CONTRACT OF GUARANTEE

Definition and Meaning

Guarantee is an undertaking to answer for another’s liability and collateral thereto.

It is a collateral undertaking to pay the debt of another in case he does not pay it.
It is a provision to answer for the payment of some debt, or the performance of
some duty in the case of failure of some person who, in the first instance, is liable
for such payment or performance.

Bouvier’s Law Dictionary gives the meaning of guarantee as a promise to answer

for the debt, default, or miscarriage of another person1.

Guarantee is an. undertaking to be collaterally responsible for the debt, default or

miscarriage of another. In a banking context it is an undertaking given by the
guarantor to the banker accepting responsibility for the debt of the principal debtor,
the customer, should he or she default. The guarantor may or may not be a
customer

A Guarantee is a promise by one person, who is called the ‘guarantor’ or ‘surety’ to

answer for the present or future debt of another person who is called the ‘principal
debtor’, such promise being made to the party to whom the principal debtor is, or
will become, liable.

In Lord Halsbury’s Laws of England a guarantee is defined as "an accessary contract

whereby the promisor undertakesto be answerable to the promisee for the debt,
default or miscarriage of another person whose primary liability to the promisee
must exist or be contemplated. The words surety and guarantor are used as
synonymous terms in Indian law and English Law.

In American law, guarantee is distinguished from suretyship in being a secondary,

while suretyship is a primary, obligation; or, as sometimes defined, guarantee is an
undertaking that the debtor shall pay; suretyship, that the debt shall be paid. A
surety differs from a guarantor, who is liable to the creditor only if the debtor does
not meet the duties owed to the creditor; the surety is directly liable. While a
surety’s liability begins with that of the principal, a guarantor’s liability does not
begin until the principal debtor is in default.

In India, Contract of Guarantee is included in the Indian Contract Act, 1872 and is
defined under section 126 as follows

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 person who gives the guarantee
is called the "Surety"; the person in respect of whose default the guarantee is given
is called the "Principal debtor", and the person to whom the guarantee is given is
called the "Creditor". A guarantee may be either oral or written.

Though a contract of guarantee may be oral or in writing in India it must be

required to be in writing only in England. Oral Guarantee In P.J. Rajappan v
Associated Industries (P) Ltd [1990 (1) All India Bkg Law Judgments 321],
the guarantor, having not signed the contract ofguarantee, wanted to wriggle out
ofthe situation. He contended that he did not stand surety for the performance
ofthe contract. Evidence showed involvement of the guarantor in the deal, having
promised to sign the instrument later.

The Kerala High Court held that a contract of guarantee is a tripartite agreement,
involving the principal debtor, surety and the creditor. In a case where there is an
evidence of involvement of the guarantor, the mere failure on his part in not
signing the agreement is not sufficient to demolish otherwise acceptable evidence
of his involvement in the transaction leading to the conclusion that he guaranteed
the due performance of the contract by the principal debtor. When a court has to
decide whether a person has actually guaranteed the due performance of the
contract by the principal debtor all the circumstances concerning the transactions
will have to be necessarily considered. Court cannot adopt a hypertechnical attitude
that the guarantor has not signed the agreement and so he cannot be saddled with
the liability. Due regard has to be given to the relative position of the contracting
parties and to the entire circumstances which led to the contract.

Under Section 126 of the Contract Act, a contract of guarantee need not necessarily
be in writing; it may be express by words of mouth, or it may be tacit or implied
and may be inferred from the course ofthe conduct of the parties concerned.
Contracts of guarantee have to be interpreted taking into account the relative
position of the contracting parties in the backdrop of the contract. The court has to
consider all the surrounding circumstances and evidence to come to a findingwhen
the guarantorrefutes his lability.

In Mathura Das v Secretary ofState (AIR 1930 All 848) and in Nandlal
Chanandas v Firm Kishinchand (AIR 1937 Sindh 50), it was held that contract
of guarantee can be created either by parol or by written instrument and that it
may be express or implied and may be inferred from the course of the conduct of
the parties concerned. There is overwhelming evidence in this case that the second
defendant had guaranteed the due performance ofthe contract by the first
defendant, principal debtor. Hence the mere omission on his part to sign the
agreement cannot absolve him from his liability as the guarantor.

To be legally effective a guarantee must be given for debt which is enforceable. If

the debt is not enforceable, the guarantee will not be enforceable. Thus a minor not
being answerable for a debt he incurs, a guarantee for such debt is likewise void.
-Coutts & Co v Brown Lecky and others [1946] 2 All E.R. 207

Some banks include a clause in their form of guarantee providing that where the
debtor is under a legal disability, such as minor, etc., the surety shall be liable as
principal.

A guarantee is a very convenient form ofsecurity, and because ofthe ease with
which it can be given, a banker should be careful to make clear to a proposed
surety the nature of the document which he has to sign, although such a party
cannot later plead ignorance of the contents of the guarantee.

A contract of guarantee should be entered into freely and voluntarily by the

guarantor. Fry J. in Davies v London and Provincial Marine Insurance Co.
said "Everything like pressure used by the intending creditor will have a very
serious effect on the validity of the contract". It is essential that a guarantee form
should be most carefully drawn so as to create an effective security, and bankers
have their own printed forms of guarantees drafted so as to meet, as far as
possible, the various requirements of a good and complete guarantee.

Value of the Guarantee

A guarantee is probably the simplest form of banking security, more easily obtained
than any other and yet frequently most difficult to realise.

It is an intangible security which may or may not be of adequate value when it is

most needed. Few guarantors ever expect to be called upon to honour their
contract and therefore it is imperative that the lending banker should exercise the
greatest care in obtaining the guarantee and thereafter in ensuring that it is at all
times worth what is required from it.

The real value of any guarantee depends entirely on the financial ability or solvency
of the guarantor to meet the liability with reasonable promptitute when called upon
to do so. The undoubted standing of the guarantor must apply not only when the
contract is signed, but throughout the subsistence of the contract of guarantee.
Fortunes can still change overnight, so that a vigilant watch must always be
maintained on the financial position of the guarantor upon whom reliance is placed.

Essentials of a Guarantee

Guarantees are encrusted with law. This is no doubt attributable to the fact that
guarantors have, historically, sought every available legal means to avoid a liability
which, human nature being what it is, they did not expect to have to meet when
they gave the guarantee. As a result lawyers have drafted provisions into
guarantees to counter vulnerability of the obligation and to redress the balance.
The business side of the contract of guarantee is concerned with solvency of the
surety, the legal side with the provision of an effective contract which will in
conceivable circumstances give the banker a good legal remedy against the surety.

The best banking approach to the subject of guarantees is to recognise the

following essentials :

1. The value of the guarantee, which must be maintained throughout the period of
the advance to the customer

2. The validity ofthe guarantee, which means in general that the guarantor’s mind
must run with his pen at the time he signs his guarantee and that nothing shall
happen to enable the guarantor later to avoid liability on the grounds of mistake,
duress, or undue influence.

3. The form of guarantee which must cover all possibilities, limiting the common
law rights of the guarantor and permitting wide freedom to the banker in dealing
with the borrower. Each bank has its own form ofguarantee printed for general use.
At first sight it is a verbose (using more words than are needed) and unduly lengthy
document, but every phrase and condition is essential.

4. The greatest care is necessary when obtaining the signature _ of the guarantor
to the guarantee. The endless legal phraseology ofthe document itselfwill be of little
value ifthe guarantor’s mind does not run with his pen. As many guarantors will
seek some loophole to try to wriggle out ofthe liability, patience and close attention
is always necessary at the outset to ensure that the guarantee is valid. It is not a
routine task but one demanding skill and knowledge and any attempt to rush the
completion is fraught with danger. The trouble arises when the security needs to be
realised and carelessness can jeopardise the bank’s cause of action against the
guarantor.

The law leans in favour of the guarantor, with the result that ifthe creditor
oversteps in any way the letter of his contract he will usually find that his security
has vanished. It should be borne in mind that no guarantor ever expects to have to
pay and, when called upon to do so, will inevitably be pained and surprised

Liability

The word ‘liability’ in Section 126 of the Indian Contract Act, 1872, means a
liability which is enforceable at law, and ifthat liability does not exist, there cannot
be a contract of guarantee. A surety, therefore, is not liable on a guarantee for
payment of a debt which is statute – barred- Manju Mahadev v Shivappa (1918)
42 Bom. 444; 46 IC 122
. The Supreme Court in Chattanatha Karayalar v Central Bank ofIndia Ltd AIR
1965 SC 185 laid down that if a transaction is contained in more than one
document between the same parties, they must be read and interpreted together.
Although a guarantor may join the principal debtor in executing the promissory
note he will not be a co - obligant where the underlying transaction and the conduct
of the parties show that he is a surety under Section 126 of the Contract Act.

Guarantor, a Preferred Debtor

Bankers always insist on getting the contracts signed on their printed guarantee
forms with practically no loophole since, to make a guarantor liable, the terms of
the guarantee are to be interpreted strictly. The Supreme Court in the State
ofMaharashtra v Dr. M.N.Kaul AIR 1967 SC 1634 confirmed the view that
under the law a guarantor cannot be made liable for more than he has undertaken;
a surety is a favoured debtor and he can be bound "to the letter of his engagement

Consideration for Guarantee

Section 127 of the Contract Act provides that anything done, or any promise
made, for the benefit of the principal debtor may be a sufficient consideration to the
surety for giving the guarantee.

Consideration is the legal detriment incurred by the promisee at the promisor’s

request and it is immaterial whether there is or is not any apparent benefit to the
promisor. Sonarlinga v Pachai Naicken (1913) 38 Mad 680; 22 IC 1

A contract of guarantee executed after the contract between the creditor and
principal debtor and without consideration is void. It must be contemporaneous
with the contract of the creditor and principal debtor. Past benefit to the principal
debtor is not a good consideration. Ram Narain v Lt. Col. Hari Singh AIR 1964
Rajasthan 76

The mere fact that A lends money to B on the recommendation of C is no

consideration for a subsequent promise by C to pay the money in default of B.
Muthukaruppa v Kathappudayan (1914) 27 MLJ 249

In an interesting case New Bank of India Ltd v Govinda Prabhu AIR 1964
Kerala 267 decided by the Kerala High Court, the Branch Manager of New Bank of
India Ltd made irregular advances on the advice of a clerk. Later on an undertaking
was given by the employees namely the manager and the clerk that the amount
ofthe two advances will be repaid within a month and also undertook to be
personally responsible for such payment (i.e. ifthe customers do not pay, they
would pay). As the amounts were not paid the bank filed suit against those two
customers and also joined the said two employees who were responsible for the two
irregular transactions and as per their undertaking, these employees stated that
their guarantee was without consideration and therefore it could not be enforced
against them. The court however held that the fact of not taking disciplinary action
against the two employees was sufficient consideration for the undertaking for their
misconduct and payment agreement as the said undertaking amounted to a lawful
contract of indemnity. On the question of limitations the court held that the
limitation began to run one month from the date of the undertaking and as the suit
was not brought within 3 years after the expiry of one month ofthe undertaking it
was time - barred against the said two employees and as such dismissed.

Thus it will be clear that it is not necessary that consideration should imply
something done for the benefit of the guarantor but anything done for the benefit
of the principal debtor is considered as an adequate consideration for the guarantor
to make the contract valid. Even forbearance on the part of the bank not to sue the
debtor will constitute a good consideration. In State Bank of India v Premco
Saw Mill AIR 1984 Gujarat 93 , the State Bank gave notice to the debtor -
defendant and also threatened legal action against her, but her husband agreed to
become surety and undertook to pay the liability and also executed promissory note
in favour ofthe State Bank and the Bank refrained from threatened action. It was
held that such forbearance on the bank’s part constituted good consideration for
guarantor.

In Bank of Credit and Commerce International S.A. v V.KAbdul Rahiman

(1998) 92 Camp. Cas. 739 (Kerala , the Kerala High Court observed that a
guarantee is a collateral engagement to answer for the debt, default or miscarriage
of another as distinguished from an original and direct engagement for the party’s
own act. For the validity of a contract of guarantee it is adequate consideration if
anything is done or any promise made for the benefit ofthe principal debtor. The
creditor must have done something for the principal debtor to sustain the validity of
the contract of guarantee. Anything done or any promise made for the benefit of
the principal debtor must be contemporaneous to the surety’s contract ofguarantee
in orderto constitute consideration therefor. A contract ofguarantee executed
afterwards without any consideration is void. The word ‘done’ in the Section 127
ofthe Indian Contract Act, 1872 is not indicative ofthe inference that past benefit
to'the principal debtor can be good consideration.

The consideration for the surety’s promise has not to come from principal debtor,
but from the creditor. It need not benefit surety although it may do so and it may
consist wholly of some advantage given to or conferred on the principal debtor by
the creditor at the surety’s request. The consideration may take the form of
forbearance by the creditor at the surety’s request, to sue the principal debtor or of
the actual suspension of pending legal proceedings against him. The mere fact
offorbearance is not, however, of itself a consideration for a person’s becoming
surety for the payment of a debt. There must be either an undertaking to forbear or
an actual forbearance at surety’s express or implied request. An agreement to
forbear for a reasonable time will provide sufficient consideration to support a
surety’s promise.

Scope of Guarantee

In determining the scope of guarantee, two important points arise : Is the

guarantee a specific one, that is, one intended to apply to a particular debt, or a
continuing one which extends to a series oftransactions between the banker and his
debtor? In case of specific guarantee, the guarantor’s liability will cease as soon as
the particular advance is repaid. The guarantor will not be liable if the debtor pays
back the amount borrowed and takes a fresh loan from the bank. On the other
hand, if the guarantee is to be a continuing one the guarantor will be liable for the
balance irrespective of the payments made by the principal debtor, as they would
go towards the repayment of earlier advances. For this reason, bankers always
prefer to have a continuing guarantee so that the guarantor’s liability will not be
limited to the original advance but should also extend to all subsequent debts. By
Section 38 ofthe Indian Partnership Act, 1932 which lays down that "a
continuing guarantee given to a firm or a third party in respect of the
transactions of the firm is, in the absence of an agreement to the contrary, revoked
as to future transactions from the date of any change in the constitution ofthe
firm". That is to say, except where an agreement to the contrary exists, a
guarantee extending to a series of transactions, given by surety to the firm as
creditor, or to a third party on behalf of the firm as principal debtor, is revoked as
to future transactions by a change in the constitution of the firm which may occur
by death, insolvency or retirement of a partner, or by the admittance of a new
partner. A banker has to see that such contingencies are provided for in the
continuing guarantees.

Continuing guarantees may be revoked by giving notice to the creditor. If the

guarantee provides that notice of certain length of time should be given, the surety
should comply with the same Offord v Davies (1862) 12 CBNS 748 . In the
absence to the contrary, the death of the guarantor operates as revocation of a
continuing guarantee as to future transactions. After the death of the guarantor the
guarantee is revoked for future transactions and guarantor’s estate will be liable for
all transactions entered into before the death of the guarantor. Where continuing
guarantee is given by two or more persons and one of them dies, the survivor or
survivors remain liable. Beeket v Addyman (1882) 8 QBD 783

In Margaret Lalitha Samuel v Indo Commercial Bank Ltd, the Supreme Court
held that in continuing guarantee the period of limitation will commence to run only
from the date of breach. In this case an overdraft was given by the bank to the
company and the Director executed a continuing guarantee bond. The Supreme
Court held that so long as the account is a live account in the sense it is not settled
and there is no refusal on the part ofthe guarantor - director to carry out the
obligation the period of limitation does not commence to run. Limitation will run
only from the date ofthe breach under Article 115 ofthe schedule to the Indian
Limitation Act, 1908.

It was held by the Calcutta High Court in Montosh Kumar Chatterjee v Central
Calcutta Bank Ltd (1953) 23 comp. Cas. 491 that the effect of a continuing
guarantee is not to secure amounts advanced on different occasions but to secure
the floating balance which may be due from time to time and it is the date of the
accrual of that balance which is relevant for the purposes oflimitation when it is
sued for. The surety’s obligation to pay would arise immediately on default
committed by the principal debtor and once a cause of action against the surety has
arisen the commencement of the running of time is not further postponed till the
making of a demand.

Surety as Trustee

So far as the expression ‘Fiduciary Capacity’ is concerned it is not restricted to

technical or express trusts, but includes imparting of a confidence on the basis of
which a person acts as a guarantor while giving an undertaking. It is within the
knowledge ofthe guarantor that the money is being advanced on the strength of the
confidence reposed in the guarantor and in such cases, the position of the
guarantor is very near to that of a trustee. In the case V.Velayudhan v State
Bank of India , (1988) 64 Comp. Cas 52 (Kerala) the bank had obtained a decree
for recovery of a loan on the basis of a guarantee and since the principal debtor
died, the bank took execution proceedings against the guarantor. The guarantor
pleaded that he had no means to pay the debt which was not accepted by the court
and it was held that the surety could be proceeded against tinder Section 51 (c) of
the of Civil Procedure, 1908 (for arrest and imprisonment). The court further held
that the surety who guaranteed repayment had an obligation to account in fiduciary
capacity.

The Supreme Court in Jolly George Varghese v The Bank of Cochin observed
that the words "or has had since the date ofthe decree, the means to pay the
amount ofthe decree" occuring in Section 51, C.P.C. may imply, ifsuperficially read,
that if at any time after the passing of an old decree the judgment - debtor had
come by some resources and had not discharged the decree, he could be detained
in prison even though at the later point of time he was found to be penniless. This
was not a sound position apart from being inhuman going by the Art. 11 ofthe
International Covenant on Civil and Political Rights and Art. 21 of the Constitution.
Where the judgment - debtor if once had the means to pay the debt but
subsequently after the date of decree, has no such means or he has money on
which there are some other pressing claims; it is violative ofArt. 11 ofthe Covenant
to arrest and confine him in jail so as to coerce him into payment. Section 51 of the
Civil Procedure Code embodies same principle as that which is embodied in Art. 11
of the Covenant.

The Covenant bans imprisonment merely for not discharging the decreed debt.
Unless there be some other vice or mens rea apart from failure to foot the decree,
international law frowns on holding the debtor’s person in civil prison, as hostage
by the court. 20 AIR 1980 SC 470 108 The simple default to discharge the decree is
not enough. There must be some element of bad faith beyond mere indifference to
pay, some deliberate or recusant disposition in the past or alternatively, current
means to pay the decree or a substantial part of it. The provision emphasises the
need to establish not mere omission to pay but an attitude ofrefusal as demand
verging on dishonest disowning ofthe obligation under the decree. Here
considerations of the debtor’s other pressing needs and straightened circumstances
will play prominently. The Supreme Court further held that it is too obvious to need
eleboration that to cast a person in prison because of his poverty and consequent
inability to meet his contractual liability is appalling. To be poor, in this land of
Daridra Narayana (land of poverty) is no crime and recover debts by the procedure
of putting one in prison is too flagrantly violative of Art. 21 of the Constitution
(protection of life and personal liberty) unless there is some proof of the minimal
fairness of his wilful failure to pay in spite of his sufficient means and absence
ofmore terribly pressing claims on his means such as medical bills to treat cancer or
other grave illness. Article 11 ofthe International Covenant on Civil and Political
Rights states that no one shall be imprisoned merely on the ground ofinability to
fulfil a contractual obligation. The Supreme Court elaborately discussed the
provisions of Section 51 (c) of Civil Procedure Code in comparison with Article 11 of
the International Covenant on Civil and Political Rights.

It is submitted that the Supreme Court decision has laid down the dictum
that the debtor or guarantor cannot be arrested and imprisoned under
Section 51 (c) of CPC for his mere failure or inability to meet his
contractual liability.

Principle of Co - Extensiveness

Section 128 of the Contract Act provides that the liability of the surety is co -
extensive with that of the principal debtor, unless it is otherwise provided by the
contract.

A surety’s liability to pay the debt is not removed by reason of creditor’s omission
to sue the principal debtor. The creditor is not bound to exhaust his remedy against
the principal debtor before suing the surety, and a suit may be maintained against
the surety though the principal debtor has not been sued. But where the liability
arises only upon the happening of a contingency, the surety is not liable until that
contingency has taken place Subankhan v Lalkhan AIR 1947 Nag. 643

The liability of the guarantor to pay the amount under the guarantee is not
automatically suspended when the liability ofthe principal debtor is suspended
under some statutory provision. Thus a contract of guarantee being an independent
contract is not affected by liquidation proceedings against the principal debtor
M.S.E.B, Bombay v Official Liquidator H.C. Ernakulam AIR 1982 SC 1497

If on account ofa contract ofpartnership being illegal, the principal’s liability is

unenforceable, the surety will also not be liable Varadarajulu v Thavasi Nadar
AIR 1963 Madras 942

In Gerrad v James, the English Court held that a Company Director who
guaranteed a contract by the company which is ultra vires that company, remained
liable to the creditor.

The Bombay High Court held in E G. Bankruptcy : Jagannath v Shivnarayan

AIR 1940 Bombay 387 that a discharge of the principal debtor by operation of law
does not discharge the surety. If a contract ofsuretyship is a guarantee in the true
sense, namely which contains a promise to answer for the ‘debt, default or
miscarriage’ of another, then there is a strong prima facie rule of construction that
the surety’s obligations are to be interpreted as co - extensive with those ofthe
principal debtor. Accordingly, it has been held that the obligations of a guarantor of
"the due fulfilment of any obligation" of a party to a charterparty which contained
an arbitration clause, covered the debtor’s liability to pay interest and costs as well
as the principal sum awarded by the

When a surety guarantees the performance of a contractual liability on the part of

the principal to make certain payments to the creditor by instalments, there may
now be difficulties in construing the contract of guarantee in accordance with the
principle of co - extensiveness. The starting point ofthose difficulties is well
explained in Lep Air v Moschi27. In that case, the debtor defaulted under a contract
for payment in instalments for services already provided by the creditor. The
creditor treated the contract as repudiated. The question which arose was whether
the creditor could sue the surety for the balance monies due under contract at the
time ofthe repudiation, notwithstanding that when he accepted the repudiation the
debtor’s primary obligation to pay specific instalments of money became translated
into secondary obligations to pay damages. The surety’s obligation was to see to it
that the debtor performed his contractual obligations, so that when the debtor
defaulted, the surety became liable to ‘pay the creditor a sum of money for the loss
he thereby sustained’.
However, it was quite clearly envisaged in that case that the liability of the debtor
and guarantor would remain co - extensive and that no rule of construction would
be used to breach this fundamental principle. Thus Lord Diplock said in that case as
under : "Whenever the debtor has failed voluntarily to perform an obligation which
is the subject of the guarantee the creditor can recover from the guarantor as
breach ofhis contract ofguarantee whateversum the creditor could have recovered
from the debtor himself as a consequence of that failure. The debtor’s liability is
also the measure ofthe guarantor’s liability. 27 (1973) AC 331 112 Despite this
clear affirmation of the principle of co - extensiveness, the Court of Appeal and the
House of Lords subsequently construed two similar guarantees in a way which, at
least prima facie, appears to derogate from the principle of co - extensiveness. In
two cases concerning guarantees ofinstalments due from purchasers ofships under
shipbuilding contracts, the surety was held liable for certain accrued instalments
rather than the damages which the debtor was liable to pay for breach of his
obligation to pay those instalments28. The courts purportedly relied on what was
said in Lep Air case in order to reach this result. It may be that the cases turned on
their special facts and that when construed against the factual matrix the
"guarantees" were in truth indemnities, though the reasoning is hard to reconcile
with that explanation. It also appears that the principle of co - extensiveness may
not have played a very substantial part in the argument. Until the matter is
resolved, particular care will have to be used when drafting or advising on the
construction of such contracts of guarantee. Co - extensiveness of liability is one of
the essential characteristics of a guarantee that distinguishes it from contract of
indemnity. Where, therefore, the liability of a promisor under an agreement
exceeds that ofthe primary debtor, in that, for example, he may be liable, when the
primary debtor is not, or for an amount for which he is not, then the agreement is
not a guarantee, and the promisor undertakes primary liability himself. In such
circumstances, the contract in question can be viewed as an indemnity. 28 Hyundai
Shipbuilding & Heavy Industries Co. Ltd v Pournaras (1979) 1 Lloyd’s Rep 130 and
Hyundai Heavy Industries Co Ltd v Papadopoulos (1980) 1 WLR 1129 113 However,
the principle ofco - extensiveness is not an immutable rule. The precise extent of
the liability of the surety will always be governed by the provisions ofguarantee on
their true construction ofthe document, and the parties remain free to provide for
limitations of the liabilities of the surety without detracting from the nature ofthe
contract as guarantee. For example, the surety guarantees only the future
transactions, and not the past indebtedness. Furthermore, the court has not always
regarded itself as bound to treat the surety as co - extensively liable with the
principal, and there are circumstances where the surety will remain liable
notwithstanding the fact that the principal is not, or is no longer, liable for the
principal obligations29. An interesting case entitled Radha Thiagarajan v South
Indian Bank Ltd30 was decided by the Kerala High Court. In that case, the
appellant and her husband executed a continuing guarantee in favour ofthe
respondent bank for grant ofan over draft account to a textile company, the terms
of which provided that the liabilities of the sureties would remain unaffected,
notwithstanding any indulgence or release granted to the company. The bank
instituted a suit against the company and the sureties for recovery of money under
the overdraft account. The company was, meanwhile, taken over under section 18A
of the Industries (Development and Regulation) Act, 1951 and subsequently
nationalised under the Sick Textile Undertakings (Nationalisation) Act, 1974. The
suit was dismissed as against the company on the ground of availability of
alternative remedy 29 Moschi v Lep Air Services Ltd (1973) AC 331 (1988) 63
Comp. Cas. 61 30 114 under the Nationalisation Act, but decreed as against the
appellant. The appellant contended that since the liability of the principal debtor
was extinguished under the Nationalisation Act, the liability ofthe sureties was also
extinguished. It was held that under Section 5 of the Nationalisation Act, every
liability ofthe textile undertaking, other than a liability arising from loans advanced
by Government after it had been taken over under the Industries (Development
and Regulation)Act, 1951 was the exclusive liability of the owner and enforceable
against him only. Under Section 24 of the Nationalisation Act, the liability of the
owner stood discharged in respect of a claim only to the extent the claim was
admitted in terms of Section 23(4) of the Act. The discharge under the section had,
therefore, no effect upon any claim which had been rejected in part or whole, and
in regard to any such claim, the remedy against the owner had to be pursued
outside the statute. The liability of the surety remained unimpaired in respect of the
undischarged debt. This case clearly points out that the discharge ofthe principal
debtor is not discharge ofthe surety where it is not brought about by the voluntary
act ofthe creditor, but by operation oflaw. The principle of co - extensiveness is
farther reinforced by the decision of the Supreme Court in the following two leading
cases; 115 Bank ofBihar Ltd v Damodar Prasad and Another31 The palnitiff- bank
had lent moneys to Demodar Prasad (Defendant No.l) on the guarantee of P.N.
Sinha (Defendant No. 2). In terms of his guarantee bond, Sinha had agreed to pay
and satisfy the liability of the principal debtor upto Rs.12,000/- and interest thereon
two days after demand by the bank. The bond also provided that the bank would be
at liberty to enforce and recover upon the guarantee, notwithstanding any other
guarantee, security or remedy which the bank might hold or be entitled to in
respect of the amount secured. As, despite its demands, the bank could not recover
the dues from either the borrower or the surety it filed a suit against both ofthem.
The trial court decreed against them, but ordered that the hank could enforce its
dues in question against the surety, only after having exhausted its remedies
against the borrower. The bank’s appeal to the Patna High Court against this order
was dismissed. The bank successfully appealed to the Supreme Court. The Supreme
Court held that the demand for payment ofthe liability of the principal debtor was
the only condition for the enforcement of the bond. The condition was fulfilled.
Neither the principal debtor nor the surety discharged the admitted liability of the
principal debtor in spite of demands. Under Section 128 of the Indian Contract Act,
save as provided in the contract, the liability of the surety is co - extensive with
that of the principal debtor. The surety became thus liable to pay the entire
amount. His liability was immediate. It was not deferred until the creditor
exhausted his remedies against the principal debtor 31 AIR 1969 SC 297 116
Before payment the surety has no right to dictate terms to the creditor and ask him
to pursue his remedies against the principal debtor in the first instance. Lord Eldon
observed in Wright v Simpson (1802) 6 Ves. Jr. 714, 734, "But the surety is a
guarantor, and it is his business to see whether the principal pays, and not that
ofthe creditor". In the absence of some special equity the surety has no right to
restrain an action against him by the creditor on the ground that the principal is
solvent or that the creditor may have relief against the principal debtor in some
other proceedings. Likewise, where the creditor obtained a decree against the
surety and the principal, the surety has no rightto restrain execution against him
until the creditor has exhausted his remedies against the principal debtor. The
solvency of the principal is not a sufficient ground to restrain execution ofthe decree
against the surety. It isthe duty ofthe surety to pay the decretal amount. On such
payment, he will be subrogated to the rights of the creditor under section 140 of
the Indian Contract Act, and he may then recover the amount from the principal.
The veiy object of the guarantee will be defeated ifthe 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 the banker. The
security will become useless ifhis rights against the surety can be so easily cut
down. 117 State Bank ofIndia v Indexport Registered32 The Supreme held in this
case that a surety’s liability to pay the debt is not removed by the reason ofthe
creditor’s omission to sue the principal debtor. The creditor is not bound to exhaust
his remedies against the principal before suing the surety, and a suit is
maintainable against the surety though the principle has not been sued. The
Supreme Court cited the following passage from Chitty on Contracts33: "Prima facie
the surety may be proceeded against without demand against him and without first
proceeding against the principal debtor". The court also cited the following passage
from Halsbury’s Laws of England:34. "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 Supreme Court
emphasized the principle of Section 128 of the Contract Act and referred toBank
ofBiharLtd v DamodarPrasad and Another (AIR 1969 SC 297) quoted supra. The
Supreme Court also 32 AIR 1992 SC 1740 33 24th Edn. Vol, 2, para 4831 34 4th
Ed, Vol 20 para 159 118 approved the Karnataka High Court decision in the case
ofHukumchand Insurance Co Ltd v Bank of Baroda35, Venkatachellich J (as His
Lordship then was) speaking for the Division Bench observed as follows : "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 aforesaid principles laid down
by the Supreme Court were later followed by Madhya Pradesh High Court in State
Bank ofIndia v M.P. Iron and Steel (P) Ltd?6 and Madras High Court in Balakrishnan
v Chunnilal Bagmar37. The Kerala High Court in StateBank ofIndia v G.J.Herman
and others38 following the Supreme Court decision made the following observations
while dwelling on the liabilities ofthe co - surety : 35 AIR 1977 Kant 204 36 AIR
1998 MP 93 37 AIR 1998 Madras 175 38 AIR 1998 Kerala 161 119 "The Principle
laid down by the Supreme Court is that the liability of the sureties is co - extensive
with that of the principle debtor. Consequently creditor can proceed against the
principal debtor or against the sureties, unless it is otherwise provided in the
contract. The same should be principle with regard to the rights and liabilities
between the co - sureties as well. A co - surety cannot insist that the creditor
should proceed either against principal debtor or against other sureties before
proceeding against him, since the liability of a surety is joint and several. To the
extent to which they stood guarantee, they are liable to be proceeded against by
the creditor. The option is entirely that ofthe creditor to decide against whom he
could proceed either against principal debtor or against any ofthe sureties. Court for
that matter, or a co - surety cannot insist that creditor should proceed against other
sureties before proceeding against him. Such a direction is directly against the
principle of co - extensiveness. It is heartening to note that Indian Courts have
thoroughly recognised the principle of co - extensiveness even before the
enactment of the Indian Contract Act, 1872. In the year 1869, the Bombay High
Court in the case Lachman Joharimal v Bapu Khandu and another39 stated as
under. "This Court is of the opinion that a creditor is not bound to exhaust his
remedy against the principal debtor before suing the surety and when a decree is
obtained against a surety, it may be enforced in the same manner as a decree for
any other debt". 39 (1869) 4 Bom HC Rep 241 120 Thus it is clear that the contract
of guarantee is an independent contract making the liability of the surety co -
extensive with that of the principal debtor, unless otherwise agreed upon. The
creditor can opt to proceed to recover debt against the surety independently of the
principal debtor. Even though the contract of surety may originate from the same
transaction it creates rights and liabilities "separate and distinct" from the rights
and liabilities created by contract between the principal debtor and the creditor. The
two cannot be mixed up. It is, therefore, clear that subject to contract to the
contrary, liability ofsurety remains intact so long as the debt of the principal debtor
is not discharged. This is what the word "co - extensive" in Section 128 ofthe Indian
Contract Act, 1872 means. Since the contract ofsurety is an independent contract,
the surety cannot require the creditor to recover the debt from the principal debtor
personally or from the securities furnished by the principal debtor. It is submitted
that Section 128 ofthe Contract Act indicates the liability ofthe surety and not the
manner of discharge ofthe debt ofthe principal debtor. Thus the guarantor’s liability
is absolute. Surety’s Liability when Principal is Insolvent Usually if the principal is
known to be insolvent, the creditor will bring his action against the surety instead.
He may prove in the bankruptcy or liquidation of the principal. However the
question may arise as to the creditor’s right to claim against the surety if a
payment made by the principal to the creditor is set aside as wrongful preference,
and he has to repay the money to the liquidator or trustee in bankruptcy. The
position 121 appears to be that if the creditor was not a party to the preference, he
probably can recover the money from the surety, on the grounds that there was no
valid payment to him and he has not done anything to discharge the surety on
equitable grounds40. Claims Against The Estate of the Surety Ifthe liability ofthe
surety has not accrued by the time he dies, the general rule is that his personal
representatives cannot be forced to set aside a sum out of his estate to meet the
potential future liability on the guarantee. In Antrobus v Davidson41, an application
made by the executor ofthe deceased creditor against the representatives ofthe
deceased surety for an order that the latter should set aside a sufficient sum of the
estate to answer future contingent demands, was dismissed. However, ifthe liability
of the surety has already accrued, or ifthe terms of the guarantee are worded in
such a way that he appears to be a principal debtor with a liability to make
payment on a fixed future date, albeit he is really a surety, a sufficient sum must
be set aside out of his estate to meet that liability, even ifthere is a prospect that
the principal debtor might pay the debt instead42. 40 Petty v Cooke (1871) LR 6
QB 790 41 (1817) 3 Mer 569 42 Atkinson v Grey (1853) 1 Sm & G 577 122
Banker’s Negligence and Surety’s Liability Section 139 of the Indian Contract Act,
1872 provides that if the creditor does any act which is inconsistent with the rights
ofthe surety, or omits to do any act which his duty to the surety requires him to do,
and the eventual remedy of the surety himself against the principal debtor is
thereby impaired, the surety is discharged. Under this section, the negligence of the
banker in handling the security will discharge the surety’s liability to the extent
ofthe impairment ofsuch security. Any negligent or improper handling by banker of
the securities belonging to the debtor which reduces their value will diminish the
liability of the guarantor to the extent to which the securities depreciate, unless
there is a clause in the contract of guarantee allowing the banker to deal with the
securities as he may think fit. Similarly, ifthe banker holds some securities
belonging to the principal debtor, he should not return them wholly or partially to
the principal debtor, as thereby he will prejudice the interests ofthe surety. In
StateBank ofSaurashtra v ChitranjanRangnathRaja and another,43 the bank
granted a cash credit facility to the customer against pledge of goods by the
principal debtor and the personal guarantee of the surety. Goods pledged under the
custody of the bank were lost by the negligence of the bank. The Supreme Court
held that the surety is 43 AIR 1980 SC 1528 123 discharged to the extent of the
security of the goods lost. The Court observed that even if the surety of the
personal guarantee is not aware of the security offered by the principal debtor, yet
once the right ofthe surety against the principal debtor is impaired by any action or
inaction, which implies negligence appearing from lack of supervision undertaken in
the contract, the surety would be discharged to the extent of the value of the
securities so impaired. In State Bank ofIndia v Quality Bread Factory44, cash credit
was given by the bank on open cash credit system. Hypothecated goods were lost
by the negligence ofthe bank. Based on the aforesaid decision of the Supreme
Court, Punjab and Haryana High Court held that it has not been laid down in the
Contract Act that this principle applies only to pledges and not the hypothecation.
Therefore the law applies equally to open credit system. The bank should, as a
pledgee, keep requisite vigilance on the debtor both in the "lock and key" system
and "Open Credit System" in order to protect himself and the security against the
illegal actions ofthe debtor. Any negligence or inaction on the part ofthe bank by
which he loses the security absolves the surety from his liability. In Jose Inacio
Lourence v Syndicate Bank,45 the bank had given a loan for purchase of a vehicle
and since the loan was not paid by the principal debtor the bank filed a suit both
against the principal debtor and surety which was decreed. The case of the surety
in appeal was that the principal debtor had transferred the vehicle which was now
registered in 44 AIR 1983 Punjab & Haryana 244 (1989) 65 Comp. Cas. 698 45 124
another State and the Bank had failed to register the charge (Hire Purchase or H.P.
Clause) with the Regional Transport Authority and it was unable to produce the
vehicle for the benefit of the surety. In such circumstances, the Bombay High Court
held that this amounted to parting with security and the surety stood discharged to
the extent of the value of the security. The failure to register the charge was an act
which was inconsistent with the rights of the surety within the meaning of Section
139 of the Indian Contract Act, 1872, as the eventual remedy of the surety had
been impaired. In Amrit Lai Goverdhan Lalan v State Bank of Travancore46, the
bank lost goods of Rs.35,690/- with it due to its negligence. The Supreme Court
held that the surety was discharged of the liability to the bank to the extent of
Rs.35,690/-. In M.R. Chakrapani Iyengar v Canara Bank47, the surety informed the
bank that an electric oven hypothecated by the principal debtor to the bank was
sold to a particular party and gave details. The bank did not take steps to seize the
property to sell it and recover its dues which could easily have been done. The
surety prayed for discharge since the bank was negligent in realising the security.
The trial court negatived his contention and passed a decree against the principal
debtor and the surety. The surety filed a Civil Revision Petition before the
Karnataka High Court. The amount due was Rs.4000/- to be paid to the bank to
liquidate the debt. The court held that the bank was grossly negligent in not seizing
and 46 AIR 1968 SC 1432 47 (1999) 95 Comp. Cas. 862 125 selling the
hypothecated goods though the surety had intimated the factual position to the
bank. The bank could have filed even a police complaint for tracing of the asset,
which was not done. The court heavily came down on the bank stating the bank
had been guilty of negligence or gross inaction and the surety had been wrongly
foisted with the liability which would have otherwise been discharged through the
seizure and sale of the property. The court allowed the appeal ofthe surety and set
aside the trial court’s order as far as the surety was concerned. In Chistovan Vaz
and another v Indian Overseas Bank and others48, the first respondent bank
advanced a loan of Rs.96,000/- for purchase of a mini - bus against hypothecation
of the mini bus. The appellantsstood guarantee. The principal borrower defaulted in
repayment. The bank attached the vehicle and with the help of the police the said
vehicle was detained for five months. Thereafter the branch manager took
possession of the said vehicle which was auctioned fetching a value of Rs. 10000/-
only. The trial court decreed the suit against the principal debtor and sureties who
filed an appeal before the Bombay High Court Panaji Bench. The High Court held
that the bank took possession of the hypothecated vehicle without informing the
surety and allowed the vehicle to deteriorate due to exposure to rain and sun and it
had to be sold as scrap. The court further held following the Supreme Court’s
decision in State Bank of Saurashtra v Chitranjan Rangnath Raja49 that in
maintaining the mini bus, the bank was absolutely negligent and their 48 (2000)
100 Comp. Cas. 16 49 AIR 1980 SC 1528 126 negligence contributed to the
deterioration of the mini bus. Therefore, any reduction in the value ofthe security is
to be accounted for by the bank and the sureties stand discharged to that extent
under the combined operations of Sections 139 and 141 ofthe Indian Contract Act,
1872. Surety’s Right of Subrogation According to Bouvier’s Law Dictionary50,
"Subrogation is the substitution of another person in the place ofthe creditor, to
whose rights he succeeds in relation to the debt. That change which puts another
person in the place ofthe creditor, and which makes the right, the mortgage, or the
security which the creditor has pass to the person who is subrogated to him - that
is to say, who enters into his right". It is the substitution of another person in place
of the creditor, so that the person substituted will succeed to all the rights of the
creditor, having reference to a debt due him. It is independent of any mere
contractual relations between the parties to be affected by it, and is broad enough
to cover every instance in which one party is required to pay a debt for which
another is primarily answerable, and which in equity, and conscience ought to be
discharged by the latter. The surety’s right to be placed in the creditor’s position on
the discharge ofthe principal debtor’s obligation, to the extent that the surety’s
property has been used to satisfy the creditor’s claim and to effect such discharge,
is called the surety’s "right of subrogation". 50 3rd Edn, 1914, Vol 3, p.3166 127
The surety’s right of subrogation should be distinguished carefully from the
creditor’s right of equitable subrogation. On the principal debtor’s default the
creditor has the right to resort to any security which has been deposited by the
debtor with the surety. The creditoris subrogated to the surety’s right against the
property ofthe principal debtor. This right of the creditor to reach such security is
called "the right of equitable subrogation". Until the principal debtor’s default the
surety has the obligation to preserve the security. The origion and nature ofthe
right ofsubrogation,was laid down in Morgan v Seymore51 where it was held that a
surety who has performed the obligations of the principal which are the subject of
his guarantee is entitled to stand in the shoes ofthe creditor and to enjoy all the
rights that the creditor had against the principal. This is an equitable right. It is a
right that arises out ofthe relationship ofsurety and creditor itself. Equity intervenes
to assist the surety because, he having paid off the principal debt, it would be
unconscionable for the principal then to recover the securities from the creditor
while remaining under an obligation to indemnify the surety for the payment. The
right of subrogation can be expressly excluded by clear words in the contract of
guarantee. It seems that the statutory right ofsubrogation is also excluded by
sufficient words or conduct. The surety cannot be deprived ofhis rights
ofsubrogation by an agreement between the creditor and the principal to that
effect52. 51 (1638) 1 Rep Ch 120 Steel v Dixon (1881) 17 Ch D 825 52 128 The
right extends to all securities which the bank has received from its customer before,
contemporaneously with, or after the execution of the guarantee, and it is
immaterial whether or not the guarantor knew oftheir existence at the time when
he signed the guarantee53. A guarantor who pays off the whole debt is entitled, not
only to securities deposited by the customer, but also to those deposited by third
parties. This is what right ofsubrogation is under English Law. In India, the right
ofsubrogation has been enunciated in Sections 140 and 141 ofthe Indian Contract
Act, 1872. Section 140 provides for the right ofsubrogation as under : "Rights
ofsurety on payment or performance Where a guaranteed debt has become due, or
default of the principal debtor to perform a guaranteed duty has taken place, the
surety upon payment or performance of all that he is liable for, is invested with all
the rights which the creditor had against the principal debtor". When the surety has
paid all that he is liable for he is invested with all the rights which the creditor had
against the principal debtor. The surety steps into the shoes ofthe creditor. The
creditor had the right to sue the principal debtor. The surety may, therefore, sue
the principal debtor in the rights ofthe creditor. 53 Forbes v Jackson (1882) 19 Ch.
D 615 129 The Supreme Court has laid down inAmritLai Goverdhan Lalan v State
Bank of Travancore54 that the surety will be entitled to every remedy which the
creditor had against the principal debtor; to enforce every security and all means of
payment; to stand in the place ofthe creditor; to have the securities transferred to
him, though there was no stipulation for that; and to avail himself of all those
securities against the debtor. This right of surety stands not merely upon contract,
but also upon natural justice. The language of Section 140 which employs the
words "is invested with all the rights which the creditor had against the principal
debtor" makes it plain that even "without the necessity of transfer, the law vests
those rights in the surety". In Kadamba Sugar Industries (P) Ltd v Devro Ganapathi
Hegde55, the Corporation Bank advanced a loan to Appellant No.l and a mortgage
was created by depositing the title deeds towards security for the loan. The loan
was not paid and a suit had to be filed. During the pendency of the suit, the
Respondents 1 to 5 paid the amount as they were sureties to the loan. It was held
by the court that the sureties had the right of subrogation provided under Section
140 of the Indian Contract Act, 1872. A question arose as to whether the surety,
impleaded as defendant in the suit can apply for attachment before judgment and
temporary injunction in respect ofthe property ofthe principal debtor. It was held by
54 AIR 1968 SC 1432 55 (1993) Vol II Bank Cas. 507 130 Bombay High Court in
Jugalkishore Ram Pratap and Rathi v Brijmohan Ram Pratap and Rathi and
Another56 that a surety is so entitled to protect his interests. It was decided by the
Bombay High Court in State Bank ofIndia v Fravina Dyes Intermediate57 that the
guarantor by invoking the doctrine of subrogation can apply for a temporary
injunction against the debtor even before making payment to the creditor if he
apprehends that the debtor threatens or is about to remove or dispose of his
property with intent to defraud the creditor. That is, the guarantor is entitled to a
grant of Quia Timet injunction against the principal debtor under certain
circumstances. Section 141 of the Indian Contract Act, 1872 reads as under:
"Surety’s right to benefit of creditor’s security A surety is entitled to the benefit of
every security which the creditor has against the principal debtor at the time when
the contract ofsuretyship is entired into, whether the surely knows ofthe existence
ofsuch security or not; and ifthe creditor loses, or, without the consent of the
surety, parts with such security, the surety is discharged to the extent of the value
of the security". It was held by the Supreme Court in State ofM.P. v Kaluram58 that
the term "Security" in Sec 141 is not used in any technical sense; it 56 (1993) ISJ
(Banking) 266 57 AIR 1989 Bombay 95 58 AIR 1967 SC 1105 131 includes all
rights which the creditor had against the property of the principal at the date of the
contract. The difference between the English Law and the principle laid down in Sec
141 was explained by the Supreme Court inAmrit Lai Goverdhan Lalan v State Bank
ofTravancore59 as under: "It is true that Section 141 has limited the surety’s right
to securities held by the creditor at the date ofhis becoming his surety and has
modified the English rule that the surety is entitled to the securities given to the
creditor both before and after the contract ofguarantee. But subject to this
variation, Section 141 incorporates the rule of English Law relating to discharge
from liability of a surety when the creditor parts with or loses the security held by
him". In Bank ofIndia v YogeshwarKant Wadhera60, the Punjab and Haryana High
Court held that where the delivery of goods is not given to the creditors as in the
case of hypothecatee (bank), the surety was not entitled to claim protection
ofSection 141 ofthe Indian Contract Act, 1872. As in hypothecation the possession
ofthe goods is with the borrower, it will be wrong to say that the goods are in
constructive possession ofthe creditor - bank because it has no effective control
over them. By hypothecation, only an equitable charge is created and nothing more
and therefore the Section 141 is not applicable to hypothecation. 59 AIR 1968 SC
1432 60 AIR 1987 P & H 176 132 The Punjab and Haryana High court has, by this
decision, overruled its earlier decision in State Bank ofIndia v Quality Bread Factory
(page 123 supra).

Surety for Minor’s Contract

The obligation of sureties is an obligation accessory to that of a principal debtor.

Ifthe principal debtor is not obliged, neither is the surety, as there can be no
accessory without a principal obligation according to the rule of law. The guiding
principle applicable to contracts ofguarantee is that the liability ofthe surety is co -
extensive with that ofthe principal debtor. This is because a contract ofguarantee is
an undertaking to the creditor that the principal debtor will perform his principal
obligation. Accordingly, as Lord Selbome said in Lakeman v Mountstephen61 :
".... until there is a principal debtor, there can be no suretyship. Nor can a man
guarantee anyone else’s debt unless there is a debt ofsome other person to be
guaranteed". However the fact that the principal obligation is void or unenforceable
will not necessarily release the surety from his liability under the guarantee. The
surety may find himselfliable to the creditor where the principal debtor is not, or
under a liability to the creditor different from that of the principal debtor. 61 (1894)
LR 7 HL 17 133

In accordance with the principle of co - extensiveness, the fact that the principal
obligation is void will mean that as a general rule the surety will not be liable under
his guarantee of the principal’s obligations thereunder, for example where the
principal obligation is void for minority ofthe debtor. However, there are a number
of different situations in which the general rule does not apply, and the surety will
be liable notwithstanding the voidness of the principal obligation.

In Wauthier v Wilson82, the creditor had lent money to a minor, whose father
had given a promissory note to the creditor as a surety. Although the debt was void
under the provisions of the Infants Relief Act, 1874 (England), the court held that
the father was not released from liability under the note. At the trial Pickford J. held
the father liable though he was treated as a guarantor. The Court ofAppeal affirmed
this decision on another ground. It treated the father as having entered into a joint
obligation with his son. The fact that the son was not bound did not exonerate the
father from his separate and distinct liability treating the father’s contract as one of
indemnity.

In Coutts & Co v Brown Lecky63, where an overdraft to a minor was

guaranteed by an adult, Oliver J. held that since the overdraft was absolutely void
under the provisions of the Infants Relief Act 1874, the guarantee was
unenforceable by the bank. As a guarantee is a secondary or ancillary undertaking,
it cannot be more effective than the primary obligation which it aims to secure.
62(1911) 27 TLR 582 63(1947) KB 104 134 The decision in Coutts & Co case has
been criticised in particular on the ground that the provisions of the Infants Relief
Act 1874 afforded a personal privilege to the minor that was open to him and to no
body else. This privilege should not be granted to an adult who has guaranteed the
debt of a minor.

In Stadium Finance Co Ltd v Helm64, where a finance company had hired a car
to a minor under a hire - purchase agreement which had been co - signed by his
mother, the Court of Appeal held that she was a surety for the minor, and not an
indemnifier, and that because the minor was not liable under the principal contract
she could not be liable under the guarantee. It appears from the judgment of
Denning MR in the transcript that in fact it was conceded by the finance company
that a guarantee of a minor’s void debt is unenforceable, and so it may be said to
be authority for the proposition that the surety is not liable even where he or she
knew of the principal’s incapacity.

In Yeoman Credit v Latter65, a finance company released a car to a minor under

a hire - purchase agreement. To back the minor’s undertaking, an adult executed a
document entitled an Indemnity, in which he undertook to "make good" to the
finance company any loss incurred under the hire - purchase agreement. The minor
defaulted, whereupon the finance company brought an action to enforce its rights
against the adult. It was argued, as a preliminary point, that the document in
question 64(1965) 109 SJ 447 65(1961) 1 WLR 828 135 constituted a guarantee
and it fell together with the hire - purchase contract. The Court ofAppeal held that
the adult’s undertaking constituted an indemnity, which was unaffected by the
avoidance ofthe hire - purchase agreement. A guarantee constitutes a promise to
compensate a creditor against loss incurred by the main debtor’s default. An
indemnity is a promise to reimburse to the beneficiary thereof any loss incurred in a
given venture. In practice, it is not always easy to distinguish between a guarantee
and an indemnity. A guarantor is usually granted the right ofsubrogation, which
enables him to recover from the debtor any amount paid under the guarantee to
the creditor. No such right is conferred by the indemnity. An indemnity is a
separate and distinct undertaking to pay money, and the person giving it is a
principal and independent debtor, not, as is a guarantor, merely a secondary
debtor. This would seem to leave available to lenders the security offered by adults
in support of advances to minors provided it is in the form ofindemnity rather than
of guarantee. The law in England was changed by the enactment of Minors’
Contracts Act 1987. Section 1 of that Act repealed the Infants Relief Act 1874.
Section 2 of the Act provides that where a guarantee is given in respect of an
obligation of a party to a contract made after the commencement of the Act and the
obligation is unenforceable against him (or he repudiates the contract) because he
was a minor when the contract was made, the guarantee shall not for that reason
alone be unenforceable against the surety. It is not clear whether the surety who
has paid the creditor has a right of indemnity against the minor principal. The Law
136 Commission Report on Minors’ Contracts (Law Com 134) in England suggested
that there was a right of recovery only where the minor could, under the common
law rules, have been sued by the original creditor. It is now well settled in English
Law after the enactment of Minors’ Contracts Act 1987 that the surety for a minor’s
contracts is liable as a principal debtor or indemnifier, despite earlier conflicting
judicial decisions in respect ofsuch surety’s liability. It is well known that most of
the commercial enactments in India follow the principles of English Law. Section 11
ofthe Indian Contract Act, 1872 provides that a minor is not competent to contract.

In Mohiribibi v Dharmodas66, the Privy Council held in respect ofsection 11 of

the Contract Act as under : "Looking at Section 11 their Lordships are satisfied that
the Act makes it essential that all contracting parties should be competent to
contract and especially provides that a person who by reason of infancy is
incompetent to contract cannot make a contract within the meaning ofthe Act. The
question whether a contract is void or voidable presupposes the existence of a
contract within the meaning of the Act, and cannot arise in the case of an infant".
66 (1903) 30 IA 114 137 Ever since this decision it has not been doubted that a
minor’s agreement is absolutely void. The ruling of the Privy Council in the
Mohiribibi Case has been generally followed by courts in India and applied both to
the advantage and disadvantage of minors. Section 128 of the Indian Contract Act,
1872 provides that the liability of the surety is co - extensive with that of the
principal debtor. When Section 128 is read with section 11, the minor’s obligation
under the contract is void and hence the surety for the minor’s obligation is not
liable. The principle of co - extensiveness does not make the surety for a minor
liable due to the principal obligation ofthe minor being void. The dictum is that
guarantee being a collateral or secondary obligation cannot be enforced when the
principal obligation is void.

Bombay High Court in Kashiba v Shripat67 held that the surety to a bond passed
(executed) by a minor was liable. When the original agreement is void e.g. a
contract by minor, the surety is liable as a principal debtor. This case laid down the
principle that the surety for a minor’s contract is liable while the minor being
principal debtor is not liable. Kashiba’s case was considered by a Bench of the
Madras High Court in Kelappan Nambiar v Kunhiraman68. The Bench held that
in the absence of special circumstances like fraudulent representation, or in the
absence of other features from which a court can infer a contract to be 67 (1895)
19 Bom 697 68 (1956) 2 MU 544; AIR 1957 Madras 164 138 one of indemnity the
liability of the surety is only ancillary and rests only on a valid obligation on the part
of the party whose debt or obligation is guaranteed. Where the liability ofthe
principal is held unenforceable, there is no question ofthe surety being made liable.
This case establishes that a surety for a minor’s contract is not liable since the
principal obligation of the minor is void. Minor’s contract is the foundation for the
surety to guarantee the obligation. When the foundation is itselfa nullity the
surety’s ancillary contract of guarantee is also a nullity. The case also laid down
that the contract of guarantee is collateral to the main contract of the principal
debtor with the creditor. When the main contract is void the collateral contract is
also void. Since the liability ofthe surety is secondary, not primary, it does not arise
at all when no liability can ever be fastened on the principal debtor because ofhis
minority at the time of entering into the contract. It is apparent that the decisions
ofBombay High Court and Madras High Court are in conflict with each other.
Bombay High Court decision is more relevant to Indian commercial law. The legal
provisions relating to personal disabilities are intended for the protection ofthe
person affected by that disability. It follows that others cannot share in this
protection. To this extent the rule that the contract of guarantee is accessory to the
main contract is inoperative. The guarantee is given for the purpose ofprotecting
the creditorjust against the possibility of the debtor pleading his incapacity, like
minority. 139 One can be surety not only for obligations which are enforced by civil
law, but also for obligations which are based on natural law. Thus it may happen
that a surety may be legally compellable and the principal debtor not (as in the
case ofminor principal). Ifthe main contract is invalid merely because of personal
qualities. On the part of the debtor, the guarantor is liable as a joint debtor.
Guarantees forthe debts ofminors perform a useful function, because they enable
minors to obtain credits which theymay require and which they may not be able to
obtain without such valid guarantees. The interests of the minor which the law
wants to protect are not endangered by enforcement of the guarantor’s lability. It is
pertinent to note that in the U.S.A, guarantees for the debts of minors are
considered as fully valid and binding on the ground that contracts ofminors are
merely voidable, not void69.

Mistaken Belief about Guarantees

The proverbial litigation attendant upon the guarantees is perhaps due to the
popular beliefthat the signing of contract ofguarantee is nothing more than a "mere
formality". Even in the face ofreligious warnings in the Holy Bible against the risks
ofsuretyship, persons do enter into contract of suretyship without taking thought for
the morrow and the possibility of their being called upon to discharge the liability.
69 Williston, On Contracts (1920 Edn) S 484 140 Jesus, the son of Sirach advises
"Guaranteeing loans has ruined many prosperous men and caused them unsettling
storms of trouble"70. It is easy to put one’s pen to paper and complacently append
one’s signature to a contract ofguarantee, but to be compelled to put one’s hands
into one’s pockets or loosen the strings of one’s purse when the fruit ofthe friendly
act is demanded, is usually an unexpected and painful experience. Even when the
eventual liability falls on him the surety generally imagines that he will be called
upon to pay, only when all means of compelling the debtor to pay have been
exhausted. It is a fallacy because many judicial decisions fasten absolute liability on
the surety. Letters of Comfort The situation sometimes arises in which a third
party is unable or unwilling to provide a guarantee for a loan made to a
borrower71, but is prepared to give a written assurance to the lender ofits
continued support for, interest in, or dealings with, the borrower. These written
assurances are known as letters of comfort because they are intended to afford
"Comfort" to the lender by indicating to him that the borrower is likely to be able to
repay the loan. Although the use of letters of comfort is not confined to banking
transactions, they are perhaps most prevalent in this area, and are often given by
parent companies in respect of prospective loans to their less affluent subsidiaries.
70 Good News Bible, Sirach (Ecclesiasticus) Chapter 29 verse 17 71 Eg : if it would
be ultra vires for a company to give a guarantee for its subsidiary; or if it would be
undesirable to give a guarantee because its contingent liability would have to
appear in its balance sheet. 141 The contents of a letter of comfort may range from
a statement that the parent company intends to continue to hold a controlling
interest in the subsidiary, and to use that controlling interest so as to procure that
the subsidiary conducts its affairs in a particular way, to an assurance that it will
ensure that the subsidiary keeps sufficient reserves to enable it to meet its
obligations to repay the loan. A bank which is offered a letter of comfort in place of
a guarantee would be well advised to study the proposed wording very carefully
before accepting it. It should be borne in mind that the question whether the letter
of comfort gives rise to a binding legal obligation is often difficult to resolve72.

Statements of Promise or Present Intention

There is a clear distinction between a statement which involves a promise to ensure

that a particular state of affairs exists or continues to exist and a statement of
present intention. The former may give rise to a binding contractual obligation (in
an appropriate case, it may even amount to a guarantee or indemnity) whereas,
provided the latter is an honest statement of the writer’s intention at the time when
it is made, there is nothing legally to prevent the giver of the letter of comfort from
changing his mind at any time in the future. The distinction is illustrated by the
case of Kleinwort Benson Ltd v Malaysian Mining Corporation Bhd12, in
which the Court of Appeal had to construe the following statement in a 72 In
business matters there is usually a presumption that an agreement is intended to
create legal relations unless the opposite intention is clearly shown : Rose & Frank
Co v JR Crompton & Bros Ltd (1923) 2 KB 261 73 [1988] 1 WLR 799 142
letter written by a parent company to a bank : "It is our policy to ensure that the
business of(the subsidiary) is at all times in a position to meet its liabilities to you
under the above arrangement". The subsidiary became insolvent and the loan was
not repaid. Although the bank had relied on the letter when advancing money to
the subsidiary, and there was evidence that both the bank and the parent company
had treated it as a matter of commercial importance, it was held, reversing the
decision of Hirst J74, that the letter of comfort merely stated the parent company’s
present intention. Since the statement was honestly made, the only obligation on
the parent company to maintain that policy was a moral one, and therefore a
subsequent change in its intention did not entitle the bank to claim damages75. The
statement had to be construed' in the context ofthe rest ofthe letter, and against
the factual matrix, which included a refusal by the parent company throughout the
negotiations to assume any legal liability for repayment ofthe loan. In the light of
all these factors, there was no binding promise76. 74 Kleinwort Benson Ltd v
Malaysian Mining Corporation Bhd [1988] 1 WLR 799 75 Of course, if the person
making the statement "changed his mind" veiy shortly after the loan was advanced,
a court might be persuaded that the statement was not made honestly in the first
place. The person who gives the letter ofcomfort must therefore be prepared
tojustify any change in his position 76 This approach is to be contrasted with that of
HIRST J, who had pointed out that even if a formal guarantee has been rejected,
that does not mean that the parties are not willing to enter into some other
contractual obligation 143 This case can be contrasted with Chemco Leasing SPA v
Rediffusion pic11, in which the parent company had given a letter of comfort in
these terms : "We assure you that we are not contemplating the disposal of our
interests in [the subsidiary] and undertake to give Chemco prior notification should
we dispose of our interest during the life ofthe leases. Ifwe dispose of our interest
we undertake to take over the remaining liabilities to Chemco of [the subsidiary]
should the new shareholders be unacceptable to Chemco". The Court of Appeal held
that the parent company was not liable, because Chemco had failed to give it
reasonable notice that the new shareholders were unacceptable to it [and thus an
implied condition precedent to the undertaking in the second sentence had not been
fulfilled]. However, it appears that the decision of Staughton J that the parent
company was liable as guarantor would have been upheld butfor the failure of
issuance ofthe notice. Of course, it is rarely the subjective intention ofthe person
giving the letter of comfort to make a binding legal commitment to the person
receiving it. For the avoidance of any doubt, therefore, the company which gives
the letter may insist that it includes an express statement that the contents are not
intended to give rise to any enforceable legal obligation on the part of the writer. In
order to strengthen its position further, it may also insist that the bank signs and
returns a copy of the letter accepting 77 [1987] 1 FTLR 201 144 that it does not
give rise to any binding contract. Such disclaimers are now common. A bank may
be prepared to accept such a letter of comfort from a business whose financial
standing is well - known to it, on the basis that failure to adhere to its promise
would cause it such a commercial damage that the risk of default would be minimal.
On the other hand, if the bank has had no prior dealings with the companies
involved, it is more likely to insist that there should be some form of binding legal
obligation even ifit falls short of a guarantee, such as a letter in the terms ofthe
first sentence of the relevant paragraph in the Chemco case. Even ifthe letter of
comfort does not give rise to a binding contract, it will not afford the bank the same
degree of protection as a guarantee or indemnity. The subsidiary may become
insolvent and fail to repay the loan, but that will not necessarily involve any breach
of its obligations by the parent company. Further more, even ifa parent company
does renege on its promise by withdrawing support from the subsidiary or selling its
shareholding, the bank will have to establish a sufficient causal connection between
that default and any loss which it suffers. In determining whether a letter of
comfort is acceptable where it might otherwise have required a guarantee, a bank
must understand the nature and extent of the commitment which is being given.
While it might be thought that the considerations which generally give rise to the
use of a comfort letter rather than a guarantee are such that the giver would
necessarily wish to ensure that the comfort letter did not in itselfconstitute a legally
binding commitment, it appears that courts will in fact treat such letters as being
capable of constituting binding obligations unless the contrary intention is clearly
expressed. 145 The taking ofproceedings on a letter of comfort may be more
complex than the making of a claim for a debt under a guarantee since, depending
on the precise nature of the "Comfort" given, it may be necessary for the bank to
establish a causal link between its loss and the breach by the writer of the
obligations that it undertook. A further danger may occur if in fact the subsidiary
does go into liquidation, and the parent company does then repay the bank. The
liquidator may attack the bank on the grounds that this repayment constitutes a
fraudulent preference. The letter of comfort is intended to be taken in rare cases
from companies ofhigh - credit rating and good reputation, keeping in mind that the
obligations undertaken by the author ofthe letter of comfort are mostly moral
obligations. Though banks in India are accepting letters of comfort the
enforceability and binding nature of such letters does not appear to have been
tested before the courts of law so far. Therefore the principles of English Law are
the guiding light for the banks in India while dealing with comfort letters.