Discharge of Surety from Liability

A contract of guarantee is a legally binding agreement where one party, known as the surety, agrees to be responsible for the debt or obligation of another party, known as the principal debtor, in case the debtor fails to fulfil their obligations. The surety is a third party who provides a guarantee to the creditor that the debt will be repaid or the obligation will be fulfilled if the debtor defaults.

The surety’s liability under a contract of guarantee is secondary to that of the principal debtor. This means that the creditor must first attempt to recover the debt from the principal debtor before seeking payment from the surety. However, if the principal debtor fails to pay, the surety becomes liable to fulfil the obligation under the guarantee.

The Indian Contract Act, 1872, provides various provisions regarding the rights and liabilities of sureties, as well as circumstances under which a surety may be discharged from their obligations. These provisions aim to protect the interests of sureties and ensure fairness in guarantee agreements.

Meaning of Discharge of Surety from Liability

The Indian Contract Act, 1872 outlines the circumstances under which a surety can be discharged from liability. A surety is relieved of liability when their obligation to fulfil the promise, in the event of default by the principal debtor, ceases to exist.

The situations in which a surety can be discharged from liability are as follows:

Discharge of Surety from Liability by Revocation

• Revocation of guarantee by giving notice (Section 130).
• Revocation due to the death of the surety (Section 131).

Discharge of Surety from Liability by the Conduct of the Parties

• Variance in terms of the contract (Section 133).
• Release or discharge of the principal debtor (Section 134).
• Compounding by the creditor with the principal debtor (Section 135).
• Creditor’s act or omission impairing the surety’s eventual remedy (Section 139).
• Loss of security (Section 141).

Discharge of Surety from Liability by the Invalidation of the Contract

• Guarantee obtained by misrepresentation (Section 142).
• Guarantee obtained by concealment (Section 143).
• Failure of a co-surety to join as a surety (Section 144).

Discharge of Surety from Liability by Revocation

Discharge of surety from liability by revocation refers to the cancellation or termination of a guarantee. Under Section 130 of the Indian Contract Act, 1872, a continuing guarantee, which applies to a series of transactions, can be revoked by giving notice to the creditor. Additionally, Section 131 specifies that the death of the surety results in the automatic revocation of the guarantee contract, thereby discharging the surety’s liability.

Revocation of Surety by Giving Notice

Section 130 of the Indian Contract Act, 1872 allows for the revocation of a continuing guarantee, which is a guarantee for a series of transactions, by serving notice to the creditor. However, revocation of a specific guarantee is not possible if the contract has already been acted upon.

Upon analysis of Section 130, it can be inferred that a continuing guarantee can only be revoked for future transactions by serving notice. The surety remains liable for transactions already entered into. This explains why the section does not include revocation of a specific guarantee, as there are no future transactions pending. The notice must be clear and specific, stating the intention to terminate liability for future transactions and should be given to the creditor at any time, provided there is no contract to the contrary.

An illustrative case is Sita Ram Gupta v Punjab National Bank. In this case, the appellant attempted to revoke the guarantee before the amount was advanced to the principal debtor. However, the guarantee contract contained a clause stating that the guarantee is of a continuing nature and cannot be cancelled or revoked. The court held that the appellant had waived his right to revoke the contract and therefore could not do so.

Revocation by Death

Section 131 of the Indian Contract Act, 1872 states that in the event of the death of the surety, the surety’s liability is discharged.

Interpreting Section 131, it can be understood that the death of the surety results in the surety’s discharge. The surety is relieved from future transactions entered into.

However, the legal heirs of the deceased surety are obligated to fulfil the transactions for which the surety provided the guarantee if those transactions have already occurred. The legal heirs are liable only to the extent of the property inherited and cannot be personally liable for the surety’s obligations. Additionally, the contract should not contain any provision contrary to this section.

Discharge of Surety from Liability by the Conduct of the Parties

Discharge of surety from liability by the conduct of the parties refers to situations where the actions or agreements between the parties involved in the contract lead to the discharge of the surety’s liability. This can occur due to various reasons as outlined in the Indian Contract Act, 1872:

Discharge by Variance in Terms of the Contract

Section 133 of the Indian Contract Act, 1872 allows for the discharge of a surety’s liability in the event of a material alteration or variance in the terms of the contract.

The provision suggests that a surety can be relieved of liability if there is a variance in the contract without the surety’s consent, especially in the case of a continuing contract of guarantee. The key factor determining the discharge of the surety is the materiality of the variance. The court must consider all facts to decide whether the variance is material. If the variance benefits the surety, the court may exercise discretion in determining its materiality.

In the case of Bonar v Macdonald, the defendants guaranteed the conduct of a bank manager. The bank later increased the manager’s liability without the surety’s consent, leading to a loss. The court ruled that the variation was material and made without the surety’s consideration, thus discharging the surety from liability.

This case illustrates that material changes in the contract can discharge the surety’s duty. The surety’s liability was based on the manager’s default, which was affected by the material change in the contract terms.

Release or Discharge of the Principal Debtor

Section 134 of the Indian Contract Act provides for the discharge of the surety’s liability if the principal debtor is released from their obligation to repay the amount.

Section 134 deals with the discharge of the surety’s secondary liability when the principal debtor’s primary liability is discharged. However, the discharge of the surety does not automatically discharge the principal debtor. There are two situations specified in the section for the release of the principal debtor:

Existence of a Contract or Laws: If the principal debtor’s liability is discharged, the surety with secondary liability is also discharged. For example, if the principal debtor’s liability is reduced under the Debt Relief Act, the surety is only liable for the reduced amount. However, if the principal debtor is discharged due to insolvency, the surety is not discharged.

Act or Omission: If the creditor’s act or omission discharges the principal debtor’s liability, the surety is also discharged. For instance, if the creditor fails to perform their promise, which leads to the discharge of the debtor’s liability.

Compounding by Creditor with Principal Debtor

Section 135 of the Indian Contract Act allows for the discharge of the surety if there is a composition or a new agreement between the creditor and the principal debtor. This section specifies three circumstances under which the surety can be discharged:

• Composition: If there is a variation in the original contract, such as adding terms that were not present initially, without the surety’s consent, it would discharge the surety’s liability.

• Promise to Give Time: If there is an agreement between the principal debtor and the creditor where the creditor agrees to give more time to repay the debt without considering the surety, the surety is discharged.

• Promise Not to Sue: If there is an explicit contract stating that the creditor will not sue in case of default, it would discharge the surety’s liability. However, mere forbearance to sue without an explicit contract will not discharge the surety.

Section 136 specifies that if the creditor agrees to give time to a third party, it does not discharge the surety.

Creditor’s Act/Omission Impairing Surety’s Eventual Remedy

It is the duty of the creditor to refrain from any act that would impair the surety’s remedy to recover the amount from the principal debtor after repayment. This right of the surety to discharge his liability is outlined in Section 139 of the Indian Contract Act, 1872.

This rule is closely related to the surety’s right of subrogation after repaying the loan. Subrogation allows the surety to step into the shoes of the creditor after repayment, enabling the surety to exercise all the rights that the creditor has. If any of these rights are impaired or if the remedy against the principal debtor is impaired due to any act or omission by the creditor, it would discharge of surety from liability.

Loss of Security

Section 141 of the Indian Contract Act, 1872 grants the surety the right to claim any security that was held by the creditor after repaying the amount. If the security is lost and the surety does not receive it for any reason, the surety can be discharged from liability.

Under Section 141, it is irrelevant whether the surety was aware of the security held by the creditor. If the surety does not receive the security after repayment, he can be discharged from liability. The discharge will be to the extent of the value of the security that was not delivered to the surety. If the value of the lost security is less than the surety’s liability, the surety will be discharged to that extent. However, if the value of the security exceeds the liability, the surety will be fully discharged.

These provisions are based on the right of subrogation, which allows the surety to claim the creditor’s rights and position after repaying the debt. Different courts have different views on contracts that contradict these provisions. While some rulings suggest that such clauses can invalidate Sections 133, 134, 135, 139 and 141, others maintain that Section 133 cannot be invalidated under any circumstances.

Discharge of Surety from Liability by the Invalidation of the Contract

The concept of discharge of surety from liability by the invalidation of the contract in the context of suretyship is a fundamental aspect of contract law. It revolves around the idea that if the contract underlying the surety arrangement is found to be invalid or unenforceable, the surety’s liability is discharged. This principle is enshrined in various sections of the Indian Contract Act, 1872, which address different scenarios where the contract may be invalidated, leading to the discharge of the surety.

Guarantee Obtained by Misrepresentation (Section 142)

Misrepresentation occurs when one party makes a false statement of fact or law that induces the other party to enter into a contract. Section 142 of the Indian Contract Act deals with situations where a guarantee is obtained by misrepresentation.

If the facts are misrepresented or falsely presented to the surety and the surety relies on these misrepresentations in providing the guarantee, the contract is considered invalid. As a result, the surety is discharged from liability under the guarantee.

For example, if a creditor misrepresents the financial status of the principal debtor to the surety, leading the surety to believe that the debtor is creditworthy, the guarantee obtained by such misrepresentation would be considered invalid. In such a case, the surety would be discharged from their obligations under the guarantee.

Guarantee Obtained by Concealment (Section 143)

Concealment occurs when one party fails to disclose material facts that would have influenced the decision of the other party in entering into the contract. Section 143 of the Indian Contract Act deals with situations where a guarantee is obtained by concealment.

If the creditor conceals material facts from the surety that would have affected the surety’s decision to provide the guarantee, the contract is considered invalid. Consequently, the surety is discharged from liability under the guarantee.

For instance, if a creditor fails to disclose to the surety that the principal debtor has a history of defaulting on loans, which would have been crucial information for the surety in assessing the risk involved, the guarantee obtained by such concealment would be considered invalid. In such a case, the surety would be discharged from their obligations under the guarantee.

Failure of a Co-Surety to Join as a Surety (Section 144)

In some cases, a guarantee may require the participation of multiple co-sureties, who jointly provide the guarantee. Section 144 of the Indian Contract Act deals with situations where there is a failure of a co-surety to join as a surety.

If the guarantee contract specifies that multiple co-sureties are required and one of them fails to join, the contract is considered invalid. As a result, the other sureties are discharged from their obligations under the guarantee.

For example, if three individuals are required to provide a guarantee as co-sureties for a loan and only two of them sign the guarantee agreement, the contract would be considered invalid due to the failure of the third co-surety to join. In such a case, the two individuals who signed the agreement would be discharged from their obligations under the guarantee.

Conclusion

The discharge of a surety’s liability under a guarantee is a crucial aspect of contract law that ensures fairness and equity in contractual relationships. The Indian Contract Act, 1872, provides various provisions that allow for the discharge of a surety from liability under different circumstances, such as revocation of the guarantee, variance in terms of the contract, release of the principal debtor and others.

These provisions aim to protect the surety from undue liability and ensure that they are not held accountable for obligations beyond their control. By providing clear guidelines for the discharge of a surety, the Act promotes transparency and accountability in contractual dealings, fostering trust and confidence among parties involved in guarantee agreements.