With the help of an illustrated example, this article discusses drafting solutions that guarantors can incorporate into their guarantee agreements to rapidly recover from the principal debtor, the amounts paid as part of the guarantee.
The article also discusses the advantages of executing loan-cum-guarantee agreements over executing separate loan and guarantee agreements
Keywords: Agreement of Guarantee, Guarantor, Principal Debtor, Personal Guarantee
Reference: Indian Contract Act, Section 145, Illustration a
Section 145, Indian Contract Act
Section 145 of the Indian Contract Act gives legal recognition to the principle that a guarantor has the right to recover from the principal debtor the sums paid to the creditor under the agreement of guarantee. However, section 145 clarifies that the guarantor can only recover sums rightfully paid.
Section 145, Illustration a
“B is indebted to C, and A is surety for the debt. C demands payment from A, and on his refusal sues him for the amount. A defends the suit, having reasonable grounds for doing so, but is compelled to pay the amount of the debt with costs. He can recover from B the amount paid by him for costs, as well as the principal debt.”
In most cases, the principal debtor will refuse to pay both the debt amount and the costs, alleging that the guarantor paid the entire amount wrongfully. Therefore, in the above illustration, the guarantor can face two issues:
- The debtor may refuse to pay, arguing that the guarantor had paid wrongfully paid the debt.
- The debtor may inordinately delay making payment to the guarantor.
A, a Limited Liability Partnership Firm, worked as a distributor for car manufacturers, availed a credit facility from B, a bank. C, one of the firm’s Partners, stood guarantor for any dues that A might owe to B.
Per the agreement, A was to make a ‘Drawn Down Request’ to B, who would then transfer the money to the vehicle manufacturers. Upon receipt of the money, the manufacturer would send the vehicles to A, who had 90 days to repay B.
A few months after the agreement was signed, A and C received a summons to appear in proceedings initiated by B, alleging that A had failed to repay amounts allegedly released under a particular Drawn Down Request. A and C defended themselves in the suit because A never made the Drawn Down Request, in respect of which B was seeking repayment. However, the court ruled in favor of A and C, in order to avoid further litigation and legal expenses, and to protect his reputation, paid the decree amount and the costs of the suit to A.
When C demanded that A repay the amounts he had paid to B, A refused, arguing that A was in challenging the decree, and C ought to have waited till all legal recourse was exhausted before paying the decree amount and costs.
Left with no other alternative, C sued A for recovery of the debt amount and the costs incurred in defending the suit against him by B.
Interpretation and Analysis:
In our example, as is usually the case, A does not have any grounds to refuse to repay C. However, if the contract is not rapid resolution friendly, A could raise frivolous defenses and unduly delay making payment to C. Therefore, it is essential that C can rapidly enforce the agreement and recover the money from A.
To make the dispute rapid resolution friendly, the agreement ought to incorporate the clauses discussed below.
The Drafting Solutions:
Solution 1 – Provide A Fixed Time Within Which The Debtor Must Pay The Guarantor
Even though section 145 provides that the guarantor is entitled to recover the amounts paid to the creditor under the guarantee agreement, unless the debtor is bound by the contract to pay within a specified time once a demand is made, it is unlikely that the guarantor will be able to recover the money quickly. Most debtors will unduly delay making the payment.
To ensure that a guarantor can quickly recover the money paid to the creditor under the guarantee agreement, the debtor’s agreement must contain a clause specifying a fixed time within which the debtor must pay.
It is pertinent to mention here that, to provide the guarantor the ability to recover money paid under a guarantee rapidly, it is best if the parties execute a tripartite loan-cum-guarantee agreement. This is because if separate agreements are executed, the debtor and guarantor will not be parties to the same agreement. Therefore, it is not possible to incorporate any obligations on the debtor vis-à-vis the guarantor.
Solution 2 – Accelerates The Dispute Resolution Process
The agreement gives the claimant the right to ask for the arbitrator’s appointment by a named institution or ODR platform; and for such appointment to be made within 35 days of receipt of the defendant receiving notice.
In these cases, it will better serve the parties if the institution or ODR platform promises a process that binds the arbitrator to rapid resolution. Platforms often do this by minimizing oral hearings, not accepting documentation delays, and not allowing adjournments unless in emergencies.
Guarantors must be able to quickly and inexpensively enforce their right to recover money paid to creditors under guarantee agreements. Unless they are able to do so, the right to do so provided under the contract act is of no actual use.
Explainer For The Layman:
Top Line Motors LLP, a Limited Liability Partnership Firm that worked as a distributor for car manufacturers, availed a credit facility from Bharat Bank. Chetan, one of the firm’s Partners, stood guarantor for any dues that Top Line might owe to Bharat Bank.
Per the agreement, Top Line was to make a ‘Drawn Down Request’ to the Bank, who would then transfer the money to the vehicle manufacturers. Upon receipt of the money, the manufacturer would send the vehicles to Top Line, who had 90 days to repay the loan.
A few months after the agreement was signed, Top Line and Chetan received a summons to appear in proceedings initiated by Bharat Bank, alleging that Top Line had failed to repay amounts allegedly released under a particular Drawn Down Request. Top Line and Chetan defended themselves in the suit because Top Line never made the Drawn Down Request in respect of which B was seeking repayment. However, the court ruled in favour of the Bank and Chetan, in order to avoid further litigation and legal expenses, and to protect his reputation, paid the decree amount and the costs of the suit to the Bank.
When Chetan demanded that Top Line repay the amounts he had paid to Bharat Bank, Top Line refused, arguing that it was challenging the decree, and Chetan ought to have waited till all legal recourse was exhausted before paying the decree amount and costs.
Left with no other alternative, Chetan sued Top Line for recovery of the debt amount and the costs incurred in defending the suit filed by the Bank.
While Top Line had no real ground to do so, as there was no contract between Top Line and Chetan, Top Line was able to delay making payment for several years.
Chetan cold have rapidly recovered the amounts paid under the guarantee agreement if he had insisted on the following:
- The loan agreement was a tripartite loan-cum-guarantee agreement, which imposed an obligation on Top Line to repay any amounts paid by the guarantor to the Bank within a fixed time.
- The agreement contained a clause mandating that disputes be resolved using an Online dispute Resolution Platform
About the article
Rapid Contract Enforcement is an essential requirement for the growth and prosperity of India. It will enable more investment, entrepreneurship, and trust for all stakeholders in business and commerce. The community of lawyers in India does not have access to a practical and scholarly manual that gives them a path to deliver rapid contract enforcement to their clients. Such a manual will also help lawyers to draft contracts that enable timely enforcement. Rapid enforcement requires the effective use of the Arbitration Act, the institutional framework, and technology-enabled dispute resolution infrastructure. This article belongs to a series where the author analyses each of the Illustrations available in the Contract Act and recommends practical approaches to rapid enforcement.
About the Author:
Dushyant Krishnan is a Mumbai based lawyer and the co-founder of House Court, an online dispute resolution platform.