Guarantor must obtain a Counter Indemnity Bond from the Borrower

CONTRACT OF GUARANTEE - SCHEME OF CONTRACT ACT,1872

1(a) It is submitted that Sections 133, 134, 135, 139, 140,141 and 145 of the Indian Contract Act, 1872 provide as follows.

133. DISCHARGE OF SURETY BY VARIANCE IN TERMS OF CONTRACT.—Any variance, made without the surety’s consent, in the terms of the contract between the principaldebtor and the creditor, discharges the surety as to transactions subsequent to the variance.

134. DISCHARGE OF SURETY BY RELEASE OR DISCHARGE OF PRINCIPAL DEBTOR.—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.

135. DISCHARGE OF SURETY WHEN CREDITOR COMPOUNDS WITH, GIVES TIME TO, OR AGREES NOT TO SUE, PRINCIPAL DEBTOR.—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.

139. DISCHARGE OF SURETY BY CREDITOR’S ACT OR OMISSION IMPAIRING SURETY’S EVENTUAL REMEDY.—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.

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

141. 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.

145. 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.

CERTAINLY, THERE IS NO MANDATE OF CONTRACT ACT THAT FINALLY THE PRINCIPAL DEBT IS TO BE RECOVERED FROM THE GUARANTOR

1(b) The scheme of Indian Contract Act on the subject of a Contract of Guarantee may be summarized as follows:

(a) A contract of guarantee is a tripartite agreement which contemplates the principal debtor, the creditor and the surety {Punjab National Bank v. Sri Vikram Cotton Mills, (1970) 1 SCC 60; AIR 1970 SC 1973; (1970) 2 SCR 462; 40 Comp Cas 927}. The purpose of a guarantee being to secure the repayment of a debt, the existence of a recoverable debt is necessary. It is of the essence of a guarantee that there should be someone liable as a principal debtor and the surety undertakes to be liable on his default. If there is no principal debt, there can be no valid guarantee. This was so held by the House of Lords in the Scottish case of Swan v. Bank of Scotland {(1836) 10 Bligh NS 627} decided as early as 1836.

(b) 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 payment or performance of all that he is liable for, is invested with all the rights which the creditor had against the principal debtor (section 140). 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 (section 141).

(c) 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 (section 145).

(d) In essence, ultimately the debt is to be recovered from the principal debtor, either primarily by the creditor or finally by the surety. Certainly, there is no mandate of Contract Act that finally the principal debt is to be recovered from the surety.

(e) Surety’s right: There is an implied promise by the principal debtor to indemnify the surety and on its basis the latter is entitled to recover from the former whatever sum the latter had rightfully paid under the contract of guarantee;C.K. Aboobackerv.K.P. Ayishu,AIR 2000 Ker 29 (NOC).

1(c)It is respectfully submitted that, on the contrary, consciously against the express provisions of section 145 of the Contract Act, hon’ble Supreme Court in Industrial Finance Corporation of India Ltd vs Cannanore Spinning & Weaving Mills Ltd {(2001) 5 SCC 54; Decided on 12 April, 2002} has observed that the right of the appellant to recover money from guarantors arises out of the terms of the deeds of guarantee which are not in any way superseded or brought to a naught merely because the appellant may not be able to recover money from the principal-borrower, and held as follows.

“………In Maharashtra State Electricity Board, Bombay v. The Official Liquidator, Hig hCourt, Ernakulam & Anr., AIR 1982 SC 1497 where the liability of the guarantor in a case where liability of the principal debtor was discharged under the insolvency law or the company law, was considered. It was held in this case that in view of the unequivocal guarantee such liability of the guarantor continues and the creditor can realize the same from guarantor in view of the language of Section 128 of the Contract Act as there is no discharge under Section 134 of that Act. In our opinion, the principle of the aforesaid decision of this Court is equally applicable in the present case. The right of the appellant to recover money from respondents 1, 2 and 3 who stood guarantors arises out of the terms of the deeds of guarantee which are not in any way superseded or brought to a naught merely because the appellant may not be able to recover money from the principal-borrower.” (emphasis supplied)

1(d) Further, hon’ble High Court of Punjab and Haryana in Anil Kaur Vs. Haryana Financial Corporation (AIR 2011 P & H 140; Decided on April 08, 2011) has observed and held as follows.

“(15)……….Liability of the guarantor being co - extensive with the principal debtor the liability of the petitioner should terminate when the liability against the principal debtor stood crystallized on completion of the winding up proceedings. There has also been failure on the part of the Corporation to recover debt from the Company on various factors noticed here - in - above. As a matter of fact, the liability of the principal borrower i.e. the Company is confined only to the debt when winding up order was passed. The debt and the interest should freeze on the date of passing of the winding up order. The Corporation being a party to the winding up proceeding and having not opted out of the same, nor initiated any proceedings by seeking leave of the Company Court under S.446, it cannot claim anything beyond the amount determined by the Official Liquidator on the date of winding up.(emphasis supplied)

1(e) It is well known that a contract of guarantee, being a dotted line contract, is not based upon a real consent at all. It is rather an imposition upon a needy person. There is such an inequality of bargaining power between the parties that Bank can cause economic duress to the Guarantor/Borrower. In Road Transport Organisation of India vs. Barunai Powerloom Weaver’s Coop Society Ltd (1994 84 Cal LT 174) the Calcutta High Court held that the law requires that before making a person bound by any such term (a clause in a consignment note as to exclusive jurisdiction) it must be proved that the same was brought to the knowledge of the consignor in such a way that it should seem to be the result of a mutual assent. Recently, a full bench of Delhi High Court in HDFC Bank Ltd. vs Satpal Singh Bakshi {WP(C) NO. 3238/2011; Decided on 13 September, 2012} has honestly admitted that the bank entered into agreement with the respondent herein on its own standard form formats. The arbitration clause was foisted by the bank itself upon the respondent, though in law, it becomes mutually acceptable between the parties, and held as follows.

“16. Another significant fact which has to be highlighted is that the bank entered into agreement with the respondent herein on its own standard form formats. The terms and conditions of the loan were set out and decided by the bank. The respondent signed on dotted lines. In this scenario, when it was the proposal of the bank to have an arbitration clause to which the respondent had agreed, bank cannot now be permitted to say that this arbitration clause is of no consequence. Accepting the contention of bank would mean that the arbitration clause is rendered nugatory. It defeats the very effect of the said arbitration clause which was foisted by the bank itself upon the respondent, though in law, it becomes mutually acceptable between the parties.” (emphasis supplied)

CONCLUSION

1(f) Therefore, in consideration of the Guarantor having executed at the request of Borrower a Letter of Guarantee in favour of Bank, the Borrower is obliged to undertake and agree to indemnify the Guarantor pursuant to section 145 of the Contract Act. Therefore, the Guarantor must obtain a Counter Indemnity Letter executed by a Director duly authorized by a Board Resolution on behalf of the Borrower Company.

WINDING UP OF BORROWER COMPANY

1(g) Further, this Counter Indemnity Letter should be secured by creating a statutory 1st charge by hypothecation and mortgage of all the existing plant and machinery, Leasehold Land & Buildings and Factories of the Borrower Company (pursuant to section 145 of the Contract Act). The Borrower Company should also arrange to file with the ROC the statement of particulars of charge created to secure said Counter Indemnity Letter pursuant to section 77 of the Companies Act, 2013, and deliver a copy of the Certificate of Registration to the Guarantor. So that, in the event of winding up of the Borrower Company in the intervening time due to any reason, the Guarantor, being a secured creditor, would be reimbursed at least some portion of the total amount paid by him to the creditor on enforcement of his personal guarantee. (END)

Note:the views expressed are my personal and a view point only.

Author:

Narendra Sharma,

Consultant (Arbitration, DRT, Securitisation)

Expert (Director's Personal Guarantee)

e-mail:nkdewas@yahoo.co.in