IS GUARANTEE FOR PAST DEBT VALID? -AN ANALYSIS OF THE CONFLICT BETWEEN SECTION 127 OF THE INDIAN CONTRACT ACT, 1872 AND ITS THIRD ILLUSTRATION
– Nitya Jain
The wording of Section 127 of the Indian Contract Act, 1872 which uses the phrase “anything done” gives one the impression that anything done in the past will constitute as valid consideration for a contract of guarantee. However, it is in contradiction to its third illustration which clearly makes past consideration inapplicable in case of guarantee. This stark contradiction within the Section has given rise to diverse opinions by Courts in India. While some decisions rely on the wording of the main section itself, others solely rely on its third illustration. Still others hold that illustrations cannot restrict the meaning of the main section. The whole discussion boils down to the fulfilment of two conditions for a guarantee for a past debt to be valid. First, that there must be some detriment suffered by the creditor and the second requirement is that such detriment must be at the instance or request of the surety. The first condition is nothing but an application of the wider principle that in all cases of contract the really necessary element of consideration is the legal detriment incurred by the promisee. As for the second condition, if the consideration had already moved without the instance of the surety then the principal debtor has already received the benefit and the creditor has already voluntarily suffered the detriment even before the surety came into picture. Now, if the surety executes a contract of guarantee he acts not for the benefit of the principal debtor but as surety for the benefit of the creditor in the sense that he guarantees receipt of payment by the creditor which defeats the purpose of the guarantee.
As a general principle of Law of Contracts, every contract must be supported by some consideration. The same applies to a contract of guarantee. A contract of suretyship like any other contract must be supported by some consideration for it to be valid. A guarantee without consideration is void.1
1 Janaki Paul v Dhokar Mall Kidarbux, (1935) 156 IC 200.
However, there need be no direct consideration between the surety and the creditor.2 It has been observed that “no court of common law has ever said that there should be a consideration directly between the persons giving and receiving the guarantee. It is enough if the person for whom the guarantor becomes surety receives a benefit, or the person to whom the guarantee is given suffers inconvenience, as an inducement to the surety to become guarantor for the principal debtor.”3 This is also evident from the definition of consideration in the Indian Contract Act, 1872 which states that consideration can move from the promisee or any other person.
Where the surety guarantees some future debt or transaction, the consideration may be a promise on part of the creditor to grant the credit or enter into transaction or the actual act of doing so.4
However the problem arises when the surety guarantees some past debt or transaction which has already taken place between the creditor and the principal debtor but has not been paid for by the principal debtor. There is some divergence on the view whether the benefit is given at the time of the execution of the guarantee or even a past benefit can constitute a valid consideration for the sustenance of such an engagement.5
There is considerable conflict of opinion as to whether the past benefit to the principal debtor amounts to a good consideration. In other words whether past consideration can be a good consideration for a contract of guarantee.6
The reason for such conflict is the wording of Section 127 of the Indian Contract Act, 1872 which states that “anything done” will constitute as valid consideration for a contract of guarantee, which is in contradiction to its third illustration which clearly makes past consideration inapplicable in case of guarantee.
Courts in India have given diverse opinions on the matter. While some agree with the interpretation that past consideration is good consideration for a contract of guarantee, majority of the decisions hold otherwise.
2 Marley v Boothby (1825) 3 Bing 107.
4 Pitts v. Jones (2007) ECWA Civ 1301.
5 Ram Narain v Lt. Col. Hari Singh and Anr. AIR 1964 Raj 76.
6 Mir Niyamath Ali Khan v. Commercial & Industrial Bank, AIR 1969 AP 294.
Section 127 of the Indian Contract Act, 1872 states that-
“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.”7
The purpose of this section is manifold. Firstly, it makes it clear that consideration is required in a contract of guarantee. Next, it establishes that a direct flow of consideration between the creditor and the surety is not essential. Anything which is for the benefit of the principal debtor will be sufficient consideration for the surety to give guarantee. In Chakhan Lal v. Kanhaiya Lal, the Learned Judges held that there was sufficient consideration for the undertaking of suretyship for the whole sum to render it valid even though the surety may not have benefited from any of the advances made.
Finally it creates an impression that any act of the creditor done in the past before giving of the guarantee will also constitute valid consideration. In Ghulam Husain Khan v. Faiyaz Ali Khan, it has been held that the word ‘done’ in Section 127 shows that past benefit to the principal debtor can be good consideration for a bond of guarantee. Hence, where a lessee has agreed to pay the amount due under the lease by certain instalment and after some days a person executes a surety bond binding himself to pay certain amount in default of payment of instalments the surety bond cannot be said to be without consideration.10
However, in Union Bank of India vs Avinash P. Bhonsle,11 the contention of the counsel for the defendant was that “anything done or promise made” cannot be construed to mean that anything done or promise made had reference to something done in the past. i.e. prior to the contract of guarantee and cannot be deemed to be sufficient consideration for the surety for giving the guarantee.
Also, in Ram Narain v Lt. Col. Hari Singh And Anr.12 the Judge was unable to agree with the interpretation of the Section as done in Ghulam Husain Khan13 case and said that “With great respect, I regret, I am unable to agree with the interpretation put by their Lordships in this judgment. It is giving the word ‘done’ an unnatural meaning.”14
7 Indian Contract Act, 1872.
8 Chakhan Lal v. Kanhaiya Lal, AIR 1929 All 72.
9 Ghulam Husain Khan v. Faiyaz Ali Khan, AIR 1940 Oudh 346.
10 Supra Note 5.
11 Union Bank Of India vs Avinash P. Bhonsle, (1991) 93 BOMLR 282.
12 Ram Narain vs Lt. Col. Hari Singh and Anr AIR 1964 Raj 76.
13 Supra Note 9.
14 Supra Note 12.
The decision15 was also criticised in Pollock and Mulla16 where it is stated that “this seems to attribute an unnatural meaning to the word, which it is submitted and as the rest of the section shows, refers to an executed as distinguished from an executory consideration.” 17
Illustration (c) To Section 127
The third illustration to Section 127 states that-
“A sells and delivers goods to B. C afterwards, without consideration, agrees to pay for them in default of B. The agreement is void.”18
Illustration c implies that a guarantee for a past debt would be invalid. There must be some fresh consideration moving from the creditor at the time of guarantee, for example- a further advance is made or the creditor refrains from suing the principal. 19
In Ram Narain v Lt. Col. Hari Singh And Anr.20 The Judge while answering the question on validity of past debt in guarantee held “From this illustration, I feel fortified in my conclusion that anything done or any promise made for the benefit of the principal debtor must be contemporaneous to the surety’s contract of guarantee in order to constitute consideration therefore. A contract of guarantee executed afterwards without any consideration is void. Illustration (c) to Section 127 completely negatives a consideration which the Oudh Court21 has chosen to give to Section 127 of the Indian Contract Act.”22
However, various comments were made by Courts on the correctness of giving decisions based solely on an illustration to a section. These illustrations, although attached to, do not in legal strictness form part of, the Acts, and are not absolutely binding on the Courts. They merely go to show the intention of the framers of the Acts, and in that and in other respects they may he useful, provided they are correct.23 The Judge while commenting on the third illustration to Section 127 said that “This illustration appears to have received much more attention in the lower Courts than Section 127 itself. In fact, the lower Appellate Court goes entirely upon it, and at the hearing of this appeal it was almost entirely relied on, notwithstanding repeated
15 Supra Note 9.
16 Indian Contract and Specific Relief Act, 8th Edn (1957) p.517.
18 Supra Note 7.
19 M C Kuchhal Mercantile Law – 7th Edn.
20 Supra Note 12.
21 Supra Note 9.
22 Supra Note 12.
23 Nanak Ram v Mehin Lal (1875) ILR 1 All 487.
attempts on my part to point out that it was the meaning of Section 127 itself and not the illustration that was material. This illustration (c) is so vague and bald as to be open to misapprehension. To be of real service to those for whose assistance these illustrations are intended, they ought to be placidly clear in their phraseology and, if possible, I had almost said infallibly sound in their law.”24
The purpose of illustrations is to illustrate the section.25 It is well settled that just as Illustrations should not be read as extending the meaning of a section, they should also not be read as restricting its operation, especially so, when the effect would be to curtail a right which the plain words of the section would confer. Though the illustrations may be looked into in order to understand the meaning of the section, they do not exhaust its meaning. The illustration thus understood does not in any manner restrict the operation of the section. It just illustrates its meaning and does nothing more.26
Also, in the case of Shambhu Nath Mehra v. The State of Ajmer27 the Court observed “We recognise that an Illustration does not exhaust the full content of the section which it illustrates but equally it can neither curtail nor expand its ambit.”28
It is therefore clear that if the language of the text of Section 127 of Contract Act is clear and unambiguous, the sweep of the text cannot be curtailed by using Illustration (c) to impose a limitation on the expression “anything done or any promise made for the benefit of the principal debtor” that it should be done at the time of giving the guarantee. The language is wide enough to include anything that was done or a promise made before giving the guarantee and would not restrict the application of the section only what was contemporaneously done.29
Thus contrary views exist when the question of the validity of a contract of guarantee with respect to a past debt arises. While some decisions rely on the wording of the main section itself, others solely rely on its third illustration. Still others hold that illustrations cannot restrict the meaning of the main section. While deciding which of the plethora of opinions is sound we need to analyse Section 127 in light of the basic principles of
25 Aniruddha Mitra v. The Administrator General of Bengal and Ors. (1949) 51 BOMLR 971.
27 Shambhu Nath Mehra v. The State of Ajmer 1956 AIR 404.
29 Supra Note 11.
contract. It is important to remember that a contract of guarantee is essentially a “contract” first and thus the principles regarding consideration which apply to any other contract will also apply to a contract of guarantee.
It has been widely argued that for a contract of guarantee for a past debt to be valid the creditor must suffer a detriment at the instance of the surety. This is nothing but an application of the wider principle that in all cases of contract the really necessary element of consideration is the legal detriment incurred by the promisee at the promisor’s request and it is immaterial whether there has been any apparent benefit to the promisor.30
This argument has two aspects, the necessity for there to be detriment suffered by the creditor and the requirement that such detriment must be at the instance or request of the surety.
1) Sufferance of detriment by the Creditor
A valuable consideration in the sense of the law, may consist either in some right, profit or benefit accruing to one party or some forbearance, detriment, loss or responsibility, given, taken or suffered by the other.31 This means that whatever is provided by way of consideration should be a benefit to the person receiving it or a detriment to the person giving it.
It is a well-established rule that for a contract of guarantee to be valid there must be some detriment caused to the creditor. Even if the surety derives no benefit from the transaction, the creditor suffers a detriment which is enough consideration.32 The “something” which the promisee has done cannot be a merely illusory thing. For instance, if B asks his friend A to take Rs. 5 from A’s left-hand pocket and put it into A’s right-hand pocket and A accordingly transfers the money from his left-hand pocket into his right-hand pocket, A suffers no detriment at all by complying with that request of B. It would be against common sense to hold that A’s above act at B’s request will be good consideration for B’s signing a promissory note in favour of A for Rs. 1000.
In Paulo Verghese v, Ittipe Abraham34 after a debt had been contracted, A (the alleged surety) came forward and promised that he would see that the debtors duly discharged
30 Pollock & Mulla, Indian Contract and Specific Relief Act, 8th Edn (1957) p.1795.
31 Currie v Milsa, (1875) LR 10 Ex 153.
32 Chitty on Contracts, Specific Contracts, p. 1651.
33 Muthukaruppa Mudali and Ors. vs Pi. Mu. Kathappudayan and Ors. (1914) 27 MLJ 249.
34 Paulo Verghese v, Ittipe Abraham AIR 1952 Tr & Coch 202.
their obligation. The Court held that “there is no suggestion of any benefit which the creditor was prepared to confer on the principal debtor at the request of the surety. The debt was already contracted and subsequently the alleged surety is stated to have come forward and said that he would be responsible for the discharge of the debt. The creditor did not suffer any detriment at the instance of the surety. This is an obvious instance of a promise not supported by consideration and for that reason cannot be enforced in a Court of Law.”35
2) Detriment at the request of the surety
In accordance with the position as regards contracts in general, consideration to support a promise of guarantee may be found in an act done before it is made, provided that the act is done at the guarantor’s request, that the parties understood that the act was to be remunerated in some way and that the conferment of a benefit would have been legally enforceable had it been promised in advance.36
It is imperative here to draw a distinction between a request and a recommendation. The mere fact that a person recommends certain advances to be made to another and they are made accordingly is not sufficient consideration in law for a subsequent promise by him guaranteeing their payment.37
In case of Muthukaruppa Mudali And Ors. v Pi. Mu. Kathappudayan and Ors.38 it was argued that the advances made to other persons on the recommendation of the 1st defendant were good past consideration for the contract. Section 127 of the Indian Contract Act says that anything done, for the benefit of the principal debtor may be a sufficient consideration to the surety. Consideration is defined in Section 2(d)-” When at the desire of the promisor, the promisee… has done…something, such act…is called a consideration.” The Court referred to the case of Sindha Shri Ganpatsing v. Abraham
The Court further pointed out that “the appellants were unable to refer us to any case in which a recommendation was held to be within the words of the section……”
In a case reported in Juggot Indur Narain Roy Choudhry v. Nistarinee Dassee40 decided
subsequent to the passing of the Indian Contract Act, but, it may be arising before that
36 Pau On v Lau Liu Long (1980) A.C. 614, 629.
37 Supra Note 33.
39 (1895) I.L.R. 20 B 755.
40 (1876) 24 W.R. (Civil Rulings) 445.
78 The legal Voice of India
date, there is a dictum that a mere recommendation by one party to another to lend money to a third party does not render the first party liable to repay the loan.
The Court in Muthukaruppa41 also referred to English Law on this point and said that “according to English law also a recommendation alone cannot be valuable
consideration. Vide Halsbury’s Laws of England ,42
–consideration where is ” the
promise does some act (in India it would include ‘has done some act’) from which a third person benefits and which he would not have done but for the promise.”
The distinction between the recommendation by A of B to C for a certain favour to be shown to B and a request by A to G to do a service to B may no doubt become in many conceivable cases a very thin distinction but, when we know the circumstances under which a particular recommendation or a particular request is made, it is not usually difficult in most cases to recognise the distinction. A desire or request shows much more earnestness and personal anxiety than a mere recommendation.43
Thus, guarantee for a past debt can be valid provided that the past debt was executed at the request of the surety and was detrimental to the creditor. In case the consideration had already moved without the instance of the surety then the principal debtor has already received the benefit and the creditor has already voluntarily suffered the detriment even before the surety came into picture. Now, if the surety executes a contract of guarantee he acts not for the benefit of the principal debtor but as surety for the benefit of the creditor in the sense that he guarantees receipt of payment by the creditor. Thus, instead of the principal debtor receiving the benefit it is the creditor who receives the benefit of the contract of suretyship where it is actually supposed to be other way around.
41 Supra Note 33.
42 Volume 7, paragraphs 793 and 794.
43 Supra Note 33.