A contract of guarantee is an arrangement where a surety promises to discharge the liability of a principal debtor if the latter defaults on their duties to a creditor. This mechanism is important in commercial transactions because it provides a secondary layer of security for the creditors. However, the surety's liability is not absolute since it can be discharged under specific circumstances given under Indian Contract Act, 1872. These circumstances ensure fairness and protect the surety from undue prejudice. Understanding the discharge of surety under contract of guarantee is essential for anyone involved in such contracts as they define the limits of the surety's responsibility and the conditions under which they can be released from liability.
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Meaning of Discharge of Surety from Liability
A surety is someone who promises to pay a creditor if the borrower (principal debtor) fails to do so. The discharge of a surety from liability means the surety is no longer responsible for fulfilling this promise. Under the Indian Contract Act, 1872, this can happen in several ways
Revocation: The surety can cancel or revoke their commitment, usually before the debt is due or if the contract allows it.
Conduct of Parties: If the creditor or debtor does something that changes the agreement (like altering terms without the surety’s consent) then, the surety may be released.
Invalid Contract: If the original agreement becomes void or unenforceable, the surety’s obligation ends.
These rules protect the surety from being unfairly held responsible, ensuring fairness in the agreement between the creditor, debtor and surety.
Discharge of Surety from Liability by Revocation
A surety can be discharged from liability by revoking their guarantee under several conditions, which is primarily applicable to continuing guarantees.
Revocation of Surety by Giving Notice
According to Section 130 of Indian Contract Act, 1872, a continuing guarantee can be revoked by the surety at any time by giving notice to the creditor. This revocation applies only to future transactions and does not affect the liability of the surety for transactions that have already occurred. For example, if A guarantees B’s payments up to ₹50,000 and later revokes the guarantee then, A remains liable for payments made before the revocation but not for future ones. However, an ordinary guarantee for a specific transaction cannot be revoked once it has been acted upon.
Revocation by Death
Section 131 of the Indian Contract Act, 1872, provides that the death of the surety operates as a revocation of a continuing guarantee for future transactions, unless there is a contract to the contrary. For past transactions, the legal representatives of the deceased surety remain liable to the extent of the property inherited by them. This ensures that the surety’s estate is not indefinitely bound for future obligations after their demise.
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Discharge of Surety from Liability by the Conduct of the Parties
The surety can be discharged due to actions or omissions by the creditor or principal debtor that affect the rights and obligations of a surety.
Discharge by Variance in Terms of the Contract
Under Section 133, any variance in the terms of the contract between the creditor and the principal debtor, made without the surety’s consent, discharges the surety as to transactions subsequent to such variance. This protects the surety from being liable for a contract they did not originally agree to.
Release or Discharge of the Principal Debtor
Section 134 states that the surety is discharged by any contract between the creditor and the principal debtor that releases the principal debtor or by any act or omission of the creditor that legally discharges the debtor. This includes express agreements or actions that indirectly release the debtor, except in cases of insolvency where the surety may remain liable for a reduced amount under debt relief acts.
Compounding by Creditor with Principal Debtor
As per Section 135, if the creditor enters into a composition with the principal debtor, promises to give them time, or agrees not to sue them without the surety’s consent, the surety is discharged. This provision, along with Section 136 (agreement with a third party does not discharge the surety) and Section 137 (mere forbearance does not discharge) ensures that the surety is not bound by unauthorized alterations to the repayment terms.
Creditor’s Act/Omission Impairing Surety’s Eventual Remedy
Section 139 provides that if the creditor does any act inconsistent with the surety’s rights or omits to do something required by their duty to the surety, impairing the surety’s eventual remedy against the principal debtor, the surety is discharged. For example, if the creditor’s actions prevent the surety from recovering from the debtor, the surety is released from liability.
Loss of Security
Section 141 entitles the surety to the benefit of any security held by the creditor against the principal debtor at the time of the guarantee, whether the surety was aware of it or not. If the creditor loses or parts with this security without the surety’s consent, the surety is discharged to the extent of the value of the security. This was reinforced in Amritlal Goverdhan Lalan v State Bank of Travancore, where the Supreme Court clarified the surety’s right to securities.
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Discharge of Surety from Liability by the Invalidation of the Contract
The surety can be discharged if the contract of guarantee is invalidated due to defects in its formation.
Guarantee Obtained by Misrepresentation (Section 142)
If a guarantee is obtained by the creditor through misrepresentation of a material fact, the contract is invalid and the surety is discharged. This ensures that the surety is not bound by a contract based on false information provided by the creditor.
Guarantee Obtained by Concealment (Section 143)
Similarly, if the creditor obtains a guarantee by concealing a material fact, the contract is invalid and the surety is discharged. This protects the surety from entering into a contract without full knowledge of relevant circumstances.
Failure of a Co-Surety to Join as a Surety (Section 144)
If a person gives a guarantee on the condition that another person will join as a co-surety and that condition is not fulfilled, the guarantee is invalid and the surety is discharged. This ensures that the surety’s liability (Section 128) is contingent on the agreed-upon terms of co-suretyship.
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Summary
The Indian Contract Act, 1872, provides for the discharge of a surety from liability under a contract of guarantee, where these provisions protect the surety against unfair practices, unauthorized changes in the contract or defects in its formation. By clearly outlining the circumstances under which a surety can be discharged, the law promotes fairness and transparency in guarantee agreements along with safeguarding the interests of all parties involved. Understanding these mechanisms is crucial for creditors, debtors and sureties to navigate their obligations and rights effectively.
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Discharge of Surety under Contract of Guarantee: FAQs
Q1. What is a discharge of surety?
A discharge of surety occurs when a surety’s liability under a contract of guarantee is extinguished due to specific actions or events, such as contract variation, creditor’s release of the debtor, or impairment of the surety’s remedies.
Q2. What is discharge of surety section 135?
Section 135 of the Indian Contract Act, 1872, states that a surety is discharged if the creditor and principal debtor make a new agreement varying the original contract terms without the surety’s consent, provided the variation materially affects the surety’s liability.
Q3. What is the discharge of sureties under CPC?
Under the Code of Civil Procedure (CPC), sureties may be discharged if the court decree is satisfied, the principal debtor is released, or the surety’s obligations are fulfilled, as seen in provisions like Order 38, Rule 5 for security bonds.
Q4. What is Section 132 of the contract of guarantee?
Section 132 of the Indian Contract Act, 1872, provides that when two or more persons are co-sureties, the release of one co-surety by the creditor does not discharge the others, nor does it free the released surety from liability to contribute to the others.
Q5. What is the case law for discharge of surety?
In Union of India v. Manku (1987), the Supreme Court held that a surety is discharged if the creditor’s actions, like releasing securities without consent, prejudice the surety’s rights, illustrating discharge under Section 141 of the Indian Contract Act.
