INTRODUCTION

Section 126 of the Indian Contract Act, 1872, defines a contract of guarantee as under:

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 section further provides that :

The person who gives the guarantee is called the surety, the person in respect of whose default the
guarantee is given is called principal debtor , and the person to whom the guarantee is given is called the
creditor.

A guarantee may be either oral or written.

For example, A takes a loan from bank. A promises to the bank to repay the loan. B also makes a promise to
the bank saying that if A does not repay the loan then I will pay. In this case, A is the principal debtor,
who undertakes to repay the loan, B is the surety, whose liability is secondary because he promises to
perform the same duty in case there is default on the part A. The bank in whose favour the promise has been
made is the creditor.

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WHO IS A SURETY ?

A surety is a person who comes forward to pay the amount in the event of a borrower failing to pay the
amount. In the event of a decree in favour of the creditor against the principal borrower, the wings of the
decree can also be extended against the sureties as their liability in coextensive with the principal debtor. But
when a suit against the principal debtor was dismissed foe default and the decision became final, there being
no liability surviving against the debtor, the suretys liability gets automatically terminated.

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 RIGHTS OF SURETY

I. AGAINST THE PRINCIPAL DEBTOR

1. Right of Subrogation

After the payment of the debt to the creditor, the surety is subrogated to the rights of the creditor i.e., he has
the same rights as those of the creditors. Therefore, he can sue the principal debtor to exercise those rights.
Thus if the surety has performed his promise towards the creditor, all the rights of the principal debtor
against the creditor devolve upon him.

2. Right of Indemnity

In every contract of guarantee, there is an implied promise by the principal debtor to indemnify the surety
i.e., to compensate the surety. Therefore, upon the payment of debt of the principal debtor, the surety
becomes entitled to recover from the principal debtor, all the amount including interest plus costs rightly
paid to the creditor under the guarantee. The reason is that the surety is entitled to full indemnification.

3. Right to be Relieved Earlier

A surety can, even before making any payment, compel the debtor to relieve him from liability by paying off
the debt. But, before doing so, the debt should be ascertained.

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 II. AGAINST THE CO SURETIES

When two or more persons give a guarantee for the same debt, they are called as co-sureties. All of them are
equally liable to the creditor for the payment of the debt to the creditor. The rights of one co-surety against
the other co-sureties are as follows:

1. Right to Contribute Equally

If two or more persons are co-sureties for the same debt either jointly or severally, or whether under the
same or different contracts and whether with or without the 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 shares of the
whole debt, or that part of it which remains unpaid by the principal debtor.

Sometimes, one co-surety discharges the entire obligations. In such cases, he can obtain equal contribution
from the other co-sureties.

2. Liability of Co-sureties bound in Different Sums

If the co-sureties are bound in different sums, they are liable to pay equally but not more than the maximum
amount guaranteed by each one of them.

Example: A, B and C are sureties for D, enter into three several bonds, each in a different penalty, such as A
in the penalty of Rs.5,000, B in that of Rs.10,000, C in that of Rs.20,000, conditioned for Ds duly
accounting to E. D failed to the extent of Rs.15,000, A, B and C are each liable to pay Rs.5,000 each.

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 III. AGAINST THE CREDITOR

1. Rights in Case of Fidelity Guarantee

In case of fidelity guarantee i.e., guarantee as to good behaviour, honesty, etc., of the principal debtor, the
surety can ask the employer to dispense with the services of the employee if the latter is proved to be
dishonest.

2. Before the Payment of the Debt Guaranteed

A surety may, after the debt has become due but before he is called upon to pay, require the creditor to sue
the principal debtor to recover the debt. But, in such cases, the surety must undertake to indemnify the
creditor for any risk, delay or expense resulting there from.

3. Right to Claim Securities

After payment of the debt to the creditor or the performance of the promise of the principal debtor, the surety
can recover all the securities which the creditor had with him either before or after the contract of guarantee
was entered into. This right is available to the surety whether or not he knows about the existence of such
security. He is entitled to all of them.

4. Right of Equities

After paying the amount due to the creditor, the surety is entitled to all equities of the creditor that he had
against the debtor as well as any other person with regard to the debt.

5. Right of Set-off

Sometimes, the principal debtor is entitled to certain counter claim or deductions from the loan obtained
from the creditor. In such cases, the surety is entitled to the benefit of such counter claim or deductions, if
the creditor files a suit against the surety.

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 CASE STUDY :

NAME OF THE PARTIES: N. Chandrashekhar v. Special Dy. Tahsildar1

FACTS OF THE CASE:

( 1. ) The petitioner was the Director of m/s. Power Packs Private Limited (PPL, for brevity), which was
established for manufacturing electronic items like sealed rechargeable nickle cadmium cells in the small
scale sector so as to supply the products to defence, railways, para-military forces and other Government
bodies. The said company availed term loans from andhra Pradesh Industrial Development corporation
(APIDC ). It also availed term loan in a sum of Rs. 39. 99 lakhs from Andhra pradesh State Financial
Corporation (APSFC ). The loan was sanctioned by second respondent on different occasions-an amount of
Rs. 30. 00 lakhs on 29. 03. 1985, rs. 6. 20 lakhs on 31. 03. 1987, Rs. 2. 13 lakhs on 21. 10. 1987 and Rs. 1.
68 lakhs on 22. 04. 1989. The petitioner, one Udaya sankar who was Managing Director of the company and
another gave personal guarantee to secure the loan besides mortgaging company's assets as security for the
loan sanctioned by APSFC.
( 2. ) PPL could not make much headway. Due to various reasons like paucity of funds, the company
incurred losses. Therefore, petitioner and two others approached p. K. Rajgarhia and Associates, New Delhi
(Rajgarhia, for brevity) for additional funds. Upon agreement between them, PPL and its Directors allegedly
with the consent of financial institutions, APSFC transferred the company to Rajgarhia on 13. 01. 1992
along with assets and liabilities of PPL. Such transfer was accepted in a multiparty meeting of the parties and
financial institutions on 07. 05. 1991. Payment of balance loan was rescheduled. It was also agreed that
Rajgarhia would substitute personal guarantees with new guarantors. It appears Rajgarhia executed
indemnity bond insulating petitioner and other Directors of ppl against losses or damages they might suffer
in connection with personal guarantees. The further case of petitioner is that with effect from 13. 01. 1992,
Rajgarhia was managing PPL and he had no knowledge of further development except that Form no. 32 was
sent to Registrar of Companies (Roc) of Andhra Pradesh. Rajgarhia addressed letter, dated 13. 01. 1992 to
State bank of India, Balkampet (SBI) requesting to discharge personal guarantees of petitioner and two
others. Petitioner alleges that in view of circumstances surrounding the takeover and multiparty meeting on
07. 05. 1991, personal guarantees given by petitioner and two others were treated as cancelled. In spite of the
same, second respondent issued notice, dated 14. 08. 1997 to petitioner and two others calling upon them to

1
A.I.R. 2009 (NOC) 383 (A.P.)
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pay a sum of rs. 71,70,478/- being dues payable by PPL. The petitioner got issued reply through an advocate
inter alia stating that petitioner and two others resigned from the Board of directors on 13. 01. 1992 and that
they ceased to be the guarantors. A year, thereafter, second respondent issued yet another communication
informing petitioner that consequent on several defaults committed by PPL, APSFC seized the unit and sold
it under Section 29 of the State financial Corporations Act, 1951 and that the sale proceeds have been
adjusted to the credit of loan account. It was further informed that even after such adjustment, there is still an
outstanding amount of rs. 51,86,552/- towards principal and interest and petitioner was called upon to pay
the said amount within fifteen days. The petitioner and two others then filed writ petition being W. P. No.
28958 of 1998 seeking a writ of certiorari to quash communication of second respondent, dated 03. 10. 1998.
This Court disposed of the writ petition on 25. 01. 1999 giving liberty to petitioners to file explanation to the
said notice and APSFC was directed to consider the same and pass appropriate orders after issuing notice to
petitioners and Rajgarhia. In furtherance thereof, the petitioner and two others submitted an explanation,
dated 08. 02. 1999 through their advocate. Second respondent or head office of APSFC, it is alleged - did not
pass any orders. At that stage, Special deputy Tahsildar, APSFC (first respondent herein) issued impugned
notice calling upon the petitioner to pay a sum of rs. 49,86,751/- towards principal and interest within a
period of fifteen days, in default of which, APSFC would take action under section 52-A of A. P. Revenue
Recovery Act, 1864 (RR Act, for brevity ). Petitioner sent a reply, dated 06. 02. 2001 through his advocate
requesting to withdraw the impugned letter, in vain, necessitating filing of present writ petition. The
petitioner contends that in view of the consent given by Andhra Pradesh industrial Infrastructure Corporation
Limited (APIIC), APIDC and Government of Andhra pradesh for takeover of PPL by Rajgarhia, apsfc
cannot proceed against petitioner. He also contends that Rajgarhia effectively substituted guarantees by
addressing letters to all concerned, and therefore, petitioner stood discharged from guarantee. Petitioner also
contends that any action under RR Act is barred by limitation.

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JUGDEMENT:

Respondent filed counter affidavit as well as additional counter affidavit. The allegations of petitioner are
denied. The brief summary of various counter averments is as follows. The petitioner is managing Director
of PPL. APSFC and other financial institutions permitted the original promoter to transfer shareholding in
PPL in favour of Rajgarhia. He and other directors of company were required to complete legal formalities
by executing personal guarantee in favour of financial institutions. However, rajgarhia failed to review
personal guarantees and petitioner failed to ensure executing personal guarantees by Rajgarhia. Even before
such substitution of guarantees, petitioner handed over possession of the unit to Rajgarhia, and therefore,
APSFC treated permission granted for transfer as cancelled. APSFC is not a party to indemnity bond
executed by Rajgarhia and it is nothing to do with the liability and the same does not have the effect of
extinguishing the liability of petitioner as long as personal guarantee executed by him is in force. His
liability is co-extensive with the principal debtor. The petitioner also failed to comply with the conditions
stipulated by APSFC for transfer of PPL to Rajgarhia. The allegation that the recovery is barred by
limitation is denied. It is also stated that pursuant to the order of high Court in W. P. No. 28958 of 1998,
petitioner submitted explanation. Second respondent issued notice, dated 05. 07. 2001 requesting petitioner
and Rajgarhia to meet second respondent for review and settlement of the case. There was no response from
rajgarhia. Petitioner visited the branch office on 30. 01. 2001 but no proposal or commitment to pay the dues
was given in respect of the proceedings under RR Act. Even before the case could be considered by second
respondent, petitioner filed instant writ petition. If the petitioner and the transferee i. e. , Rajgarhia appear
before the apsfc, the matters could be sorted out. The matter was initially heard on 16. 09. 2008. In view of
the admitted fact that apsfc did not pass any orders after receiving explanation submitted by petitioner on 08.
02. 1999, this Court directed APSFC or concerned branch to give necessary response/pass orders on the
explanation submitted by petitioner pursuant to the orders of this Court in the earlier writ petition. In
obedience thereto, second respondent by communication, dated 18. 09. 2008, informed petitioner that the
incoming directors have not taken up any documentation with APSFC with regard to take over of the
liability of the company and therefore, the liability of the petitioner is subsisting. A reference was also made
to a letter, dated 27. 02. 1992 of principal Secretary to Government of Andhra pradesh in Industries and
Commerce department pointing out that substitution of guarantees to institutions was not attended by
Rajgarhia. Even though a copy of the said letter was handed over to learned counsel for petitioner in the
Court, the petitioner has not taken any steps for amending the writ petition nor petitioner has filed any reply
affidavit to counter and additional counter filed by second respondent.

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 CONCLUSION

By doing this project I could learn a lot of things regarding Contact II and its subheadings mainly about the
surety. A surety is a person who risks to guarantee for some other person in terms of repaying certain debts.
This project mainly covers the topics like the definition of the surety, the rights of the surety against the
principal debtor, creditor and the co-sureties. It also covers a brief case study in relation to the rights of the
sureties or which can also be called as obligations. The project just not helped me in the detailed studies
regarding surety but also will ought to help me in scoring good marks in the university exams and to the
topping it also changed my views and it grew a certain enthusiasm in my mind.

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 BIBLIOGRAPHY

BOOK:-

1. Bangia R.K., Contract II, ALLAHABAD LAW AGENCY; 2009.

STATUTE:-

( Indian Contract Act, 1872)

WEBLIOGRAPHY:-

http://www.indiankanoon.com

http://www.judis.nic.in

https://www.lawstudenthelpline.com

https://en.wikipedia.org/wiki/surety

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