CONTRACTS OF INDEMNITY

AND GUARANTEE
 Sec 124 of Indian Contracts Act 1872
Contract of Indemnity

 A contract by which one party promises to save the other from loss caused to him
by the conduct of the promisor himself or by the conduct of any other person.
 Indemnity is the protection against loss, esp. in the form of a promise to pay, or
payment for loss of money/goods. So it is more like a security/compensation for
loss.
 In a contract of indemnity;
• The person who promises to indemnify => Indemnifier (Promisor)
• The person in whose favour such a promise is made => Indemnity holder/
indemnified (Promisee).
 Sec 124 covers indemnity for loss caused by human agency. But it does not deal
with those cases where indemnity arises from loss caused by events/ accidents
which may not depend upon the conduct of the promisor/any other person, or by
reason of liability incurred by the indemnified at the request of the indemnifier.
Insurance contract: Whether contract of
indemnity?
 India:
The scope of indemnity as contemplated in S. 124 is restricted to the following cases, that is,
in case of loss caused
 By the indemnifier/promisor
 By any other person
 So sec 124 does not cover loss arising from non-human intervention.
 The definition excludes from its purview cases of loss arising from accidents such as fire,
tsunami etc.
 Though insurance contracts other than life and personal accident insurance are contract of
indemnity, they are not covered under sec 124.
 So, if under a contract of insurance, an insurer promises to pay compensation in the event
of loss by fire, such a contract does not come under the purview of sec.124. However,
such contract are valid, as being contingent contract (S.31).
 Oriental Insurance Co Ltd Vs Gujarat State Warehousing Corp
(AIR 2003 Guj 159)

 Plaintiff: Statutory Corp established with an object of providing scientific godown

facilities to the pvt and public sectors at competitive rates and has various such
centres all over the State of Gujarat. It has godowns in Ahmedabad and godowns at
Balaji Estate was used for storing fertilizer bags of Gujarat State Fertilizer Co Ltd
(GSFC).
 Defendant: Insurance Co, which issued policy named ‘Fidelity Insurance Policy’
covering the period from 1-4-1987 to 31-3-1988 agreeing to indemnify the plaintiff
corp against the risk subject to the limit of Rs. 15 lakhs from 1-4-1987 covering the
risk under Fidelity.
 On 4-1-1988- It was noticed that 354 bags of Fertilizers belonging to GSFC were
missing out of the total number of 36,906 bags and it was notified to the appellant
on 19/1/1988 and 29/1/1988.
 Appellant corp refused to make the payment of the claim made by the plaintiff of the
loss suffered amounting to Rs.43,471.

 Appellant contended that the suit of the plaintiff is not legal and proper, since the
plaintiff is required to give notice in writing to the appellant within 14 days of the
discovery of any fact and then 3 months after such notice, full details of the claims with
the proof needs to be furnished to the company. Since respondent did not adopt the
condition, he cannot recover.

 The court however held that the alleged breach of condition in the contract notice to be
given to the defendant regarding discovery of such act could not be said to be
fundamental breach. And the court would not permit the appellant to negate the
legitimate claim of the plaintiff, hence decreeing suit for declaration and recovery of
amount with interest by Trial court was proper.
 Life Insurance contract is not a contract of indemnity because in such a contract,
different consideration apply. In contract of life insurance- the payment of certain sum
of money is provided either on death of the person/ on the expiry of a stipulated period
of time( even when assured is alive).

 Even if certain sum is payable in event of death, unlike property, the life of a person
cannot be valued, the whole of the amount assured becomes payable. For that reason
life insurance contract is not a contract of indemnity.

 The Indian Contract Act does not specifically provide that there can be an implied
contract of indemnity.

 The Privy Council has however recognized an implied contract of indemnity in the
following case:
Secretary of State V The Bank of India Ltd
 Secretary of State V The Bank of India Ltd
(AIR 1938 P.C 191)

 A Broker endorsed a govt promissory note in his possession to a bank with false endorsement.
The Bank received it for value and applied to the Public Debt Officer (PDO) in good faith for a
renewal of promissory note in their name.

 The Bank was given a renewed promissory note from the PDO. In meantime, the true owner
sued the Secretary for conversion. The Secretary in turn sued the bank on the basis of implied
indemnity.

 Even in Adamson V Jarvis case, where the plaintiff, an auctioneer sold certain cattle, on the
instruction of the defendant. It turned out that the live stock did not belong to the defendant,
but to another person who made the auctioneer liable. The auctioneer can in turn sue the
defendant for indemnity for the loss suffered by acting on the defendant’s direction.
 It was held that the express indemnity clause is not necessary in face of implied right
to indemnity already existing under the Indian Laws.

 It is the principle of law that when an act if done by a person at the behest of another
and the act is not itself manifestly tortious to the knowledge of the person doing the
act, the person doing the act has a right to indemnity from the man who requested
such an act be done when the act in question turns out to be injurious to the rights of
a 3rd party.

 The Law Commission of India in its 13th Report, 1958 has recommended amendment
to Sec 124. And according to the recommendation Sec 124 has to be expanded to
include cases of loss caused by events which may/may not depend upon the conduct
of any person. It should also provide that the promise may also be implied.
 England:

 Under English Law, the word ‘indemnity’ carries wider meaning. It includes a contract
to save the promisee from loss, whether it is caused by human agency/ any other event
like fire etc. Under English Law, a contract of insurance except life is a contract of
indemnity.
 Right of Indemnity-Holder When Sued
 Sec 125 lays down the extent of liability of the indemnifier and the rights of the
indemnity holder when sued.
 Sec 125 states that the promisee in a contract of indemnity, acting within the
scope of his authority, is entitled to recover from the promisor-
1. all damages which he may be compelled to pay in any suit in respect of any
matter to which the promise to indemnify applies;
2. all costs which he may be compelled to pay in any such suit if, in bringing or
defending it, he did not contravene the orders of the promisor, and acted as it
would have been prudent for him to act in the absence of any contract of
indemnity, or if the promisor authorized him to bring or defend the suit;
3. all sums which he may have paid under the terms of any compromise of any such
suit, if the compromise was not contrary to the orders of the promisor, and was
one which it would have been prudent for the promisee to make in the absence of
any contract of indemnity, or if the promisor authorized him to compromise the
suit.
 So in a suit against the indemnity holder, he may have been compelled to pay
damages, and incurred costs. So in his own turn, he can bring an action against
the promisor (indemnifier) to recover damages and costs paid by him, if the
indemnifier has promised an indemnity in such a case.
 The question arises whether the indemnifier can be asked to indemnify
before the indemnity holder has actually suffered the loss, or does his
liability arise only after the loss has been suffered?
 According to English Common Law : No action could be brought against the
indemnifier until the indemnity holder had suffered actual loss.
 However, this situation had a lot of hardship when the indemnity-holder was not
in a position to meet the claim out of his own pocket. So, in such cases, Court of
Equity provided ‘Relief’.
 According to the rules evolved by the Court of Equity -->

“it was no more necessary for the indemnity holder to be

demnified before he could be indemnified.”

 So, the indemnity-holder can now compel the indemnifier to save him from the
loss in respect of liability against which indemnity has been promised.
 There is difference of opinion in various High Courts in India as to this matter.
 Gajanan Moreshwar V. Moreshwar Madan
AIR (1942) 44 Bom 302
 The Plaintiff (P) got a plot of land on lease from Municipal Corp of Mumbai. ‘P’,
on D’s request transferred the land to ‘D’, on the consideration that he (P) would be
discharged of all the liability arising out of that land.
 ‘P’ allowed Defendant (D) to erect building on that land since he transferred the
lease and the Municipality approved the transfer but did not issue any fresh lease
deed. In their books lease continued to be in the name of ‘P’.
 ‘D’ in the course, incurred debt of Rs.5000 from building material supplier (K),
twice.
 On both occasion, at the request of ‘D’, ‘P’ mortgaged part of the land to ‘K’. The
mortgage contained a covenant making ‘P’ personally liable for D’s default.
 ‘D’ failed to adhere to his consideration as he defaulted in payment of interest on
the mortgage loan.
 ‘P’ filed a suit for discharge of liability on him, alleging ‘D’ to be indemnifier and
so he is entitled to indemnity from ‘D’.
 The issue was whether the suit for indemnity was premature as ‘P’ had not yet
incurred any loss as such?
 The court held that sec 124 deals with one particular kind of indemnity in which
loss is caused by conduct of indemnifier himself/ 3 rd person and not cover cases
outside/ cases when liability arises because of something done by the
indemnified at the request of indemnifier.
 The sec deals with subsequent conduct but here in this case, liability was due to
past conduct and the liability was clear and absolute.
 The Court of Equity has also stated that if indemnity holders liability had
become absolute, then he was entitled to get the indemnifier to pay off the
claim.
 Therefore, if the indemnified has incurred an absolute liability, he is entitled to
call upon the indemnifier to save him from that liability and to pay it off.
(Indemnified before demnified)
 Contract of Guarantee
 Sec 126 states that a :
1. ‘Contract of guarantee’ => is a contract to perform the promise, or discharge the liability,
of a third person in case of his default.
2. ‘Surety’ => The person who gives the guarantee is called the ‘surety’.
3. ‘Principal Debtor’ => the person in respect of whose default the guarantee is given is
called the ‘principal debtor’, and
4. ‘Creditor’ => the person to whom the guarantee is given is called the ‘creditor’.
 A guarantee may be either oral or written.
 Guarantee may be classified as
A. Performance Guarantee: It is when the surety undertakes the responsibility of
performing the promise made by the principal debtor to the creditor in case of principal
debtor’s default.
B. Liability Guarantee: It is when the surety undertakes the responsibility of making the
payment to the creditor of loan given by the creditor to the principal debtor, in case of
the principal debtor’s default.
 Illustration:

‘A’ borrows money from Bank as loan. ‘A’ promises to repay it. ‘B’ makes a
promise to the bank stating that if ‘A’ defaults in paying, then ‘B’ will repay.
Here ‘A’ is the principal debtor, who undertakes to pay the loan. ‘B’ is the
surety who promises to pay the loan in case of default made by ‘A’, so his
liability is secondary. And the Bank is the Creditor in whose favour the
promise has been made. This is a ‘Contract of Guarantee’.
 Object
 The object of such contract is to provide additional security to the creditor in
the form of a promise by the surety to fulfil a certain obligation, in case the
principal debtor fails to do so.
 There are three contracts in a contract of guarantee:
1) The principal debtor makes a promise in favour of creditor to perform a
promise.
2) The surety makes a promise in favour of creditor to undertake the liability in
case the principal debtor defaults.
3) An implied promise by the principal debtor in favour of the surety that in case
the surety discharges the liability because of the default of the principal debtor,
the principal debtor will indemnify the surety for the same.
 When the borrower and the guarantor both sign an agreement in favour of a
bank, they are both jointly and severally liable under that contract.
 Essential Features of a Guarantee
 The Contract may be either Oral or Written:
According to sec 126, a guarantee may be either oral or in writing. However,
there is a difference of opinion with this regard between Indian and English
Law. Under English Law, for a valid contract of guarantee, it should be in
writing and signed by the party to be charged therewith.
 There should be a principal debt:
A guarantee contract requires that there should be some one liable as principal
debtor and the surety undertakes to be liable on his default. So the essence of
guarantee contract is that there should be a principal debt or an obligation to
be discharged by the principal debtor. And the surety undertakes to be liable
only on the default by the principal debtor.
 Benefit to the principal debtor is sufficient consideration:
Consideration is also needed in a contract of guarantee. A guarantee without
consideration is void.
Sec 127 states Consideration for guarantee: 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.
For the surety promise, it is not necessary that there should be direct consideration
between the creditor and the surety, it is enough that the creditor had done something
for the benefit of the principal debtor.

Benefit to Sufficient
To give
principal debtor consideration
guarantee
to surety

Past consideration is not a valid consideration for a contract of guarantee.

Example: A sells and delivers goods to B. C afterwards, without consideration,
agrees to pay for them in default of B. The agreement is void.
Illustrations:
 B requests A to sell and deliver to him goods on credit. A agrees to do so,
provided C will guarantee the payment of the price of the goods. C
promises to guarantee the payment in consideration of A’s promise to
deliver the goods. This is a sufficient consideration for C’s promise.
Here the promise by the surety is regarding sale of goods on credit to the
principal debtor.
 A sells and delivers goods to B. C afterwards requests A to forbear(refrain)
to sue B for the debt for a year, and promises that, if he does so, C will pay
for them in default of payment by B. A agrees to forbear as requested. This
is a sufficient consideration for C’s promise.
In this illustration the goods have already been sold but ‘C’ stands as a surety
for ‘B’ , if ‘A’ forbear to sue ‘B’. There is either a benefit to the principal
debtor or damage to the creditor which has prompted the surety to give
guarantee.
 Consent of the surety should not have been obtained by misrepresentation
or concealment:
The creditor should not have obtained guarantee either by any misrepresentation
or concealment of any material facts, concerning the transaction. If it has been
obtained that way, the guarantee is invalid.
Keeping silence regarding material circumstances, which would affect the
surety’s mind to stand as surety or not, would render the guarantee void.
Sec 142- Guarantee obtained by misrepresentation, invalid:
Any guarantee which has been obtained by means of misrepresentation made by
the creditor, or with his knowledge and assent, concerning a material part of the
transaction, is invalid.
Sec143-Guarantee obtained by concealment, invalid:
Any guarantee which the creditor has obtained by means of keeping silence as to
a material circumstance, is invalid.
Illustrations:
 A guarantees to C payment for iron to be supplied by him to B to the amount of
2,000 tons. B and C have privately agreed that B should pay five rupees per ton
beyond the market price, such excess to be applied in liquidation of an old debt.
This agreement is concealed from A. A is not liable as a surety.
 A engages B as clerk to collect money for him. B fails to account for some of his
receipts, and A in consequence calls upon him to furnish security for his duly
accounting. C gives his guarantee for B’s duly accounting. A does not acquaint C
with B’s previous conduct. B afterwards makes default. The guarantee is invalid.
 If I appoint a cashier and he has been found guilty of theft/ misappropriation but
this has not been disclosed when a surety has been made to guarantee, for the
future conduct of the cashier, the surety will not be liable.
 If a surety is made to guarantee an employee’s existing and future liabilities
without being informed about the employee being indebted already to an extent
more than that of the guarantee, the guarantee is invalid.
 Liability of Surety: Its Nature and Extent
 Sec 128- Surety’s liability:
The liability of the surety is co-extensive with that of the principal debtor, unless it is
otherwise provided by the contract.
 This means that the surety liability is same as that of the principal debtor. If payment of
loan bond is guaranteed, the surety is liable not only for the amount of loan but also for
any interest and charges which may have become due on it.
Creditor can recover from
Creditor RECOVER surety all that he could have
From Surety
recovered from principal
debtor.

 The term ‘co-extensive’ shows the maximum extent of the surety’s liability. But
sometimes, the surety may restrict his liability to a part only of the principal debtor’s
liability.
 It is open to the creditor to bring an action against the guarantor without first proceeding
with the principal debtor.
Illustrations:
• A guarantees to B the payment of a bill of exchange by C, the acceptor. The bill is
dishonoured by C. A is liable, not only for the amount of the bill, but also for any
interest and charges which may have become due on it.
• Principal Debtor makes a default in the payment of debt of Rs.5000. The creditor
can recover from the surety the amount plus interest if any due plus the expenses
spent by the creditor in recovering the amount.

If the principal debtor’s liability is reduced, then the liability of the surety is also
reduced. The liability of surety is joint and several with that of the principal debtor.
So if a creditor has recovered a part of the amount from the property, the liability
of the surety is reduced and stands to the remaining part alone.
 Narayan Singh V. Chattarsingh
A.I.R 1973 Raj. 347
 In this case, the liability of an agriculturist, who was the principal debtor, was
scaled down under the Rajasthan Relief of Agricultural Indebtedness Act 1957. It
was held that the effect of scaling down the principal debtor liability would scale
down the surety liability as well. If not, and the surety is made liable for the full
amount, then he will be entitled to recover the same from the principal debtor, and
this will negative the benefit conferred upon the agriculturist principal debtor
under the statue.
 So the court held that if the principal debtor liability is scaled down in an
amended decree or extinguished in whole or in part by a statue, the liability of the
surety would also pro tanto (to an extent) be reduced/ extinguished.
 Bank of Bihar V. Damodar Prasad
A.I.R. 1969 S.C. 297
 The plaintiff bank lent money to Damodar Prasad, on the guarantee of Paras Nath Sinha.
In spite of demands by the bank, the loan was neither repaid by Damodar Prasad
(Principal Debtor), nor by Paras Nath (Surety).
 The bank then filed a suit against both the principal debtor and the surety. Trial court
passed a decree in favour of the bank but with the condition that the plaintiff bank shall
be at liberty to enforce its dues against the surety only after having exhausted its
remedies against the principal debtor.
 High court confirmed the decree
 The bank in its appeal to the Supreme Court challenged the validity of the condition.
Supreme court overruling the above decision held that a condition of this kind would
defeat the parties intentions. Before payment, the surety has no right to dictate terms to
the creditors and ask him to pursue his remedies against the principal debtor in the first
instance. Where the liability is otherwise unconditional, the court cannot of its own
introduce a condition into it. So creditors can sue the surety without exhausting
remedies against the principal debtor.
 State Bank Of India vs Indexport Registered And Ors

 A composite decree was passed against the surety, the borrower and the
mortgaged property of the borrower. The High Court of Delhi ordered that the
decree should first be enforced against the mortgaged property and only for the
balance if any, against the surety.

 The Supreme Court did not agree with this order and allowed the decree
holder to proceed as he liked.

 The guarantor cannot insist that the creditor must first proceed against the
principal borrower and not the guarantor. It is open to the creditor to proceed
for making recovery against the guarantors without first proceeding against the
principal debtor.
 State Bank of India V Gautmi Devi Gupta
A.I.R. 2002 M.P. 81

 In this case, it was held that if there is a decree in favour of the creditor
bank and in his favour certain goods have been hypothecated, it is not
necessary that the decree holder bank should proceed to recover decretal
amount first from the hypothecated goods and then proceed against the
surety. Even without proceeding against the hypothecated goods, the bank
can proceed against the surety.
 Limit on surety’s liability by contract

 Sec128 states that the liability of the surety is co-extensive with that of
the principal debtor, unless it is otherwise provided by the contract. It
means that if the contract between the parties so provides, surety’s
liability may not be there to the full extent as that of the principal
debtor but smaller than that.

 Thus if the surety undertakes to be liable for Rs. 10000, he will be

liable only to that extent and not more.
 Yarlagadda V Devata China Yerakayya
A.I.R. 1966 A.P. 151
 The bond executed by the surety limited his liability to the extent of Rs.
15000/- with a stipulation that he might be liable to any amount that might
be finally decreed.

 It was held that the respondent (Surety) had undertaken the liability only to
that extent and the clause rendering him to be liable to any amount that
might be finally decreed should be construed as not exceeding Rs. 15000/-.
 Liability of co-surety
 It is clearly noted that the liability of the surety is co-extensive with that of the
principal debtor.

 It implied that the creditor has a discretion of proceeding against the principal
debtor or the surety, unless it is otherwise provided in the contract.

 The same principle is applicable for co-sureties. They have the same rights and
liabilities of that of a surety.

 The liability of co-sureties are joint and several, so one co-surety cannot insist that
the creditor should proceed first proceed against the principal debtor or against any
other surety before proceeding against him. (State Bank of India V. G.J.
Herman)
 Continuing Guarantee
 Sec129=> ‘Continuing guarantee’—A guarantee which extends to a series of
transactions, is called a ‘continuing guarantee’.
 A guarantee for a single specific transaction comes to an end as soon as the
liability under the transaction ends.
 A continuing guarantee intends to cover a number of transactions over a period
of time. The essence of continuing guarantee is that it applies not to a specific
transaction, but to any number of them and makes the surety liable for the
unpaid balance at the end of the guarantee.
 The surety is empowered to revoke a continuing guarantee as to future
transactions, by giving a notice to the creditor. His liability in respect of the
transactions which have already been made continues to exist, whereas his
liability for future transaction comes to an end.
 The death of surety also puts an end to the continuing guarantee unless there is
a contract to the contrary.
 Illustrations:
a) A, in consideration that B will employ C in collecting the rents of B’s
zamindari, promises B to be responsible, to the amount of 5,000 rupees, for the
due collection and payment by C of those rents. This is a continuing guarantee.
b) A guarantees payment to B, a tea-dealer, to the amount of £ 100, for any tea he
may from time to time supply to C. B supplies C with tea of above the value of
£ 100, and C pays B for it. Afterwards, B supplies C with tea of the value of £
200. C fails to pay. The guarantee given by A was a continuing guarantee, and
he is accordingly liable to B to the extent of £ 100.
Kay V Groves
‘A’ guarantees payment to ‘B’ of the price of five sacks of flour to be delivered by B
to ‘C’ and to be paid for in a month. B delivers five sacks to C. C pays for them.
Afterwards B delivers four sacks to C during the same month, for which C does not
pay. The surety was sued. The Court held that the guarantee given by A was not a
continuing guarantee, and accordingly he is not liable for the price of the four sacks.
 DISCHARGE OF SURETY FROM
LIABILITY
1. Revocation by the surety. (sec 130)
2. By surety’s death. (sec 131)
3. By variance in the terms of the contract. (sec 133)
4. By release or discharge of the principal debtor. (sec 134)
5. When creditor compounds with, gives time to, or agrees not
to sue, the principal debtor. (sec 135)
6. By creditor’s act or omission impairing surety’s eventual
remedy. (sec 139)
7. By loss of security by the creditor. (sec 141)
 Revocation of Continuing Guarantee
 Sec 130 states that a continuing guarantee may at any time be revoked by
the surety, as to future transactions, by notice to the creditor.
 This section permits revocation of guarantee by surety:
• When it is a continuing guarantee, and
• As regards to future transactions only.
• This can be done by a notice by the surety to the creditor in that regard.
Once notice revoking guarantee is issued, the liability of the surety would
fasten up-to that date and not thereafter.
• When the surety gives notice of revocation, his liability continues to exist
for the transaction already made, but is revoked as regards to future
transactions, i.e., the transactions made subsequent to the notice.
 Illustrations
a) A, in consideration of B’s discounting, at, A’s request, bills of exchange
for C, guarantees to B, for twelve months, the due payment of all such
bills to the extent of 5,000 rupees. B discounts bills for C to the extent of
2,000 rupees. Afterwards, at the end of three months, A revokes the
guarantee. This revocation discharges A from all liability to B for any
subsequent discount. But A is liable to B for the 2,000 rupees, on default
of C.
b) A guarantees to B, to the extent of 10,000 rupees, that C shall pay all the
bills that B shall draw upon him. B draws upon C, C accepts the bill. A
gives notice of revocation. C dishonours the bill at maturity. A is liable
upon his guarantee.
That is because when a transaction has already been made, surety’s liability
with regard to that transaction cannot be revoked by a subsequent notice.
 Offord V Davies
 A promised in favour of B that if B discounted bill for C, A would
guarantee the payment of bills to the extent of £ 600, during a period of
12 calendar months. Some bills were discounted by B and the payment
for the same was made. Thereafter, A gave notice to B that A would no
more guarantee the discounting of any bills. In spite of the notice, B
continued to discount bills. The bills not having been paid, B sued A for
the same. It was held that A could not be made liable as a surety for the
bills discounted by B, after A’s notice to B.
 Revocation as to future transaction is possible, when there are separate
distinct transactions contemplated in the contract. When the
consideration is single and indivisible, for instance, where a continued
relationship is established on the faith of a certain guarantee, no
revocation of the same is possible.
 Illustration:
If a servant is employed on the basis of guarantee as to his good conduct,
the guarantee is not revocable so long as the servant continues in service.
The employment of servant is one transaction and the guarantee for his
good behaviour is not a continuing one and cant be revoked till he stays in
employment- (Lloyds V. Harper)
Again, where the surety has entered into a continuing guarantee agreement
in terms that it is to continue and remain in operation for all subsequent
transactions, it would not be open to him to turn around and revoke the
guarantee.
 Sita Ram Gupta vs Punjab National Bank And Ors
 The agreement in the guarantee read as: “The guarantors hereby declare that this
guarantee shall be a continuing guarantee and shall not be considered as cancelled or in
any way affected by the fact that at any time the said accounts may show no liability
against the borrower or may even show a credit in his favour but shall continue to be
guarantee and remain in operation in respect of all subsequent transactions.”
 The Appellant having entered into an agreement of guarantee with the Respondent Bank
revoked by a letter written to the Manger of the Bank, before the loan was in fact
advanced by the Bank.
 Referring to the manner it which the agreement was entered into, it was held that it was
not open to the appellant to revoke the guarantee.
 The Apex Court said that the agreement not being unlawful, would override the
statutory provisions contained in Sec 130 of the Contract Act, 1972, since it had waived
the benefit of sec 130 by entering into an agreement of guarantee with the Bank.
 The appellant was thus held not entitled to deny liability to pay debt advanced by Bank.
 By Surety’s Death
 Sec 131 states revocation of continuing guarantee by surety’s death.
 The death of surety operates in the absence of any contract to the contrary, as a
revocation of continuing guarantee, so far as regard future transactions.
 The effect of the death of the surety is that it automatically revoke the continuing
guarantee as regards to future transactions.
 However, on the death of the surety, there may be no revocation of guarantee to a
contract in effect/ already existing. Legal heirs can be sued for already existing debt
but their liability is restricted to the extent of property inherited by them.
 If there is a contract to the contrary, even if the surety dies, the contract of guarantee
continues.
Illustration:
‘A’ enters into a contract of guarantee, stipulating that even after A’s death, his property or
his legal representatives will be responsible for such liability. In such case, the guarantee is
not revoked even if ‘A’ dies.
 By Variance in the Terms of Contract
 Sec 133 states discharge of surety by variance in terms of contract.
 Sec 133 states that, “any variance, made without the surety’s consent, in the
terms of the contract between the principal debtor and the creditor,
discharges the surety as to transactions subsequent to the variance”.
 When the surety has undertaken liability on certain terms, it is expected that
they will remain unchanged during the whole period of guarantee.
 So if there is any variance in the terms of the contract between the principal
debtor and the creditor, without the consent of the surety, the surety gets
discharged as regards to transactions subsequent to such changes.
 The reason is that the surety agreed to be liable for a contract which is no
more there, and he is not liable on the altered contract because it is different
from the contract made by him.
 Illustrations
 A guarantees C against the misconduct of B in an office to which B is
appointed by C, and of which the duties are defined by an Act of the
Legislature. By a subsequent Act, the nature of the office is materially
altered. Afterwards, B misconducts himself. A is discharged by the change
from future liability under his guarantee, though the misconduct of B is in
respect of a duty not affected by the later Act.
 C agrees to appoint B as his clerk to sell goods at a yearly salary, upon A’s
becoming surety to C for B’s duly accounting for moneys received by him as
such clerk. Afterwards, without A’s knowledge or consent, C and B agree that
B should be paid by a commission on the goods sold by him and not by a
fixed salary. A is not liable for subsequent misconduct of B.
 C contracts to lend B 5,000 rupees on the 1st March. A guarantees
repayment. C pays the 5,000 rupees to B on the 1st January, A is discharged
from his liability, as the contract has been varied, inasmuch as C might sue B
for the money before the first of March.
 A gives to C a continuing guarantee to the extent of 3,000 rupees for
any oil supplied by C to B on credit. Afterwards B becomes
embarrassed, and, without the knowledge of A, B and C contract that
C shall continue to supply B with oil for ready money, and that the
payments shall be applied to the then, existing debts between B and
C. A is not liable on his guarantee for any goods supplied after this
new arrangement.
 A (Defendant) becomes surety to C for B’s conduct as manager in C’s
bank. Afterwards, B and C contract, without A’s consent, that B’s
salary shall be raised, and that he shall become liable for one-fourth of
the losses on overdrafts (Discounts allowed by B), to which B agreed.
B allows a customer to over-draw, and the bank loses a sum of money.
A is discharged from his suretyship by the variance made without his
consent, and is not liable to make good this loss. – (Bonar V
Macdonald)
If there is a written contract of guarantee and there is no variance of the
same in writing, the validity of the contract is not affected.
Amrit Lal V State Bank of Travancore

The credit limit of the debtor, which had been fixed at Rs.1,00,000 was
first reduced to Rs.50,000 and then again raised to Rs.1,00,000 without
consulting the surety. This was done by oral instruction to the cashier
only and not by altering any document. It was held that in this case there
was no variance in the terms of contract within the meaning of sec 133,
and, therefore, the surety had not been discharged thereby.
 Anirudhan V Thomco’s Bank

 The appellant agreed to stand as surety to the tune of Rs.25,000 for an

overdraft to be allowed by the respondent bank to the principal debtor,
Shankaran. The bank agreed to allow the overdraft only for Rs. 20,000 and
not for Rs. 25,000. The principal debtor altered this amount of guarantee from
Rs. 25,000 to Rs.20,000. The alteration, which was made by the principal
debtor, was not to the prejudice of the surety.
 The question before the Supreme Court was whether such an alteration, which
was to the benefit of the surety, had discharged the surety?
 The Majority decision (2:1) was that when the alteration is to the benefit of
the surety, that is not a material alteration. Such an alteration is unsubstantial
and that does not discharge the surety from liability.
 Whether this decision appears to be in compliance with Sec 133?
 Novation of Contract

Novation, in contract law is the act of –

 replacing an obligation to perform with another obligation; or
 adding an obligation to perform; or
 replacing a party to an agreement with a new party.
 Satish Chandra Jain V National Small Scale Industries Corp Ltd
A.I.R. 2003 S.C. 623.

 The appellant stood as a guarantor to funding done to his son’s property business
venture. Later on, the son converted his proprietary business into private limited
company. The respondent-creditor gave his consent to such change and fresh
agreement was entered into under which the company became hirer and
appellant’s son with one another became guarantors. On default by company,
suit for recovery was filed against it and the two guarantors under the
subsequent agreement but appellant was not made a party to the suit.
 Plaint neither referred to the first agreement of guarantee nor asked any relief
against the appellant.
 The Apex Court held, that inclusion of property of appellant recovery certificate
issued was not proper because subsequent agreement amounted to novation of
contract by which guarantee of appellants stood discharged.
 By Release or Discharge of the Principal Debtor
 Sec 134 discharges the surety from liability when the principal debtor is
released or discharged.
 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.
 Since the liability of the surety is coextensive with that of the principal
debtor, if there exist a contract between the creditor and the principal
debtor whereby the principal debtor is released, or when the creditor does
any act/ omission, which will discharge the principal debtor, then the
surety will also be discharged from his/her liability.
 Illustrations

 A gives a guarantee to C for goods to be supplied by C to B. C supplies goods

to B, and afterwards B becomes embarrassed and contracts with his creditors
(including C) to assign to them his property in consideration of their releasing
him from their demands. Here B is released from his debt by the contract with
C, and A is discharged from his suretyship.
 A contracts with B to grow a crop of indigo on A’s land and to deliver it to B
at a fixed rate, and C guarantees A’s performance of this contract. B diverts a
stream of water which is necessary for irrigation of A’s land, and thereby
prevents him from raising the indigo. C is no longer liable on his guarantee.
 A contracts with B for a fixed price to build a house for B within a stipulated
time. B supplying the necessary timber. C guarantees A’s performance of the
contract. B omits to supply the timber. C is discharged from his suretyship.
 Whether a settlement between the creditor and the
principal debtor after a joint decree had been passed
against the principal debtor and the surety would result
in the discharge of the surety?
 No discharge after the decree has been passed
Charan Singh V. Security Finance Pvt Ltd.,
A.I.R. 1988 Delhi 130.
 The creditor obtained a decree for Rs.30,155 jointly against two principal debtors and
the surety. After that, the creditor entered into an agreement with one of the principal
debtors that if he paid a sum of Rs.10,000/-, the creditor (decree-holder) will not
proceed further against him. After this, the amount has been paid, the creditor sought
to recover the balance from the surety. It was held that such a compromise after the
decree had been passed did not discharge the surety and, therefore, the creditor was
entitled to recover the balance of the amount from the surety.
 Itwas held that the provisions of Sec 133 to 139 apply only where the rights of the
parties have not been crystallized and merged in a decree of the Court, and they do not
apply to the judgment-debtors.
 When Creditor compounds with, gives time
to, or agrees not to sue the Principal debtor.
 Sec 135 states that when a contract between the creditor and the principal debtor, by which
the creditor makes a composition with, or promises to give time to, or not to sue, the
principal debtor, discharges the surety, unless the surety assents to such contract.
 So according to this section, a contract between the creditor and the principal debtor
discharges the surety on the following circumstances:-
I. When the creditor makes composition with the principal debtor,
II. When the creditor promises to give time to the principal debtor, and
III. When the creditor promises not to sue the principal debtor.
 So in the above circumstances, the surety is discharged if the creditor and the principal
debtor make such contract without the consent of the surety.
 But is such contract is made with the consent of the surety, the surety is not discharged.
I. Creditor compounding with the principal debtor
 When the creditor makes compositions with the principal debtor without the consent
of the surety, this means variance in the original contract, which will lead to discharge
of surety from liability.
 For example: A borrows Rs.10,000 from B. C stands as a surety as regards the
repayment of loan by A to B. Thereafter, A and B agree that A may repay Rs.5,000
instead of Rs.10,000. C is thereby discharged from liability as surety.
II. Creditor promises to give time to the principal debtor
 It means extending the period of payment which was not contemplated in the contract
of guarantee. The surety expects that the creditor will take the performance from the
principal debtor without any delay. If the creditor causes delay by giving more time to
the principal debtor and then the surety is asked to be liable on the debtor’s default,
this would delay the surety’s action for reimbursement against the principal debtor,
and therefore such an arrangement works to the prejudice of the surety.
 And so when such extension of time is given to the principal debtor without the
surety’s consent, the surety is discharged even if such extension of time is for the
benefit of the surety.
 Kurian V. The Alleppey C.C.M.S. Society

 The creditor filed a suit against the debtor for the recovery of some money
due from the debtor. Then there was a compromise between the two parties to
the suit according to which the debtor was allowed to pay the decretal money
within nine months from the date of the compromise.
 This happened without the knowledge or consent of the surety. It was held
that this arrangement meant giving time to the debtor within the meaning of
sec 135, and the surety was, therefore discharged from his liability.
 Amrit Lal V. State Bank of Travancore
A.I.R. 1968 S.C. 1432

 Respondents are partners of another respondent firm and they entered into an
agreement with a Bank (R1) to open a cash credit account to the extent of Rs.
100,000 to be secured by goods to be pledged with the Bank. The agreement
provided that the borrowers shall be responsible for the quantity and quality of
goods pledged. The appellant (A) became surety for the borrowers for the
account up-to Rs.100,000 and allowed the Bank to recover, notwithstanding any
other security the Bank may hold. The stock pledged was initially valued at
about Rs. 99,991 but after verification shortage of goods to the value of Rs.
35,690 was found. It was alleged that R2-R6 must have taken away the goods.
They were granted time to make up the deficit but they failed to do so. After
adjusting the money realized on the sale of the goods pledged and other
adjustments, a sum of Rs. 40,933.58 was found due to the Bank from R2-R6.
The Bank filed a suit against them and A.
 Main Contentions:
 Certain entries in the account books of the Bank showed that the maximum
limit of credit was reduced to Rs. 50,000 and again raised to Rs. 100,000
without consulting the appellant, therefore there was variation in the terms
of the contract without the surety’s (appellant’s) consent and, under s. 133 of
the Indian Contract Act the liability of the appellant was discharged.
 Under s. 135 of the Act, the conduct of the Bank in giving time to R2-R6 to
make up the deficit in the quantity of goods absolved A of all liability.
 Under s. 141 of the Act, since a portion of the security was parted with or
lost by the creditor without surety’s consent, the liability of A was
discharged to the extent of the value of the security so lost.
 JUDGMENT
 (w.r.t1st contention of A) The entries in the books of account were mere internal instructions
not legally binding on the respondents, and in view of the formal record in the original
agreement and letter of guarantee, there could not have been a variation in the terms without
a proper written agreement. Therefore, there was no variance in the terms of the contract and
the provisions of s. 133 of the Act were not attracted.
 (w.r.t 2nd contention of A) The act of the Bank in giving time to the principal debtor to make
up the quantity of goods pledged is not tantamount to giving of time to the principal debtor
for making payment of the money, within the meaning of the section 135 and hence it is not
attracted. What really constitutes a promise to give time within the meaning of s. 135 of the
Act is the extension of the period at which, the principal debtor was by the original contract
obliged to pay the creditor, by substituting a new and valid contract between them, or,
whenever the taking of a new security from the principal debtor operates as giving time.
 (w.r.t 3rd contention of A) Under s. 140 of the Contract Act the surety is, on payment of the
amount due by the principal debtor, entitled to be put in the same position in which the
creditor stood in relation to the principal debtor. Under s. 141 of the Act the surety has a right
to the securities held by the creditor at the date when he became surety. The shortage was
brought about by the negligence of the Bank and to that extent it must be deemed to be a loss
by the Bank of the security. Contention accepted.
 Agreement by the creditor with the principal debtor to take the payment in instalments
instead of in lump sum, amounts to giving time to the principal debtor and that results
in the discharge of the surety.
 The position is the same even after a joint decree is passed against the principal debtor
and surety. Thus, if after the passing of the decree, the creditor without consent of the
surety, grants instalments to the principal debtor, that amounts to giving time to the
principal debtor and the surety is thereby discharged.
 For the discharge of surety under sec 135, there should be contract between the creditor
and the principal debtor.
 Sec 136 states Surety not discharged when agreement made with third person to give
time to principal debtor.
 Where a contract to give time to the principal debtor is made by the creditor with a
third person, and not with the principal debtor, the surety is not discharged.
Illustration:
C, the holder of an overdue bill of exchange drawn by A as surety for B, and accepted by
B, contracts with M to give to B. A is not discharged.
III. Creditor promising not to sue the
principal debtor
 A contract between the creditor and the principal debtor whereby the
creditor promises not to sue the principal debtor, also results in the
discharge of the surety. The surety has a right to sue soon after
payment becomes due, the creditor will take action against the
principal debtor to recover the same. Therefore, the promise by the
creditor not to sue the principal debtor is inconsistent with the right
of the surety, and therefore, the surety is discharged as a result.
Mere forbearance to sue not enough
 Sec 137 states, Creditor’s forbearance to sue does not discharge surety.
 Mere forbearance on the part of the creditor to sue the principal debtor or to
enforce any other remedy against him does not, in the absence of any
provision in the guarantee to the contrary, discharge the surety.
 Although a promise by the creditor not to sue the principal debtor discharges
the surety, but a mere forbearance to sue on his part does not discharge the
surety.
 The reason is that by promising not to sue, the creditors right of suing is
given up and the right to sue is extinguished whereas by mere forbearance to
sue, the right to sue can still be exercised.
 Illustration: B owes to C a debt guaranteed by A. The debt becomes payable.
C does not sue B for a year after the debt has become payable. A is not
discharged from his suretyship.
 Forbearance to sue until the end of the period of
limitation
 Sometimes, there is forbearance to sue the principal debtor by the creditor for such
a long time that because of law of limitation, the action against the principal
debtor becomes time barred.
 So in these situation the question arises whether the surety is discharged from
liability?
English Law:
 surety not discharged.
 Two reasons for that.
i. Eventhough the action becomes time barred, it does not result in complete
extinction of the debt.
ii. Even though the creditor’s right of action against the principal debtor may not be
possible, the surety can himself set the law in operation against the principal
debtor.
 India:
Majority of the High Courts have also adopted the same position and
held that even though by forbearance to sue by the creditor, the action
against the principal debtor is time barred, the surety is not discharged.
By Creditor’s act or omission impairing surety’s
eventual remedy- Sec 139
 Sec 139 states that if the creditor does any act which is inconsistent with the
rights of the 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.
 So when the act or omission on the part of the creditor is inconsistent with the
interest of the surety and the same results in impairing or affecting his
eventual remedy against the principal debtor, the surety is discharged thereby.
 According to Sec 140, which deals with Rights of surety on payment or
performance, states that 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.
 So if the creditor does an act/ omission, the effect of which is to damage the surety’s
remedy against the principal debtor, the surety is discharged.
Illustrations
I. B contracts to build a ship for C for a given sum, to be paid by instalments as the
work reaches certain stages. A becomes surety to C for B’s due performance of the
contract. C, without knowledge of A, prepays to B the last two instalments. A is
discharged by this prepayment.
II. C lends money to B on the security of a joint and several promissory note made in
C’s favour by B, and by A as surety for B, together with a bill of sale of B’s
furniture, which gives power to C to sell the furniture, and apply the proceeds in
discharge of the note. Subsequently, C sells the furniture, but, owing to his
misconduct and wilful negligence, only a small price is realized. A is discharged
from liability on the note.
III. A puts M as apprentice to B, and gives a guarantee to B for M’s fidelity. B promises
on his part that he will at least once a month, see M make up the cash. B omits to see
this done as promised, and M embezzles. A is not liable to B on his guarantee.
 State of M.P. v. Kaluram
A.I.R. 1967 S.C. 1105
 The State of M.P. made a contract for the sale of ‘felled trees’ with one Jagat
Ram, who was the highest bidder in the auction sale. The payment for these
trees was to be made by instalments. Kaluram was a surety for the payment by
the purchaser of trees.
 The purchaser failed to pay the second and subsequent instalments. The State
of M.P. did not take any steps to recover this amount, nor did they stop the
removal of the felled trees on default of payment.
 It was held that since the State Govt. had failed to take necessary steps to
recover the amount from the purchaser by allowing him to take away the trees,
the surety’s remedy against the purchaser (Jagat Ram) had thereby been
impaired, the surety (Kaluram) was discharged from his liability.
 But if the goods are lost without the fault of the creditor, the surety is not
discharged thereby.
 M.R.Chakrapani v. Canara Bank
1997 (2) KarLJ 357
 The property hypothecated to the bank was sold by the principal debtor. The
surety immediately furnished the particulars of the sale to the bank, but the
bank took no steps either to trace and seize the property or failed to take
action against the principal debtor by lodging a complaint with the police or
filing a case in a criminal court for tracing and attachment of property and
recovering the dues.
 The court held that the surety was discharged because of the inaction on the
part of the bank.
 When the bank loses the security deposited with it by the principal debtor due
to its negligence, the surety would stand discharged in respect of the loan
given by the bank on the basis of the security.
Union Bank of India, Bombay v. S.B.Mehta

 ‘A’, a principal debtor, at the time of taking loan from a bank executed a
promissory note, an agreement of hypothecation of goods and other
documents in favour of the said bank, and ‘B’ stood as surety for the loan
granted by the bank to ‘A’. The bank sued ‘A’ & ‘B’ to recover the amount
of loan.
 It was found that the goods which were the subject-matter of
hypothecation had been disposed by A (the principal-debtor) due to
inaction and negligence on the part of the plaintiff bank.
 Due to that B’s remedy to proceed against A had come to an end, and,
therefore, it was held that B was discharged as surety towards the plaintiff
bank.
 By loss of the security by the creditor -
Sec 141
 According to Sec 141 states Surety’s right to benefit of creditor’s securities.
 A surety is entitled to the benefit of every security which the creditor has
against the principal debtor at the time when the contract of suretyship is
entered into, whether the surety knows of the existence of such security or not;
and if the 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.
 Illustration: The creditor of loan who has certain goods of the principal
debtor under him as security, allows the buyer (Principal debtor) to take away
the goods without insisting payment of loan, the surety who guaranteed the
repayment of loan is discharged from his liability.
 If the creditor did not lose the security but they are lost without the creditor’s
fault, the surety is not discharged thereby.
 Substitution of surety
 If the surety is replaced by a party without the written approval of the
creditor, the surety is not discharged.
H.P.S.I.D.C v. M/S Manson India Pvt Ltd
A.I.R. 2009 (NOC) 409
• The Defendant company and its promoters had taken loan from the appellant
corporation. The promoters unilaterally without waiting for prior approval
from the corporation as was required under the agreement entered into
between them, transferred their interest in the company to new Directors and
changed management of the company.
• The Court held that the promoters were not absolved of their personal
liabilities under the deed of guarantee with the corporation.