Bank of Bihar Ltd v Damodar Prasad (1969)

S. 128 contains one of the shortest and most consequential rules in the Contract Act: "The liability of the surety is co-extensive with that of the principal debtor, unless it is otherwise provided by the contract."

The word co-extensive carries two ideas that students routinely collapse into one. The first is about extent: the surety is liable for as much as the principal debtor, and for no more — including, as the illustration to the section shows, interest and charges. The second is about time: the surety's liability arises at the same moment as the principal debtor's, on default. It is not a secondary or reserve liability that comes alive only when the creditor has run out of other options.

Bank of Bihar establishes the second idea. Indexport applies it to the situation students find hardest — a composite decree against principal debtor, surety and mortgaged property. Between them they answer the standard question: "Can a creditor sue the surety without first proceeding against the principal debtor? Discuss with reference to decided cases."

The Bank of Bihar Ltd lent money to Damodar Prasad, who was the first respondent and the principal debtor. The second respondent stood surety for the loan, and the guarantee was in unconditional terms — it contained no clause requiring the bank to look first to the borrower, and none requiring the bank to realise any security before calling on the surety. The bank made a demand; the borrower did not pay; the bank sued both.

The trial court found for the bank and passed a decree. But it attached to the decree a direction of its own making: the bank was not to enforce the guarantee against the surety until it had exhausted its remedies against the principal debtor. Its stated reason was that the principal debtor appeared to be solvent, so the surety ought not to be troubled. The High Court at Patna affirmed the decree along with the direction. The bank appealed to the Supreme Court.

The point was therefore a narrow one on the facts and a very large one in principle. Nothing in the contract entitled the surety to that protection. The question was whether the court could supply it.

1. Where the surety's liability under the contract of guarantee is unconditional, may a court nevertheless direct that the creditor shall not proceed against the surety until he has exhausted his remedies against the principal debtor?
2. Is the solvency of the principal debtor a ground for restraining execution against the surety?
3. (In Indexport) Where a single decree is passed against the borrower, the surety and mortgaged property, must the decree-holder sell the mortgaged property first and proceed against the surety only for the shortfall?

The surety's case was one of equity rather than contract. A guarantee, it was said, is by its nature an accessory obligation; the surety is a debtor of last resort; where the principal is able to pay there is no justice in making a stranger to the benefit of the loan pay first, only to have him chase the borrower afterwards for indemnity under s. 145.

The bank's answer was that the argument, whatever its moral appeal, rewrites the bargain. The commercial value of a guarantee lies precisely in its immediacy. A guarantee that can be enforced only after the creditor has pursued the borrower to the end of the road is worth a fraction of the guarantee the parties actually made, and the surety is asking the court to give him a term for which he did not contract.

The Supreme Court allowed the appeal and struck out the direction. The judgment was delivered by Bachawat J, sitting with Sikri and Hegde JJ. The reasoning is compact and famously rhetorical:

"The very object of the guarantee is defeated if the creditor is asked to postpone his remedies against the surety. Is the creditor to ask for imprisonment of the principal? Is he bound to discover at his peril all the properties of the principal and sell them; if he cannot, does he lose his remedy against the surety? Has he to file an insolvency petition against the principal?"

The Court noted that the trial court had given no reason for its "extraordinary direction" beyond the principal debtor's apparent solvency, and held that "the solvency of the principal is not a sufficient ground for restraining execution of the decree against the surety."

On the surety's real protection the Court was equally clear. His remedy is not to hold the creditor back but to pay and then step into the creditor's shoes: "It is the duty of the surety to pay the decretal amount. On such payment he will be subrogated to the rights of the creditor" — the right conferred by s. 140. Before payment, however, "the surety has no right to dictate terms to the creditor and ask him to pursue his remedies against the principal in the first instance. The surety is a guarantor; and it is his business to see that the principal pays, and not that of the creditor."

The Court added the qualification that keeps the rule honest: in the absence of some special equity, the surety has no right to restrain execution against him until the creditor has exhausted his remedies against the principal.

Where the contract of guarantee imposes an unconditional liability, the creditor may proceed against the surety immediately on default, without first suing the principal debtor, without obtaining a decree against him, without executing such a decree and without realising any securities. A court cannot import into an unconditional guarantee a condition that the parties did not agree to. The solvency of the principal debtor is irrelevant.

Everything the surety is entitled to comes after he pays: indemnity from the principal debtor (s. 145), subrogation to the creditor's rights and securities (ss. 140 and 141), and contribution from co-sureties (ss. 146–147).

The result follows from taking "co-extensive" seriously. If the surety's liability is of the same extent as the principal debtor's and arises at the same time, then as against the creditor the two are joint and several. A creditor holding a joint and several obligation has never been obliged to sue his debtors in any particular order, and there is no reason of principle to invent such an obligation for guarantees.

Bachawat J's rhetorical questions do real analytical work. They show that "exhausting remedies against the principal debtor" is not a workable legal standard. What would count as exhaustion — a decree, an unsatisfied execution, an adjudication of insolvency? Who bears the risk of the creditor's failure to discover assets? A direction of that kind converts a definite obligation into an indefinite one and, in a case like the present, effectively converts the surety's liability into an indemnity against the borrower's ultimate insolvency, which is not what a guarantee is.

Notice also what the case does not decide. It does not say that a surety can never contract for a prior-recourse condition. S. 128 itself says "unless it is otherwise provided by the contract", and a well-drafted guarantee can make the surety's liability conditional on the creditor first exhausting his remedies. The point is that such a condition must come from the contract, not from the court.

Union of India v Manku Narayana, (1987) 2 SCC 335 briefly went the other way. The Supreme Court there held that where a decree covered a mortgage as well as a guarantee, the creditor must proceed against the mortgaged property first and against the surety only for the balance — even though the decree was composite and only part of it was covered by the mortgage.

State Bank of India v Indexport Registered, (1992) 3 SCC 159 overruled that view. A composite decree had been passed against the borrower, the guarantor and the borrower's mortgaged property. The Delhi High Court directed the bank to execute first against the mortgaged property and to reach the guarantor only for any shortfall. Yogeshwar Dayal J, for the Supreme Court, held that the decree-holder is entitled to execute the decree as he chooses. A composite decree does not merge the personal liability of the guarantor into the mortgage; the two are independent and the decree-holder may put either in motion first. To hold otherwise would restore, in a different guise, exactly the restriction Bank of Bihar had removed.

The position has been reaffirmed since — notably in Industrial Investment Bank of India v Biswanath Jhunjhunwala, (2009) 9 SCC 478, where the Court repeated that the decree-holder may execute against the guarantor without first proceeding against the principal debtor. High Courts have applied the same logic to a range of situations: a decree against the surety is not bad merely because no decree was obtained against the borrower; failure to implead the legal representatives of a deceased principal debtor does not defeat the suit against the surety; and where the suit against the surety was dismissed while the principal debtor was allowed to pay by instalments, the dismissal was held improper because the surety's liability is co-extensive and joint and several.

A short and conservative note on insolvency law, since examiners have begun to ask about it. Two decisions under the Insolvency and Bankruptcy Code 2016 are consistent with the co-extensive principle:

• State Bank of India v V. Ramakrishnan (2018) held that the moratorium declared under s. 14 of the Code in respect of a corporate debtor does not extend to a personal guarantor. The creditor is therefore not barred from proceeding against the guarantor while the corporate insolvency resolution process runs.
• Lalit Kumar Jain v Union of India (2021) upheld the notification bringing the Code's provisions relating to personal guarantors to corporate debtors into force, and held that the approval of a resolution plan in respect of the corporate debtor does not by itself operate to discharge the personal guarantor of his liability under the contract of guarantee.

Both are best stated in one or two sentences in an answer. They are decisions on the Code, and the detailed scheme for personal guarantors continues to develop; do not present them as settling anything wider than the two propositions above.