DR.

RAM MANOHAR LOHIA NATIONAL

LAW UNIVERSITY, LUCKNOW

Law of Contracts II
Project Topic

CONTRACT OF GUARANTEE AND THE INCIDENT OF

VIJAY MALLYA

Submitted to: Submitted by:

Mr. Mahendra Singh Paswan Vipin Kumar Verma
Asst. Professor (LAW) Roll no. 168
Semester III
Section - B
BA. LL.B. (hons.)

0
 ACKNOWLEDGEMENT

I thank the people who contributed in the completion of it, without whose aid this
project wouldnt have seen practicability.
I extend my gratitude to my Contracts II teacher, Mr. Mahendra Singh Paswan, whose
continuous guidance provided me the requisite impetus and gave me insight into the
topic. I am grateful to the IT Staff and the Library Staff for providing me the
assistance anytime needed.

1
 RESEARCH METHODOLOGY

Subject: Law of Contracts II

TOPIC: CONTRACT OF GUARANTEE AND THE INCIDENT OF

VIJAY MALLYA

The present study is essentially doctrinal study; research undertaken is descriptive in

nature with an analytical approach to the percolate guidelines laid in given case. Both
primary and secondary data has been used and examine in the holistic manner for the
purpose of the dissertation

The data collected by me in this project is of secondary nature. The data has been
collected through books, journals, legal databases and websites.

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 CONTENTS

Table of Cases

Introduction

Chapter 1-Liability of the Surety

Chapter 2-The liability of the surety is co-extensive with that of the principle
debtor, unless it is otherwise provided by the contract. Case Analysis.

Chapter 3- Suretys Rights against the Principal Debtor

Conclusion

Bibliography

3
TABLE OF CASES

1. Anand Singh v. Collector of Bijnor AIR 1932 All 610

2. Associated Japanese Bank (Intl) Ltd. V Credit Du Nord SA [1988] 3 All ER
902
3. Bank of Bihar, Ltd v. Damodar Prasad AIR 1969 SC 297
4. Badeley v. Consolidated Bank (1886) 34 Ch D 536
5. Board v. Official Liquidator AIR 1982 SC 1497
6. Brojondra v. Hindustan Co-operative Society ILR 44 Cal 978
7. Bur Singh v. Labhu Ram 1930 Lah 399
8. Carr Lazarus Phillips v. Alfred Ernst Mitchell AIR 1930 Cal 17
9. Chhaju Singh v. Emperor AIR 1921 Lah 79
10. Craythorne v. Swinburne 1803-13 All ER Rep 181
11. Holl v. Hadley (1835) 2 A&E 758
12. Industrial Finance Corporation of India Ltd. V. Cannore Spinning & Weaving
Mills (2001) 5 S.C.C. 54
13. Jaggannath Baksh Singh v. Chandra Bhukan Singh and another AIR 1937
Oudh 19
14. Kahn Chand Singh v. Tek AIR 1968 J&K 93
15. Maroti v. Hussain Miya AIR 1925 Nag 392
16. M S E B, Bombay v. Official Liquidator, AIR 1982 SC 1497
17. Narayan Singh v. Chattarsingh AIR 1973 Raj. 347
18. Pawan Kumar Jain v. Pradeshiya Industrial and Investment Corpn. Of Uttar
Pradesh
19. AIR 1998 All 57
20. Punjab National Bank Limited v. Sri Bikram Cotton Mills Ltd AIR 1970 SC
1973
21. Re Fox, Walker & Co ex p Bishop (1880) 15 Ch D 400 (CA)
22. SBI v. M. P. Iron and Steel Works Pvt. Ltd., Raipur AIR 1998 M.P. 93

4
23. State Bank of India v. Krishnan, IN THE DEBT RECOVERY APPELLATE
TRIBUNAL AT CHENNAI, RA-43/2004 (OA-866/1999-DRT, Bangalore)

5
 Introduction

Section 128 of the Indian Contract Act, 1872, states that the liability of the surety is
co-extensive with that of the principal debtor, unless it is otherwise provided by the
contract. Section 126 defines surety as the person who gives the guarantee and
principle debtor as the person in respect of whose default the guarantee is given.

The origin of the contract of surety lies in the Roman law. A surety is one who takes
upon himself the obligation of another, that other still being liable. Firstly, the surety
undertakes to the creditor that the principal debtor, who remains bound, will perform
his commitment, and secondly that if the principal debtor fails to do so, the surety
will execute it or failing that indemnify the creditor. This indemnity generally takes
place in the form of the payment of money to the creditor. 1

The phrase co-extensive with that of the principal debtor 2 in section 128 of the
Indian Contract Act, 1872, primarily shows the maximum extent of the suretys
liability. A surety however, may restrict his liability by contract. A surety is as much
liable to the creditor as the principal debtor, unless he has specified the extent of his
liabilities in a contract of guarantee.3

The suretys liability arises when the principal debtor has made a default. On the
commission of the default by the principal debtor, causing loss or damage to the
creditor, the surety is, unless the terms of the contract of guarantee specify otherwise,
at once liable to the degree of his commitment. A notice of default is not required,
unless it is specified in the contract. It is the desire of the creditor to recover the
damages either from the principal debtor or from the surety. The creditor can employ

1
Popatlal, Sanguita, The Contract of Guarantee in South African Law, as cited in
www.bowman.co.za/LawArticles/Law-Article.asp, last visited on 20th june,2007.
2
Narayan Singh v. Chattarsingh, AIR 1973 Raj. 347, Maharashtra State Electricity Board v. Official
Liquidator ,AIR 1982 SC 1497
3
Singh,Avtar,1989, Extent Of Sureties liability, Law Of Contract,5th edition, Eastern book Company
,pp 384-385.

6
the same mode of recovery against the surety as against the principal debtor. 4But if
the contract of guarantee provides for certain conditions precedent to the suretys
liability, for instance, that the creditor will first initiate proceedings against the
principal debtor etc, the surety will be made liable only after those conditions have
been satisfied. 5

Where a contract provides that the surety would be held liable for what may finally be
found due from the principal debtor, the surety is not liable until the deficiency or
contingency is found by the creditor by taking steps against the principal debtor. In
Punjab National Bank Limited v. Sri Bikram Cotton Mills Ltd 6, Here, the guarantee
bond secured the ultimate balance remaining due to the creditor. In this case the
liability of the surety did not arise until the ultimate balance was determined.7

In the case of liability for past transactions, a surety is not liable for any of the
liabilities incurred by the principal debtor prior to the signing of the contract of
suretyship, unless something of that kind is specified in the contract. 8 The liability of
the surety is joint and several with the principal debtor.9 It is the responsibility of the
surety to pay for the losses to the creditor, after which he would be subrogated to the
rights of the creditor as per s. 142 of the Indian Contract Act, 1872.10

The creditor cannot be restrained from executing his decree on the pre text of the
solvency of the principal debtor.11 A surety is discharged from liability by the release
or discharge of the principle debtor, as laid down in s. 134 of the Indian Contract Act,

4
Pawan Kumar Jain v. Pradeshiya Industrial and Investment Corpn. Of Uttar Pradesh,
AIR 1998 All 57
5
Bhadbhade, Nilima, 2001, Pollock and Mulla- Indian Contract and Specific Relief Acts, Vol 2,
Butterworths, New Delhi. pp-1779-1781
6
AIR 1970 SC 1973.
7
Supra note 6
8
Ibid.
9
State Bank of India v. Krishnan, IN THE DEBT RECOVERY APPELLATE TRIBUNAL AT
CHENNAI, RA-43/2004 (OA-866/1999-DRT, Bangalore) as cited in www.drat.tn.nic.in/Judgements/J-
028.htm last visited on 18th june,2007
10
Bank of Bihar, Ltd v. Damodar Prasad, AIR 1969 SC 297
11
ibid

7
1872. There are various pre texts for this discharge such as death of the surety,
variance in the terms of the contract, act of omission of the creditor etc.12

12
Mallick, M.R. ,J, 2000,Suretys Liability, Commentaries on Indian Contract Act,1 st edition, Kamal
Law House, Calcutta, p-860-861

8
 Liability of the Surety

(1) The Concept of Surety.

S. 126 of the Indian Contract Act, 1872 provides that,

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.

For instance, X, a business man takes a loan from bank Y and promises the bank that
he would repay the loan. Z, who is the uncle of X also makes a promise to the bank
saying that if X is not able to repay the loan, then he (Z) will. Here, X is the principal
debtor, who undertakes the task of repaying the loan, Y is the surety, who promises to
perform the same duty in case there is default on part of X. The bank in whose favour
the promise has been made is the creditor.13

The surety provides the supplementary security to the creditor in the form of a
promise to fulfill certain responsibilities, in case the principle debtor fails to do that.

13
Bangia, R.K., 2000,Contracts of Indemnity and Guarantee, Indian Contract Act, 9th
edition,Allahabad Law Agency, Faridabad,p-341

9
(2) Extent of the suretys liability under different circumstances under the
Indian and the English Law.

According to Section 128 of the Indian Contract Act, 1872,

The liability of the surety is co-extensive with that of the principle

debtor, unless it is otherwise provided by the contract.

Section 128 codifies the English common law rule that the liability of the surety is
co-extensive with that of the principal debtor,14 i.e the suretys liability is exactly the
same as the principal debtor and in case of a default by the principal debtor, the
creditor can recover from the surety everything he could have recovered from the
debtor. But this depends on the terms and conditions of the contract.

This section, however, lays down only the measure of the obligation of a surety when
the terms of the contract do not specify it. It has got no reference to the nature of the
obligation of the principal.15 The extent thus mentioned in this section must be
restricted to the liability of the principal debtor and not to the method of discharge of
debt of the principal debtor.16 Hence it was rightly held in SBI v. M. P. Iron and Steel
Works Pvt. Ltd., Raipur17that the right to recover a debt partially or completely lies in
a creditor till such time the debt of the principal debtor is discharged and only then
will the liability of the surety come to an end.

14
M S E B, Bombay v. Official Liquidator, AIR 1982 SC 1497
15
Brojondra v. Hindustan Co-operative Society, ILR 44 Cal 978
16
Mallick, M.R. ,J, 2000,Suretys Liability, Commentaries on Indian Contract Act,1 st edition, Kamal
Law House, Calcutta, p-838
17
AIR 1998 M.P. 93, p-98

10
When there is a condition precedent to the suretys liability, he will not be liable
unless that condition is fulfilled first.18 For instance, in a contract of guarantee, there
is a condition, that in case of default by the principal debtor, the creditor will first take
proceedings against the principal debtor. In such a case, in case of a default the surety
could be made liable only after the creditor has initiated proceedings against the
debtor. 19

Any express or implied condition which is precedent to the suretys liability has to be
fulfilled before any remedy can be had to him. 20 In cases where a guarantee provides
that the surety will be liable for what may ultimately be due from the principal debtor,
the surety is not liable until the deficiency is found after taking measures against the
debtor.21 . In Punjab National Bank Limited v. Sri Bikram Cotton Mills Ltd 22, the
guarantee bond secured the ultimate balance remaining due to the creditor. In this
case the liability of the surety did not arise until the ultimate balance was
determined.23

The liability of the principal debtor and the surety is joint and several and the creditor
can either proceed against the principal debtor or the surety or the both of them
simultaneously.24 The law on this point has been well settled by the Supreme Court in
Industrial Finance Corporation of India Ltd. V. Cannore Spinning & Weaving
Mills25, where it was held that the rights of the creditor to recover money from the
guarantors arises out of the terms of the deed of guarantee which are not in any way
superseded or brought to naught only because the creditor may not be able to recover
money from the principal debtor.

18
Bhadbhade, Nilima, 2001, Pollock and Mulla- Indian Contract and Specific Relief Acts, Vol 2,
Butterworths, New Delhi, pp-1779-1781
19
Holl v. Hadley (1835) 2 A&E 758
20
Associated Japanese Bank (Intl) Ltd. V Credit Du Nord SA [1988] 3 All ER 902
21
Carr Lazarus Phillips v. Alfred Ernst Mitchell AIR 1930 Cal 17
22
AIR 1970 SC 1973.
23
Ed.Bhadbhade, Nilima, 2001, Pollock and Mulla- Indian Contract and Specific Relief Acts, Vol 2,
Butterworths, New Delhi. pp-1779-1781
24
ibid, p-1791
25
(2001) 5 S.C.C. 54

11
In case of a contract between the principal debtor and the creditor, where the contract
is voidable at the option of the principal debtor and is avoided by him, or where the
contract is void ab-initio, the surety is not necessarily discharged of his obligations. In
Chhaju Singh v. Emperor26, a minor had entered into a contract (the contract being
void ab-initio as the minor does not have the capacity to enter into legally enforceable
contract). Here, even though the contract was void, the surety was liable as a principal
debtor.

Section 134 of the Indian Contract Act discusses the discharge of surety by release or
discharge of the principal debtor. It states,

The surety is discharged by any contract between the creditor and the
principal debtor, by which the principal debtor is released, or by any act
or omission of the creditor, the legal consequence of which is the
discharge of the principal debtor.

In Kahn Chand Singh v. Tek 27, the creditor accepted a compromise and released the
principal debtor. Here, the surety was also likewise released. It was held that any
release of the principal debtor is a release of the surety also. In cases of Debt Relief
Acts, where the liability of the principal debtor is reduced under the provisions of a
statute, the liability of the surety is also thereby diminished. 28 In cases of Insolvency
Acts, the Honble Supreme Court has laid down that a discharge which the principal
debtor may secure by reason of winding up or insolvency does not absolve the surety
of his liability.29

26
AIR 1921 Lah 79
27
AIR 1968 J&K 93
28
Narayan Singh v. Chattarsingh, AIR 1973 Raj. 347
29
M S E B, Bombay v. Official Liquidator, AIR 1982 SC 1497

12
Chapter 2

The liability of the surety is co-extensive with that of the principle

debtor, unless it is otherwise provided by the contract.

CASE ANALYSIS

(1) Narayan Singh v. Chattarsingh 30

Facts: A decree from the Civil Court was obtained by the decree-holder against
Jeetmal.pd respondent and appellant Narayan Singh who stood surety for the debt
advanced by the decree-holder to the principal debtor, i.e. Jeetmal. After the
decree was put in execution, principal debtor made an application under Section 6
of the Rajasthan Relief of Agricultural Indebtedness Act. 1957, before the Debt
Relief Court for the re-determination of his decretal amount as he was an
agriculturist. The executing Court abated the execution proceedings against both
the judgment-debtors. On appeal, the learned Judge, relying on an authority of
this Court in Brij Gopal v. Bhanwarlal, 1965 Raj LW 19631, upheld the order of
abatement against the principal debtor only and directed that execution
proceedings may continue against the appellant judgment-debtor (surety) as he
was not an agriculturist. Narayan Singh appealed against this judgement on the
ground that the liability of a surety-judgement-debtor is co-extensive with
that of the principal debtor and, therefore, unless the debt is re-determined

30
AIR 1973 Raj. 347
31
The HC later denied the relevance of considering this judgement in the current case. It held that
judgment is clearly distinguishable as in Brij Gopal case all the judgment-debtors against whom the
decree was passed were mortgagors and out of those only one of the mortgagors was an agriculturist
who made an application under Section 6 of the Act for determination of the debt. Under mortgage
debt the liability of the mortgagors is not co-extensive with each other and so those mortgagors who
were not agriculturists could not claim any benefit of the provisions of the Act because if the debt is
scaled down in the case of agriculturist mortgagor, that scaling down would apply only to the benefit of
the agriculturist and not for non-agriculturists who could not take recourse under the provisions of the
Act.

13
 by the Debt Relief Court, the amount of the decree cannot be executed
against that judgment-debtor who stood surety for the principal debtor to
pay off the debt if the principal debtor failed to discharge his liability.

Judgement- The High Court quoted the decision in A. L. S. PL. Subramania Chettiar
(deed.), v. Moniam P. Narayanaswami Gounder32, where the learned Judges after an
extensive scrutiny of the liabilities of a surety as well as of the principal debtor, who
was an agriculturist held that a non-agriculturist surety will not be liable for the whole
debt when the principal debt has been scaled down under the provisions of the Debt
Relief Act but will be liable only to the extent to which the debt is scaled down and is
due from the principal debtor. The court further cited the judgement of Spencer. J.in
Sami Iyer v. Ramaswami Chettiar33, where it was said ;

"Ordinarily the liability of a surety is co-extensive with that of the

principal debtor unless it is otherwise provided for ..... An illustration of
the effect of Section 128, Contract Act occurs in Shek Suleman v.
Shivram Bhikaji. (1888) ILR 12 Bom 71 where it was observed that if an
amount recoverable by a plaintiff, from a defendant debtor is diminished
in appeal, the surety's engagement, being one of indemnity, would
diminish in like proportion. So, if the sum recoverable became zero,
owing to the decree being reversed, the surety's liability would also be
reduced to nothing."

Hence, it was held that the effect of scaling down the principal debtors liability was
that the suretys liability had also accordingly been reduced. The decree-holder was
entitled to recover the amount of the decree as modified by the Debt Relief Court
from the surety.

32
AIR 1951 Mad 48 (FB)
33
AIR 1923 Mad 340

14
(2) Bank of Bihar v. Damodar Prasad34

Facts- The plaintiff bank, lent money to Damodar Prasad ( principal-debtor) on the
guarantee of Paras Nath Sharma (surety). The loan was neither repaid by Damodar
Prasad nor by Paras Nath Sharma despite repetitive demands by the bank. The
plaintiff bank then filed a suit against them in the Court of the subordinate judge,
Patna, claiming a decree for the amount due. The Trial Court passed a decree in
favour of the bank both on the condition that the bank shall be able to enforce its dues
against the surety only after having exhausted all its remedies against Damodar
Prasad (debtor). The plaintiff appealed to the High Court, which dismissed the appeal.
The plaintiff appealed to the SC challenging the legality of the direction given by the
HC.

Judgement-- Justice R. S. Bachawat opined that the creditor can sue the surety even
though he has not exhausted his remedies against the principal. He further expressed
his view on this point by stating that,

Before payment, the surety has no right to dictate terms to the creditor
and ask him to pursue his remedies against the principal in the first
instance. 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 in some other proceedings.

Where the creditor has obtained a decree against the surety and the
principal, the surety has no right to restrain execution against him until
the creditor has exhausted his remedies against the principal.

If the creditor is asked to postpone his remedies against the surety, then the whole
purpose of the Guarantee is defeated. The court further said that the guarantee is a

34
AIR 1969 SC 297

15
collateral security taken by the banker and will become useless if his rights against
the surety can be so easily cut down.

The court finally allowed the appeal and directed the plaintiffs to recover the dues
from Dr. Paras Nath Sinha i.e the plaintiffs could recover the dues from the surety
without exhausting their remedies against the principal debtor, Damodar Prasad.

(3) Maharashtra State Electricity Board v. Official Liquidator, H.C. Ernakulam35

Facts-The appellant Maharashtra State Electricity Board (MSEB) (creditor) entered

into a contract with a company, Cochin Malleables Pvt. Ltd to supply goods to the
board according to tenders issued .The company had made a security deposit of Rs.
50,000 with the MSEB in the form of a bank guarantee given by the Canara Bank,
which stated,

THE CANARA BANK LTD. hereby agrees unequivocally and

unconditionally to pay, within 48 (Forty eight) hours, on demand in
writing from the Maharashtra State Electricity Board or any officer
authorised by it in this behalf, of any amount upto and not exceeding
Rs. 50,000/- (Rupees Fifty thousand only) to the said Maharashtra State
Electricity Board, Bombay on behalf of M/s. Cochin Malleables
(Private) Ltd., Trichur, who have tendered and/or contracted or may
tender or contract hereafter for supply of materials equipment or service
to the Maharashtra State Electricity Board and have been exempted
from payment of earnest money and/or security deposit against such
tenders or contracts.
The MSEB on August 27, 1973, called upon the Bank to pay the guarantee amount of
Rs. 50,000. Thereafter reminders were sent and a final demand was made on May 23,

35
AIR 1982 SC 1497

16
1974. In the meanwhile Company filed a petition on July 30, 1973 on the file of the
High Court of Kerala for the winding up of the Company in liquidation. By an order
dated September 16, 1974 the High Court ordered the winding up of the Company in
liquidation and directed the Official Liquidator to take charge of its affairs.

The bank wrote a letter to the official liquidator stating that the company was liable to
the Bank for Rs. 50,000 demanded by the MSEB as per the terms of the bank
guarantee. The liquidator sought an order from the company judge restraining the
MSEB from recovering the amount covered by the guarantee on the basis that since
the company had been ordered to be wound up the MSEB could not claim the amount
of guarantee from the bank, as such a claim would affect the assets of the company in
liquidation. The MSEB appealed.

Judgement- Justice Venkataramiah opined that there was no dispute regarding the terms
of the document on the basis of which the Electricity Board had claimed the amount from
the Bank as the contract was one of guarantee and not of indemnity. The payment of the
amount guaranteed by the Bank to the tune of Rs 50,000 was not made dependent upon
the proof of any default on the part of the Company in liquidation. The Bank could not
plead that it is liable only to the extent of loss that might have been suffered by the
MSEB owing to any default on the part of the company in liquidation. The liability was
absolute and unconditional. The fact that the principal debtor had gone into liquidation
also would not have any effect on the liability of the Bank i.e. the guarantor.

He cited Jaggannath Ganeshram Aggarwala v. Shivnarayan Bhagirath, 36 wherein it was

established that,

36
AIR 1940 Bom 247

17
 A surety is no doubt discharged under Section 134 of the Indian Contract
Act37 ..But a discharge which the principal debtor may secure by
operation of law in bankruptcy (or in liquidation proceedings in the case of
a company) does not absolve the surety of his liability,

The court said that the Company Judge could not make any order under the Companies
Act, barring the Electricity Board from recovering the amount guaranteed by the Bank as
this had nothing to do with the assets of the Company in liquidation. Hence, no relief as
granted to the company and it was held that the board had the right to and was entitled to
enforce payment of guarantee and the bank had the right to reimburse itself out of the
securities.

37
Refer to p-9 of the written submissions.

18
Chapter 3

SURETYS RIGHTS AGAINST THE PRINCIPAL DEBTOR

As stated in s. 128 of the ICA, 1872, the liability of the surety is co-extensive with that of
the principal debtor. A surety is required to make good the losses suffered by the creditor
emerging out of the contract of guarantee. A creditor has full right to seek damages from
either the principal debtor or the surety or the both of them. In cases when the creditor
seeks the compensation of losses from the surety, the surety after completing its
obligation (ie the obligation of compensating the creditor) steps into the shoes of the
creditor (subrogation) and has full right to seek indemnification or reimbursement
from the principal debtor both under the law and under equity.

Section 140 of the ICA, 1872 states,

Rights of surety 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 the payment or
performance of all that he is liable for, is invested with all rights which
the creditor had against the principal debtor.

i.e. the surety steps into the shoes of the creditor and has the same rights conferred
upon it which the creditor had against the principal debtor. Hence, the surety can ask
for indemnity from the principal debtor for the amount he has fairly paid under the
guarantee as per s. 145 of the ICA, 1872 and is also allowed to the gains of every
security which the creditor had against the principal debtor when the contract was
entered into, as per s. 141 of the ICA.38

38
Bangia, R.K., 2000,Contracts of Indemnity and Guarantee, Indian Contract Act, 9th
edition,Allahabad Law Agency, Faridabad,pp-364-365

19
Suppose A gets hurt in a car accident and it is clearly not his fault. His car is wrecked
and he has been badly injured. He is covered for both the damage to his car and his
personal injuries, and so he calls his insurance company and the company pays all of
his expenses relating to the accident. Later, the insurance company, realizing that the
other party at fault also has insurance that will cover the damages, seeks out
reimbursement from that insurance company since its insured was actually at fault for
the accident, by the principal of subrogation.

The insurance company after paying for As claim, is subrogated to the rights of the
insureds policy and can step into the shoes of the insured to go after or sue the
negligent party on the insureds behalf.

Section 145 of the ICA propounds that,

Implied Promise to indemnify surety- - In every contract of guarantee,

there is an implied promise by the principal debtor to indemnify the
surety, and the surety is entitled to recover from the principal debtor,
whatever sum he has rightfully paid under the guarantee, but no sums
which he has paid wrongfully.

A surety who pays off the debts of another party is subrogated to the creditor's former
claims and remedies against the debtor to recover the sum paid.39

READ THE JUJMENT----In Craythorne v. Swinburne40, Sir Samuel Romilly said

that the entire doctrine of principal and surety, with all its consequences etc, lies upon
the principles of equity and not that of contract. He further opined that a surety is
entitled to each and every remedy that the creditor has against the principal debtor
and is allowed to enforce every security and all means of payment to stand in the
shoes of the creditor, not only through the medium of an expressed contract but also
by means of security entered into without the suretys knowledge and he has a right to
have those securities transferred to him and to benefit himself of all those securities

39
Forbes v Jackson (1882) 19 Ch D 615
40
1803-13 All ER Rep 181

20
against the principal debtor. This right of a surety also stands, not upon contract, but
upon a principle of natural justice.

In Bur Singh v. Labhu Ram41, Labhu Ram (Creditor) obtained a money decree
against Bela Singh (debtor). During the execution of the decree, Bur Singh (surety)
gave security that if the judgement debtor fails to appear before the court, he, Bur
Singh, would be liable for the decretal amount due. Bela Singh defaulted and as a
result Bur Singh was arrested. He paid the decretal amount in the court. Bur Singh
filed a suit against the both Bela Ram and Labhu Singh42, contending that the decretal
amount had been illegally obtained from him by the two and that Bela Singh was
liable to pay him for the same under the implied contract of indemnity.

The Court held that since, Bur Singh was made to pay the decretal amount on the
ground of the default of the performance of the conditions of the security bond by
Bela Singh, He is entitled to claim for the same from him (Bela Singh), because when
a person acts as a surety for another, there is an implied warranty by the latter that he
would indemnify the former in case he is damnified due to a default by him in the
performance of the conditions of the security bond.

It was also held in READ____Maroti v. Hussain Miya43 that a surety is entitled to

indemnity, where the mortgage suit was dismissed against the principal debtor, but
money decree was passed against the surety.44

In Anand Singh v. Collector of Bijnor 45, it was held that where after the decree
against the principal debtor and the surety, the principal debtor, applied to a Debt
Conciliation Board, which on the failure of the decree holder to prove his debt,
discharged him from the debt, but not the surety, The surety after the payment under

41
1930 Lah 399
42
His claim against Labhu Singh was dismissed as the court held that it was not open to him to contest
his liability under the security bond as between him and the decree holder, by means of a separate suit.
43
AIR 1925 Nag 392
44
Pollock & Mulla, 2006, MULLA- Indian Contracts and Specific Relief Acts,ed. Padia, R.G., Vol 2
13th edition, Lexis Nexis Butterworths, New Delhi.p-1918
45
AIR 1932 All 610

21
the decree was entitled to be re-imbursed by the principal debtor, under the provisions
of s. 145 of the ICA.46

In another case, Jaggannath Baksh Singh v. Chandra Bhukan Singh and another,47
the appellant, J B Singh, wrote a letter to the deceased father, S B Singh, of the
respondents, requesting him o advance a loan of Rs. 1200 to D H Singh. With regard
to the recommendation, S B Singh advanced the loan and obtained a pro-note the
same day. The plaintiffs sued on the basis of this pro-note, impleading J B Singh as
a surety. J B Singh contended that he was not liable as a surety and also questioned
his liability for interest.

The court held that for a contract of suretyship, there should be concurrence of the
principal debtor, the creditor and the surety, but this does not mean that there must be
an evidence ascertaining that the surety undertook his obligation at the express
request of the principal debtor. Besides, there was ample of circumstances to show
that the letter was written at the request of D H Singh and since the appellant had
made himself liable in case there was any problem in the payment of the money i.e.
payment by the principal debtor, all the necessary requirements of a contract of
guarantee are satisfied and the appellant was held liable as a surety.

Hence, the guarantors right to indemnification is his right to be reimbursed with the
amount which he has paid for the principal debtor (this amount includes the interest
as well).48And in cases where the surety has sustained damages beyond the principal
and interest which he has been made to pay under his guarantee, he is allowed to
recover that damage as well.49

46
Pollock & Mulla, 2006, MULLA- Indian Contracts and Specific Relief Acts,ed. Padia, R.G., Vol 2
13th edition, Lexis Nexis Butterworths, New Delhi.p-1916
47
AIR 1937 Oudh 19
48
Re Fox, Walker & Co ex p Bishop (1880) 15 Ch D 400 (CA) as cited in Pollock & Mulla, 2006,
MULLA- Indian Contracts and Specific Relief Acts,ed. Padia, R.G., Vol 2 13th edition, Lexis Nexis
Butterworths, New Delhi.p-1919
49
Badeley v. Consolidated Bank (1886) 34 Ch D 536 , supra note 46

22
Conclusion

The researcher, has, through this project, tried to establish the relationship between
the Surety and the Principal Debtor. The surety acts as an assurance to the creditor
that the principal debtor, who is bound by the contract, will perform his commitment,
and also that if the principal debtor fails to do so, the surety will execute it or failing
that indemnify the creditor.

As per Section 128 of the Indian Contract Act, the liability of the surety is co-
extensive with the liability of the principal debtor. However, the extent of the liability
is subjected to the contract to the contrary. The liability of the surety is joint and
several with the principal debtor. It is the choice of the creditor to recuperate the
amount either from the principal debtor or the surety after the default of the debtor.

The liability of the surety is immediate and the surety can in no way ask the creditor
to proceed against the debtor first, unless and until it is expressly laid down in the
contract. A surety is discharged of his liability depending on various incidents, for eg,
variance in the terms of the contract, act of omission of the creditor etc. Besides, the
surety is also discharged by a contract between the creditor and the debtor, by which,
the debtor is released, as per s. 134 of the Indian Contract Act.

However, the surety also has a right to get indemnified in cases where the creditor
seeks the compensation of losses from the surety. The surety, in such cases, after
completing his obligation, steps into the shoes of the creditor (subrogation) and
has full right to seek indemnification or reimbursement from the principal debtor
both under the law and under equity. And also where the surety has sustained
damages beyond the principal and interest, which he has been compelled to pay
under the contract of guarantee, in such cases, the surety, is allowed to recover
that extra damage as well. PNB v. BCmills
Ranjit singhmanaging agentBC mills. BC mills opened a cash credit account
eith PNB & to secure repayment of balance 4 docs wer exchanged, 3 by BC mills
and one by Ranjit. Ranjit executed a deed called, deed of guarantee agreeing to

23
pay all monies which may be due as ultimate balance from the company to the
bank. The board of trustees were to determine this amount to be payable to the
bank. This casecontract of guaranteenot that of indemnitySCThe bank
under the terms of the bond executed by ranjit singh, entitled to claim at n etym
the money due from the company as well as from Ranjit singh under the
promissory note and the bond. The suit therefore is not premature. The H instead
of dismissing the suit should have stayed it till the ultimate balance was
determined.( bc mills had closed its business, bt ranjit singh was liable as surety).

24
 VIJAY MALLYA INCIDENT

SBI TAGGED VIJAY MALLYA WILFUL DEFAULTER, OTHERS

STILL DRAGGING FEET. WE NEED SPECIAL COURTS TO FIX
CRONY PROMOTERS

The banks' battle with Kingfisher Airlines continues with the leading lender in the
consortium State Bank of India (SBI) finally tagging Vijay Mallya and two of his
companies as wilful defaulters.

According to the PTI report, besides Mallya, the grounded Kingfisher Airlines and its
holding company United Breweries Holdings, too have been tagged as wilful
defaulters by SBI after Mallyas lawyers failed to make a strong case in the Supreme
Court on their clients genuine state of stress in repaying bank money. Mallya owes
more than Rs 7,000 crore to some 17 banks, most of them state-run lenders.

One good thing about SBI's move is that it may prompt the other more than a dozen
banks in the consortium too to clamp down on Mallya now since most of them have
been waiting for cues from the country's largest lender.

According to a senior banker at United Bank, the lender was looking at the progress
of SBI-Kingfisher case in Bombay High Court, before taking further action on
Mallya. The bank would reassess the situation now, the official said.

However, a look at the history of the case, which has seen a protracted legal battle,
shows that it may not be all that easy for them.

On 18 September, the SC had given permission to Mallya to present his side in the
court represented by lawyers and not him in person, despite the fact that there was a
clear case of default that happened way back in December, 2011 and alleged fund
diversion and financial irregularities by Mallya while dealing with the bank money.
One cant be so sure how long will the tag remain on Mallya, since the liquor baron
still can file a review petition in the apex court.

25
The way Indian courts have handled cases of large defaults and wilful defaults would
make the crony promoters happy. This is because in most instances, they have
managed to use the judiciary to their advantage for delaying the loan recovery process
and leaving the banking system helpless.

Some time towards the middle of last year, Kolkata-based United bank of India first
declared Mallya as a wilful defaulter. But, that tag stayed only until December, when
Mallyas lawyers challenged the banks action on technical grounds.

They said the committee that identified Mallya as a wilful defaulter comprised of four
members instead of three as mandated by the Reserve Bank of India (RBI). Wilful
defaulter tag, once imposed on an individual or entity, ostracises that party from the
Indian financial system. He cannot borrow any more or be part of any listed
companies.

The Kingfisher case clearly highlights the need for a separate court to deal with large-
ticket chronic non-performing asset (NPA) cases. Currently, such cases are heard
across multiple judicial platforms ranging from debt recovery tribunals to the
Supreme Court. The prolonged process delays the loan recovery and leads to painful
degradation of assets, like what happened in the Kingfisher case.

Though Mallya owes over Rs 7,000 crore to lenders, at a recent effort by banks to
auction some of the Kingfisher assets the reserve price of these assets was set at just
Rs 65 lakh. This means chances are that banks will recover only a minuscule fraction
of their several thousand crores of dues even if they manage to sell these assets.

Banks experiences in similar cases are not too different. One must remember that
when an asset is tagged as bad, the value deterioration begins and banks stop earning
from that asset. If such cases get entangled in years of legal battle, there would be
nothing much left at the end for banks to recover.

According to another report in the Business Standard, Mallya is willing to settle his
dues with banks by selling his stake in group companies.;0.l

26
The report says Mallyas 32.62 per cent stake in United Breweries is valued at Rs
8,500 crore, but a part of this stake is pledged, requiring him take the lenders into
confidence before encashing this. If indeed this plan works out, this can offer a big
relief to banks, who have been hoping to get their money back. But one needs to wait
and watch whether banks actually get their money back.

Remember, Kingfisher became NPA in late 2011. Mallya has not so far showed his
willingness to repay but has chosen to confront the creditors in courts.

The bottomline is this:

The Kingfisher case shows that Mallya has cleverly managed to use the judicial
system to delay the loan repayment to banks. Creation of a separate court to address
large-ticket chronic debt NPAs can solve this problem to a great extent.

This court should be constituted with a clear mandate of fast track resolution of NPA
disputes and should have pan-India jurisdiction to handle all such cases. The current
system of multiple courts has proved inefficient to handle big-ticket bank NPA cases.

Even the success of proposed bankruptcy code would depend up on faster resolution
of legal disputes. Its not wise to let cronies misuse the judicial system to their
advantage and take the banking system for a ride. Till the time an effective judicial
platform is set up to handle such cases, even the wilful defaulter tag once
described by RBI governor Raghuram Rajan as a powerful weapon is nothing
more than a child's toy.

27
WHAT CONSTITUTES A WILFUL DEFAULT?

According to a Reserve Bank of India circular of July 1, 2014, and a subsequent

amendment of January 7, 2015, a default not meeting loan repayment obligations
is wilful when it fulfils one of the following four conditions:

* A borrower (or an entity) does not pay up even when it has the capacity to pay,
* a borrower has not used the loan for the purpose borrowed and diverted the money
elsewhere,
* a borrower has siphoned off the funds and the money is not available with it in the
form of other assets, and,
* a borrower sells assets given as security against the loan without informing lenders.

WHO CAN BE TERMED A WILFUL DEFAULTER?

Wilful defaulters can be individuals, juristic persons (groups of individuals, such as

corporations, which are treated by law as though they are persons) and all forms of
business enterprises. In case of business enterprises (other than companies), banks
and financial institutions can report the names of those persons who are in charge, and
are responsible for the management of the affairs of the business enterprise.

HOW DO BANKS IDENTIFY A WILFUL DEFAULTER?

According to bankers, an internal committee, typically headed by an executive

director and consisting of two senior bank officials, scrutinises cases of deemed wilful
defaults based on reports by the credit monitoring or recovery departments. This
panel also looks into the efforts made by the bank to recover the dues, the repayment
capacity of the borrower, and end use of the funds before identifying an individual as
a wilful defaulter. Of late, banks have started conducting forensic audits on deemed
defaulters through a third party before referring it to this committee.

Once a borrower is identified as a wilful defaulter, a showcause notice is issued, and

the borrower is generally given 15 days to reply. The internal committee order and the
submission made by the borrower is reviewed by a so-called review committee,

28
usually headed by the chairman and managing director, or by another executive
director. If the review committee confirms the findings, the bank declares a borrower
a wilful defaulter.

WHY HAVE MALLYA, KINGFISHER AND UNITED BREWERIES

(HOLDINGS) BEEN NAMED WILFUL DEFAULTERS?

State Bank of India has alleged that funds were diverted several times from
Kingfisher Airlines to various UB Group companies and other firms. It said as much
in an August 2014 notice sent to Mallya, Kingfisher, United Breweries, and its
directors, and filed in the Bombay High Court. The notice also alleged that United
Breweries (Holdings), the parent company, had been deliberately avoiding payment
to lenders.

The SBI notice was based on the findings of a forensic audit of Kingfisher Airlines.
However, Mallya has claimed that all inquiries have failed to find any evidence of
misappropriation of funds by him and Kingfisher Airlines. He and United Breweries
have challenged the SBI order, and the case is now pending in the Bombay High
Court. Apart from SBI, United Bank of India and Punjab National Bank have
declared Kingfisher and Mallya wilful defaulters.

29
RBI: GUARANTOR TO BE TAGGED AS WILFUL DEFAULTER IF
OBLIGATIONS NOT MET

Tightening noose around loan defaulters, the Reserve Bank today said guarantors,
who refuse to fulfil their obligations to banks despite having adequate resources, will
also be treated as wilful defaulters.

Once branded a wilful defaulter, a person or entity cannot access institutional credit.
Such a person cannot hold office of director.

"In case the...guarantor refuses to comply with the demand made by the
creditor/banker, despite having sufficient means to make payment of the dues, such
guarantor would also be treated as a wilful defaulter," an RBI circular said.

However, this will be applicable prospectively and not to cases where guarantees
were taken prior to the circular.

"Banks/Financial Institutions may ensure that this position is made known to all
prospective guarantors at the time of accepting guarantees," the central bank said.

Elaborating, RBI said where a banker has made a claim on the guarantor on account
of the default made by the principal debtor, the liability of the guarantor is immediate.

A guarantor could be individual or a company.

Also, in cases where guarantees furnished by the companies within the Group on
behalf of the wilfully defaulting units are not honoured when invoked by the banks
and financial institutions, such Group companies should also be reckoned as wilful
defaulters, the circular said.

30
With an aim to deal firmly with wilful defaults in payment of bank loans like
Kingfisher, the government is also planning to come out with a separate legislation in
the next session of Parliament.

Recently, United Bank of India declared Kingfisher Airlines, its promoter Vijay
Mallya and three other directors as wilful defaulter citing alleged diversion of funds.
IDBI Bank is also considering similar action and is serving out a 15-day notice period
on non-payment of dues.

As per the Contract Act 1872, the liability of surety is "co-extensive" with that of the
principal debtor, unless it is otherwise provided by the contract.

Therefore, RBI said when a default is made in making repayment by the principal
debtor, the banker will be able to proceed against guarantor or surety even without
exhausting the remedies against the principal debtor.

Lenders have to inform RBI about guarantors while reporting wilful default cases.

31
 Bibliography

Statutes
Indian Contract Act, 1872

Books
Singh, Avtar, 1989, Extent Of Sureties liability, Law Of Contract,5 th
edition, Eastern book Company, Lucknow

Bangia, R.K., 2000,Contracts of Indemnity and Guarantee, Indian Contract

Act, 9th edition, Allahabad Law Agency, Faridabad

Beale, H.G, 2004, Suretyship, Chitti on Contracts, Vol 2, Sweet and

Maxwell, London.

Lord Haitshan of St. Maryleborne, 1978, Guarantee and Indemnity,

Halsbury Law Of England, Vol 20, 4th edition, Butterworths, London.

Bhadbhade, Nilima, 2001, Pollock and Mulla- Indian Contract and Specific
Relief Acts, Vol 2, Butterworths, New Delhi.

Moitra, A.C., 2005, Law of Contracts and Specific Relief, 5 th edition,

Universal Law Publishing Co.Pvt Ltd, delhi.

Mallick, M.R. ,J, 2000,Suretys Liability, Commentaries on Indian Contract

Act,1st edition, Kamal Law House, Calcutta

32
 Mukherjee, T.K.,2003, Law of Contracts, Vol 2, 1st edition, Rep 2003, Premier
Publishing Company, Allahabad

Pollock & Mulla, 2006, MULLA- Indian Contracts and Specific Relief
Acts,ed. Padia, R.G., Vol 2, 13th edition, Lexis Nexis Butterworths, New
Delhi.

Articles
THE CONTRACT OF GUARANTEE IN SOUTH AFRICAN LAW, By
Sanguita Popatlal as cited in www.bowman.co.za/LawArticles/Law-
Article.asp, last visited on 20th june, 2007.

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