A Contract of Guarantee refers to a Contract wherein one party promises to
save the other from suffering any losses due to the non-performance of the
promise of another. There are essentially three parties involved in such a
Contract namely the Creditor, Principal Debtor, and the Surety. Disputes might
arise in respect to the powers and the relationship among each of them in a
Contract. This case was a landmark judgement in deciding the course of Guarantee
Contracts in India.
In this case, the respondents, who were partners in a firm, entered into a
Contract with the State Bank of Travancore to open a cash credit account up to
the limit of Rs 1 Lakh. It was further agreed that in case they failed to repay
the amount, the Bank has full right to claim the amount from their estate.
However, a month later, the appellant executed a letter of guarantee with the
bank in respect of any liability of the respondents up to the limit of Rs
1,00,000 for the cash credit account and also for the discounted bills up to the
limit of Rs 45,000. The respondents, in this case, failed to pay the amount
along with the appellant. As a result, the bank decided to sell the stock that
had been pledged. However, the stock which was worth Rs 99,991 was found to be
overvalued by around Rs 30,000.
The bank further gave additional time to respondents to make up for the stock
that had been misplaced or lost but they failed to do so. As a result, the Bank
filed a suit against the respondents as well as the appellant based on the
allegation that they had taken away the stock. The respondents didn't contest
the suit and it was only contested by the appellant on certain grounds claiming
variance in terms of Contract by the bank thereby absolving his liability.
The case was first referred to the Trial Court and later to the High Court both
of which confirmed the decree in favour of the respondents. The decision was
later challenged by the Appellant and brought before the Supreme Court.
The primary issues before the Supreme Court were as follows:
The legal provisions applicable in this case are as follows:
- Whether there was a variance in the terms of the Contract without surety
(Appellant's) consent thereby absolving his liability?
- Whether giving additional time to respondents for the repayment of debt
absolves the Appellant's liability?
- Whether the loss of security on part of the Creditor absolved the
Surety's liability to that extent?
- Section 133 of the Indian Contracts Act, 1872
- Section 135 of the Indian Contracts Act, 1872
- Section 141 of the Indian Contracts Act, 1872
Since this case involves a Contract of Guarantee involving three parties namely
the Bank (Creditor), respondents (Principal Debtors), and the appellant
(surety), the various provisions under the Indian Contracts Act, 1872 concerned
with a guarantee were applied by the Court. A guarantee contract is a tripartite
agreement i.e., its entered into between three parties namely the debtor,
creditor, and the surety who guarantees to pay the amount for the goods availed
by the principal debtor in case he/she defaults.
As per Section 133 of the Indian Contracts Act, 1872, in case there is a
variance in terms of a Contract originally entered into between the Creditor and
the Principal Debtor without the Surety's consent, the surety is discharged from
liability. The Contract between the Creditor and the Principal debtor is the
primary contract from which the secondary contract of Guarantee emerges. As soon
as the creditor and debtor enter into an agreement with the due consent of the
surety, the terms can't be changed without the surety knowing about the same.
Now in the present case, the maximum cash credit limit had been first decreased
to Rs 50,000 and was again increased to Rs 1 Lakh without the consent of the
However, this limit was merely meant for the internal accounting of the bank and
was not binding on the respondents because of the already existing agreement as
can be seen from the facts. As a result, it is fair for the Court to hold that
without a formal written agreement having the consent of all parties, there can
be absolutely no variance in the contractual terms as the reduction in limit was
only for internal purposes which wasn't enforceable.
Another major issue, in this case, was that the creditor had extended the time
period for the bringing back of the lost stock by the respondents in this case.
As per Section 135 of the Indian Contracts Act, 1872 if the creditor gives time
to the principal debtor for repayment of the amount then it discharges the
surety unless the surety assents to this Contract. This section shall apply only
in the case where the creditor had to take any new security from the principal
debtor or had to take some money from the debtor under a new Contract for the
However, in this particular case, it was not the repayment of money that had
been asked for. Since this additional time was to bring back the lost goods, it
doesn't discharge the surety from his liability because these goods had already
been the subject matter of the Contract and were not to be found under a new
Another legal point in this case clearly doesn't call for the liability of the
Surety. Since in this case it was the creditor only who was at fault and the
surety had only guaranteed against the negligent act of debtors, they should not
be liable to compensate to the extent of goods lost.
As per Section 141 of the Indian Contracts Act, 1872, if the creditor loses out
on the security the surety is not liable to pay to the extent of the securities
lost and their liability is discharged. This section is concerned with the
rights of a surety against the creditor. The creditor is essentially entitled to
all the securities held by the creditor against the principal debtor. This right
exists regardless of the fact whether the creditor was actually aware of the
same or not.
Since in this given case, the goods were lost because of the negligence of the
bank itself, the surety is not to be held liable and his liability would be
discharged to the extent of the lost goods. Hence the lost stock worth Rs 30,000
is of no concern to the surety and he isn't required to compensate for it.
As a result, it can be clearly inferred that the surety's liability can't be
discharged completely but only in part to the extent of the lost goods because
of the negligence of the bank.
The Court decided in this particular case with respect to Surety's liability
that they are not discharged from their liability just because the banks
extended the time for returning the goods for the respondents. Further, there is
also no variance in contractual terms and this reduction in limit was not
enforceable and was even changed to the original value later on.
However, the Court decided that the surety's liability is discharged to the
extent of lost goods which was clearly justified in this case, and can only
claim Rs 5,000 from the appellant. This judgement, even in the present times
proves to lay down vital guidelines to be followed for Guarantee Contracts. In
any Contract of Guarantee, the surety is only liable to compensate for any
losses caused by the acts of the Principal Debtor and not for the fault or
negligence of the Creditors.