THE LIABILITY OF THE GUARANTOR / SURETY AND PRINCIPAL DEBTOR IS CO-EXTENSIVE BUT NOT IN THE ALTERNATIVE – A CRITIQUE

By Dr. T. Padma

MA (Economics), MA (Lit), MA (J & MC),

MSc (Psychology), MBA, PGDCL, PGADR,

PGDHR, LLM, PhD (Law), (LLD)

kethepadma@gmail.com

Meaning of Contract of Guarantee

A contract of guarantee is a contract to perform the promise, or discharge the liability, of a third person (principal debtor) in case of his default. It is a trilateral contract, that is, among three persons — the surety, the principal debtor and the creditor.  The person who gives the guarantee is called the surety/guarantor. 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.

The liability is Co-extensive

The liability of the surety towards the creditor is co-extensive with that of the principal debtor, unless it is otherwise provided in the contract of guarantee. A guarantor, in common law, is in no better footing than the principal debtor. It is open to the creditor to proceed legally against the guarantor first for remedy.

In the case of a loan, if a guarantor binds himself to a maximum limit of the principal debt, his liability towards the creditor would not be beyond that. A guarantee which extends to a series of transactions between the creditor and principal debtor is called continuing guarantee. It may at any time be revoked by the surety, as to future transactions between the creditor and principal debtor, by notice to the creditor.

A surety's liability to pay the debt is not removed by reason of the creditor's omission to sue the principal debtor. 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 though the principal has not been sued[1].

It is not necessary for the creditor, before proceeding against the surety, to request the principal debtor to pay, or to sue him, although solvent, unless this is expressly stipulated for[2].

The term “co-extensive” has been defined in the celebrated book of Polock & Mulla on Indian Contract and Specific Relief Act, Tenth Edition, at page 728 as under:

“Co - extensive. Surety's liability is co-extensive with that of the principal debtor. A surety's liability to pay the debt is not removed by reason of the creditor's omission to sure the principal debtor. The creditor is not bound to exhaust his remedy against the principal before suing the surety, and a suit may be maintained against the surely though the principal has not been sued.”

In Chitty on Contracts, 24th Edition, Volume 2 at page 1031 paragraph 4831 it is stated as under,

“Conditions precedent to liability of surety. Prima facie the surety may be proceeded against without demand against him, and without first proceeding against the principal debtor.”

In Halsbury's Laws of England, Fourth Edition,Vol. 20, paragraph 159 at page 87 it has been observed that "it is not necessary for the creditor, before proceeding against the surety, to request the principal debtor to pay, or to sue him, although solvent, unless this is expressly stipulated for”.

The question as to liability of a surety, its extent and the manner of its enforcement has always been a highly controversial issue in India. The Supreme Court, in the case of Industrial Investment Bank of India Ltd v. Biswanth Jhunjhunwala[3], has discussed the issue elaborately and reiterated that the liability of the guarantor / surety and principal debtor is co-extensive and not in the alternative.

Facts of the Case

The Appellant Industrial Investment Bank of India Ltd sanctioned the first short term working capital loan of ` 3 Crores in favour of Modern Malleables Limited (“Borrower Company”) on September 27, 1994. This loan agreement was signed by the Director of the Borrower Company, the Respondent herein, on behalf of the Borrower Company. The Respondent executed a demand promissory note for ` 3 Crores drawn in favour of the Appellant along with a deed of undertaking to create mortgage in respect of the immovable properties of the Borrower Company. Following this, a deed of personal guarantee was also executed by the Respondent in respect of the said loan.

The Appellant further sanctioned a second term working capital loan of `   3 Crores on March 15, 1995 in favour of the Borrower Company, in respect of which the Respondent again executed a promissory note and a deed of undertaking to create mortgage in respect of the immovable properties of the Borrower Company.

Thereafter, the Borrower Company committed defaults in the repayment of the principal amount of the loan, the accrued interest and the liquidated damages arising thereof. Some of the cheques issued on behalf of the Borrower Company by the Respondent were dishonored for want of funds. Consequently proceedings were initiated against the Respondent under section 138 of the Negotiable Instruments Act, 1881.

In view of the defaults committed by the Borrower Company, the Appellant issued a demand notice to the Borrower Company and subsequently filed an application in the High Court of Calcutta under Section 40 of the Industrial Reconstruction Bank of India Act, 1984[4] for attachment and sale of the assets of the Borrower Company. Pursuant to the above, the High Court of Calcutta issued an injunction restraining the Borrower Company from parting with any possession, disposing of or alienating or encumbering any of its said assets in any manner. The Respondent was not made party to these proceedings.

The Appellant thereafter invoked the personal guarantee given by the Respondent and served a notice upon the Respondent, calling upon him to pay a sum of `  5.4 Crores  together with further interest and liquidated damages and also filed an application against the Respondent in the Debts Recovery Tribunal[5], Calcutta for a certificate against the Respondent for a sum of ` 5.4 Crores along with further interest and liquidated damages.

While rejecting the plea of the Respondent that the rights of the Appellant against the Respondent as guarantor did not crystallize till the rights of the Appellant against the Borrower Company are established, the Presiding Officer of the Tribunal held that the Appellant cannot be forced to exhaust remedies elsewhere before proceeding against the guarantor and clarified that the liability of the guarantor is co-extensive with that of the principal debtor.

Aggrieved by this order, the Respondent filed an application under Article 227 of the Constitution of India in the High Court of Calcutta against the order, which was allowed and stay of proceedings before the Debt Recovery Tribunal was granted.  Subsequently, the Appellant preferred an appeal to the Supreme Court.

Judgment of the Apex Court

The counsel on behalf of the Appellant, inter alia, relied upon the earlier decision of the Supreme Court in the case of Bank of Bihar vs. Damodar Prasad & Another[6] in which case it was held by the Supreme Court that a creditor is not bound to exhaust his remedy against the principal debtor before suing the surety and that when a decree is obtained against a surety, it may be enforced in the same manner as a decree for any other debt.

The decision of the Division Bench of the Bombay High Court in the case of Jagannath Ganeshram Agarwala vs. Shivnarayan Bhagirath and Ors[7]. was also relied upon wherein it was held that both the principal debtor and the surety are liable to the creditor at the same time.

In view of the arguments advanced and authorities cited, it was held by the Supreme Court that the liability of the guarantor and the principal debtor is co-extensive and not in the alternative. Notwithstanding the fact that they stem out from the same transaction, the two liabilities are separate and distinct.

The Supreme Court, therefore, set aside the impugned order of the High Court of Calcutta and awarded costs of  ` 50,000 to the Appellant.

Some Judicial Pronouncements on same issue

In a series of decisions the Supreme Court has restated the law relating to the extent and proportion of liability of a guarantor/surety. Referring to a wide array of decisions on the issue, the Supreme Court reiterated the legal position that the liability of the surety/guarantor is co-extensive with the principal debtor, unless it is otherwise provided by the contract and that a creditor is not bound to exhaust his remedy against the principal debtor before suing the surety/guarantor. The Supreme Court discussed these decisions as under:

1)     In Bank of Bihar Ltd. v. Damodar Prasad & Another[8],  the court referred to a judgment in Lachhman Joharimal v. Bapu Khandu and Tukaram Khandoji[9], in which the Division Bench of the Bombay High Court held as under:

"The court is of opinion that a creditor is not bound to exhaust his remedy against the principal debtor before suing the surety and that when a decree is obtained against a surety, it may be enforced in the same manner as a decree for any other debt."

The Apex Court, while approving the said judgment, observed that,

“the very object of the guarantee is defeated if the creditor is asked to postpone his remedies against the surety. In the present case the creditor is a banking company. A guarantee is a collateral security usually taken by a banker. The security will become useless if his rights against the surety can be so easily cut down.”

2)     A Division Bench of the Bombay High Court in Jagannath Ganeshram Agarwala v. Shivnarayan Bhagirath and Ors[10] held that the liability of the surety is co-extensive, but is not in the alternative. Both the principal debtor and the surety are liable at the same time to the creditors.

3)     In the case of Lachhman Joharimal v. Bapu Khandu and Tukaram Khandoji[11], in which the Division Bench of the Bombay High Court held as under:

"The court is of opinion that a creditor is not bound to exhaust his remedy against the principal debtor before suing the surety and that when a decree is obtained against a surety, it may be enforced in the same manner as a decree for any other debt."

The Apex Court, while approving the said judgment, observed that, "the very object of the guarantee is defeated if the creditor is asked to postpone his remedies against the surety. In the present case the creditor is a banking company. A guarantee is a collateral security usually taken by a banker. The security will become useless if his rights against the surety can be so easily cut down."

4)     In State Bank of India v. M/s. Indexport Registered[12], the Apex Court held that the decree holder bank can execute the decree against the guarantor without proceeding against the principal borrower. Guarantor's liability is co- extensive with that of the principal debtor. In that case, this court further observed that, "the execution of the money decree is not made dependent on first applying for execution of the mortgage decree. The choice is left entirely with the decree- holder. The question arises, whether a decree which is framed as a composite decree as a matter of law, must be executed against the mortgage property first or can a money decree, which covers whole or part of the decretal amount covering mortgage decree can be executed earlier. There is nothing in law which provides such a composite decree to be first executed only against the principal debtor. The court further observed that "the liability of the surety is co-extensive with the principal debtor, unless it is otherwise provided by the contract".

5)     In the case of Jagannath Ganeshram Agarwala v. Shivnarayan Bhagirath and Ors[13], a Division Bench of the Bombay High Court held that the liability of the surety is co-extensive, but is not in the alternative. Both the principal debtor and the surety are liable at the same time to the creditors.

6)     In The Hukumchand Insurance Co. Ltd. v. The Bank of Baroda & Others[14], a Division Bench of the High Court of Karnataka had an occasion to consider the question of liability of the surety vis-a-vis the principal debtor. The court held as under:-

"The question as to the liability of the surety, its extent and the manner of its enforcement have to be decided on first principles as to the nature and incidents of suretyship. The liability of a principal debtor and the liability of a surety which is co- extensive with that of the former are really separate liabilities, although arising out of the same transaction. Notwithstanding the fact that they may stem from the same transaction, the two liabilities are distinct. The liability of the surety does not also, in all cases, arise simultaneously."

The case of the respondent has never been that the liability of the guarantor is only contingent and if remedies against the principal debtor failed to satisfy the dues of the decree holder, then only the bank can proceed against the guarantor.

7)     In Transcore v. Union of India & Another[15], the Apex Court in great detail examined whether withdrawal of suit pending before the Debts Recovery Tribunal under DRT Act is not a pre-condition for taking recourse to the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 and held that it is for the bank or the financial institution to exercise its discretion.

8)     In A.P. State Financial Corporation v. M/s Gar Re- Rolling Mills & Another[16]  the Apex  Court observed that the right vested in the corporation under section 29 of the Act is besides the right already possessed at common law to institute a suit or the right available to it under section 31 of the Act. In that case, it was further observed that on a conjoint reading of sections 29 and 31 of the said Act, it appears that in case of default in repayment of loan or any installment or any advance or breach of an agreement, the Corporation has two remedies available to it against the defaulting industrial concern, one under section 29 and another under section 31. Since, the corporation must be held entitled and given full protection by the court to recover its dues it cannot be bound down to adopt only one of the two remedies provided under the Act. The Court further held that the doctrine of election is not applicable to this case.

Conclusion

Now, the legal position with regard to the liability of a guarantor or a surety, is crystallized by a series of judicial pronouncements as discussed above. Thus, the liability of the guarantor and a principal debtor is co-extensive and not in alternative. A creditor is not bound to exhaust his remedy against the principal debtor before suing the surety and that when a decree is obtained against a surety, it may be enforced in the same manner as a decree for any other debt. The surety has no right to restrain execution of the decree against him until the creditor has exhausted his remedy against the principal debtor for the reason that it is the business of the surety/guarantor to see whether the principal debtor has paid or not. Therefore a guarantor’s liability to pay the debt is not dissolved simply due to the creditor’s omission to sue the principal debtor and a suit may be maintained against the guarantor even though the principal debtor has not been sued at all. Summarising the law on the issue of recovery of loan from its guarantors in the light of various earlier judgments, the Apex Court said recovery of public dues must be made strictly in accordance with the procedure prescribed by law.

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[1] Polock & Mulla on Indian Contract and Specific Relief Act, Tenth Edition, at page 728

[2] Halsbury's Laws of England, Fourth Edition,Vol. 20, paragraph 159 at page 87

[3] Industrial Investment Bank of India Ltd v. Biswanth Jhunjhunwala ; (2009) 9 SCC 478

[4] Section 40 of the IRBI, 1984 states in detail the procedure for “Enforcement of claims by the Reconstruction   Bank”.

[5] Under section 19 of the Recovery of Debts Due to Bank and Financial Institutions Act, 1993

[6] Bank of Bihar vs. Damodar Prasad & Another ; (1969) 1 SCR 620

[7] Jagannath Ganeshram Agarwala vs. Shivnarayan Bhagirath and Ors; AIR 1940 Bombay 247

[8] Bank of Bihar Ltd. v. Damodar Prasad & Another; (1969) 1 SCR 620

[9] Joharimal v. Bapu Khandu and Tukaram Khandoji; (1869) 6 Bombay High Court Reports 241

[10]  Jagannath Ganeshram Agarwala v. Shivnarayan Bhagirath and Ors;  AIR 1940 Bombay 247

[11] Lachhman Joharimal v. Bapu Khandu and Tukaram Khandoji (1869) 6 Bombay High Court Reports 241

[12] State Bank of India v. M/s. Indexport Registered ; 1992 AIR 1740, 1992 SCR (2)1031

[13] Jagannath Ganeshram Agarwala v. Shivnarayan Bhagirath and Ors; AIR 1940 Bombay 247

[14] The Hukumchand Insurance Co. Ltd. v. The Bank of Baroda & Others; AIR 1977 Kant 204

[15] Transcore v. Union of India & Another; (2008) 1 SCC 125

[16] A.P. State Financial Corporation v. M/s Gar Re- Rolling Mills & Another; (1994) 2 SCC 647