Validity of Past Debt as consideration in Guarantee Contract

Validity of Past Debt as consideration in Guarantee Contract written by Garvit Daga student of NALSARUniversity of Law

INTRODUCTION

It is a general rule in the Law of Contracts that consideration is an integral part of any agreement. The same general rule applies to a contract of guarantee too. A guarantee without consideration is void. Consideration, in the Contract Act, 1872, has been defined as any act done/abstinence/promise made, at the desire of the promisor, by the promisee or any other person, which has some value in the eyes of law. But, in a contract of guarantee, anything done/ promise made for the principal debtor’s benefit may constitute sufficient consideration. This means that there is no need for a direct flow of consideration between the surety and creditor.
The complication doesn’t arise in cases of guaranteeing some future loans/credit transactions but it does, in cases where a past debt is guaranteed. There have been numerous conflicting views amongst various High courts in India on this issue. This divergence exists, owing to the terminology of S.127 of the Contract Act, 1872, which mentions “anything done” shall be sufficient to be a valid consideration in a guarantee contract. This phrase is in stark contradiction with illustration (c) of the section. Some courts are of the view that past debt can constitute valid consideration, whereas others opined that past debt cannot constitute valid consideration.

TREND IN THE DECISIONS ON “VALIDITY OF PAST DEBT AS VALID CONSIDERATION IN GUARANTEE CONTRACT”

The period in which the cases considered in the paper lie is 1875-2005. The researcher has divided this period into 3 parts based on the cases referred to in this paper: 1. 1875-1928 (Invalidity of Past debt being majority view) 2. 1929-1952 (Validity of Past debt being majority view) 3. 1952-2005 (No consensus).

1875-1928 (INVALIDITY OF PAST DEBT BEING MAJORITY VIEW)

The issue of the validity of past debt as a valid consideration in guarantee first arose in the case of Nanak Ram v. Mehin Lal, where the Allahabad High Court held that though “illustrations”, in legal strictness, are not a part of the Act and thus, do not bind the courts unconditionally, yet past debt isn’t a valid consideration in a guarantee contract according to the language (“anything done”) of S.127. Later, in Muthukaruppa Mudali and Ors. vs Pi. Mu. Kathappudayan and Ors, the Madras High Court reiterated that past debt is no consideration in guarantee because the performance of a pre-existing legal obligation is no consideration for any new promise. The issue then became a complicated one, in the case of Kali Charan v. Abdul Rahman where a guarantee was furnished post the compromise between the creditor and debtor but in accordance with the compromise-agreement conditions of furnishing enough security for the lease. Two opposite interpretations of this have arisen – some are of the view that it supports the validity of past debt being valid consideration, whereas others opine that this case is not one of past consideration because the guarantee was furnished according to the agreement conditions though it was post-compromise-agreement.
Once again, in the case of Pestonji Meekji Mody v. Meherbai, it was held by the Bombay High Court that past consideration/benefit cannot constitute a valid consideration in a contract of surety.

1929-1952 (VALIDITY OF PAST DEBT BEING MAJORITY VIEW)

This trend of past debt as invalid consideration was slightly deviated from in Chakkan Lal v. Kanhaiya Lal. In this case, the court considered a past debt to be valid consideration for a surety because of various reasons like re-acknowledgment of debt from time-to-time through the renewal of hundies by Chakhan Lal (the debtor), joint execution of some hundies by the debtor, and surety and creditor’s promise to lend further sums to the debtor if Balak Ram (surety) would act as a surety. Another vital decision in this regard was made by the Madras High Court in Taluk Board Of Koilpatti v. Senthattikalai Pandia, where it was held that if a seller grants credit/goods based on the guarantee given, the guarantee may be extended to cover both the credit transaction as well as prior debts if the language of the guarantee deed is clear enough. In 1940, the Oudh High Court, in Gulam Hussain v. Faiyaz Ali, took up the question of whether the phrase “anything done… for the benefit of principal debtor” will include in its ambit, the acts done by the creditor in past as valid considerations. The court held that past benefit can constitute good consideration for a guarantee. Though the court held that it is not necessary that the past benefit be given at the desire of the surety, the court took note of the fact that the guarantee was given to the principal creditor because it (dargah committee) had passed a resolution requiring the debtor to furnish some security, failing which, the lease would be canceled. Thus, even in this case, the guarantee was furnished in pursuance of the contract and for the benefit of the principal debtor. This decision has been criticized as one attributing unnatural meaning to the phrase “anything done”.
Further, in Varghese v. I. Abraham, the Kerala High Court held that past debt is not a valid consideration because the creditor does not suffer any detriment at the instance of surety nor was there any benefit extended to the principal debtor at surety’s request.

1952-2005 (NO CONSENSUS)

Later in Ram Narain v. Hari Singh also the Rajasthan High Court held that reading past debt within the word “done” in S127, attributes an unnatural meaning to it. Thus, Past debt is not a valid consideration in a contract of guarantee. But in Jayakunvar Manilal Shah vs Syndicate Bank, the Karnataka High Court held that past consideration is a valid consideration in a contract of guarantee. Again in Bank of Credit and Commerce International S.A. v V.KAbdul Rahiman, the Kerala High Court reiterated that past benefit is not a valid consideration in a guarantee contract. Later, in Sicom Limited vs Padmashri Mahipatrai, the Bombay High Court held that where a guarantee is given subsequent to the grant of benefit to the principal debtor, it cannot be said that the guarantee is void for want of consideration u/s 23 of the Contracts Act.
Therefore, it is clear that that the law on the validity of past debt as a valid consideration in a guarantee is still unsettled. The trend visible from the above discussion is that past benefit has been held to be an invalid consideration in a guarantee contract by a majority of the Indian courts.

ANALYSIS AND COMMENTS ON THE DEVELOPMENTS OF THE SAID ISSUE

It is seen that some courts have relied only on the third illustration of S.127 while many others have placed reliance on the wording of the aforementioned section. The courts have also held that illustrations can neither restrict nor expand the definition and ambit of any section. In order to comment upon the validity of past debt as a valid consideration in guarantee, the principle u/s 127 of Contract Act has to be read largely in consonance with the basic elements constituting a contract though there may be slight variations (“Guarantee” being a specific contract).
There are three distinct principles that ought to be considered in analyzing the validity of Past Debt as a valid consideration in a guarantee contract. Firstly, any contract (generally) requires consideration that has some value in the eyes of law. It need not be adequate. It is an established rule in the Indian Contract law that past consideration in a contract is valid in the case of past voluntary services (Section 25(2) of the Contract Act) and past service at the request. Secondly, a mere ‘recommendation’ differs from ‘request’ made. Lastly, a Contract of Guarantee is entered into for the benefit of the principal debtor and not that of the principal creditor.
Past voluntary service refers to any service provided without any prior request/promise for the performance of the service and there is a promise to pay for that past service made in the future. According to the Indian Contract Act, past voluntary service includes an act done voluntarily for the “promiser”. Where a guarantee is given for past debt, there is no voluntary service done in favor of the guarantor at the time of advancement of a loan but in favor of the principal debtor. The idea here is that the surety is nowhere in contemplation of the principal creditor when he advances a prior loan to the principal debtor. Furthermore, once the creditor contracts with the debtor to advance benefit to the debtor, he becomes legally bound by the contract and it is well settled that performance of a task, which a person is legally bound to do doesn’t constitute valid consideration for a new promise unless there are practical benefits for the promise. Thus, past debt to a principal debtor can’t be read into S.25(2) of the contract act, to constitute valid consideration.
Past service done at request has long been construed to be included under section 2(d) of the Contract Act to constitute a valid consideration. It has been upheld in Lampleigh v. Brathwait that a past service performed at request constitutes valid consideration for a subsequent promise. In Upton-on-Severn RDC vs Powell, it was held that despite there being no subsequent promise for a past act done at request, the court can infer an implied promise in the request. It was also held in Sindha Shri Ganpat Singh Ji v. Abraham that services rendered to a minor at his request but continued after his attaining majority at the same request constituted a valid consideration for the minor’s promise to pay. Therefore, past debt can constitute a valid consideration in a guarantee contract if the benefit was advanced to the principal debtor at the request of the future guarantor. Here, a distinction has to be noticed between “request” and “recommendation”. A request is “A notice of a desire on the part of the person making it, that the other party shall do something in relation to a contract.” A recommendation, on the other hand, allows persons and institutions to make known their views and opinions about a person/organization without any responsibility for injury (if any) sustained by the third party (to whom the recommendation is given) as a result of such recommendation, provided, the recommender acts in good faith. The court, in a case reported in Juggot Indur Narain Roy Choudhry v. Nistarinee Dassee, passed a dictum that a person will not be liable as a surety for a loan advanced to a third party by the lender on a mere recommendation of his.
Thus, it is clear that past debt can be a valid consideration if the creditor has incurred some detriment to advance some benefit to the debtor at the request of the surety. In a case where the creditor has advanced the benefit to the debtor without any prior request made by the surety, it means that the creditor has voluntarily undertaken the risk of advancing the benefit to the debtor without the surety in the contemplation. If a guarantee is executed subsequently, it would mean that the guarantee is for the benefit of the creditor rather than that of the debtor, which reverses the object of a guarantee contract.
Another mode of a guarantee contract where a past benefit can be allowed to be a valid consideration is when the principal creditor advances some additional benefit to the principal debtor when the subsequent guarantee is given by the surety and there is a clear understanding that guarantor’s liability is extended for all the obligations of the debtor which are coupled up. Such an arrangement would be valid because the additional benefit advanced to the principal debtor is sufficient consideration for the surety to guarantee even the prior debts of the debtor. Moreover, such a guarantee would be for the benefit of the principal debtor. The past benefit can also constitute a valid consideration in a subsequent guarantee where the creditor demands the principal debtor to furnish some security post the advancement of benefit due to the debtor’s failure in fulfilling his obligations as per contract (for instance, failure to pay installments for a lease/goods) and failing such furnishment, the benefit advanced would have to return. In such cases, the guarantee advanced would be for the benefit of the principal debtor. Such a situation arose in the Gulam Hussain case.

CONCLUSION

As is evident, there hasn’t been any consensus reached among the courts on the validity of past benefits to constitute valid consideration in a guarantee contract. The trend of cases shows that majority of the Indian courts are not in favor of past benefit being a valid consideration in a guarantee contract. Based on the above analysis the researcher concludes that past benefit can constitute a valid consideration in at least three forms of arrangements in a guarantee contract. Firstly, subsequent guarantee for the past act done on request. Secondly, the additional benefit being advanced to the principal debtor and guarantor’s liability being extended to the prior debts of the principal debtor with a clear understanding of the same. Lastly, in a case where the creditor demands the benefit to be returned unless the debtor can furnish some security because of the debtor’s failure in fulfilling certain contractual obligations. Thus, it is high time that the Supreme Court should interpret the law on this issue, settle the issue and provide an illustrative list of circumstances (if any) where past debt can be considered valid in a guarantee contract.