An Overview of Guarantees as a Contract

The term ‘guarantee’ has been defined by the Black’s Law Dictionary simply as the assurance that a contract or a legal act will be duly performed. [1] In other words guarantee is the promise by one to fulfil the obligations of another towards a third party in case the oblige defaults in performing the obligations or pay off the debt. The Indian Contract Act, 1872, (hereinafter referred to as ‘the Act’) defines the term guarantee as a contract to perform the promise, or discharge the liability of a third person, in case of his default. [2] Thus if A contracts a debt with B and it is said that C is the one who provides a guarantee of the repayment of the debt of A (C is called the surety), then C is liable to pay back to B in case A defaults in the payment as per the terms of the debt.

The surety, in contracts of guarantee has certain rights which are protected by the provisions of the Act. Even outside this Act, the rules protecting the rights of a surety are an integral part of the common law with regard to contracts of guarantee. One of such rules is that in case any alteration is made in the contract of guarantee without the consent of the surety, the surety is discharged from his obligations. It is indeed true that the alteration spoken about is a material alteration. One of the general principles of contract law is that if any material alteration takes place in a contract without the consent of one of the parties to it, then the contract becomes voidable and the party whose consent has not been taken can rescind it. Thus it is necessary that an alteration, to affect the contract, must be material.

This principle has been embodied in Section 133 [3] and Section 135 of the Act. It provides that any variance in the contract between the principle debtor and the creditor without the surety’s consent will discharge the surety from his obligations under the contract. It is to be seen here that in order to discharge the surety from his obligations, he should not have consented to the alteration made. If there is consent, whether implied or express, the variation would not result in the discharge of the surety. However it is also to be seen that in case the alteration is made while the guarantee is in the hands of the creditor, the surety is discharged, however if it is made by a person who acts as the agent of the surety, then the surety is not discharged.

The section speaks of an alteration and such alteration as mentioned earlier had to be material. Now a question that arose before the Supreme Court in the instant case is that if the alteration is immaterial or in a case it benefits the surety, can it lead to a discharge of the surety? Can it be said that that by entrusting the letter of guarantee in the hands of the principal debtor, the surety is discharged or can, in such a case, the principal debtor be considered to be acting on behalf of the surety?

This case answered the above question in the negative. It held that in both cases the surety cannot be discharged from his obligations under the contract of guarantee. It was for the first time that such a case had arisen under the topic of guarantee although the question of material alteration had been dealt with earlier.

Research Methodology

The researcher here has adopted doctrinal method of research, with the NALSAR library and internet being the main sources of information. Also an effort has been made to critically analyze the decision in the instant case in the light of the good law given both by the Act and the decisions of the common law courts.

1.2 Formatting Styles

The researcher has followed the style of formatting given by Dr. Vijender Kumar, Professor of Law, NALSAR University of Law, Hyderabad.

2. Facts of the case

The appeal in the Supreme Court arose out of a suit filed by one Thomco’s Bank in Trivandrum against the appellant N.S. Anirudhan and one V. Sankaran in the trial court. The suit was based against V. Sankaran on a promissory note executed by him in favour of the Bank on February 24, 1947 and against the present appellant on a letter of guarantee dated May 24, 1947. By this letter of guarantee the appellant had undertaken to repay to the Bank the balance due on the overdraft account opened in favour of Sankaran, up to a maximum of Rs. 20,000/- which was also the maximum amount for which the overdraft had been arranged. The letter of guarantee submitted to the court bore two corrections both in figures as well as in the written words mentioning the amount of guarantee. The figure ‘5’ in the amount of guarantee of Rs. 25000/- appeared to have been altered to ‘0’ resulting in the sum being Rs. 20000/-. Also in the words ‘Rupees Twenty Five Thousand’ the word ‘five’ appeared to have been struck out, resulting in the sum being ‘Rupees Twenty Thousand’ in words.

It was contended by the appellant Anirudhan in the trial court that he had furnished a guarantee of only Rs. 5000/- which was altered by the principal debtor Sankaran to Rs. 20000/- without his consent. However this set of facts of alteration in the letter of guarantee as put forth by Anirudhan and the case made out of it was not accepted in the Trial Court. The Trial Court found that the original amount of guarantee was of Rs. 25000/- and was altered to Rs. 20000/- without the consent of the surety and also since no question about the material nature of the alteration was raised, the suit against the appellant was dismissed.

On appeal in the High Court of Kerala, it was found that there was no prior oral contract between the surety and the Bank. The contention of the Bank was that after having contracted to provide a loan of Rs. 20000/- , Sankaran brought the letter of guarantee and asked for a further loan of Rs. 5000/- which was refused by the bank. Then Sankaran took back the letter of guarantee and then returned it after sometime making the alterations mentioned above. These changes were not consented to by Anirudhan but the Bank however kept the letter and sued Anirudhan on it. The High Court allowed the appeal by the Bank and made Anirudhan liable to pay the amount of guarantee mentioned in the letter. Against this decision of the High Court, Anirudhan appealed in the Supreme Court.

3. Judgment of the Supreme Court:

In the instant case, M. Hidayatullah and J.L. Kapur JJ held that the alteration in the letter of guarantee was not material or substantial and will not amount to discharge of the surety from his obligations under the letter. However A.K. Sarkar J dissented and held that the alteration would amount to discharge of the surety from his obligations. Thus by majority it was the court order was that the alteration had no discharged the appellant from his obligations as a surety and he was still liable to the Bank to the tune of Rs. 20000/-

3.1 Ratio decdendi of the decision and analysis

Kapur J reasoned that since the surety is not discharged from his obligations he entrusts the letter of guarantee to the principal debtor by himself and the principal debtor makes any alteration in such a letter, such a condition squarely applies to this case. Here Anirudhan, the appellant, entrusted his letter of guarantee to the principal debtor Sankaran, where upon the said alteration was made by Sanakaran. In such a cased, Kapur J opined that the principal debtor acts as an agent of the surety and thus the surety is not discharged.

According to Sarkar J. the alteration in the letter of guarantee was done not to carry out the intention of the parties. He held that the alteration was made without the authorisation of the appellant and thus without his consent. Such an alteration was not binding on the surety. Also he held that if the alteration was ignored then no contract came into existence and the surety could not be sued upon it. Also if the alteration was without his consent then the altered document did not give rise to the contract that the surety was being sued upon as he never consented to it. He thus held the surety discharged from the obligations of the contract to the Bank.

According to Hidyatullah J., the alteration made in the letter of guarantee was immaterial and unsubstantial. He held that if on inquiry it is found that the alteration is unsubstantial or for the benefit of the surety, the surety will not be discharged and will be liable. Further he also gave the reasoning of agency as given by Kapur. J. Also he considered the alteration which law would have provided for had it not been made, as the sum that could be lent was only Rs. 20000/-

4. Analysis:

a. The following are the reasons for the unimpeachability of the judgment

4.1. Whether the alteration made by Sakaran in the letter of guarantee by reducing the

amount of guarantee a material alteration?

It is a principle of common law that any variance made in the absence of the consent of the surety, in the contract of guarantee will result in discharge of the surety. As quoted in the instant case, in the early case of Pigots, [4] it was resolved that in case there is alteration in the document of guarantee, the surety can plead that the document has been materially altered and hence it is not his document and that he is discharged. Also it was resolved that in case of such material alteration, the document becomes void. [5] The principle of law on the discharge of sureties is that the surety like any other contracting party cannot be held bound to something for which he has not contracted. [6]

An unauthorised material alteration avoids a contract so that so that if a promisee after a written contract has been executed materially alters it without the consent of the promisor whether by adding anything or striking out any part of the contract or otherwise, the contract is avoided as against the person who was otherwise liable upon it. [7] It may also be taken to be the law that even if the alteration is made by a stranger without the knowledge of the promise the other party is discharged if the contract is in possession of the promisee or his agent; but is the contract is altered by a stranger when the contract was not in custody of the promisee, the promisor is not discharged. [8]

The law relating to the discharge of surety because of alteration in the letter or contract of guarantee has been codified in India in Section 133 of the Indian Contract Act, 1872 (hereinafter ‘the Act’). This section provides that if any variance is made in the terms of the contract between the principal debtor and the creditor without the consent of the surety, then the surety stands discharged. [9]

Going by the bare wordings of the above section, it would seem that any alteration made in the terms of the contract between the principal debtor and creditor would result in the discharge of the surety. Such strict interpretation would then include an alteration made by the surety himself or an alteration made by the principal debtor when the surety has entrusted the letter of guarantee to the principal debtor. Also it would include any slight alteration which did not change the legal character of the document and merely reflected the facts as they stood without any detriment to the surety.

Thus it is necessary that the variation be made in such manner that it materially affect and alters the position of the surety and in other words, is to his detriment. If there is any change in the position of the principal debtor as regards his creditors it must materially affect the position of the surety before the latter can be absolved from liability. [10] Thus it is necessary that the alteration spoken of by the section is material and substantial and not immaterial and such as not affecting the position of the surety. For this it is necessary that either such alteration has to either change the legal character of the document or be of substantial detriment to the surety. Material alteration has been explained in a similar manner in Kalianna Goudner v. Palani Goudner. [11] Here the Supreme Court quoted Halsbury’s Laws of England: “A material alteration is one which varies the rights, liabilities or legal position of the parties as ascertained by the deed in its original state, or otherwise varies the legal effect of the instrument as originally expressed”. [12]

In the instant case, the contention of Anirudhan that he had given a guarantee only for Rs. 5000/- was disproved in the trial court as well as the High Court. As a result the facts stood that he had given a surety for Rs. 25000/- which on being produced to the Bank by Sankaran was turned down as the Bank could only furnish a loan for Rs. 20000/-. On this Sankaran reduced the amount to Rs. 20000/-. This alteration is not material as it neither changes the legal status or character of the document nor does it work towards the detriment of the surety. Going by the above definition of material alteration as given in Halsbury’s Laws, the alteration made in the instant case does not vary the rights, liabilities or legal position of the parties. With regard to the surety, it is to be seen that he had given a guarantee of Rs. 25000/-. This was in fact reduced to Rs. 20000/- which was anyways included in the initial sum of guarantee. Thus the liability of the surety was not varied or altered as he now was liable for a sum which was included in the initial amount of guarantee. Also the legal effect of the document which is providing a guarantee to the repayment of the loan by the principal debtor, Sankaran, was not varied. It still remained a letter of guarantee albeit for an amount lesser than what was initially proposed.

Also such an alteration was in no way detrimental to the surety as the reduced sum was already included in the amount of guarantee originally furnished i.e. if the amount stood at Rs. 25000/- the appellant would have had to anyways cover the amount of Rs. 20000/- while paying off the debt of Rs. 25000/-. Thus a reduction of an amount already consented to be paid would not require a distinct consent and such consent can be taken as implied.

Thus the alteration made by Sankaran in the letter of guarantee cannot be considered as a material one.

4.2. Is the appellant, M.S. Anirudhan discharged because of such an alteration?

Now remains the question as to whether the appellant Anirudhan could be discharged from his obligations as a surety because of such alteration. It is to be seen that in order to discharge the surety from his obligations under the contract of guarantee it is necessary that the alterations must be made without his consent, whether express or implied. Here Anirudhan would have been totally discharged from his obligations if any material alteration was made by the promisee i.e. the Bank. However, it is clear from the facts that it was not the Bank which made such alterations. In case it was Anirudhan who made the alterations he cannot claim exemption as it was his own act. It remains to be seen if any alteration made by Sankaran, the principal debtor in this case, discharges Anirudhan from his obligations.

As has been mentioned above, if the contract of any of its terms are altered materially by the promisee without the consent of the promisor the latter stands discharged as it would amount to a unilateral transaction. Further it is also to be seen that whenever there is a contract between the creditor and the principal debtor, the surety’s consent ought to be taken, but where the contract or any changes in it are for the benefit of the surety or manifestly unsubstantial the surety is not discharged although his consent was not taken. [13] This view has been taken and the case itself has been quoted by Hidayatullah J. in his judgment in the instant case. Thus it can be seen that the strict rule laid down in Pigots case [14] as quoted above can no longer be considered an authority or good law. Furthermore it is to be seen that if a guarantor entrusts a letter of guarantee to the principal debtor, and the principal debtor makes an alteration without the consent of the appellant then the guarantor is liable because it its due to the act of the guarantor that the letter of guarantee remains with the principal debtor and what the principal debtor did will estop the guarantor from pleading want of authority. [15]

In other words if by the act of the surety himself the letter of guarantee is placed into the hands and in the control of the principal debtor and certain alterations are made in the contract of guarantee, the surety will be liable all the same as before.

In the instant case, the appellant handed over the letter of guarantee to the principal debtor for the purpose of depositing it in the bank. However since the Bank refused to furnish a loan equal to the amount guaranteed the amount was reduced by the principal debtor to the amount of the loan being furnished. Thus it is evident that the surety entrusted in the principal debtor the letter of guarantee. Thus an alteration made by the principal debtor will be seen to have the consent of the surety as the letter of guarantee remains with the principal debtor because of the act of the surety himself. In such a case the principal debtor is deemed to be acting on behalf of the surety as it is at his instance that the surety is furnishing the guarantee and also has entrusted his letter of guarantee with him. This entrusting is important because by this the surety hands over his guarantee to the principal debtor while he could have given it directly to the creditor on the basis of the debt incurred by the principal debtor. Thus he would be bound by any immaterial alteration in the document as long as it is made by the principal debtor in whose hands he has entrusted the letter of guarantee.

The case also gives an example to illustrate this point: If A guarantees the payment for 10 goods sold to B on credit and then B later on finds that the goods available for sale are only 6 and having the letter of guarantee with himself, changes the number of goods from 10 to 6. This will not discharge the surety because firstly the alteration is not material as shown in section 1 and secondly because by entrusting the letter to B, he is deemed to be the agent of A and should also be deemed to have the authority to reduce the amount it not increase it.

Also when a particular alteration equally reduces the liability on parties who are also initially equally liable then such a reduction by means of alteration would be unsubstantial and immaterial. In the instant case, the alteration by Sanakaran reduced the liability on himself as well as the surety i.e. Anirudhan. It has also to be seen that the object of Section 133 of the Act is to prevent the creditor or the principal debtor from taking undue advantage of the guarantee available by escalating it at their own volition and thereby putting the surety at peril. However when the liability is equally reduced such a peril does not feature and will not attract section 133. The law accepts that unsubstantial alterations which are to the benefit of the surety do not discharge the surety from the liability. [16]

Thus the decision reached by the court, albeit by majority and not by unanimity, is cogent and based on sound reasoning. In other words it is unimpeachable.

b. Criticism of the Judgment

There is always one criticism which is attached to this decision. Interestingly this case was not decided on the law laid down in Section 133 of the Act. In fact the decision nowhere refers to Section 133 of the Act. The case has been decided on principles of common law and not on the law laid down in the said section. The law in Section 133 of the Act is specifically applicable to a continuing guarantee and not to a specific guarantee. The section speaks about the discharge of the surety with respect to transactions which were carried on after the variation had been made. Thus it essentially speaks about a contract of guarantee which extends to a series of transactions and which discharges the surety for the transactions carried on after such a variance was made in the contract while the surety will still be responsible for the transactions which were entered into before the variation took place. Thus in the face of an existing codified law, the court decided the case upon the principles of common law.

It is not that the Act completely fails to provide a law for cases like the one instantly at hand. Section 135 [17] of the Act provides that the surety is discharged when the creditor compounds, agrees to give time or agrees not to sue the principal debtor. Here the section does not refer to the extent to which the surety is discharged like it is mentioned in Section 133 [18] . Thus when Section 135 does not specify any qualification in the extent of discharge of surety, it is to be taken as a complete discharge especially when a certain other section does speak specifically about the extent to which a surety is discharged. A case with analogous interpretation of Section 27 of the Act is Madhub Chander v. Raj Coomar [19] Here while deciding that the provision regarding restraint of trade applied both to partial as well as complete restraint, the judge referred to the words of Section 28 of the Act which uses the word ‘absolutely’ to qualify the degree of restraint of legal proceedings which can be considered contrary to law as per the Act and Section 28. The judge decided that while Section 28 does qualify explicitly the degree of restraint, Section 27 does not and hence it has to be taken as a partial restraint. Thus when the Act does not provide the degree of qualification, the Court cannot read one into it and the provision is to be taken to apply to all kinds of situations which arise and which are relevant to the law laid down in the said provision.

In section 135, a surety can be discharged if:

a. The creditor compounds with the principal debtor; or

b. The creditor agrees to give time to the principal debtor beyond the time for the repayment of the debt; or

c. The creditor agrees not to sue to principal debtor in case of a default.

In the above instances, the surety is taken to be completely discharged as submitted above. Here composition inevitably involves a variation of the original contract and therefore the surety is discharged. [20] The common law principal which the judges use here is specifically codified in Section 135 of the Act and hence this case should have been specifically decided under the given provision which is installed in the Act. While the criticism here is not with regard to the decision itself, as anyways the decision would have been the same, it is about the source of the law. When the Act provides for the law applicable to this case, it is submitted to better use the law codified and applicable specifically to India instead of deciding the matter on the law. However as mentioned above, the decision anyways would have been the same. This case thus should rightly be an authority for an interpretation of both Section 133 and Section 135 of the Act

6. Conclusion

It is necessary to note, as a concluding point, that this decision laid down the law for the interpretation of the principle of discharge of surety by variance in the terms of the contract of guarantee. In spite of the criticism above, the interpretation of the rule of discharge of surety, as laid down in this judgment is still a good law. This in the humble opinion of the researcher, this decision is a precedent and thus unimpeachable. In fact, as mentioned before, this judgment laid down an Indian authority on the fact that any alterations in the terms of guarantee which is not material or is beneficial for the surety shall not be considered to discharge the surety from his obligations under the contract.