VALIDITY OF PAST CONSIDERATION IN GUARANTEE CONTRACTS: ANALYZING THE CONFLICT BETWEEN SECTION127 AND ITS THIRD ILLUSTRATION of ICA,1872 BY: AMRUTA VENKATACHALAM
VALIDITY OF
PAST CONSIDERATION IN GUARANTEE CONTRACTS:
ANALYZING
THE CONFLICT BETWEEN SECTION127 AND ITS THIRD ILLUSTRATION of ICA,1872
AUTHORED BY: AMRUTA VENKATACHALAM
Abstract
The inception of contract law in
India dates back to 1872, but certain provisions remain a subject of contention
and require clarification in light of the ever-evolving global economy. One of
the key issues under debate pertains to the acceptance of past considerations
in guarantee contracts. The dispute revolves around Section 127[1] of
the Indian Contract Act, which defines the concept of consideration in
guarantee contracts. This debate has persisted for years, with various courts
offering differing interpretations regarding the validity of past
considerations. The wording of Section 127, which employs the phrase
"anything done," initially suggests that actions taken in the past
can constitute valid consideration for a guaranteed contract.
However, this seems to contradict its
third illustration, which excludes the applicability of past considerations in
guarantee cases. This glaring inconsistency within the section has led to different
opinions among Indian courts. Some decisions rely primarily on the language of
the main section itself, while others place significant weight on its third
illustration. Still, some maintain that illustrations should not restrict the
interpretation of the main section. This paper seeks to discuss the varied
interpretation of consideration in guarantee contracts through a series of judgments
that have tried to uphold consistency beyond the conflict under Section 127 of
ICA, 1872.
INTRODUCTION:
A contract of guarantee is a special
contract as given under Section 126[2] of
the ICA under which one person promises to discharge the liability of a third
person in case of a default in payment. The three parties to a contract of the guarantee
are the ‘Surety’ who promises to guarantee; the ‘Principal Debtor’ whose
liability is to be discharged; and a ‘Creditor’ to whom the guarantee is given,
in the form of a tripartite contractual obligation. Therefore, there is a
contract of guarantee between the surety and the creditor and a contract of
indemnity between the Principal Debtor and the surety. As a general principle
of the Law of Contracts, some consideration must support every contract. The
same applies to a contract of guarantee[3]. 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 a
valid consideration for a contract of guarantee. However, it is in
contradiction to its third illustration which makes past consideration inapplicable
in case of guarantee.
Consideration for a guaranteed
contract is given in Section 127 of the Indian Contract Act. Any commitment
made by the creditor in favor of the principal debtor serves as a valid
consideration for the surety. According to this section, it doesn't matter
whether or not there is any advantage for the surety. For example, if the
creditor agrees to purchase goods from the principal debtor, this constitutes
adequate consideration for the surety, even if it doesn't benefit the surety.
Dispute over
consideration:
There has been a dispute over whether
past consideration will be considered valid consideration under Section 127 of
ICA. There is some disagreement on whether the benefit must be provided at the
time of guarantee execution or if a previous benefit can also qualify as a valid
consideration for upholding such an arrangement. It has been noted that
"no court of common law has ever stated that there must be consideration
directly exchanged between the parties providing and receiving the guarantee.
It suffices if the individual for whom the guarantor becomes surety receives a
benefit, or the person to whom the guarantee is given experiences
inconvenience, as an incentive for the surety to become a guarantor for the
principal debtor"[4].
This issue arises due to the
ambiguity in the terms 'anything done' and the example 'c' in the section. It
becomes evident from illustration c that if credit has already been extended to
the principal debtor, and there is no other consideration at the time the surety
agrees to provide the guarantee, then the guarantee contract is void. However,
the word ‘anything done’ is often construed to have a wide enough meaning to
not restrict the ambit of consideration to be contemporaneous for a valid
contract.
Interpretation
of Section v. Illustration: Diverging Judgements
Section 127 of the Indian Contract
Act (ICA) specifies 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." This section underscores the necessity
of consideration in a contract of guarantee, similar to any other contract, and
establishes that a direct exchange of consideration between the creditor and
the surety is not mandatory. Instead, the benefit provided to the principal
debtor serves as sufficient consideration for the surety. This was held in Chakhan
Lal v. Kanhaiya Lal[5], where
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. This provision
validates that any action taken by the creditor in the past, before the
guarantee is given, is also a valid form of consideration. The inclusion of the
term 'done' in Section 127 emphasizes that past benefits can indeed constitute
valid consideration. In a case involving
the Oudh High Court in SBI v. Premco Saw Mills[6],
it was held that when a lessee agrees to pay a debt in installments and the
surety agrees to discharge this liability at a later date, it qualifies as
valid past consideration because it functions as a past benefit to the debtor.
The courts interpret the term
"anything done" broadly enough to encompass the interests of the
creditor, even if the benefit was provided before the suretyship arrangement
was formed. the Karnataka HC in the case of Jayakunvar Manilal Shah v
Syndicate Bank[7] went on
to say that the benefit to the principal debtor and execution of the surety
bond need not be contemporaneous. Analysis
of Section 2(d) of the ICA was held such that past consideration is valid and
that we need not follow the English law which says that it needs to be
contemporaneous[8].
There has however been judgment restricting
the acceptance of past consideration and being held invalid[9]. There
have been judgments such as Union of India v. Avinash P. Bhonsle[10]
where it was argued that ‘anything done’ cannot be construed to mean anything
done in the past as this connotes an ‘unnatural’ meaning to the same. In Ram
Narain v Lt. Col. Hari Singh and Anr., it was held that Past consideration
cannot be held that past consideration must be contemporaneous and the same is
substation by the third illustration. The line of reasoning used is that
Section 2(d) of ICA talks about consideration moving at the desire of the
promisor and if it has been done in the past, then it isn’t moving at the
desire of the promiser as required while giving a guarantee. The Judge while
answering that question on the validity of past debt 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 to constitute consideration therefore. A
contract of guarantee executed afterward without any consideration is void.
Illustration (c) to Section 127 completely negatives a consideration which the
Oudh court has chosen to give to Section 127 of the Indian Contract Act.”
This has been criticized in cases
where it has been said that illustrations cannot have presiding or binding
legality concerning the original section as they are merely meant to show the
intention of the framers, and while facilitating the meaning of the section,
they cannot exhaust it of its usual interpretation as held in Aniruddha
Mitra v. The Administrator General of Bengal and Ors[11]. The
courts recognize that illustration isn’t capable of exhausting the context of a
section as it cannot curtain or expand its ambit. The language of Section 127
is wide enough to construe anything that was done or a promise made before
giving the guarantee and cannot restrict application to anything done
contemporaneously.
Therefore, conflicting views exist on
the question of past debt. Some belief in the wording of the main section,
while others rely on the illustration. Some others believe that it's against
legal principles to give precedence to an illustration over the main section.
With a plethora of diverging opinions, we should realize that a contract of guarantee
is a contract first, and thus, standard principles of consideration apply
nonetheless. For the past debt to be valid in a contract, the creditor should
have suffered a detriment at the instance of surety. There are two aspects to
keep in mind, that is the necessity of suffering detriment by the creditor and
such detriment being at the instance of the surety.
Creditor
enduring a loss:
For the first element, a good
consideration would be one where some profit or benefit accrues to the party
for some detriment or loss suffered. This means that consideration should be
one which either benefits the receiving it or a detriment to the person giving
it. Even if the surety derives no benefit, the creditor must suffer a detriment.
In Paulo Verghese v. Ittipe Abraham[12],
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.”
Detriment
incurred at the behest of the surety:
The second element requires the
detriment to be at the request of the surety. In general, consideration to
support a promise of guarantee is seen in an act done before it is made, if the
act is done at the surety’s request such that parties understand that the act
is meant to be compensation is a way that conferment of a benefit would be
legally applicable had it been a promise in past[13]. However,
in many conceivable situations, once we understand the specific circumstances
behind a particular recommendation or request, distinguishing between the two
is usually not a challenging task. A request or desire typically conveys a
greater sense of urgency and personal concern compared to a mere
recommendation. In Muthukaruppa Mudali. vs Kathappudayan[14] the
court held that the contrast between a request and recommendation is important
to be drawn as just because a person recommends certain advances, this isn’t
sufficient consideration for expecting a subsequent promise to be made
guaranteeing their payment. It was also argued that the advances made to another
person on recommendation of the respondent were sufficient past consideration.
The court in this case referred Juggot Choudhry v. Nistarinee Dassee[15]
where one of the obiter dicta said that mere recommendation by one party to
another to lend money to a third party doesn’t render the first party liable to
repay the loan.
Hence, a guarantee for a previous
debt can remain legally valid as long as the past debt was incurred at the
request of the guarantor and proved to be detrimental to the creditor. If the
consideration had already been transferred without the involvement of the
guarantor, the principal debtor would have already received the advantage, and
the creditor would have voluntarily suffered the loss before the guarantor
became involved. When a guarantor enters into a guarantee contract, their role
is not to benefit the primary debtor but to ensure payment on behalf of the
creditor. Consequently, rather than the primary debtor benefiting, it is the
creditor who gains an advantage from the suretyship contract, which is contrary
to the expected outcome.
CONCLUSION:
Many international jurisdictions such
as that of Hong Kong, Singapore, and the UK, circumvent the traditional
interpretation of the law stating that past consideration is invalid mainly due
to a lack of commercial sense. For instance, in Hong Kong, the strict literal
interpretation of the law would lead to the conclusion that past consideration
is not valid. However, judicial decisions in Hong Kong have viewed the act of
giving a guarantee as part of a single transaction along with the underlying
contract. In many cases, there is an implied term to secure a guarantee when
forming the contract. Therefore, if the surety becomes involved after the
contract is formed, it cannot be argued that there is no consideration, as it
is considered part of one continuous transaction. The courts in Hong Kong have
consistently suggested that to avoid this ambiguity and address the issue, parties
should execute a guarantee contemporaneously with the underlying contract[16].
Even though the Supreme Court hasn’t
decided on any case related to this issue, in a recent case in 2020 the Supreme
Court did make a statement that “Under Indian Law, which is significantly
different from English Law of Contract, past consideration or the consideration
towards third person is statutorily held to be good consideration as defined in
Section 2(d) and as mentioned in Section 127 of the Contract Act However, this
particular case[17] was not
related to past consideration and hence it is only obiter dicta and not binding”.
But Indian Courts allow for past consideration to create more flexibility and
execution of contracts created with the intention of suretyship or guarantee. This
interpretation has been upheld by numerous High Courts and, more recently, by
the Supreme Court. Although the matter is still subject to debate, the Supreme
Court's statement affirming the validity of past consideration has provided a
clear direction for the country's courts to follow. This direction is expected
to be advantageous for commercial activities in India.
[1] Section 127, Indian Contract Act,
1872.
[2] Section 126, Indian Contract Act,
1872.
[3] Janaki Paul v Dhokar Mall
Kidarbux, (1935) 156 IC 200.
[4] Marley
v Boothby (1825) 3 Bing 107
[5] Chakhan Lal v. Kanhaiya Lal, AIR
1929 All 72.
[6] SBI v Premco Saw Mills, AIR 1940
Oudh 346
[7] Jayakunvar Manilal Shah v
Syndicate Bank, 1991 SCC OnLine Kar 467
[8] Devukutty Amma v Madhusudanan
Nair, (1955) 2 KLT 118.
[9] Nanak Ram v Mahin Lal and Pestonji
Meekji Mody v. Meherbai (1875) ILR 1 All 487
[10] Union of India v Avinash P
Bhonsle, 1991 Mah LJ 1004.
[11] Aniruddha Mitra v. The Administrator General of
Bengal and Ors. (1949) 51 BOMLR 971.
[12] Paulo Verghese v, Ittipe Abraham
AIR 1952 Tr & Coch 202.
[13] Pau On v Lau Liu Long
[14] Muthukaruppa Mudali and Ors. vs
Pi. Mu. Kathappudayan and Ors. (1914) 27 MLJ 249
[15] Juggot Indur Narain Roy Choudhry
v. Nistarinee Dassee (1876) 24 W.R. (Civil Rulings) 445.
[16]
DEACONS,https://www.deacons.com/news-and-insights/publications/have-you-provided-good-consideration-for-your-guarantee.html,
(last visited May 22, 2021).
[17] Anuj Jain v Axis Bank Limited
& Ors, MANU/SC/0228/2020