The consideration for this work was Rs. 19 Crore (approx.).
n  The contract was to be completed by 15.11.1985. However,

given the Contractor could not finish the work on time, an
extension was granted to him up until 31.03.1987.
n  The Contractor could not complete his work even up until the
extended time period.
n  Thereafter, some disputes arose between the two parties

which were referred to Arbitrators as per their Arbitration
Agreement.
n  Thereafter, by mutual agreement, the contract work was

reduced and the contract price was fixed at Rs. 4.5 crore. This
reduced work was also not completed within the extended
time period.
n  Now, while all this was going on, Bank of India gave 14
guarantees in favor of Hindustan Steel at the instance of the
Contractor.
n  By these bank guarantees, Bank of India had undertaken to

compensate Hindustan Steel against any loss or damage caused
to or suffered by it by reason of any breach by the contractor of
any term and condition of the contract.
n  It is also stipulated in the bank guarantees that Hindustan Steel

shall be the sole judge on the question as to whether the
contractor has committed any breach of the contract and what is
the extent of loss or damage.
n  It is further stipulated therein that the decision of Hindustan

Steel in this behalf shall be treated as final and binding on the
bank. The Bank further agreed to pay to Hindustan Steel any
amount payable by the contractor, without any demur & protest
and also agreed that any such demand by Hindustan Steel will
be regarded as binding on the bank notwithstanding any
difference between Hindustan Steel and the Contractor.
n  Now, given that the Contractor had breached multiple time-lines,
Hindustan Steel rescinded the contract and sent demand letters
to the Bank claiming Rs. 1,49,76,580.
n  The Contractor on coming to know of this demand, filed a suit

praying for an injunction restraining Hindustan Steel from
encashing the bank guarantees. The ground urged was that
there are genuine disputes between the parties and that the
disputes are referred to Arbitrators. The Court refused to grant
an injunction.
n  The Contractor appealed to the High Court arguing that the
guarantee will be encashable only when the Arbitrators
conclude that the Contractor was in breach and the amount of
loss / damages are quantified.
n  The High Court (in its revision petition) held that unless there
is fraud or special circumstances, the beneficiary cannot be
restrained from encashing the bank guarantee even if there
are disputes between the beneficiary and the person at
whose instance the guarantee is given by the bank.
n  After stating the foregoing, the High Court went on to

consider if there were “special circumstances” in this case. It
then held that any term in the agreement that one of the
parties shall be the sole judge to quantify the damages has to
be held invalid. The Court further held that such a duty was
of the Arbitrators in this case. The High Court also held that
the liability to pay damages would arise only after it is
established that there is a breach of the contract.
n  The High Court therefore restrained Hindustan Steel from

encashing the Bank Guarantees.
n  Now, the argument of the Appellants is that the Court should
not as a rule interfere unless it is a clear case of fraud and it is
likely to result in irretrievable injustice. The argument of the
Respondents is that Court should interfere where special
circumstances exist leading to irretrievable injustice(as held
by the High Court in this case).
Issue:
n  Whether or not special circumstances exist in this case to

warrant an injunction against encashing bank guarantees?
Decision:
n  The Court ruled in favor of Hindustan Steel.
Rationale:
n  The Court quoted from one of its earlier judgment, “It is only in
exceptional cases that the courts will interfere with the
machinery of irrevocable obligations assumed by banks. They
are the lifeblood of international commerce… Except possibly in
clear cases of fraud of which the banks have notice, the courts
will leave the merchants to settle their disputes… The
commitments of banks… must be allowed to be honoured, free
from interference by the courts. Otherwise, trust in international
commerce could be irreparably damaged…”
n  The High Court erred in holding the one party cannot be the
sole judge in holding breach of contract. A bank guarantee is
an independent and distinct contract between the bank and
the beneficiary and is not qualified by the underlying
transaction between the person at whose instance the bank
guarantee is given and the beneficiary.
n  In case of an unconditional bank guarantee, the nature of

obligation of the bank is absolute and not dependent upon
any dispute or proceeding between the party at whose
instance the bank guarantee is given and the beneficiary.
n  Whether the bank guarantee is towards security deposit or

mobilization advance or working funds or for due
performance of the contract, if the same is unconditional and
if there is a stipulation in the bank guarantee that the bank
should pay on demand without a demur and that the
beneficiary shall be the sole judge not only on the question
of breach of contract, but also with respect to the amount of
loss or damages, the obligation of the bank would remain the
same and that obligation has to be discharged in the manner
provided in the bank guarantee.
n  Commitment of banks must be honored free from

interference by the courts and it is only in exceptional cases,
that is to say, in case of fraud or in a case where irretrievable
injustice would be done if bank guarantee is allowed to be
encashed, the court should interfere.
n  In this case, fraud is not pleaded and relief for injunction is
sought on the ground that special circumstances exist, these
being serious dispute as to who has committed breach. These
factors are not sufficient to make this case an exceptional
case.
+
Rights of Surety
Section 140
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.
n  The broad meaning of this section is that the surety steps into
the shoes of the creditor, after he has paid the guaranteed debt
or performed whatever he was liable for.
n  It seems that the intention of the ICA is to keep alive for surety’s
benefit any right of the creditor, under a security or otherwise,
which would otherwise have been extinguished at law by the
payment of the debt or performance of the duty.
n  This right of the surety to step into the shoes of the creditor is
known as the surety’s right of subrogation.
+
Rights of Surety
n  Automatic Subrogation: Once the surety has paid the

guaranteed amount to the creditor, he can sue the principal-
debtor in his own name. The surety is invested with this right
automatically, without any pre-conditions attached to it.
n  All the rights of the Creditor: The surety is subrogated to

all the remedies and rights which the creditor has, not only
against the principal, but also against all persons claiming
under the principal, and to all the securities and right of
action generally which the creditor has in respect of the debt.
He (surety) is entitled to the same priority, as the creditor, in
the event of insolvency or winding up of the principal debtor.
He is also entitled to the lien, where the creditor was so
entitled over the property of the principal-debtor given as
security.
+
Rights of Surety
Example: A (seller) and B (buyer) enter into an agreement for the
sale of 100 tons of olive oil for Rs. 5 lakhs. C stands as surety to A
under a valid contract of guarantee. B defaults on the payment as he
has no money. A has not made any demand for payment to C, yet. In
the meanwhile, B wants to sell off his only property worth Rs. 5 lakhs
to another person D. Can C sue B and obtain an injunction on the sale
of this property?
Even before the payment of the debt by the guarantor to the creditor,
the guarantor, by invoking the equitable doctrine of subrogation, can
apply for temporary injunction for restraining the principal-debtor
from disposing off his personal property till the disposal of the suit filed
by the creditor. However, it is important to note that this line of
argument may not be applicable under all circumstances. In this
example, equity plays a big role as C will be left without a remedy after
he pays off the guarantee amount. Also, its not clear what the intention
of B is in selling off his only property. Therefore, please take all the
circumstances into consideration before arriving at any conclusion.
Note: Rules of CPC which govern the granting of an injunction also
come into play in this situation, which are not discussed herewith.
+
Rights of Surety
Example: A (in Mumbai) agrees to sell to B (in Delhi) laptops worth Rs.
50 lakhs. C is standing as surety to A for the whole amount. This valid
contract of guarantee stipulates that the liability of C is absolute and
that A will be the sole decision maker of whether B has failed in
fulfilling his part of the contract. Another stipulation in this contract is
that B is going to transfer Rs. 25 lakhs when the laden truck starts from
A’s facility. Another Rs. 25 lakhs was to be paid when the truck was
midway. When the truck laden with laptops started, A informed B of it.
No money was received from B until the truck was about to reach mid-
way. A called B again to inform him that the truck has reached mid-way.
No money received from B up until the time when the consignment is
barely 5km from the agreed place of delivery in Delhi. A now calls up
C and demands Rs. 50 lakhs. C pays this money to A without protest.
What can C do next, other than of course suing B?
C steps into the shoes of A (the seller) and he has every right to stop the
laptops from reaching B. This is the seller’s right to stop in transit.
+
Rights of Surety
Section 141
A surety is entitled to the benefit of every security which the

creditor has against the principal debtor at the time when the
contract of suretyship is entered into, whether the surety knows 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.
n  The basis of the above rule is that, as between the principal
debtor and surety, the principal is under an obligation to
indemnify the surety; and it is, from this obligation that the right of
surety to the benefit of securities held by the creditor is derived.
Note: This section is also relevant for “Discharge of Surety”, which is

discussed later in these slides.
+
Rights of Surety
Example (Modified illustration): C (landlord) advances to B (C’s

tenant), Rs. 2000 on the guarantee of A (surety). C has also a further
security for Rs. 2000 by a mortgage of B’s furniture, of which A is
totally unaware, but which was executed on the date on which the
contract of guarantee was signed. After some time, C (landlord)
unilaterally cancels the mortgage on the request of B (C’s tenant).
Now, B (C’s tenant) becomes insolvent, and C sues A on his
guarantee. Has A (surety) been discharged from his liability to C?
This is the simplest example of Section 141 in action. A is discharged

from liability to the extent of the amount of the value of the furniture.
This is because C cancelled the mortgage without the consent of the
surety. Moreover, it doesn’t matter that A was not aware of this further
security.
+
Rights of Surety
n  The expression ‘security’ in this section is not used in any

technical sense; it includes all moveable, immoveable
properties of the principal debtor, to which the creditor had
acquired rights at the time of entering into the contract of
suretyship.
Note: A creditor is not bound to insist upon any particular kind of

security from the principal debtor. It is only when he takes some
security that the surety can claim a right to the benefit of that
security. Not otherwise.
n  Where the surety becomes a surety for one of the several debts
owed by the debtor to the creditor, who holds different
securities for different debts, the surety is entitled to the benefit
of only that particular security for which the surety is liable for;
+
Rights of Surety
n  The expression ‘when the contract of suretyship is entered into’,

essentially limits the surety’s right to securities held by the
creditor at the date of his becoming surety. This expression also
means that the surety cannot claim the benefit of any security
available to the creditor even before the date of the suretyship
agreement under this section. This may, however, be possible
under Section 140.
n  Loses or parts with: A creditor can be said to have parted with
the security when, by reason of what he has done, he cannot give
him the securities in exactly the same condition as they formerly
stood in his hands.
n  Also, the words ‘if the creditor loses security’ refer to deliberate
action by the creditor, and not a mere fortuitous situation beyond
the control of the creditor. It is immaterial, whether the loss is due
to a positive act on the part of the creditor, or his inaction.
+
Rights of Surety
n  Failure by the creditor to preserve the security given by the

surety would discharge the surety. However, a mere passive
inactivity on the part of the creditor, by failing to realize the debt
from the collateral security, is not sufficient in itself to discharge
the surety.
n  Extent of Discharge: If the value of the security is less than the
liability undertaken by the surety, then the surety must be held
to be discharged to the extent of the value of the security, and
that he will still be required to discharge the liability which
exceeds the value of security. However, if the value of the
security given is in far excess of the liability, the surety must be
held to be discharged wholly.
n  Surety can sue the Creditor: If securities to which the surety is
entitled are not voluntarily given up to him by the creditor, he
may bring an action to compel delivery or claim his share from
the property.
+
Rights of Surety
Example: A (buyer) and B (seller) agreed to a deal whereby B

would supply 50,000 cans of Coke to A for Rs. 15 lakhs. C, in
this case stands as a surety to B. It’s a valid contract of
guarantee. This contract, however, provides that C will not claim
any benefit under Sections 140/141. Now, in case A fails to
make the payment, can C (surety) go after A’s security that B
holds?
It is a well settled principle that the parties to a contract can

contract out of the right of the surety under Section 141 and it is
not against public policy to do so. Thus, where the surety has
agreed to such a stipulation, one cannot then not rely on it. The
Supreme Court has now stated that a surety can waive all rights
available to him under Chapter VIII because these are
advantages to his benefit.
+
Rights of Surety
Example: A (buyer) and B (seller) agree for the supply of 100

tons of olive oil at the cost of Rs. 25 lakhs. C stands as surety to B
in this valid contract of guarantee. C’s liability is limited to Rs. 10
lakhs. B also has A’s property (worth 15 lakhs) mortgaged to
him. Now, A (buyer) fails to pay the money due and accordingly,
C pays up Rs. 10 lakhs to B on his demand. Can C (surety) now
compel B (seller) to sell A’s property and secure his 10 lakhs?
The Contract Act does not lay down at what point of time the surety
is entitled to have the creditor’s securities made over to him.
Whether it is when the debt of the creditor is paid off, or when the
surety pays the amount of his guarantee. Majority of the Courts,
however, have held that the surety is not entitled to the benefit of a
portion of the creditor’s securities until the whole debt due to
original creditor is paid off.
+
Rights of Surety
Section 145
In every contract of guarantee there is an implied promise by

the principal debtor to indemnify the surety; and the surety is
entitled to recover from the principal debtor whatever sum he
has rightfully paid under the guarantee, but no sums which he
has paid wrongfully.
Illustration: B is indebted to C, and A is surety for the debt. C

demands payment from A and on his refusal sues him for the
amount. A defends the suit, having reasonable grounds for doing
so, but he is compelled to pay the amount of the debt with
costs. He can recover from B, the amount paid by him for costs,
as well as the principal debt.
+
Rights of Surety
n  Now, given that there exists an implied promise of indemnity

between the surety and the principal debtor, all the rules of
indemnity will apply as between them. For example: (1) The
surety can sue the principal debtor for the guarantee
amount, as soon as his liability becomes absolute, unless the
terms of the guarantee provide otherwise. (2) The surety may
recover all damages, all costs (instructions + prudence) and
all sums ((instructions + prudence) in accordance with
Section 125 of ICA.
n  Rightfully paid: This term ‘rightfully paid has to be decided

in the context of the circumstances. Though, academics opine
that the use of the words ‘reasonable’ and ‘unreasonable’
would have been more appropriate.
+
Rights of Surety
n  Express Indemnity: There is a possibility that the principal

debtor enters into a formal agreement of indemnity with the
surety. In such a scenario, the precise extent of that indemnity
will be determined by the contract.
+
Rights of Surety
Example: A (buyer) enters into an agreement with B (seller) for

the purchase of 1000 laptops worth Rs. 5 lakhs. C (surety)
stands as a guarantor for this arrangement through a valid
contract of guarantee. A fails to pay for the laptops. B, being a
billionaire businessman forgets about this contract. When he is
in financial trouble (4 years later), he realizes that he hasn’t
asked C (surety) for this money. He immediately sends a
demand notice to C and C obliges and pays the money
immediately. C now sues A to claim his money. A argues that
the suit of B against A would have been time barred (under the
Limitation Act) and therefore this payment from C to B is not
“rightful” under section 145 of the ICA. What do you think?
+
Rights of Surety
n  There are conflicting opinions on the question whether a

surety paying debt, which is barred by limitation, can be said
to have paid ‘rightfully’ within the meaning of this section.
n  This confusion still persists, however, the Law Commission of

India in this 13th Report in 1958, accepted the view that a
surety paying a time-barred debt against the principal
debtor can be said to have paid it ‘rightfully’, because the
rights of the creditor arise, not from the liability of the debtor,
but from the discharge of his own liability; The Law
Commission also recommended adding an Explanation to
this effect. This has never been done though!
+
Rights of Surety
Example: A (buyer) enters into an agreement with B (seller) for

the purchase of 1000 laptops worth Rs. 5 lakhs. C (surety)
stands as a guarantor for this arrangement through a valid
contract of guarantee. A fails to pay for the laptops. B asks C to
pay up. C asks B if instead of Rs. 5 lakhs, the deal can be done
in Rs. 4.5 lakhs. B agrees. C finally pays Rs. 4.5 lakhs to B and
settles the matter. Now, C sues A for Rs. 5 lakh. Would the Court
decree this suit?
A surety can only claim the actual amount (rightfully paid

amount) of money that has been paid by him/her. Therefore, it is
likely that the Court will ask C to amend his plaint to claim Rs. 4.5
lakhs only.
+
Discharge of Surety
n  Sections 133 – 139 of the ICA provide certain circumstances

in which the surety is “discharged”. i.e. the law will not deem
the surety liable on the guarantee any more.
n  Generally speaking, you may also call these the rights of the
surety, as they are ultimately scenarios where the surety will
not be liable on the guarantee any more.
n  It is important to understand that a contract of guarantee is a

“contract”. Therefore, it will be discharged in any manner in
which a contract can be discharged. For example: where a
guaranteed obligation is properly discharged by
performance, the obligations of the surety are also
discharged, unless of course the surety has assumed greater
liability than the principal debtor.
+
Discharge of Surety
Section 133 (Discharge by variance)
Any variance, made without the surety’s consent, in the terms of

the contract between the principal debtor and the creditor,
discharges the surety as to transactions subsequent to the
variance.
n  This section essentially is a corollary to the general rule that

all parties must be privy to the contract of guarantee.
n  It states that as soon as the contract is amended without

taking the surety on board, the surety is discharged of his
liability with respect to subsequent transactions.
n  Generally also, any party cannot be bound to something for

which he has not contracted.
+
Discharge of Surety
Illustration: A becomes surety to C for B’s conduct as a manager

in C’s bank. Afterwards, B and C contract, without A’s consent,
that B’s salary shall be raised, and that he shall become liable
for one-fourth of the losses on overdrafts. B allows a customer
to overdraw, and the bank loses a sum of money. Is A
discharged?
Illustration: A guarantees C against the misconduct of B in an

office to which B is appointed by C, and of which the duties are
defined by an Act of the Legislature. By a subsequent Act the
nature of the office is materially altered. Afterwards, B
misconducts himself. Is A discharged?
+
Discharge of Surety
n  If unsubstantial / immaterial alteration is made to the

agreement, then the surety is NOT discharged. If the alteration
benefits the surety, then also the surety is NOT discharged.
However, this is so provided the unsubstantial alteration / benefit
to surety is SELF EVIDENT. If it is not self-evident that the
alteration is unsubstantial, or one which cannot be prejudicial to
the surety, the Court will not inquire the effect of such alteration,
but will hold that in such a case the surety himself must be the
sole judge of whether or not he will consent to remain liable
notwithstanding the alteration, and that if he has not so
consented, he will be discharged.
n  Note: If the alteration is substantial and/or prejudicial

(disadvantageous) to the surety, the surety stands discharged.
n  Note: The surety continues to be liable for transactions effected

before such variation! The surety is discharged only as to the
transactions subsequent to the variance.
+
Discharge of Surety
Note: For a variation to be called “material”, it is necessary that

this variation is such that it varies the rights, liabilities or legal
position of the parties as ascertained by the deed in its original
state, or otherwise varies the legal effect of the instrument as
originally expressed. (See: Anirudhan v. The Thomco’s Bank Ltd.
AIR 1963 SC 746)
+
Discharge of Surety
Section 134 (Discharge by release of Principal Debtor)
The surety is discharged by any contract between the creditor and the
principal debtor, by which the principal debtor is released, or by any
act or omission of the creditor, the legal consequence of which is the
discharge of the principal debtor.
n  This section is on the lines of Section 128 which says that the liability
of the surety is co-extensive with that of the principal debtor.
n  The reason why the surety is discharged with the principal debtor is
that this release / discharge of the principal debtor extinguishes the
principal obligation to begin with!
+
Discharge of Surety
n  Express release / discharge: This is a situation where there’s

an express contract between the creditor and the principal
debtor enunciating such release / discharge.
n  Implied release / discharge: The words “by any act or

omission of the creditor, the legal consequence of which is the
discharge of the principal debtor” refer to an implied
release / discharge.
+
Discharge of Surety
n  Illustration: A contracts with B for a fixed price to build a

house for B within a stipulated time, B supplying the
necessary timber. C guarantees A’s performance of the
contract. B omits to supply the timber. Is C discharged?
n  Illustration: A contracts with B to grow a crop of indigo on A’s

land and to deliver it to B at a fixed rate, and C guarantees A’s
performance of this contract. B diverts a stream of water
which is necessary for irrigation of A’s land. Is C discharged?
+
Discharge of Surety
n  The acts or omissions contemplated by this section are possibly those
referred to in Sections 39, 53, 54, 55 & 67. If the principal debtor is
discharged from his obligation by reason of any acts or omissions
specified in these sections, the liability of the surety also stands
extinguished.
n  Section 39 (when a party to a contract has refused to perform, or disabled

himself from performing his promise in entirety)
n  Section 53 (when a contract contains reciprocal promises, and one party to
the contract prevents the other from performing his promise)
n  Section 54 (when a contract contains reciprocal promises, such that one of
them cannot be performed till the other has been performed)
n  Section 55 (When a party to a contract promises to do a certain thing at or

before a specified time and fails to do any such thing within that time)
+
Discharge of Surety
n  Section 67 (If any promisee neglects or refuses to afford the

promisor, reasonable facilities for the performance of his promise)
n  Note: The majority of Courts have held that if the creditor fails to
sue the principal debtor within the period of limitation, it does
not amount to “an act or omission, the legal consequence of which
is to discharge the principal debtor”. Therefore, the surety is not
discharged solely for the reason that the creditor failed to initiate
action against the principal debtor within the limitation period.
This rationale is based on the well established distinction
between the barring of the remedy and the complete extinction
of debt. (See Section 137 also)
+
Discharge of Surety
n  Note: If there is an express term in the guarantee which

preserves the liability of the surety even if the creditor releases
the principal debtor, then the surety is not discharged. (We
have discussed earlier that the Supreme Court has now stated
that a surety can waive all rights available to him under Chapter
VIII because these are advantages to his benefit. Same logic
applies here as well.)
+
Discharge of Surety
Section 135
A contract between the creditor and the principal debtor, by which

the creditor makes a composition with, or promises to give time to,
or not to sue the principal debtor, discharges the surety, unless the
surety assents to such contract.
n  This section is a natural extension of Section 133.
n  Meaning of “makes a composition with”: It essentially means that

if the creditor makes any sort of compromise with the principal
debtor (without the consent of the surety) with respect to the debt
in question, it discharges the surety.
n  Note: Not all compromises will discharge the Surety! It depends
on the facts and circumstances of each case. If the compromise is
prejudicial to the Surety, it will definitely release him.
+
Discharge of Surety
n  Meaning of “promises to give time to”: Where a creditor,

without the consent of the surety, extends time for the
payment of debt, surety stands discharged.
n  The principal basis for such a provision is that the surety’s
right, at any time, to pay the debt and then sue the principal
debtor in his own name is also delayed. Moreover, the
analogy drawn is that in a situation where the creditor gives
time to the principal debtor, creditor can sue the surety and
the surety can then claim the money from the principal
debtor in breach of the original agreement.
n  Note: Even if the giving of such time does not injure the
surety (say the deadline is extended only by an hour), by the
principles of equity, the surety will still stand discharged!
+
Discharge of Surety
n  Meaning of “promises not to sue”: If the creditor agrees with

the principal debtor to not to ever pursue any legal recourse
against him, the surety stands discharged.
n  Meaning of “unless the surety assents to such contract”: The

section is very clear in saying that if the instrument creating
the debt and the suretyship declares that the surety shall not
be released by reason of time being given or any other
forbearance, act of omission of the creditor, then the surety is
not discharged.
+
Discharge of Surety
Section 136
Where a contract to give time to the principal debtor is made

by the creditor with a third person, and not with the principal
debtor, the surety is not discharged.
n  It is clear that when the creditor enters into a binding

contract with the principal debtor to give him time without
the assent of the surety, such giving of time discharges the
surety. But, to produce this result, two things are necessary:
(a) there must be a binding contract to give time, and (b) the
contract must be made with the principal debtor.
n  This section contemplates a situation where the creditor

makes an agreement to give time to the principal debtor,
with a third party. And this, does not discharge the surety.
+
Discharge of Surety
n  Example: A agrees with B to supply him 500 cans of coke in

consideration for Rs. 1.5 lakhs. C stands surety to this valid
contract of guarantee. A agrees with D to extend the delivery
date of B’s contractual obligations by a week. C is not
discharged in this scenario.
+
Discharge of Surety
Section 137
Mere forbearance on the part of the creditor to sue the

principal debtor or to enforce any other remedy against him
does not, in the absence of any provision in the guarantee to
the contrary, discharge the surety.
Illustration: B (principal debtor) owes to C (creditor) a debt

guaranteed by A (surety). The debt becomes payable. C does
not sue B for a year after the debt has become payable. Is A
discharged from his suretyship?
n  This section deals with a case of ‘mere forbearance’ to sue or

to enforce any other remedy. This forbearance may be
exercised for a period – short period or until the expiry of
period of limitation.
+
Discharge of Surety
Section 139
If the creditor does any act which is ‘inconsistent with the rights’
of the surety, or omits to do any act which his duty to the surety
requires him to do, and the eventual remedy of the surety himself
against the principal debtor is thereby ‘impaired’, the surety is
discharged.
n  This section in continuation of the previous few sections, builds

upon the theory that the surety must not be subjected to
something that he originally did not agree to, to begin with.
n  Note: This section is worded very broadly. Therefore, make

sure you interpret the words “inconsistent with the rights” and
“which his duty to the surety requires him to do” and
“impaired” very liberally!
+
Discharge of Surety
n  Section 139 consists of the following elements:
(1) The creditor either does something which is inconsistent

with the rights of the surety OR omits to do his duty towards the
surety,
AND BECAUSE OF THIS…
(2) The eventual remedy of the surety that he had against the
principal debtor, is impaired,
If these two conditions are fulfilled, the surety is discharged.

+
Discharge of Surety
n  Note: Sections 133, 134 and 135 deal with some of the acts /
omissions of the creditor with the principal debtor, which
discharge the surety. Now, Section 139 is a residuary
provision. The object of this section is to ensure that no
arrangement different from that contained in the surety’s
contract is forced upon him and that the surety, if he pays the
debt, has the benefit of every remedy which the creditor has
against the principal debtor.
n  Note: The substance of Section 139 is that it is the duty of the
person who has secured a guarantee, to do every act
necessary for the protection of the rights of the surety. In
essence, a “duty of care” is owed by the creditor. This duty of
care is owed to the mortgagor (the principal debtor), as well
as to the surety.
+
Discharge of Surety
n  Meaning of “acts inconsistent with the rights of the surety” and
“omission to do any act which his duty to the surety requires him to
do”: As discussed already, Section 139 is a residuary provision. i.e.
to cover aspects that may not categorically fall under some of the
previous sections. Therefore, there’s no per se list of rights / duties
that have been provided. Each case must be dealt according to its
own circumstances.
n  You may use the following indicators: (a) any variance made in the
contract, without taking the surety on board – Sec 133; (b) if the
principal debtor is released, without taking the surety on board –
Sec 134; (c) any compromise between the principal debtor and the
creditor, without taking the surety on board – Sec 135; (d) any
extension of time given by the creditor to the principal debtor,
without taking the surety on board – Sec 135; (e) any promise that
the creditor makes to the principal debtor about not suing him,
without taking the surety on board – Sec 135;
+
Discharge of Surety
n  Meaning of “eventual remedy of the surety against the

principal debtor is thereby impaired”: The case in which the
principal debtor is discharged by an act or omission of the
creditor which has the legal consequence of discharging the
principal-debtor, has been dealt within Section 134. Under
the present section, a surety will be discharged by acts or
omissions of the creditor which, though not having the legal
consequence of discharging the principal debtor, impair the
eventual remedy of the surety against him.
n  However, the whole idea is that the Surety’s remedy against
the principal debtor must be impaired (weakened).
Therefore, don’t just look whether surety’s remedy against
the principal debtor has been extinguished!! Also look if
the surety’s remedy has weakened / lessened to some extent.
That is enough!
+
Discharge of Surety
n  Example: A valid contract of guarantee exists between the

Creditor, Principal Debtor and the Surety for the repayment
of the Principal Debtor’s loan (Rs. 10 lakhs) back to the
Creditor. The Principal Debtor approaches the Creditor to
seek permission to pay this amount in installments of 5 lakhs
each, with the first installment within the original deadline
and the second installment within a few days after the lapse
of the original deadline. The Creditor agrees to the
arrangement and the Surety is informed of the decision. The
Surety now claims that he stands discharged. Is he
discharged? How?
+
Discharge of Surety
n  Example: C (a service professional who’s 23 years old) lends Rs.

25000 to B on the security of a joint and several promissory note
made in C’s favor by B and A (Surety) together. This promissory
note was executed along with a bills of sale of B’s furniture,
which gives power to C to sell the furniture, and apply the
proceeds in discharge of the note. This latter arrangement was
made as B had no money in his account left other than what he
got from C. Now, when B fails to pay up the money he owed, C
puts all the furniture he had from B outside his house for sale.
The first customer that comes to him to buy the furniture offers
him Rs. 5000 for it and he accepts the offer. C now sues the
Surety on the promissory note for the remainder of the amount.
Surety claims that he stands discharged from all liability. What
do you think?
+
Discharge of Surety

Creditor, Principal Debtor and the Surety for the repayment
of the Principal Debtor’s loan back to the Creditor (Debt #2).
The Principal Debtor also owes another prior debt to the
Creditor, for which no Surety was ever appointed (Debt #1).
Now, given that the Principal Debtor had no money to repay
Debt #1 when the time arose, the Creditor took an equitable
mortgage of all of the properties of the Principal Debtor. This
arrangement was never conveyed to the Surety of Debt #2.
The Surety now claims and proves that he knew of the
Principal Debtor’s properties to begin with, which influenced
his decision to stand as Surety for Debt #2. Accordingly, now
that those properties have been mortgaged, he stands
discharged under Section 139 of the ICA as his eventual
remedy against the Principal Debtor has been impaired.
What do you think?
+
Discharge of Surety
n  Example: Creditor lends a sum of Rs. 1 crore to the Principal

Debtor for the purchase of a new truck, for the repayment of
which the Surety executes a valid deed of guarantee. When
the Principal Debtor failed to pay the money back, the
Principal Debtor requested and the Creditor accepted that
the truck be sold immediately and all the money raised
thereof be deposited with the Creditor. The Surety was not
taken on board of this compromise. The truck was sold
without any delay for Rs. 75 lakhs and the money was
deposited with the creditor. The Surety now claims that he
stands discharged on the account of this compromise under
Section 135 and Section 139 of ICA. What do you think?
+ Continuing Guarantee
(Meaning)
Section 129
A guarantee which extends to a series of transactions is called a

‘continuing guarantee.’
n  Meaning of continuing guarantee: A continuing guarantee is one

which extends to a series of transactions, and is not exhausted by
or confined to a single transaction. In essence, the surety
undertakes to be answerable to the creditor for his dealings with
the debtor, over a certain period of time.
n  Why is it important for us to find out if a particular guarantee is a

continuing one or not: A continuing guarantee may be revoked
either by notice to the Creditor, or until the death of the Surety. On
the other hand, one may not revoke a simple guarantee under any
circumstances. Also, a continuing guarantee will run for a longer
period of time and for more than one transaction. Therefore, the
Surety could be held liable for longer and/or more!
(Meaning)
n  Note: A guarantee is not continuing one merely because the

guarantee says so. The question, whether the guarantee is for
a single or a definite number of transactions, or a continuous
one, is a question of construction, based on the specific set of
circumstances.
n  Note: In order to understand the nature of a guarantee, one

must look at: (1) the intention of the parties as expressed by
the language they have employed in the contract, (2)
surrounding circumstances, to see what was the subject
matter which the parties contemplated, (3) the use of the
expression “ultimate balance to be paid by surety” or “from
time to time”, among other indicators.
(Meaning)

Creditor (a wholesaler of medicines), Principal Debtor (a
retail pharmacy shop) and the Surety, which was signed in
March, 2014 for the supply of medicines by the Creditor to
the Principal Debtor on “as and when needed” basis, but up
to March, 2015. The Surety’s liability under this guarantee is
worded as following, “I, the Surety will be answerable for Rs.
1 lakh worth of medicines, that the Principal Debtor may buy
from the Creditor.” Is the nature of Surety’s guarantee a
continuing one?
(Meaning)
n  Example: A valid contract of guarantee exists between a House

owner, Shopkeeper and the Surety, under which the Surety is
guaranteeing the price for 5 sacks of flour to be delivered by the
Shopkeeper to the House owner, and to be paid for within a
month. The Shopkeeper delivers 5 sacks of flour to the House
owner. The House owner pays for them. Afterwards, the
Shopkeeper delivers another 5 sacks of flour to the House owner,
for which the House owner does not pay. The Shopkeeper
demands the Surety to pay up. He refuses. The Shopkeeper now
sues the Surety to recover the money saying that the guarantee
was of a continuing nature. What do you think?
(Meaning)
n  Example: An employee, employer and surety enter into a valid

contract of guarantee, whereby, the surety guarantees the fidelity
of the employee. The guarantee is worded as follows, “I, the
surety, guarantee the fidelity of the employee and will be
responsible for any loss that the employee causes to the
employer.” Is this a case of continuing guarantee?
n  Every man is supposed to have some regard for his own interest
and it is not reasonable to presume that any man of ordinary
prudence would become surety for another without limitation as to
time or amount unless he has done so in express terms! It is a
similar situation where a Father tells a shopkeeper to let her
daughter take anything from the shop and he’ll be responsible for
the payment. In case there are circumstances under which such a
fidelity agreement is held to be continuing one, then equity allows
the surety to get out of the agreement if there is a material change
in the circumstances (for example: if a proven act of infidelity of
the principal debtor comes to fore)
(Revocation by notice)
Section 130
A continuing guarantee may at any time be revoked by the surety,

as to future transactions, by notice to the creditor.
n  Given that a continuing guarantee extends to a series of

transactions, it is obvious that the surety has a right to withdraw
such guarantee.
n  Note: The Courts usually disallow revocation during the

continuance of the relationship, where a continuing relationship
is constituted and taken forward on the faith of a guarantee
n  Note: A material change in the situation will justify revocation!

(Revocation by notice to creditor)
n  Meaning of “as to future transactions”: As soon as the surety

sends across the notice of revocation to the creditor, the
surety does not remain liable for any transaction that
happens after he has given notice. However, the surety
continues to remain liable for any transaction that has already
taken place.
n  Mode of Revocation by “notice”: The section does not

prescribe a set mode of giving notice to the creditor.
Therefore, when the contract of suretyship prescribes a
particular mode of giving notice of termination of continuing
guarantee by surety, notice must be given in that mode and
no other mode will be effective. Whereas, if no such mode is
prescribed in the contract of suretyship, the notice may be
given in any form in which such notices are usually given in
that trade.
(Revocation by death of surety)
Section 131
The death of the surety operates, in the absence of any

contract to the contrary, as a revocation of a continuing
guarantee, so far as regards future transactions.
n  The liability for any transaction that took place prior to the
death of the surety will be borne by his heirs.
n  This contract to the contrary need not be in express terms in

the contract. It could also be implied from the circumstances.
n  Note: Only a continuing guarantee may be revoked by

death / notice. Therefore, in the facts, its important to first
figure if the guarantee is of a continuing nature or not!
(Revocation by death of surety)
n  Example: There exists a valid contract of guarantee between

a Creditor, a Principal Debtor and the Surety. This contract is
for a one time sale of goods for a consideration of Rs. 1 crore.
The contract of suretyship contains the following wording,
“Our heirs and legal representatives shall be bound by the
terms of this agreement in the same way in which we are
bound by them.” The Surety dies a day after signing this
contract. Is the contract of guarantee revoked by the death of
the surety?
+ Contract of Guarantee
(Obtained by misrepresentation)
Section 142
Any guarantee which has been obtained by means of

misrepresentation made by the creditor, or with his knowledge
and assent, concerning a material part of the transaction, is
invalid.
Section 143
Any guarantee which the creditor has obtained by means of

keeping silence as to a material circumstance, is invalid.
n  The sections provide that a guarantee is invalid if it has been

obtained by means of:
(1) Misrepresentation concerning a material part of the

transaction:
(a) by the creditor, or
(b) with his knowledge and assent.
(2) Keeping silent as to material circumstances.
Note: It doesn’t matter if the misrepresentation is made willfully

or innocently!
n  Misrepresentation may consist of direct assertion of a fact

which is not a fact, or may consist of statements by the
creditor which only tell only such part of the truth as is likely
to mislead, or a statement made by the creditor believing it
to be true, but later discovered to be untrue. (Please see
Section 18 of ICA which was a part of “Law of Contract I” for a
better understanding)
n  Meaning of “with his knowledge and assent”: It means that

the misrepresentation as to material facts may in fact also
come from a third party, provided the creditor knows or
assents to such an act. Thus, if a third party is acting as an
“agent” of the creditor or the creditor had notice (actual or
constructive) of the misrepresentation by this third party, then
equity stands against the creditor to set aside the transaction.
n  Meaning of “keeping silence as to material circumstances”:
To avoid a guarantee under this section, it must be proved not
only that there was silence as to a material circumstance, but
that the guarantee was obtained by means of such silence.
n  Note: The expression “keeping silence” has been interpreted

to mean intentional concealment as distinguished from mere
innocent non-disclosure.
n  Meaning of “material”: Something that strikes right at the

heart of the transaction! A tentative test to apply here is to
figure whether the misrepresentation is such that a
reasonable person in the position of the surety will re-
consider being a surety for the said transaction. If the answer
to this question is ‘yes’ under the circumstances, it is material.
If the answer to this question is ‘no’ under the circumstances,
it is not material. This test, however, may not always be
helpful.
n  Example: A Creditor, a Principal Debtor and the Surety meet

to sign a contract of guarantee. The underlying transaction is
the sale of 1 ton ‘raw mango’ for a consideration of Rs. 2
lakhs. When all the three are about to sign the agreement, the
Surety says to the Principal Debtor, “Where are all the ripe
mangoes you are contracting for, coming from?” to which the
Principal Debtor responds “Maharashtra”. The Creditor was
present when this conversation was taking place and he was
all ears. The three thereafter, signed the contract. Can the
Surety sue to set aside this contract?
+ About Co-Sureties
(Very briefly)
Section 146
Where two or more persons are co-sureties for the same debt or
duty, [either jointly or severally, and whether under the same or
different contracts, and whether with or without 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
share of the whole debt, or of that part of it which remains unpaid
by the principal-debtor.
n  The essence of this section is that if the creditor calls upon one
of the co-sureties to pay the debt or any part of it, that surety has
a right, on principles of equity, to call upon his co-sureties for
contribution. (Sometimes called as a “right of contribution”)
+ About Co-Sureties
(Very briefly)
n  Illustration: A, B and C are sureties to D for the sum of Rs.

3000 lent to E. E makes default in payment. What is the
liability of A, B and C?
n  Illustration: A, B and C are sureties to D for the sum of Rs.

1000 lent to E, and there is a contract between A, B and C that
A is to be responsible to the extent of one quarter, B to the
extent of one quarter and C to the extent of one half. E makes
default in payment. What is the liability of A, B and C?
+ About Co-Sureties
(Very briefly)
Section 147
Co-sureties who are bound in different sums are liable to pay

equally as far as the limits of their respective obligations permit.
Illustration: A, B and C, as sureties for D, enter into three several

bonds, each in a different penalty, namely, A in the penalty of Rs.
10,000, B in that of Rs. 20,000 and C is that of Rs. 40,000. D makes a
default to the extent of Rs. 30,000. What is the liability of A, B and C?
Illustration: A, B and C, as sureties for D, enter into three several

bonds, each in a different penalty, namely, A in the penalty of Rs.
10,000, B in that of Rs. 20,000 and C is that of Rs. 40,000. D makes a
default to the extent of Rs. 40,000. What is the liability of A, B and C?
+ About Co-Sureties
(Very briefly)
Section 144
Where a person gives a guarantee upon a contract that the

creditor shall not act upon it until another person has joined in
it as co-surety, the guarantee is not valid if that other person
does not join.
Section 138 (The text of the section below is not complete)
Where there are co-sureties, a release by the creditor of one of

them does not discharge the others…
*****
+
Cases
Amrit Lal v. State Bank of Travancore (Only relevant points)
Facts:
n  On February 27, 1956, a partnership firm entered into an

agreement with the then Travancore Forward Bank Ltd. (now
replaced by State Bank of Travancore) for a Cash Credit
Account to the extent of Rs. 1 lakh, secured by goods to be
pledged with the Bank.
n  Note: Generally, Cash Credit Accounts are secured lines of

credit allowing you to withdraw more money than you have in
your account, against a security.
n  Their agreement stated that the Bank could sell the pledged
goods in case the partnership firm failed to re-pay.
+
Cases
n  On March 07, 1956, the Appellant executed the letter of

guarantee in favour of the Bank guaranteeing the liability of
the borrowers in respect of the Cash Credit Account.
n  The respondent firm neglected to pay the amount due to the
Bank in time and the goods pledged with the Bank were
consequently sold with notice to the partnership firm and the
proceeds applied to the line of credit.
n  As of May 21, 1958, the balance due to the Bank stood at Rs.
40,856. Consequently, the Bank sues the Surety and the
Borrowers in a civil suit. The Surety however, zealously takes
up the following arguments to defend the suit.
n  Note: The facts of this case do not end here. The arguments in
the coming slides also contain important facts of this case.
+
Cases
Now, the borrower firm had pledged some goods (as security)
with the Bank with the following conditions / disclaimers:
n  The borrowers were responsible for the quantity and quality
of the goods pledged with the Bank.
n  The borrowers were responsible for the correctness of

Statements (dealing with market value of the goods / balance
due to the bank etc.) to be provided to the Bank.
n  At the time of pledging the goods, the borrowers declared

that the goods had not been weighed or valued and that the
Bank could do so at any time. If the goods were lacking in any
manner whatsoever, the borrower promised to recoup them.
+
Cases
n  Argument #1: The Surety argues that there has been variation
in the contract between the borrower firm and the Bank and
therefore in line with Section 133 he stands discharged.
n  The variation pointed out by the Surety was the change in the
limit of Cash Credit Account from Rs. 1 lakh to Rs. 50
thousand and then back again to Rs.1 lakh. The only evidence
in support of this condition was entries in the accounts
maintained by the Bank with the title “limit”.
n  Argument #2: The Surety argues that the Bank had given time
to the partnership firm to make up for the shortage of goods
pledged to the value of Rs. 35,000 (approx.) and therefore the
Surety stands discharged under Section 135.
+
Cases
n  Argument #3: Weekly statement on March 15, 1957 shows that
the stock of pledged goods was valued at Rs. 1 lakh.
However, in the weekly statement on April 18, 1957 shows
that the stock of pledged goods was approx. Rs. 65,000.
n  The agent of the Bank when asked how this shortfall
happened, responded, “he did not know how the shortage
occurred” and that “there was a possibility of defendants
taking away the goods.”
n  Based on the above, the Surety argues that the Bank must be
deemed to have lost the security under Section 141 and that
the Surety should stand discharged of up to Rs. 35,000.
+
Cases
n  Court’s response to Argument #1: The Court held (agreeing with
the High Court) that this might be a private instruction to the
cashier that advances were not to be made beyond Rs. 50
thousand. The Court further held (in light of the exhaustive
written agreements in place between the borrower firm and the
Bank) that it is unlikely that the Bank and the borrower firm
changed the credit limit under their contract, without another
written arrangement.
n  Court’s response to Argument #2: The Court held that this
extension of time was not the same as has been contemplated
under Section 135. The Court stated, “What really constitutes
giving of time is the extension of the period at which (by contract
between them) the principal debtor was originally obliged to
pay the creditor, by substituting a new and valid contract
between the creditor and the principal debtor to which the
surety does not assent.”
+
Cases
n  Court’s response to Argument #3: Given that the agent /

employee of the bank was unable to give an appropriate
explanation of how exactly the shortfall of the goods was
created, the Court held that the shortage was possibly brought
about either by the negligence of the Bank or for some other
reason, and to that extent there must be deemed to be a loss by
the Bank of the securities under Section 141.
n  Note: Given the frivolous nature of a few arguments in this case,
I’ve not followed the standard format for presenting cases. This
new format puts some ease of understanding in this
complicated case.
+
Cases
Anirudhan v. The Thomco’s Bank Ltd. AIR 1963 SC 746
Facts:
n  The Principal Debtor Mr. Sankaran approached the Bank for a
loan of Rs. 20,000. The Bank approved the loan in principle,
however, insisted on having a Surety for the same.
n  Mr. Sankaran approached the Surety and sought a Rs. 25,000
guarantee. The Surety gave the letter to Mr. Sankaran.
n  Mr. Sankaran then approached the Bank for a Rs. 25000 loan,
which was rejected by the Bank.
n  Mr. Sankaran then took back the letter of guarantee and
made the following changes to the letter:
+
Cases
n  (a) The figure “5” in the amount of guarantee of Rs. 25,000
appeared to have been altered to “0” so that the new
guarantee amount is Rs. 20,000. (b) Also, the word “five” was
struck out resulting in the sum being “Rupees Twenty
Thousand only”
n  These changes were NOT approved or known to the Surety,

however, it was accepted by the Bank.
n  After Sankaran defaulted on his dues, the Bank sued the
Appellant and he took up a defense that originally he had
guaranteed Rs. 25000, whereas the deed was altered to now
state his liability to Rs. 20,000.
+
Cases
n  The Argument of the Surety is based on Section 133 i.e. any
variance in the terms of the Contract without taking on board the
Surety, discharges the Surety.
n  The Argument of the Bank is that this variance is first of all
immaterial and second of all, beneficial to the surety. Therefore,
the Surety must not stand discharged by such a variance.
Issue:
Whether or not the Surety stands discharged, where he himself

hands over the possession of the letter of guarantee to the sole
custody of the principal debtor and some immaterial change is
made to the same, without taking the Surety on board?
Decision:
n  The Court held that the Surety will not be discharged.
+
Cases
Rationale:
n  Under the circumstances, the Surety handed over the letter of
guarantee solely to the Principal Debtor, thereby giving birth to
a relationship of agency between the two.
n  It is necessary that the variation made in a contract (without the

consent of the Surety) under Section 133 is such that it varies the
rights, liabilities or legal position of the parties as ascertained
by the deed in its original state, or otherwise varies the legal
effect of the instrument as originally expressed.
n  Also, such an alteration was in no way detrimental to the surety

as the reduced sum was already included in the amount of
guarantee originally furnished i.e. if the amount stood at Rs.
25,000, the Surety would have had to anyways cover the amount
of Rs. 20,000 while paying off the debt of Rs. 25,000. Thus, a
reduction of an amount already consented to be paid would not..
+
Cases
n  … require a distinct consent and such consent can be taken as

implied. Thus, the alteration made by Mr. Sankaran in the letter of
guarantee cannot be considered as a material one.
n  Note: The point to learn from this case is that if by the act of the
surety himself the letter of guarantee is placed into the hands and/or
in the control of the principal debtor and certain alterations are
made in the contract of guarantee, the surety will be liable!
n  In such a case the principal debtor is deemed to be acting on behalf

of the surety as it is at his instance that the surety is furnishing the
guarantee and also has entrusted his letter of guarantee with him.
This entrusting is important because by this the surety hands over
his guarantee to the principal debtor while he could have given it
directly to the creditor on the basis of the debt incurred by the
principal debtor. Thus, he would be bound by any immaterial
alteration in the document as long as it is made by the principal
debtor in whose hands he has entrusted the letter of guarantee.
+
Cases
n  Take the following simple example to understand this

concept: If A guarantees the payment for 10 goods sold to B
on credit and then B later on finds that the goods available for
sale are only 6 and having the letter of guarantee with
himself, changes the number of goods from 10 to 6. This will
not discharge the surety because firstly the alteration is not
material and secondly because by entrusting the letter to B,
he is deemed to be the agent of A and should also be
deemed to have the authority to reduce the amount it not
increase it.
+
Cases
Subramania Chettiar v. MPN Gounder AIR 1951 Mad 48
(Given this case is very old and that we’ve discussed more
advanced points in class already, I’m merely putting forth
pointers for this particular case)
Facts:
n  The Principal Debtor’s debt was scaled down by the Madras
Agriculturists’ Relief Act.
n  The only question before the court was whether such scaling
down of the Principal Debtor’s debt will also ensure that the
liability of the Surety is equally scaled down?
+
Cases
n  The Court after quoting Section 128 of ICA, held that this
results from the definition of the surety's engagement as
being accessory to a principal obligation and that the
extinction of the principal obligation necessarily induces that
of the surety, it being the nature of an accessory obligation
that it cannot exist without its principal.
n  The Court further added that if the release of the surety did
not follow from that of the debtor, the latter's release would
be purely illusory because the consequence would be that
the surety on being compelled to pay would immediately
turn round on the debtor.
n  Note: The liability of the Surety is always co-extensive with

that of the Principal debtor!
+
Thank you!

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Law of Contract II - Week 2 to 5

By: Nitin Gomber Esq.

Section 126 of the ICA

A ‘contract of guarantee’ is a contract to perform the promise, or

The person who gives the guarantee is called the ‘surety’;

The person in respect of whose default the guarantee is given is

The person to whom the guarantee is given is called the ‘creditor’

**A guarantee may be either oral or written.

n Summarily speaking, a guarantee is a promise to answer for

n Therefore, in case of a contract of guarantee, the primary

n Therefore, it can be said that a guarantee is an undertaking to

Number of parties to a contract – Three v. Two

n A contract of guarantee involves three parties: (1) A Creditor,

n A contract of indemnity involves two parties: (1) An

Note: A contract of guarantee must, therefore, involve a contract

Number of Contracts: Three* v. One

n In a contract of guarantee, there ought to be three contracts

n In a contract of indemnity, there’s only one contract –

Note*: There need not be three separate agreements between

Nature of Liability – Secondary v. Primary

n In a contract of guarantee, the obligation of the surety

n Under a contract of indemnity, the indemnifier undertakes an

Note: The liability of the surety presupposes the existence of a

Example: A and B have entered into a contract whereby A

In this example, C makes an oral promise to B to compensate him

Example: A (principal-debtor) takes a loan from B (creditor),

Example: A (principal-debtor) takes a loan from B (creditor),

The legal representatives / heirs of a surety continue to be liable

n Note: Whether a particular transaction is a contract of

n This section is nothing but an application of the wider principle

n The benefit may consist wholly of some advantage given to

Note: A contract of guarantee, without consideration, is void.

Illustration: B requests A to sell and deliver him goods on

Agrees to sell to B on credit

Illustration: A sells and delivers goods to B. C afterwards

Agrees to not sue B for debt, for 1 year

Illustration: A sells and delivers goods to B. C afterwards,

The liability of the surety is co-extensive with that of the principal-

n Meaning of co-extensive: The word ‘co-extensive’ is an adjective

n This section only explains the quantum of surety’s obligation

Note: The Courts are at loggerheads when it comes to figuring

Bank of Bihar v. Damodar Prasad AIR 1969 SC 297

n The Plaintiff Bank lent moneys to Dr. Damodar Prasad

n In spite of repeated reminders, neither Defendant No. 1 nor

n Interestingly, the Surety (Defendant No. 2) had agreed to pay

Whether or not the court was justified in issuing the following

n The Court ruled in favor of the Plaintiff.

n Solvency of the principal-debtor is not a sufficient ground for

n The very object of guarantee is defeated if the creditor is

n Ideally, the Creditor should have been allowed to go against

n Bank Guarantees are performance guarantees given by

n In simple words, a bank guarantee is a promise from a bank

n Lets assume Company ABC is a small, relatively unknown

n … To obtain this bank guarantee, Company ABC requests one

A bank guarantee enables companies to make purchases that

n An unconditional bank guarantee is one where the surety

n A conditional bank guarantee is one where the surety

Centax (India) Ltd. v. Vinmar Impex Inc. (1986) 4 SCC 136

n  Summarily speaking, a guarantee is a promise to answer for

n  Therefore, in case of a contract of guarantee, the primary

n  Therefore, it can be said that a guarantee is an undertaking to

n  A contract of guarantee involves three parties: (1) A Creditor,

n  A contract of indemnity involves two parties: (1) An

n  In a contract of guarantee, there ought to be three contracts

n  In a contract of indemnity, there’s only one contract –

n  In a contract of guarantee, the obligation of the surety

n  Under a contract of indemnity, the indemnifier undertakes an

n  Note: Whether a particular transaction is a contract of

n  This section is nothing but an application of the wider principle

n  The benefit may consist wholly of some advantage given to

n  Meaning of co-extensive: The word ‘co-extensive’ is an adjective

n  This section only explains the quantum of surety’s obligation

n  The Plaintiff Bank lent moneys to Dr. Damodar Prasad

n  In spite of repeated reminders, neither Defendant No. 1 nor

n  Interestingly, the Surety (Defendant No. 2) had agreed to pay

n  The Court ruled in favor of the Plaintiff.

n  Solvency of the principal-debtor is not a sufficient ground for

n  The very object of guarantee is defeated if the creditor is

n  Ideally, the Creditor should have been allowed to go against

n  Bank Guarantees are performance guarantees given by

n  In simple words, a bank guarantee is a promise from a bank

n  Lets assume Company ABC is a small, relatively unknown

n  … To obtain this bank guarantee, Company ABC requests one

n  An unconditional bank guarantee is one where the surety

n  A conditional bank guarantee is one where the surety

n  The Appellant (the buyer) covenanted to purchase and

n  Now, at the request of the Appellant, the Allahabad Bank

n  The goods were dispatched by Respondent No. 1 in

n  Respondent No. 1 failed to forward, through Bank, the

n  Since the shipping company was refusing to release the

n  The Shipping company thereafter made a demand upon

n  On getting to know this, the Appellant brought this suit

n  The argument of the Respondent is that the Appellant anyway

n  The High Court disallowed Appellant’s application for grant

n  The Court ruled in favor of Respondent No. 1

n  The shipping company on the faith and assurance of the

n  Except possibly in clear cases of fraud, of which the banks

n  Hindustan Steel awarded a contract to M/s Tarapore for

n  The contract was to be completed by 15.11.1985. However,

n  Thereafter, some disputes arose between the two parties

n  Thereafter, by mutual agreement, the contract work was

n  By these bank guarantees, Bank of India had undertaken to

n  It is also stipulated in the bank guarantees that Hindustan Steel

n  It is further stipulated therein that the decision of Hindustan

n  The Contractor on coming to know of this demand, filed a suit

n  After stating the foregoing, the High Court went on to

n  The High Court therefore restrained Hindustan Steel from

n  Whether or not special circumstances exist in this case to

n  The Court ruled in favor of Hindustan Steel.

n  In case of an unconditional bank guarantee, the nature of

n  Whether the bank guarantee is towards security deposit or

n  Commitment of banks must be honored free from

n  Automatic Subrogation: Once the surety has paid the

n  All the rights of the Creditor: The surety is subrogated to

n  The expression ‘security’ in this section is not used in any

n  The expression ‘when the contract of suretyship is entered into’,

n  Failure by the creditor to preserve the security given by the

n  Now, given that there exists an implied promise of indemnity

n  Rightfully paid: This term ‘rightfully paid has to be decided

n  Express Indemnity: There is a possibility that the principal

n  There are conflicting opinions on the question whether a

n  This confusion still persists, however, the Law Commission of

n  Sections 133 – 139 of the ICA provide certain circumstances

n  It is important to understand that a contract of guarantee is a

n  This section essentially is a corollary to the general rule that

n  It states that as soon as the contract is amended without

n  Generally also, any party cannot be bound to something for

n  If unsubstantial / immaterial alteration is made to the

n  Note: If the alteration is substantial and/or prejudicial

n  Note: The surety continues to be liable for transactions effected

n  Express release / discharge: This is a situation where there’s

n  Implied release / discharge: The words “by any act or

n  Illustration: A contracts with B for a fixed price to build a