The Indian Contract Act of 1872 says that a contract of guarantee is an agreement in which a surety promises to keep a promise or release a principal debtor from their responsibility if they don't. There is a creditor, a principal debtor, and a surety in this deal. Each has their own roles and responsibilities. As the recipient of the guarantee, the creditor has certain rights against the surety to make sure that the debtor pays their debts. This article goes into great detail about the rights of creditor against surety, including what the law says about them and when they can be used. It's a good way to learn about this important part of Indian contract law.
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What is a Contract of Guarantee
According to Section 126 of Indian Contract Act, 1872, a contract of guarantee is a contract to perform the promise or discharge the liability of a third person in case of their default. The key parties involved are:
Creditor: The person to whom the guarantee is given, generally the lender or beneficiary of the obligation.
Principal Debtor: The individual or entity whose default triggers the liability of the surety.
Surety: The person who provides the guarantee, agreeing to be responsible for the obligations of the debtor if they fail to perform their duty.
For example, if A guarantees a loan which is taken by B from C, A (the surety) becomes liable to repay C (the creditor) if B (the principal debtor) defaults, which ensures that the creditor has an additional layer of security, making the contract of guarantee a vital tool in financial and commercial transactions.
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Rights of Creditor Against Surety
The Indian Contract Act provides specific rights of creditor against surety in a contract of guarantee. These rights are governed by Sections 128 and Section 141 of the Act which ensures that the creditor can recover their dues efficiently
1. Right to Sue Surety Directly (Section 128)
The creditor has the right to proceed directly against the surety without first exhausting remedies against the principal debtor. Section 128 of the Act states that the surety’s liability is co-extensive with that of the principal debtor, unless the contract specifies otherwise. This means the creditor can demand payment from the surety immediately upon the default of debtor without needing to sue the debtor first.
Example: If B borrows ₹1,00,000 from C, with A as the surety and B defaults, C can directly sue A for the repayment of ₹1,00,000, including any accrued interest or costs.
Case Law: In State Bank of India v. Prem Chand Jain, the Supreme Court affirmed that a creditor can proceed against the surety without first pursuing the principal debtor.
This right of creditor against surety provides creditors with flexibility, efficiency and ensuring that they can recover their dues even if the principal debtor is insolvent or unavailable.
2. Right to Claim Full Amount
The surety’s liability under Section 128 is co-extensive with that of the principal debtor, which means that the creditor can claim the entire amount of the debt, including principal, interest and any associated costs, from the surety. This right ensures that the creditor is fully compensated for the default by the debtor but the contract does not limit the surety’s liability.
For Example: If the principal debtor owes ₹1,00,000 with ₹10,000 in interest, the creditor can demand the full ₹1,10,000 from the surety, unless the guarantee contract specifies a lower amount.
This right of creditor against surety underscores the protective nature of the contract of guarantee and ensures that the financial interests or creditors are safeguarded.
3. Right to Securities (Section 141)
Under Section 141 of the Act, if the creditor holds any securities (e.g., property, mortgage or pledge) from the principal debtor, the surety is entitled to the benefit of those securities. The creditor must preserve these securities for the surety’s benefit. If the surety discharges the debt, they step into the creditor’s shoes and can claim these securities.
Example: If C holds a mortgage on B’s property as security for a loan guaranteed by A and A pays off the loan, A can claim the mortgage to recover their payment from B.
Case Law: In State of Madhya Pradesh v. Kaluram, the court held that a creditor’s failure to preserve securities can discharge the surety to the extent of the value of the lost securities.
This right imposes a duty on the creditor to act responsibly with any securities, ensuring fairness in the guarantee arrangement.
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Conditions and Limitations in Rights of Creditor against Surety
While the creditor enjoys significant rights, these are subject to conditions and limitations to protect the surety’s interests. The following are key circumstances that may affect the creditor’s ability to enforce their rights
Discharge of Surety
The surety may be discharged from liability under specific conditions which limit the rights of creditor against surety
Variation of Contract (Section 133): If the creditor alters the terms of the contract with the principal debtor without the surety’s consent, the surety is discharged. For example, if C extends the repayment period for B without the consent of A, A may be released from liability.
Release of Principal Debtor (Section 134): If the creditor releases or discharges the principal debtor without the surety’s consent, the surety is discharged.
Impairment of Surety’s Remedy (Section 139): If the creditor acts in a way that impairs the surety’s eventual remedy against the principal debtor, such as by losing securities, the surety may be discharged to the extent of the impairment. For example: If C allows B to sell a secured asset without A’s consent, A may be discharged from liability to the extent of the asset’s value.
Continuing Guarantee
In a continuing guarantee (Section 129), where the surety’s liability extends to a series of transactions, the surety can revoke the guarantee for future transactions by giving notice to the creditor (Section 130). Additionally, the death of the surety revokes a continuing guarantee for future transactions, unless the contract specifies otherwise (Section 131).
Example: If A guarantees B’s ongoing credit purchases from C, A can revoke the guarantee for future purchases by notifying C, but remains liable for purchases made before revocation.
Notice of Default
In some cases, the contract may require the creditor to notify the surety of the principal debtor’s default. Failure to provide such notice, if stipulated, may affect the creditor’s ability to enforce the guarantee.
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Summary
The rights of creditor against surety in a contract of guarantee under the Indian Contract Act, 1872, are designed to provide security and assurance to the creditor while maintaining fairness for the surety. The ability to sue the surety directly, claim the full amount of the debt and benefit from securities ensures that creditors can recover their dues efficiently. However, these rights are tempered by conditions such as the discharge of the surety due to unauthorized contract variations or loss of securities. Understanding these rights and their limitations is important for creditors, sureties and legal practitioners to navigate the complexities of guarantee contracts effectively. By adhering to the provisions of the Indian Contract Act, the creditors can safeguard their interests while respecting the legal protections afforded to sureties.
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Rights of Creditor Against Surety: FAQs
Q1. What are the rights of surety under Section 140?
Under Section 140 of the Indian Contract Act, 1872, a surety, upon discharging the debt of the principal debtor, gains the right to step into the creditor's shoes and recover from the principal debtor all payments properly made, including interest, and is entitled to all securities held by the creditor.
Q2. What is Section 146 of the Contract Act?
Section 146 states that when multiple co-sureties guarantee the same debt, each is liable to contribute equally to the debt, unless otherwise agreed, but only up to the extent of their respective obligations.
Q3. What is the creditor's act for discharge of surety?
A surety is discharged if the creditor, without the surety's consent, makes a binding arrangement with the principal debtor to extend time for repayment or not to sue, as per Section 135, or if the creditor's act/omission impairs the surety's remedies (Section 139).
Q4. What is the right of indemnity in surety?
Under Section 145, a surety has the right to recover from the principal debtor all payments properly made on their behalf, including costs and losses incurred due to the guarantee, as an implied indemnity.
Q5. What are the rights of a surety against a creditor?
A surety has the right to demand all securities held by the creditor (Section 141), be discharged if the creditor impairs the surety's remedies or securities (Section 139) & seek subrogation to the creditor’s rights upon payment (Section 140).
