Legal

Understanding the various aspects of Surety’s Liability

Understanding the various aspects of Surety's Liability

The Indian Contract Act of 1872 talks about the Surety’s liability & rights & in this article, we will analyze the nature & extent of the Surety’s liability with the aid of legal provisions & judicial precedents.

What Is the Provision for Surety’s Liability & Rights?

Under the Indian Contract Act of 1872

1

, section 126 defines the contract of guarantee. According to the section, the Surety is a person giving the guarantee to fulfil a promise or discharge liability of a third person in case of default to the creditor. Thus, it can be said that the Surety assures the creditor of the Act of the principal debtor. It is clear that the Surety’s liability is collateral to the liability of the principal debtor. The act aims to protect the interest of all the 3 parties involved in this contract of guarantee & especially the Surety’s interest, as they play a crucial role in commercial transactions.

Types of Surety Bonds in India

In India, there are various types of surety bonds catering to specific purposes and industries:

  1. Bid Bond: This bond guarantees that a contractor, upon being awarded a contract, will enter into the agreement and provide the required performance and payment bonds.
  2. Performance Bond: It assures that the principal debtor will fulfil their contractual obligations, such as completing a construction project according to specified terms.
  3. Payment Bond: This bond ensures that the principal debtor will make payments to subcontractors, suppliers, and labourers involved in the project.
  4. Maintenance Bond: Also known as a warranty bond, it guarantees the quality of work for a specified period after the completion of the project.

What is the Nature & Extent of Surety’s Liability?

The liability of a surety is secondary in nature. Unlike the principal debtor, the Surety’s obligation arises only when the principal debtor fails to perform their contractual duties. The Surety’s liability is co-extensive with the principal debtor’s, but it is not immediate. The obligee must first exhaust all remedies against the principal debtor before making a claim against the Surety. Moreover, the Surety’s liability is contingent upon the occurrence of a default and the obligee’s compliance with the terms of the contract.

· Co – extensive Liability

Section 128 of the Act lays down the nature & extent of the Surety’s liability. It is mentioned in the said section that the Surety’s liability & the principal debtor’s liability is co–extensive.Co- extensive means that the Surety is liable for the whole of the amount wherein the debtor is liable & the liability depends on the amount of the principal debt. This means that the liability of Surety will have to be specified in the contract of guarantee.

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In the case of Bank of India vs. Surendra Kumar Mishra, it was held that when a principal debtor acknowledges his liability & has extended the limitation period against him, then the Surety will also be affected by the same.

· Limitation on Surety’s Liability

It is evident that the Surety’s liability is co–extensive with the principal debtor’s is not an absolute principle. There are various situations where the liability is limited to only some part of the debt. As per section 128 of the Act, it is achievable to limit Surety’s liability if it is expressly provided in the contract. It is pertinent to note that the burden is upon the Surety to prove that his liability is limited.

· Condition precedent to Surety’s Liability

There is a possibility that the contract has specified certain conditions after which the Surety’s liability will begin. In simpler terms, it means that after fulfilling the following conditions, only the Surety will become liable. Under Section 144 of the Act, the said principle is recognized. The Surety can also add some conditions that must be fulfilled for the commencement of his liability. In the case of Bank of Bihar Ltd. v. Dr Damodar Prasad, it is held that when there is no such condition prescribed to be fulfilled, then the court cannot introduce such conditions to it.

What is the Extent of Discharge or Termination of Surety’s Liability?

The discharge from liability means the Surety’s liability to fulfil the promise when the debtor fails to perform.

The following provisions lay down various situations wherein the Surety’s liability is discharged.

· Discharge by revocation

Section 130 of the Act provides for the revocation of the contract of guarantee by giving notice to the creditor. This revocation is only for future transactions & not for the transactions already entered into. Thus, where there are no future transactions that haven’t been entered into.

· Discharge by Death of Surety

Section 131 of the Act talks about the case wherein because of the Surety’s death. This discharge of liability is available only for future transactions & not those that were entered into previously.

In the case of R.K Diwan v. State of UP, the liability can be enforced against the legal heirs of the Surety to the extent of the property inherited & not in the personal capacity.

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· Discharge by Variance

Section 133 of the Act entails the provision wherein Surety is discharged from his liability if the creditor alters any terms or conditions of the contract with the principal debtor without the consent of Surety, as held in Pratap Singh v. Keshavlal.

It is understood that because of the alterations made in the terms of the contract by the creditor, Surety will be discharged from its liability. However, in this case, the situation must be analyzed correctly.

· Discharge by Release or Discharge of Principal Debtor

Section 134 of the Act provides that Surety is discharged from his liabilities & rights enlisted in any contract between the creditor & the principal debtor.

Privy Council, in an old case, held that the Surety is discharged from the right to pay the debt at any time & after the payment, the right to sue the principal in the name of the creditor.

The Supreme Court in Maharashtra SEB v. Official Liquidator held that if any contract is entered into between the creditor & the principal debtor by which, the debtor is released from the liabilities & the Surety will also be released. However, in this case, if the principal debtor is discharged by the insolvency laws or through the liquidation case, the Surety’s liability will not be absolved.

·Discharge when the Surety’s Remedy is impaired

Section 139 of the Act enlists the situations where the liability of Surety & rights can be discharged. When the creditor does any act inconsistent with the rights and liabilities of the Surety, then the Surety’s remedy will be impaired.

Risks and Considerations in India

While surety bonds provide essential protection for parties involved in contracts, they also come with certain risks and considerations in the Indian context:

  1. Financial Risks: If the Surety has to step in to fulfil the principal debtor’s obligations, it may result in financial liabilities for the Surety.
  2. Contractual Compliance: The principal debtor must adhere to the contract terms to avoid potential claims against the Surety.
  3. Legal Implications: Suretyship involves legal complexities, and it is advisable for both parties to fully understand their rights and responsibilities under the bond.

Case Laws

1. State Bank of India v. Mula Sahakari Sakhar Karkhana Ltd (2006)

In this case, the Supreme Court of India held that a surety’s liability cannot exceed the limit specified in the contract of guarantee. The court emphasized that the Surety’s obligation is confined to the liability cap, and they cannot be held liable beyond that amount, even if the actual loss suffered by the obligee is higher.

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2. Punjab National Bank v. Bikram Cotton Mills &Anr (1968)

In this landmark case, the court clarified that a surety’s liability arises only when there is a specific default by the principal debtor. Mere apprehension of default or potential losses is not sufficient to trigger the Surety’s liability. The court further emphasized that the Surety’s obligation is co-extensive with that of the principal debtor and cannot exceed the contractually agreed amount.

Conclusion

Surety’s liability is a fundamental aspect of Indian contract law, offering protection and assurance in business agreements. The Indian Contract Act entails a wide range of circumstances wherein the Surety’s liability can be discharged to the creditor. Sections 130 -139 enlists these various scenarios. The unique feature of the Surety’s liability that it is in co-existing with the debtor’s liability. The Surety can stipulate the conditions wherein his liability arises under the contract terms. It is pretty clear from the provisions mentioned above that the interest of Surety must be protected.

FAQs

Can a surety’s liability exceed the bond amount specified in the contract?

No, a surety’s liability is generally limited to the bond amount mentioned in the contract. Once the Surety has fulfilled its obligation up to that limit, its liability is discharged, even if the actual loss suffered by the obligee exceeds the specified amount.

Is a surety’s liability immediate upon the principal debtor’s default?

No, a surety’s liability is secondary and arises only after the principal debtor fails to perform their contractual obligations. The obligee must first attempt to recover from the principal debtor before making a claim against the Surety.

Can a surety be held liable without evidence of default by the principal debtor?

No, the Surety’s liability is contingent upon the occurrence of a default by the principal debtor. The obligee must provide evidence of the default before making a claim against the Surety.

Are there different types of surety bonds in India?

Yes, in India, there are various types of surety bonds, such as bid bonds, performance bonds, payment bonds, and maintenance bonds, each serving specific purposes and industries.

Can a surety’s liability be extended beyond the contract period?

No, a surety’s liability is generally limited to the duration specified in the contract. Once the contract period expires, the Surety’s obligation typically comes to an end.

Read our article: Limitation of Liability clause is important in Contracts

References

  1. https://www.indiacode.nic.in/handle/123456789/2187?sam_handle=123456789/1362

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