A SURETY IS ENTITLED TO EVERY REMEDY WHICH THE CREDITORS HAVE AGAINST THE PRINCIPAL DEBTOR

[Mr. M. GOVINDARAJAN]

     In business contracts giving surety to the borrower by some body is common whether the loan is obtained on security or not.   The surety is liable to pay the loan amount if the principal borrower fails to pay the same.   But as per the Contracts Act, the surety can get reimbursement of the same from the principal borrower by filing a suit against him.  If the loan is obtained on security, then there is the right on the surety to enforcement of every security.   This has been confirmed by the Punjab & Haryana High Court in 'Punjab State Industrial Development Corporation Limited V. Punjab National Fertilizers & Chemicals Limited (In Liquidation) and others' - (2008) 87 CA 183 (P&H). 

     In this case the applicant is a State Government undertaking.   The company is liquidation was a joint sector company promoted by the applicant.   The said company in liquidation has availed financial assistance from various financial institutions and banks.   The applicant has issued corporate guarantees in favor of the banks for the due repayment of the advances taken by the company in liquidation from the said financial institutions.

     There was default committed by the company in liquidation.  The banks and the financial institutions initiated proceedings against the said company under the Recovery of Debts Due to Banks and Financial Institutions Act, 1993.   The applicant has entered into a settlement with the banks/Financial Institutions and paid a sum of Rs.22 crores in CA NO. 258 of 2005 and a sum of Rs.7,15,95,000 in CA No. 260 of 2005 in full and final settlement.

     The applicant arranged for a meeting with the official liquidator to determine the strategies of sale.   In the said meeting, the representatives of the banks have stated that they have one time settlement with the applicant and the amount payable to the bank/financial institutions would now be payable to the applicant.   The Official Liquidator in the said meeting requested that without proper application and without the orders of the High Court, the contention of the applicant cannot be accepted.

     Therefore, the applicant filed this application to step into the shoes of the secured creditors since they have settled the dues to the banks and financial institutions on behalf of the company in liquidation for which the applicant issued guarantees.  The banks/financial institutions have admitted before the court that the applicant has paid its entire dues on account of the liability of the company in liquidation and an application for recovery for all outstanding dues filed before the Debts Recovery Tribunal has since been withdrawn.  It is also stated therein that the official liquidator would be now required to treat the applicant as secured creditor of the company in liquidation in place of the banks/financial institutions.

     The Official Liquidator has taken up a stand in the reply that as per the provisions of Sec. 125 of the Companies Act, every charge created by the company whereby any security of the company is conferred by the charge would be void against the liquidator unless the said charge together with the instrument by which the charge is created are filed with the Registrar or Companies for registration.   It is, thus, the stand of Official Liquidator that the instrument of charge in favour of the applicant has not been registered with Registrar of Companies and, therefore, the same is void against the liquidator.   It has been further contended that as per Sec. 537 of the Companies Act any execution without the leave of the court is void.  It is alleged that payment by the applicant to the banks or financial institutions in execution of the decree against the assets of the company in liquidation is void.

     The applicant relied on the following two judgments:

Amrit Lal Goverdhan Lalan V. State Bank of Travancore - AIR 1968 SC 1432;

In re. India Electric Works Ltd., (1983) 53 Comp case 573.

1. In 'Amrit Lal Goverdhan Lalan' case (supra) the applicants executed a contract of guarantee entered into by the partnership firm.  One of the aspects considered by the Supreme Court was scope of Sec. 140 of the Indian Contract Act and it was held by the court as follows:

     '….In this connection it is necessary to consider the provisions of Sec. 140 of the Indian Contract Act, 1872, which state:

"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 the rights which the credit had against the principal debtor."

The Supreme Court observed that this section embodied the general rule of equity expounded by Sir Samuel Romily as counsel and accepted by the Court of Chancery in 'Craythorne V. Swinburse (1870) 14 Ves. 160, namely:

"The surety will be entitled to every remedy which the credit has against the principal debtor-

To enforce every security and all means of payments;

To stand in the place of creditor not only through the medium of contract but even by means of securities entered into without the knowledge of the surety;

Having a right to have those securities transferred to him, though there was no stipulation for that; and

To avail himself of all those securities against the Debtor.

This right of a surety also stands, not upon contract, but upon a principle of natural justice.

The SC held that the language of the section which employs the words "is invested with All the rights which the creditor had against the principal debtor' makes it plain that even without the necessity of a transfer, the law vest those rights in the surety.

2. In 'India Electric Works Ltd., (Supra) State Bank of India presented a winding up petition against India Electric Works Ltd.   However the said company was taken over under Sec. 18A of the Industries (Development and Regulation) Act, 1951 and the entire claim of the bank together with the accrued interest was paid by the Central Government to the said State Bank of India.   A deed of assignment was executed by the State Bank of India in favour of Union of India in respect of the mortgage by and between the bank and the company.  It was submitted that by virtue of the said assignment the Central Government has the right of subrogation under the said deed of assignment, and as such the Central Government stepped in to the shoes of the State Bank of India and became a secured creditor of the company (in liquidation).   The Official Liquidator communicated a letter to the Joint Secretary, Ministry of Industrial Development and Internal Trade to the effect that if court permits the official liquidator to join as a party in the assignment deed in that case the Government of India will step into the shoes of the State Bank of India and will become a secured creditor.  The Calcutta High Court held that the Union of India is a secured creditor and has a right to pursue the claim preferred before the official liquidator as a secured creditor.

     Relying on the above two judgments the applicant contended that in terms of Sec. 140 and 141 of the Indian Contract Act, the applicant, who is a guarantor, on payment on behalf of the principal debtor steps into the shoes of secured creditors and is entitled to every remedy which the creditor has against the principal debtor to enforce every security and all means of payment and to stand in the place of creditor.   The applicant further contended that Sec. 125 of the Companies Act is not applicable in the facts of the case as the charge has not been created for the first time by the company.

     The High Court held that a perusal of the said principle leaves no manner of doubt that the surety, i.e., the applicant is entitled to every remedy which the creditors i.e., the banks or financial institutions have against the principal debtor i.e., the company in liquidation.  Such remedy includes enforcement of every security and all means of payment and to stand in place of the creditor, not only through the medium of contract  but also by means of securities entered into without the knowledge of the surety having a right to have those securities transferred to him.  It is further held that the law vests those rights in the surety even without the necessity of a transfer.

     The Court further held that Sec. 125 of the Companies Act has no application in the fact of the case inasmuch as the charge has not been created by the company which is required to be registered with the Registrar of Companies.   It is an act between the surety and the creditor.   It is an act of substitution of surety as secured creditor in terms of deed of guarantee and, therefore, the court has no hesitation to hold that the applicant is a secured creditor and is entitled to recover the amount from the company in liquidation and has stepped into the shoes of the banks/financial institutions.