CHAPTER VIII The Indian Law of Guaranties and Securities

CHAPTER VIII

The Indian Law of Guaranties and Securities BY

VATHSALA M A N Í

PART I : GUARANTIES

The negotiable instruments and documents of commercial credit no doubt provide for the credibility of payment by the buyer to the seller as much international trade (the foreign exchange laws granted) as in domestic trade. However, the main problem in international trade is not simply the one relating to payment. It is also concerned with d;ie performance of the contract of trade. The institutions of guarantees and securities perfoim the dual function of ensuring the seller of the payment on one hand, and of the performance of the contract on the other. Both guarantees and securities have as their common objective the protection of the creditor-seller's interests in the event of default of the buyer-debtor. However, since they possess different legal characteristics involving legal problems of a distinct nature, they should be considered separately.

As regards the developing countries, the operational significance of guarantees and securities is felt chiefly in the case of long-term credits when financing is required for major projects and where the means of bills of exchange and documentary credit cannot be used to guarantee payments. The creditor-seller thus insists on a guarantee from an economically reliable third party or a real security. Although one does rot find large use of guarantees and securities in private international transactions—which are more often than not covered by bilateral trade agreements—in developing countries, yet a study of the problems concerned with those modes of international payments will be useful as the countries are progressively embarking on development programmes requiring long-term credits, especially at a time when the prospects for financing them through an immediate expansion of export trade of primary products are not encouraging.

The use of guarantees and securities, as a means of ensuring payment in international transactions, is also like the other two instruments—Negotiable Instruments and Banker's Commercial Credit—limited by the differences in the laws governing the use of them. These differences arise not only due to the use of different types of guarantees and securities but also due to the difference in the meaning of the concept itself. Hence the need to examine the concept and its interpretation in different countries is essential.

120 Law of International Trade Transactions

1. Guarantees

Guarantees or Suretyship: General Concept The terms "guarantee" and "suretyship" have been used inter

changeably in Anglo-American legal systems and a sharp distinction between them does not seem to be possible.1 In Scotland, it appears, however, that a contract of suretyship is known as a 'cautionary obligation', the surety being styled as a 'cautioner'.2

In primitive societies there was no credit between individuals. Credit, as a concept, "presupposed a use, legal or moral, of the force of a fairly organized society".8 In the absence of credit, the primitive societies suffered from a serious defect that each transaction was considered final.4 Historically, the concepts of guarantee and surety seem to have been of recent origin. The origin of the idea of contract itself on which the idea of guarantee is very much dependent may be found, as Wigmore discovered at the end cf the last century, in at least four important bodies of law and language. Thus he found that in the Scandinavian, Germanic, Latin and Greek Laws and languages, the primitive word for the ideas of "pledge", "bet" (or "forfeit") and "promise", was substantially the same.5 The institution of suretyship might have emerged alongside the evolution of the family system in primitive societies. It was for long the duty of members of the family to act as surety for one another. Thus this phenomenon was perhaps an outgrowth of the concept of collective liability of the family. It is also believed that in the middle ages, in certain cases, there could have been a custom in existence, under which the vassal was expected to act as pledge for his lord.6

The general concept of suretyship or guarantee centres round various types of contracts in which a person (the surety) makes a promise in support of the contractual liability or obligation of another person (the debtor) to a third person (the creditor). The promise consists in an undertaking of an obligation by the surety either to perform the debtor's obligation in case of non-compliance by the latter or (b) to indemnify the credit-tor for such non-compliance.

Thus the surety 'guarantees' the performance of the contract between the debtor and the creditor. "The surety", it is said, "is a favoured debtor."7 Generally speaking, there is no moral obligation on the surety 1. Max Radin, Guaranty and Suretyship '8 California Law Review 21 at 23 ff(1929-30). 2. For a historical treatment of the terms like "guarantee" and "surety", see Max

Radin, Guaranty and Suretyship 17 California Law Review 605 ft" (1928-29). 3. John. H. Wigmore, The Pledge-Idea : A Study in Comparative Legal Ideas 10

Harvard Law Review 321 at 322 (1896-97). 4. William H. Lloyd, The Surety 66 University of Pennsylvania Law Review 40 (1909-

1910). 5. Wigmore, supra note 3 at 322. 6. Lloyd, supra note 4 at 41-42. 7. Lloyd, supra note 4 at 40.

The Indian Law of Guaranties and Securities 121

beyond his legal obligation. That the surety is a "favored" debtor is more pronouncedly true especially in view of the fact that the courts of law seem to be actively sympathetic towards the surety.8 The reason for this favourable disposition on the part of the courts towards the problems as regards the rights and obligations of the surety is that a person who stands surety for another aids the conclusion of the main transaction, although he does not possess active interest in it—except his interest in assisting the debtor in performance of the latter's obligations. This judicial attitude is indeed to be appreciated in the light of the significant role the surety fulfils in the commercial world facilitating credit for business transactions.9 Viewed from this perspective, the judicial policy tends to encourage co-operation in commercial transactions by reducing the risk of the accessory, i.e., the surety to the minimum.

In a commercial transaction suretyship forms a secondary obligation to the principal contract to guarantee its performance or to furnish means to indemnify the creditor in case of performance. In this sense suretyship is of relatively recent origin.

Ancient Roman Law The institution of suretyship under the Civil law has had a fairly

long trial in history going back to the ancient Roman Law.10 The development of the concept of suretyship in the Continental jurisprudence has been largely due to the doctrines established by the Roman Law which had, through the centuries of experience, stripped them off their early formalism. There had been five types of contracts of suretyship in the Roman law, namely, sponsio, fidepromiso, fidejussio, constitutum, and mandatum.11

Of these the sponsio and fidepromiso have been the most ancient ones, the former being the ancient most. Both the forms are, however, verbal contracts. In a sponsio the sponsor or surety could intervene only where the parties were Roman citizens and the obligation was created by stipulation. The formal verbal contract, typical of ancient civil law, consisted in the solemn question and answer pattern. The heir to the surety was not, however, bound.

The fidepromiso, though an ancient form, was a latter development. This form was resorted to when one of the parties to the contract was an alien. Like the sponsio, the fidepromiso also terminaetd on the death of the surety and did not devolve upon his heirs.

The liability of the surety under both the sponsio and fidepromiso was limited to two years. Where there were co-sureties, each surety was liable only for his proportionate share of the debt secured. This state of law, 8. Ibid. 9. H P. De Colyar, Suretyship 8 Journal of the Society of Comparative Legislation 44

(1905). 10. See for example, Ernst Rabel, 2 The Conflict of Laws : A Comparative Study

353 ff (Ann. Arbor. Mich., 2nd (ed., 1964); Lloyd, supra note 4 at 45 ff. 11. Moyles (ed.), Ill Institutes of Justinian 20,


was, however, brought about under the lex Furia. By virtue of the lex Apuleia, a co-surety who had paid more than his share of the debt, had a right of action against other co-sureties. The surety was under lex Cicereia entitled to be informed of the amount he became bound for, and of the number of co-sureties.

Evolved during the later years of the Roman Republic, fidejussio was commonly made in the form of a verbal stipulation. Yet it had a wider canvass of operation than the sponsio and the fidepromiso. It could be made accessory to contracts of every kind, i.e., obligations contracted re, verbis, litteris consensu. It is, however, important to note that the surety bound his heirs. Each co-surety was liable for the whole debt. This defect was subsequently sought to be mitigated. Thus, where special permission was granted by the Emperor, a surety, sued for the whole debt, could claim to have the debt apportioned into proportionate shares among the solvent co-sureties. Later on the practice developed in consequence of which the payment by a co-surety was treated not as a discharge, but as a purchase of the debt from the creditor by the paying co-surety. One restriction on special permission was tint it had to be sought before the payment was made. This limitation on special permission arose from the fact that the whole debt on payment was considered to be extinguished. Thanks to subsequent developments, the surety was made entitled to demand that the creditor should sue the principal debtor, before taking recourse to the surety, but the surety had the obligation to produce the debtor before the court within a time limit fixed by the court.12

The fourth type of suretyship was the constitutum. It was an informal agreement to discharge the debt of another on a fixe 1 day. It was made actionable by the praetor.

The fifth and the most common form of suretyship was mandalum qualificatum. In this form of surtyship, one person, the mandator, requested another, the mandatorim, to lend money to a third person. The obligation was cast on the first person to indemnify the second against any loss consequent upon the failure on the part of the third person to redeem the loan with interest. In most respects, the position of the mandator was identical with that of the surety in the fidejussio. Yet the mandalum was the nearest Roman approach to the idea of agency in contract. More importantly, the contract between the surety and the creditor under the mandalum was wholly distinct from the contract between the creditor and the debtor.

The influence of the Roman law doctrines of suretyship on the present day law, especially the continental law, has been considerable. It is undoubtedly true that the growth of European law was partly through the natural development of native institutions to meet new conditions, and partly through the absorption of Roman law owing to its intrinsic

12. This was under Justinian's beneficium, ordinis or cliscussionis.


merits, and through the dominating influence of Latin-culture, thanks mainly to the centuries-long political dominance of Rome over the entire European continent.

The contribution of the Roman law in the realm of the concept of suretyship may be well epitomized thus : The general idea that "the surety is the sponsor for the representative of the creditor" emerged significant. And, as the time passed by, the primary liability of the surety became secondary "in law as in intention".13 All this facilitated extensive use of suretyship devices in commercial transactions in Europe.

D. Common Law Halsbury defines guarantee as "an accessory contract, whereby the

promisor undertakes to be answerable to the promisee for the debt, default or miscarriage of another person, whose primary liability to the promisee must exist or be contemplated".14

Some of the Common Law rules relative to suretyship were, for the first time, given statutory basis through the English Statute of Frauds of 1677. The pre-statute law did not require any writtens evidence of a suretyship which could thus be proved in the same manner as any ordinary contract. The main purpose of the Statute of Frauds was to prevent the danger of a suretyship being established through false evidence, or by evidence of loose talk, when it was never meant really to make such a contract.15 Section 4 of the Statute of Frauds provided that no action should be brought upon any special promise to answer for the debt, default or miscarriage of another person unless the agreement upon which such action should be brought on some memorandum or note thereof should be in writing and signed by the party to be changed with it, or some other person lawfully authorized. However, this provision was a mere enactment as to evidence.16 Thus if the original written contract of suretyship was lost, oral evidence was admissible to show that the written contract had in fact existed.17 All that the statute did was to render an unwritten contract of suretyship unenforceable by an action before a court of law. It did not, by itself, render such a contract void.

The Statute, however, was not a comprehensive and foolfroof piece of legislation. It could be evaded successfully, for it permitted, for instance, treating the surety's oral promise to be answerable for another person as a false representation, for which he could b¿ made liable in tort but not in contract.18 This necessitated further legislation which was brought in

13. Lloyd, supra note 4 at 46, 47. 14. Simonas, ed., 18 Halsbury's Laws ofEngland 411 (3rd ed., London, 1957). 15. Steel v M. Kinlay, (1880) 5 A.C. 754 H.L. 16. Halsbury's Laws of England, supra note 14 at 424. 17. Barras v. Reed Times, 28th March, 1898. Crays Gas Co. v. Bromly Gas Consumer's

Co. Times, 23rd March 1901. 18. Supra note 13 at 425 fn. 4.


through the Statute of Frauds Amendment Act of 1828. The 1828 Amendment Act (generally known as Lord Tenterden's Act), provided that no representation or assurance as to the character, conduct, credit, ability, trade or dealings of any other person in order to obtain him credit, money or goods could be sued on unless it be in written form. To render the maker of the representation liable, the representation should have to be to his knowledge untrue, and been made with the intention of inducing another to act upon it, with the latter acting upon it and thereby sustaining damage.

The issue of consideration in the context of suretyship in commercial transactions does assume a shape different from that in the contest of an ordinary contract. The English Mercantile Law Amendment Act of 1856 stipulated that no "special promise" to answer for the debt, default, or miscarriage of another person, if in writing and signed by the party to be charged therewith (i.e., the surety), on some other person duly authorized, was deemed invalid to support an action, suit or other proceeding, by reason only that the consideration for such promise did not appear in writing or by necessary inference from a written document.19

Despite the Statute of Frauds, suretyship—which the statute described as a "special contract"— did not come to be in vogue until the end of the eighteenth century and the beginning of the nineteenth century. The trend in America seemd to have followed closely that of England.20

Guarantee in the sense of warranty both of lands and chattels seems to be very old in the Anglo-Saxon law. The term 'surety' too is said to have an unbroken lineage which is far older. Max Radin places the crystalization of its earliest form perhaps as early as the thirteenth century.21

The concept comprised an engagement by a person to answer for another's performance. Later, the English cases failed to distinguish between suretyship so evolved, and guarantee22 which denoted a contract and also who made it. Although the Statute of Frauds spok of suretyship or guarantee as a "special promise", the English took a long time to classify the issue whether suretyship should be governed by the same law, which governed the ordinary contracts. The reason probably was the assumption that since a surety's obligation is a "accessory to the principal debt and since its validity and extent depend on those of the principal contractual obligation, it should be subject to the same law. There is an English case as an authority to this assumption, even as late as 1875." This assumption was, however, subsequently proved wrong, especially

19. See Holsbury's Laws of England, supra note 14 at 426. 20. Max Radin, supra note 2 at 606. 21. id. at 608. 22. The term 'guarantee' came into being at a late date, the reason being that the

lawyers and merchants had already been supplied with a convenient term, 'suretyship', see Max Radin, supra note 2 at 608-609.

23. Rouquette v Overmann andSchon, L.R. (1875) 10 Q.B. 525.


because of the independent nature of the surety's obligations. A surety or a guarantee is bound by his own agreement with the creditor, as distinguished from the undertaking giving rise to the obligation of the principal debtor; and the suretyship is governed by its own law independently, in principle, from that controlling the main debt. This continental legal thought and the American practice seem to be consonant with this view of the matter.21 "Yet," as Ernst Rabel remarks, "while the law sued not necessarily be the same for the debt and its guaranty, it is a reasonable wish that it should be identical as often as possible. The problem of establishing the adequate local connection for suretyship is similar to that arising with respect to a contract to sell an immovable, for which situs is not a compulsory but a desirable contract."25

The problems in Anglo-Saxon law surrounding the question whether the liability of the surety was primary or secondary, appear to have come to the surface through the law reform by the Chancery. This denoted the emergence of what were later known as the surety's 'equities'. Of the several equities, the important are :

(1) The right to be indemnified or reimbursed for the loss sustained through his principal's default. The right to be fully indemnified against the loss arising out of his guarantee is in fact admitted not only by the Anglo-Saxon countries but also by the Continental countries.26

(2) As soon as a definite sum has become payable, the surety may apply to a court (of equity) for a decree directing ihe principal to pay the creditor so that his own liability is brought to an end.

(3) The right of subrogation or substitution :—The surety, as soon as he has paid off the creditor has a right to the benefit of all the securities which the creditor has received from the principal whether known to him or not at the time of his becoming surety.'·7 The same principle is applicable against co-sureties to the extent of their liability to contribute.

(4) Right to contribution :—The surety who has paid more than his share of the common liability is entitled to contribution from his co-sureties, in regard to the excess, in proportion to the amounts in which they are respectively liable. The equity here depends not on the contract, but upon what is called the "equity of burden."28

In this context, it appears to be pertinent to note the wide acceptance in the continental law and not in Anglo-Saxon law of two important privileges of the surety based chiefly on the Roman law :

(i) The benefit of division (beneficium divisionis) which arises where there are several sureties for the same debt and one alone is sued for the

24. Rabel, supra note 10 at 353-55. 25. Id at 357. 26. See e.g., French Civil Code, section 2028; German, Civil Code, section 775; Spanish

Civil Code, section 1838. 27. See also French Civil Code, section 2029; German Civil Code, section 774. 28. See also French Civil Code, ssction 2033; German Civil Code, sections 426, 774.


whole. Under such circumstances, upon the demand by the surety sued, the creditor is bound to divide and apportion his claim among the solvent sureties. In modern civil codes the benefit of division is preserved, but this privilege may be—and as a matter of fact, is quite frequently renounced.29

(«) The benefit of discussion (beneficium discussions) by virtue of which the creditor, on demand of the surety and at his expense, is obliged first to proceed to execution against the property of the principal debtor.30

E. Fundamental Divergency between the Civil Law System and the Common Law System The basic divergency between the two major systems of law in their

approaches to the norms of suretyship surrounds the question of form. Under the Common law—especially under the Statute of Frauds - a contract for suretyship must be in writing. In sharp contrast, the Civil law distiguishes itself with a sanction of freedom of form as a basic principle. Thus, under Civil law oral contracts are as much enforceable as written contracts. As an exceptional case, contracts for suretyship by a non-merchant are required to be in writing under the Civil codes; however, a contract of guarantee or of suretyship made by a merchant is not required to be in writing.™

F. Indian Law The Indian Contract Act of 1872 appears to follow the general

Anglo-Saxon pattern in respect to the rules governing the contractual relationship arising out of a contract for guarantee. However, it is important to bear in mind that although the relevant provisions of the Indian Contract Act partake of the English law in many material particulars, tha Act contains several points of divergency.

Section 126 of the Act defines the terms "contract of guarantee", "surety", "principal debtor" and "creditor". A "contract of guarantee" is a contract to perform the promise, or discharge the liability of a third person in case of his default. The person who gives the guarantee is called the "surety" and the "principal debtor" as the person in respect of whose default the guarantee is given. The person to whom the guarantee is given is, of course, the "creditor". The important stipulation, the said section further makes is that "[«] guarantee may be either oral or written".

The definitions of the "surety", the "principal debtor", and the "creditor", rightly find place in section 126 of the Indian Act. The section as a whole conveys the general idea of what a contract of guarantee

29. French Civil Code, section 2026; Belgian Civil Code, section 2026; Louisiana Civil Code, section 3049; Italian Civil Code, section 1912, Spanish Civil Code, section 1837.

30 French Civil Code, sections 2021-2024; Louisiana Civil Code, section 3049, German Civil Code, section, 771-773; Spanish Civil Code, sections 1831-1806; Italian Civil Code, section 1907.

31. Robsrt Charles Kelso, International Law of Commerce 84,88, 89 (Buffalo, N.Y., 1961).


is, and who are the actors in the transaction. A contract of guarantee, as the section classifies, involves three parties, namely : the creditor, the surety and the principal debtor, and a contract to which those parties are privy. The foundation, indeed, is the contract between the principal debtor and the creditor. Then there must be a contract between the creditor and the surety by which the latter guarantees the debt. However, in order to constitute a contract of guarantee, there must be a third contract, by which the principal debtor expressly or by necessary implication, requests the surety to act as a surety.32 There can be no contract of guarantee if liability does not exist. The liability of the guarantee presupposes the existence of a separate liability of the principal debtor and his liability is thus secondary, which comes into existence only in default by the principal debtor.33

Further, as section 126 stipulates, a contract of guarantee need not necessarily be in writting. It may be expressed by word of mouth or it may be tacit or implied and may be inferred from the course of conduct of the parties. Chapter VIII of the Act dealing with indemnity and guarantee is not exhaushivc on the point.34

1· Contract of Guarantee and Contract of Indemnity The distinction between a contract of gurantee and one of indem

nity is important and remains clarified in the Common Law system. Although a contract of gurantee may be discribed as a contract of indemnity in the widest sense of the term 'indemnity', points out Halsbury, yet contracts of guarantee are distinguished from contracts of indemnity ordinarily so called by the fact that a gurantee is a collateral contract, that is, ancillary or subsidiary to another contract, whereas an indemnity is a contract by which the provision undertakes an original and independent obligation. In certain cases, where there is a primary and secondary liability of two persons for one and the same debt, they may stand in relationship to one another of principal debtor and surety, even though no express contract of suretyship exists. The existence of such a primary and secondary liability- as Halsbury observes—does not, however, in every case necessarily create the relation of principal debtor and surety. Thus, despite the fact that there is a primary and secondary liability, for instance, between the transferee and the transferor of shares, the relation between them is not that of principal debtor and surety.35

As pointed out earlier, there should be three sets of contractual

32. Ramchandra B Loyalka v. Shapurji N. Bhownazree, A.I.R. 1940 Bom. 315; Jan-watory v. Jethmal, A.I.R. 1958 Rajaslhan 343; Major General Mahabir Shum Sher Jung Bahadur Rana v. Lloyds Bank Ltd. and another, A.I.R. 19SS Cal. 371.

33. Brahmayya & Co. v. K. Srinivasan Thangirayar and others, A.I.R. 1958 Mid. 122. 34. Mir Niyamat Alikhan v. Commercial and Indusrtial Bank Ltd., A.I.R. 1969 Andina

Pradesh 294. 35. 18 Halsbury's Laws of England, supra note 13 at 416.


relationships in a contract of guarantee under Indian law, in contradistinction to a contract of indemnity. One is between the creditor and the principal debtor; the second, between the creditor and the surety; and the third, between the principal debtor and the .surety. If the first two are the only contracts, the case is "clearly one of indemnity. It is the third contract—the one where the principal debtor requests a third person expressly or by necessary implication to act as surety—that constitutes a contract of guarantee.36 One of the essential elements for a transaction of a guarantee, held the Allahabad High Court in a case, is the presence of three different parties collaborating in the execution of a deed of guarantee. Where this element is missing and the principal debtor is not taken into consideration at all, clarified the Court, the deed is not one of a gurantee but is only an indemnity bond.37 Thus if a person undertakes to reimburse another for some loss which may be caused to him, say, by a third party or by himself, but not at the request, express or implied, of a third party, then the person who, having undertaken the liability and having been called upon to make good the loss, will not be able to recover the loss so caused to him from the principal debtor, the latter being not privy, but virtually a stranger to the undertaking given to the promisee. Such a contract is not a contract of guarantee but one of indemnity.38

Section 124 of the India Contract Act, 1872, defines a contract of indemnity as a contract by which one party promises to save the other from loss caused to him by the conduct of the promisee himself, or by the conduct of any other person.

2. Consideration for Guarantee Under Section 127 of the Act, 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. Explaining this provision, the Rajasthan High Court held in 1963 that in order to constitute a valid consideration for guarantee, the creditor must have done something for the benefit of the principal debtor. Anything done or any promise made for the benefit of the principal debtor must be contemporaneous to the surety's contract of guarantee in order to constitute proper consideration therefor. A contract of guarantee executed afterwards without any consideration is therefore void. The Rajasthan High Court thus took the view that the word "done" in Section 127 is not indicative of the inference that past benefit to the principal debtor can be a good consideration.39

36. A.I.R. 1940 Bom. 315; A.I.R. 1958 Raj. 343; Municipal Committee, Buldana v. Vishnu DamodarBhalrao, A.I.R. 1949 Nag. 48.

37. Ms. Radha Kunwar v. Ram Naroin and Others, A.I.R. 1952, All. 587. 38. A.I.R. 1953 Rajasthan 343. 39. Ram Naroin v. Lt. Col. Hari Singh and another, A.I.R. 1964 Raj. 76. But the Oudh

High Court, in 1940, held that the word "done" could be interpreted to mean that past benefit to the principal debtor could be a good consideration for a contract of guarantee, A.I.R. 1940 Oudh 346-


Consideration between the creditor and the principal debtor is a valid and good consideration for the guarantee given by the surety. It is not necessary that the consideration should flow from the creditor and be received by the surety.40

3. Surety's Liability Under Section 128 of the Indian Act, the liability of the surety is

co-extensive with that of the principal debtor, unless it is otherwise provided by the contract.

The courts, as a general rule, adopt an attitude favourable to the surety, for the reason that the liability incurred by the surety is only secondary. Of the several rules of practice which courts follow in cases involving liability of the surety in the Common law system, the important rules are:41

(/) The liability of the surety being secondary, a creditor cannot, before any default has been committed by the principal debtor, bring an action quia timet against a surety to force him to set apart money to provide for the prossibility of a debt becoming due from the principal debtor and the principal debtor making default.

(//) The creditor has a heavy onus to prove the liability of the surety. In an action against the surety by the creditor, a judgment or award obtained by the latter against the principal debtor is not evidence against the surety. Nor do the principal debtor's admissions of liability bind the surety.

(in) The surety's contract must be strictly construed.42 His liability flows only from the terms of the contract and he cannot be made liable for more than what he has undertaken.

(¡v) The surety cannot be made liable beyond the terms of the principal contract.

(v) The surety's liability cannot be unduly extended. However, it comprises all transactions which naturally and reasonably are entered into on the faith of the guarantee.

Section 128 of the Indian Act requires the surety to specify clearly in the contract that his liability is limited and that it is not co-extensive with that of the principal debtor. In the absence of any such stipulation by the surety, his liability, under the section, must be deemed co-extensive. There is judicial authority on the statement that the burden to prove that the liability is limited is cast on the surety.43 The only protection Section

40. A I.R. 1969 Andhra Pradesh 294. 41. Hahbury's Laws of England, supra note 14 at 443. ff. 42. A coatract of surety must be construed reasonably and strictly in favour of the

surety—Subhankhan Ramjanv. Lai Khan Haji Umakhan and others, A.I.R. 1948 Nag. 123.

43. Bharat National Bank Ltd. and another v. Thakar Das Madhok, A.I.R, 1935 Lahore 729.


128 can give him in this respect is that he cannot be asked to be liable for which the principal debtor has not bound himself liable under the principal contract.

The guarantees in trade transaction are usually given either to secure the supply of goods on -credit or advances of money and may be limited in amount, or absolutely unlimited, so far as the surety's liability thereunder is concerned. Where títere is a pecuniary limit, the guarantee continuing is not exhaustive by the first advance or credit equal to the prescribed amount. But a giirantee, though continuing and limited to a given sum, may and sometimes does, stipulate that the surety shall only be liable for a definite period of time and not longer. In the latter case, it is obvious. It is often an interesting question of construction whether the guarantee covers the transaction completed but not matured during the time limit. The question whether a particular guarantee is a continuing or non-continuing guarantee, is also a question of construction of the contract, where it is not clear either way from the face of the contract. Section 129 of the Indian Contract Act defines a continuing guarantee as a guarantee which extends to a series of transactions. The important and noteworthy point in this regard is the fact that the section does not define nor lay down any criteria of practical value as to what exactly a "series of transactions" means.44

However, the Madras High Court has for long been of the view that a request to advance money to another person up to a certain limit for his trade is a continuing guarantee.45 Revocation of a continuing guarantee is possible in either of the two ways. Under Section 130 of the Indian Act, it can at any time be revoked by the surety, as to future transactions, by notice to the creditor. Its revocation may also occur on the death of the surety—under Section 131 —of course, only in the absence of a contract to the contrary. It is worthwhile to note that both the revocations operate as against "future transactions" only.

4. Discharge of Surety's Liability Indian law, following Common law, provides for discharge of

surety in four different sets of circumstances. First, the surety is discharged when any variance is effected to the main contract between the principal debtor and the creditor.46 However, to cause discharge of the surety, the variance must have been made "without the surety's consent". The Indian law received authoritative expression on this point as early as 1934 through a Privy Council decision in Pratap Singh v. Keshavlal.47 The case involved 44. Thus it lias been held that in consdering whether the bond constitutes a continuing

guarantee, surrcunding circumstances must be considered unless the wording in the bond precludes it. Nedungadi Bank Lid. v. Daraikhaimu Animal, A I.R. 1941 Mad. 282.

45. T.N.S. Firm v. V.P.S. Muhammad Hussain and others, A.l.R 1933 Mad. 756. 46. Section 133 of the Indian Contract Act, 1872. 47. A.l.R. 1935 P.C. 21.


a guaranteed transaction of an advance of Rs. 1,25,000 on security of four properties, whereas the real transaction carried out was one of an advance of Rs. 1,000,000 on security of three properties. It was held by the Privy Council that the sureties could not be held liable in respect of the performance of the latter transaction, which was not what they had contracted to guarantee. The Council, speaking through Lord Atkin, clarified the legal position thus :

the law on the discharge of sureties has been some what obscured by the emphasis laid in the cases on an agreement between the parties to vary in the terms of the original agreement. The principle is that the surety, like any other contracting party, cannot be held bound to something for which he has not contracted. If the original parties have expressly agreed to vary the terms of the original contract no further question arises. The original contract has gone, and unless the surety has assented to the new terms, there is nothing to which he can be bound, for the final obligation of the principal debtor will be something different from the obligation which the surety guaranteed. Presumably he is discharged forthwith on the contract being altered without his consent, for the parties have made it impossible for the guaranteed performance to take place.48

Lord Atkin, expounding the principle, was indeed circumspect. He thus found it desirable to add that the application of this principle must always depend upon a correct analysis of the contract in fact made. "Guarantees", he pointed out, "frequently relate to obligations without special reference to any specific contract between the creditor and the debtor. In such a case the doctrine referred to would have a very limited operation."49

The second circumstance which discharges the surety under Indian law is by release or discharge of principal debtor. Section 134 of the Contract Act provides that the surety is discharged by any contract bstween the creditor and the principal debtor, by which the principal debtor is released or by any act or omission of the creditor, the legal consequence of which is the discharge of the principal debtor. Mahanth Singh v. U Ba F50 was a case that arose out of a suit against principal debtors and the surety, where the names of the original debtors were struck out upon an application by the creditor. The Privy Council held that the only result of the creditor's act was to preclude the bringing by the creditor of a fresh suit in respect of the subject-matter against them, and is not to release or discharge the principal debt. Lord Porter, speaking for the Council, observed that "A surety is discharged if the creditor, without his consent, either releases the principal debtor or enters into a binding

48. Id. at 24; the Council also referred with approval to Blest v. Brother, 6 L.T. 620 (of 1862); and Smith v. Wood, 130 L.T. 250 (of 1929).

49. Id. at 25. 50. A.I.R. 1939 P.C. 110.


arrangement with him to give him time. In each case the ground of discharge is that the surety's right to pay the debt at any time and after paying it, to sue the principal in the name of the creditor is interfered with."51 "While an absolute release is given," held his Lordship, "there is no room for any reservation of remedies against the surety. ..Where, however, the debt has not been actually released, the creditor may reserve his right by notifying the debtor that he does and this reservation is effective not only where the time of payment is postponed but even where the creditor has entered into an agreement not to sue the debtor. In neither case is there any deception of the debtor since he knows that he is still exposed to a suit at the will of the surety."52 The Council found that if the only result of striking out the original debtors from the action was to preclude the bringing by the creditor of a fresh suit in respect of the sub^ ject-matter against them, and was not to release or discharge, the principal debt, "then the debt remains a debt though the creditor by reason of a rule of procedure cannot himself bring an action upon it".'3 Thus it was held that the surety could not be said to have been discharged under those circumstances.

The third set of circumstances which may discharge the surety's liability has been provided in Section 135 of the Contract Act, under which a contract between the creator and the principal debtor, by which the creditor makes a composition with, or prom:ses to give time to, or not to sue, the principal debtor, discharges the surety, unless the surety assents to such contract. Three different circumstances releasing the surety of his liability have been envisaged in the section: (1) when a creditor compounds with the principal debtor; (2) when the former promises to give time to the latter; and (3) when the former agrees not to sue the latter. In all these three situations, the conditioning factor is undoubtedly "unless the surety assents to such contract". The principle is derived from the English common law.5' However, the provisions of Section 135 have not been liberally construed by the Indian courts. In Damodardas v. Muhammad, it was held that a mere gratuitous agreement by a creditor to give time to the principal debtor could not discharge the surety, but "the agreement must amount to a contract".68 In fact, in Lai Behari v. Allahabad Bank, it was even held that the section contemplated a subsequent contract between the creditor and the principal debtor whereby the time originally fixed was subsequently extended and that in the absence of such a subsequent contract the section had no application.*6

51. «.at 111. 52. Id. at 111-112. 53. Id. at 114. 54 Samuell v. Howarth, 3 Mer. 272; Polak v. Everett, 1 Q.B.D. 669. 673, 674. 55. I.I..R. 22 All. 351; see also LalBehari v. Allahabad Bank, 27 All. L.J. 1137; Maharaj

Bahadur v. Basanta, 17 C.W.N. 695. 56. 27 All. L.J. 1137.


However, the subsequent contract may be either express or implied, i.e., inferred from the acts of the parties.57

Section 135, it may be suggested, must be read along with Sections 136 and 137. The latter sections constitute exceptions to the general rule of Section 135. Under Section 136, where a contract to give time to the principal debtor is made by the creditor with a third person, and rot with the principal debtor, the surety is not discharged. Section 137, on the other hand, provides that mere forbearance on the part of the creditor to sue the principal dedtor or to enforce any other remedy against him does not, in the absence of any provision in the guarantee to the contrary, discharge the surety. Section 137 clarifies in express terms what is clearly implied in Section 135,58 that what is needed to cause the discharge of the surety is not "mere forbearance" on the part of the creditor to sue the principal debtor, but a positive act, a promise or a contract, to give time, or not to sue. Thus if the creditor shows simple neglect to sue the principal debtor, in the absence of any contrary provision in the guarantee, that does not by itself cause the automatic release of the surety.58 It has been held in Mercantile Bank v. Tahilram*0 that in applying these provisions of the law, a careful distinction must be made between a variation of a contract and a mere forbearance.

Section 139 of the Indian Act in a broad sweep covers the rest of the circumstances that cause discharge of the surety. By virtue of that provision, if a creditor (1) does any act which is inconsistent with the rights of the surety, or (2) omits to do any act which his duty to the surety requires him to do, and the eventual remedy of the surety himself against the principal debtor is thereby impaired, the surety is discharged. Thus the creditor, by his act, or omission, may cause discharge of the surety the important condition being that by such act or omission "the eventual remedy of the surety himself against the principal debtor is thereby impaired".01

57. In Rally Prosunnu v. Umbica, 18 W.R. 417, the credilor accepted, without thj surety's knowledge, a sum of money on account of interest in excess of the interest then due on a promissory note and gav: time to the debtor. It wis held thit the surety was discharged.

58. Section 135 provides as follows : A contract between the creditor and the principal debtor, by which the creditor makes a composition with or promises to give time to or not to sue, the principal debtor, discharges the surety, unless the surety assents to such contract". Section 137 lays down the following conditions : "Mere forbearance on the part of the creditor to sue the principal debtor or to enforce any other remedy against him does not in the absence of any provision in the guaraníes to the contrary, discharge the surety."

59. Oriental Financial Corporation v. Gunrey & Co., L.R. 7, Ch. 142 at 150; For Indian cases see, Kali v. Abdul, 23 C.W.N. 545 (P.C.); Tulsidas v. Hashim, 78 I.C. 868; Kali Prasad, v. Jotindra, I.L.R. 36 Cal. 626; Abid v. Lachmi, 154 I.C. 111.

60. I.C. 309. 61. Compare this provision with section 40 of th3 Indian Negotiable Instruments Act,

1881.


Joint and Several Liability of Co-sureties Section 138 of the Indian Contract Act is significant in that its pro

visions are divergent from the English law. Under the section, where there are co-sureties, a release by the creditor of one of them does not discharge the others; neither does it free the surety so released from his responsibility to the other sureties.82 The English law, on the contrary, provides that when the creditor releases one of the co-sureties who have contracted jointly and severally, the others are discharged, the joint suretyship of the others being part of the consideration of each.63 Sections 44 and 138 of the Indian Contract Act have been drafted with a view to modifying the English law.64

Section 138 makes it clear that the liability of the co-sureties in India is joint and several. But the fact that the surety bond is enforceable against each surety, severally, and that it is open to the creditor to release one or more of the joint sureties does not alter the true character of an adjudication of the court when the proceedings are commenced to enforce the covenants of the bond against all the sureties. The case in point is Sri Chand v. Jagdish Per shad.6& The Supreme Court held in that case that the mere fact that the obligation arising under the covenant may be enforced severally against all the covenantors, does not make the liability of each covenantor distinct. It is true, the court pointed out, that in enforcement of the claim of the decree-holder the properties, belonging to the sureties individually, may be sold separately; but that is because the properties are separately owned and not because the liability arises under distinct transactions.68

The principle of contribution is recognized through Sections 146 and 147. Section 146 provides that where two or more persons are co-sureties for the same debt or duty, either jointly or severally and whether under the same or different contracts, and whether with or without the knowledge of each other, the co-sureties in the absence of any contract to the contrary are liable, as between themselves, to pay each an equal share of the whole debt, or of that part of it which remains unpaid by the principal debtor. Where, however, the co-sureties are bound in different sums, they are by virtue of Section 147, liable to pay equally as far as the limits of their respective obligations permit. The co-surety's right to contribution has long been recognized on the basis of the principles of equity.67

At least on one important point the Indian judiciary has had occasion to clarify it. The question was whether the surety could be allowed to work

62. See section 44 of the Contract Act of 1872 for the identical effect of release of one joint promisor.

63. North v. IVakefield. 18 L.J. Q.B. 214; Wilkinson v. Lindo, 10 L.J. Ex. 94; Jenkins v. Jenkins, (1928) 2 K.B. 501; Re E.W.A. (1901)2 K.B. 642, 652.

64. Krishna v. Sanat, I.L.R. 44 Cal. 162, 172. 65. A.I.R. 1966 S.C. 1427. 66. Id. at 1431. 67. Ibn Hasan and another v. Brijbhukan Saran, I.L.R. (1904) 26 All. 407 at 418 (KB.).


out his rights against his co-sureties and the principal debtor and release the security in the same suit. In Kamal Chander v. Sushila Bala Dassee,™ Justice Panckridge answered the question in the affirmative.

Surety's Rights Against the Principal Debtor It may be repeated, at this juncture, that by virtue of Section 128

the liability of the surety is co-extensive with that of the principal debtor, unless it is otherwise provided in the contract. Section 140 enshrines the general common law principle that where a guaranteed debt has become due, or default of the principle 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 all the rights which the creditor had against the principal debtor. This rule is also strengthened by the principle laid down in Section 145 that in every contract of guarantee there is an implied promise by the principal debtor to indemnify the surety; and the surety is entitled to recover from the principal debtor whatever sum he has rightfully paid under the guarantee, but sums which he has paid wrongfully. To enable the surety to enforce his right under Section 140 against the principal debtor, two conditions must, however, be fulfilled: first, that the debt must subsist, and second, that his remedy against the principal debtor must remain unimpaired.89 In Darban Lai v. Mahbub70 the Allahabad High court has held that Section 140 is open only to a surety who has done all he is liable to do. If the surety does not pay the whole of the debt due to the creditor, but pays only a part thereof, the section is not applicable.

Section 141 contains the most practical application of the principle laid down in Section 140.71 For the section entitles a surety to the benefit of "every security" which the creditor has against the principal debtor at the time when the contract of suretyship is entered into whether the surety knows the existence of such surety or not, the section also provided that if the creditor loses, or, without the consent of the surety, parts with such security, the surety is discharged to the extent of the value of the security.72

Recently, the Supreme Court has had an opportunity to apply its mind to the provisions of Section 141. The State of Madhya Pradesh v. Kaluram,73 decided by the Supreme Court in 1966. was a case where Kaluram, by executing a surety bond, had undertaken to discharge the liability arising out of any act, omission, negligence or default of a forest contractor. The proceedings had been started against the surety for recovery of certain arrears of instalment payments due from the forest con-

68. 1801.C. 572̂ ~ 69. Babu v. Manak, 176 I.C. 786. 70. I.L.R. 49 All. 640. 71. Vyravan v. Official Assignees, Madras, 63 M.L.J. 615. 72. For the identical English doctrine, see Rees v. Barrington, 2 W. T.L.C. 4 ed. 1002,

cited in Wuliffv. Lay, L.R. 7 Q.B. 756, 764. 73. A.I.R. 1967 S.C.I 105.


tractor who had already removed almost the entire quantity of trees sold to him. The surety then commenced an action against the State for a declaration that he could not be held liable for the arrears of forest dues, and for an injunction restraining the State from realizing or from continuing the recovery proceedings. His chief contention, in the lower courts as well as before the Supreme Court, was that the forest authorities had given time to the contractor and omitted to take steps which their duty to the surety required them to take—such as prompt siezure and sale of the trees after the default of instalments; and that since on this account the surety's eventual remedy against the principal debtor had been impaired, he should beheld discharged from liability as surety. Upholding this contention, the Supreme Court said, classifying the scope of Section 141:

[The expression "security" in Section 141 is not used in any technical sense; it includes all rights which the creditor had against the property at the date of the contract. The surety is entitled on payment of the debt or performance of all that he is liable for, to the benefits of the rights of the creditor against the principal debtor which arise out of the transaction which gives rise to the right or liability: he is, therefore, on payment of the amount due by the principal debtor entitled to be put in the same position in which the creditor stood in relation to the principal debtor. If the creditor has lost or has parted with the security without the consent of the surety, the latter is, by the express provision contained in Section 141, discharged to the extent of the value of the security lost or parted with.74]

Following an English leading case76 on the point, the court was of the opinion that, certain minor variations apart, Section 141 "incorporates the rule of English law relating to the discharge from liability of a surety when the creditor parts with or loses the security held by him".

It was, in fact, contended on behalf of the State that mere inaction en the part of the authorities could not amount to parting with the security. Turning down this argument squarely, the Court found : "But the terms of the statute do not apply only to cases in which by positive action on the part of the creditor the security is parted with. Even if security is lost by the creditor, the surety is discharged."76

7. Invalid Guarantees The Indian Act envisages two situations of invalidity of guarantees :

(1) Any guarantee which has been obtained by means of misrepresentation made by the creditor or with his knowledge and assent, concerning the material part of the transaction, is invalid."77 (2) Any guarantee which the creditor has obtained by means of keeping silence as to material circum-

74. Id. at 1108-1109, emphasis supplied. 75. Wulff and Billing v. Jay, (1872) 7 Q.B. 756. 76. A.I.R. 1967 S.C.I 109. 77. Section 142, The Indian Contract Act, 1872.


stances is invalid.78

Concealment, under Section 143, is fraudulent. Indian law seems to make a distinction between intentional concealment and mere non-disclosure.79 To invalidate a guarantee, thus, two points will have to be proved, first that there was misrepresentation as to a material part of the transaction, or silence as to material circumstance. Second, that the guarantee was in fact obtained by means of such misrepresentation or silence.80

Indian courts have, however, distinguished between fiduciary guarantees by persons in favour of banks. In the first case, the requirement as to the disclosure of all material circumstances has to be strictly satisfied. But, where the suretyship is with regard to an advance to be made by a bank, the bank need not disclose part indebtedness to the surety.81

Indian law does not, however, consider that a guarantee is invalid, if a person gives it upon a contract that the creditor shall not act upon it until another person has joined in it as co-surety, and if the other person does not join.

8. Effect of Foreign Exchange Regulations on Guarantees The Indian Foreign Exchange Regulation Act, 1947 and the Exchange

Control Manual contain several provisions dealing with export and import guarantees and special provisions governing guarantees for persons residing outside India.

(a) Export Guarantees : The Exchange Control Manual85, issued by the Reserve Bank of India, permits authorized dealers—who are banks recognized as authorized dealers in foreign exchange by the Reserve Bank—to furnish performance bonds or guarantees (including those in lieu of earnest money) in favour of overseas buyers on account of Indian exporters without prior reference to the Reserve Bank provided they are satisfied about the bonafides of the applicant and the terms agreed to between the exporters and the foreign buyers are in accordance with the Excange Control Regulation. In those cases where exporters find it necessary to furnish a bank guarantee for an amount slightly in excess of what is asked for in the tender invitation, authorized dealers may execute guarantee of an amount up to one per cent above the percentage fixed in the tender invitations. While furnishing performance guarantees in respect of export of capital and engineering goods under deferred payment arrangement, authorized dealers should satisfy themselves that the exporter con-78. Section 143, ibid. 79. Balkrishna, V. N Krithikar and others v. The Bank of Bengal, I.L.R. (1891) 15 Bom.

585 at 591. 80. The Secretary of State for India v. Nilamkam Pillai, I.L.R. (1883) 6 Mad. 406 at

408. 81. A.R. Krishnaiwamy Iyer and another v. Travancore National Bank, A.I.R. 1940

Mad. 437 at 439; Imperial Bank of India v. V.P. Avanasi Chettiar, A.I.R. 1930 Mad. 874 at 879.

82. Reserve Bank of India, Exchange Control Manual 37 (New Delhi, 7th ed., 1971).


cerned is in a position to undertake the transaction and that the deferreed payment terms and other clauses in the contract involving foreign exchange payments which require the approval of the Reserve Bank of India have in fact been approved by the Reserve Bank. Authorized dealers are required to submit to the Reserve Bank a monthly statement of such bonds or guarantees in a prescribed form. Along with the statement should be attached a certified copy of each of the bonds.

(b) Import Guarantees : The Exchange Control Manual requires that applications from importers for guarantees in favour of foreign manufacturers or suppliers of goods for payments against imports into India should be referred to the Reserve Bank for prior approval. It is specifically stipulated by the Manual that such applications will be ordinarily entertained only in respect of import of machinery and heavy equipment proposed to be imported under licences authorizing deferred payments and should be supported by the necessary documents.

(c) Guarantees on behalf of Non-Residents : Under the Indian Foreign Exchange Regulation Act, 1947, Section 18 (3-c), a person, resident in India, can give a guarantee in respect of any debt or other obligation or liability of a person resident outside India, only upon the general or special permission of the Central Government or the Reserve Bank. The Reserve Bank, however, has given authorized dealers a general permission83 to give guarantees in favour of persons resident in India in respect of any debt or other obligation or liability of persons resident outside India subject to such instructions as the Reserve Bank may from time to time issue to them. The general permission is also given to firms and companies resident in India to give guarantees to income-tax officers and other authorities under the Income-tax Act, 1961, in respect of taxes due by nationals of foreign states in the employ of such firms or companies. The Exchange Control Manual?* further authorizes dealers to give on behalf of their overseas head offices/branches/correspondents performance bonds or guarantees in favour of residents in India in support of tenders to be submitted for the due performance of contracts, or for the refund, in the event of contracts not being fulfilled of advance payments received. The requirement, however, is that the bond of the guarantee is covered by the counter-guarantee of the head office/branch/correspondent. The Manual requires the authorized dealers to submit to the Reserve Bank a monthly statement of such guarantees furnished by them.

PART II : SECURITIES

A. General Concept The concepts of security interest and of guarantees have been,

through the long expanse of time, born out of the original, what Wigmore 83. Notification No. F.E.R.A. 230/65 R.B. of 1 April 1965. 84. See supra note 82.


calls, "the pledge—idea.*6 It should, therefore, be noted that the two concepts owe very much to each other for their evolution and share in many respects a single process of development.86

"The general concept of security", says Edward I. Sykes, an Australian authority, "involves a transaction whereby a person to whom an obligation is owed by another person called the 'debtor' is afforded, in addition to the personal promise of the debtor to discharge the obligation, rights exercisable against some property of the debtor in order to enforce discharge of the obligation".87 Security, however, is not the transaction. It is only its consequence. It is "the interest or aggregation of rights which arises from such transaction. Such interest is essentially of a "real" or "proprietary" character, not necessarily in the sense of a right amounting to full ownership of a res or thing, but in the sense of involving rights available against such res and not merely against a person".88 Sykes attempts a broad definition of security interest. According to this definition, "security is an interest vested in a person (creditor) in certain property ownd by another (debtor), whereby certain rights are made available to the creditor over such property in order to satisfy an obligation personally owed or recognized as being owed to the creditor by the debtor or some other person".89

The term "security" is being employed by the modern business community to refer to the thing over which the security is given. It is also often identified with capital issues made by modern business concerns. Thus the term is used in a special and narrow sense while referring to company or government "securities", where the term covers documents of money value such as shares, stocks and bonds.

The general concept in Roman law The concept of security seems to have been narrower under Roman

law.*0 Under the traditional trichotomy followed by the writers on Common law, security can be devided into (1) mortgages, (2) possessory securities, and (3) hypothecation. This classification has been chiefly based on the Roman law transactions of fiducia, pignus and hypotheca, fiducia, bearing great resemblance to the Common law concept of mortgages involving a transfer of the res or thing to the creditor, with a supervening contractual obligation, to retransfer the property to the debtor on redemp-

85. John H Wigmore, The Pledge—Wei : A Study in Comparative Le^al Ideas-!, 10 Harvard Law Review 321 (1896-97).

86. See generally Wigmore, Supra note 1; William H. Lloyd, The Surety 66 University of Pennsylvania Law Review 40 (1909-1910) ; Max Radin, Guaranty and Suretyship 17 California Law Review 605 (1928-29); H.P. De Colyar, Suretyship Journal of the Society of Comparative legislation 44 (1905).

87. Edward 1. Sykes, The Law of Securities 3 (Sydney/Melbourne/Brisbane, 1962). 88. Id. at 3. 89. Id. at 6. 90. W a t 10-11.


tion of the debtor. The fiducia transaction seems to have effected a full transfer to the creditor of such rights of dosminium as were previously vested in the debtor.

In a pignus transaction, the debtor does not transfer to the creditor the sum total of proprietary rights bundled in his ownership. The transaction merely involved a transfer of possession of the property, the debtor retaining the residum of his proprietary rights.

The hypotheca involved a transaction wherein the property (usually an immovable property, especially under French law) was appropriated to the creditor. The creditor could, on default on the part of the debtor, pursue certain remedies against the property and not merely against the debtor. He seems to have had certain proprietary rights with respect to the property in question.

Sykes finds that though the Roman legal theory did not categorically differentiate between pignus transactions involving right of the creditor to possession of the property, but in the practice of hypotheca, the debtor was invariably allowed to remain in occupation. At the same time the creditor, for not going into physical possession, was entitled to certain special remedies.91 This, of course, differentiated hypotheca from pignus.

Roman law influence on English law It has already been pointed out, that the orthodox writers on the

English law of securities have followed the Roman law trichotomy of security devices.82 Fiducia of Roman law seems to have paved the way for the Common law concept of mortgage. Mortgage stricto sensu, under the Common law, involves a total divesting by the mortgagor of what rights he has so that after the transaction he has nothing left except the rights of a mere contractual nature. He transfers all he has.

The second category of English Common law security devices is what is called possessory security or pledge. In the case of possessory security, resembling the Roman pignus, the debtor does not transfer all his proprietary rights on the property, but only transfers to the creditor the right of possession over it. The transfer of right of possession is, however, mandatory under Common law for transactions constituting a pledge or possessory security.93

Hypothecation, after the Roman hypotheca, has become a Common law security device. The concepts of charge and even lien seem to have emerged from it.94 The former gives the chargee certain proprietary rights that are jura in re aliena and their only objective is to enable him to recover the debt due. Being jura in re aliena, they are not immediately

91. Sykes, Supra no'c 3 at 10-11. 92. Id. at 10. 93. V.C. Fo'sum, Chatlel Mortgage and Substitutes Therefor in Latin America 3

American Journal of Comparative Law 477-78 (1954). 94. See Sykes, Supra note 3 at 12-13, 14.


realisable or exercisable. The rights are only potential and become erysta-lized only in the event of default, or in accordance with any contractual stipulation. This is what essentially differentiates hypothecation from mortgage stricto sensu and pledge under Common law. For, both in mortgage and pledge, the creditor is entitled to certain present rights respecting the res and these rights take shape from the moment of the transaction. The chargee's rights, under hypothecation, have in fact three main characteristics, namely: (1) they are only potentially exercisable; (2) being jura in re aliena, they are not dominion rights; they are exercisable over res aliena and not res propria; and (3) they do not comprise actual enjoyment rights over property.95

The concept of "floating lien" appears to have been a later development in Common law. It finds probably the best and broad expression in Article 9 of the Uniform Commercial Code of the United States.86

Under that provision, "the property in which a security interest is to be created may include property owned when the security arrangement is entered into or property to be acquired thereafter. It is further provided that the obligation secured will usually be one incurred to acquire the specific property secured, or one incurred through the contemporaneous, past, or future borrowing of money.

B. Modern security devices Several new security devices other than those that traditionally go

under the categories of pledges and mortgages owe their emergence to the genius of the business communities, particularly of countries where an expanding economy requires sources of credit that are adaptable to modem business relations. The Report of the Secretary-General to the UNCITRAL in 1969 contains a comparative survey of security devices under a wide selection of national laws.07 The Report, at the outset, notes that the approach to securities, in most countries, has on the whole been "piecemeal and fragmentary".98 The important finding that the Report makes is that the security devices adopted by several countries differ inter se both in form and substance. Following are the devices most widely used.

Pledge without dispossession and chattel mortgage Both pledge without dispossession, a characteristic of the Civil law

system, and chattel mortgage, especially of the Common law system, grew 95. Id. at 13. 96. See Petor F. Coogan, Article S of The Uniform Commercial Code : Priorities among

Secured Creditors and The Floating Lien 72 Harvard Law Review 838rT (1958-59). 97. UN Doc. A/CN. 9/20/Add. 1. 98. On a study of securities in developing countries one may be tempted to come to a

conclusion that the use of securities in those countries has be;n limited for several reasons, such as (1) that the approach has been "piecemeal and fragmentary"; (2) that laws exist only in certain limited areas; (3) that their external use is g iverned by the foreign exchange laws which are understandably vigorous in those countries.


out of the traditional concept of pledge. The traditional concept of pledge always involved transfer of possession by the pledgor to the pledgee. The requirement of transfer of possession has often proved to be an inconvenient method of securing credit in modern business practice. As the Secretary-General's Report rightly points out, this traditional requirement comes in the way of an attempted smooth business operation in cases where credit is sought to acquire capital goods in order to develop commercial, industrial or agricultural activities. For, these are the particular cases where the debtor will obviously wish to utilize the goods for that purpose, and the requirement of transfer of possession will naturally defeat the very purpose of the credit transaction. The Civil law system, therefore, developed the concept of pledge without dispossession." A comparison may be made between the Civil law pledge without dispossession and the Common law chattel mortgage. The chattel mortgage sale is sale of personal property upon chattel mortgage. The transaction involves a double conveyance. Both the possession and title to the goods pass to the buyer at the time of the sales contract. Full payment of the purchase price is not made at that time. To secure the balance due, the buyer then gives to the seller an instrument reconveying the title to the goods to the seller as security for the unpaid purchase price. As a general rule the reconveyance or what is called the chattel mortgage provides for the mode of payment, most invariably payment of the balance due in instalments. As the buyer finally pays up his dues, the chattel mortgage is cancelled, or a release is given to the buyer, and along with it the title to the goods is reconveyed to him.100 The Civil law pledge without dispossession compares well with the Common law chattel mortgage in that they both create a security interest in favour of the creditor without involving the transfer of goods.

The Secretary-General's Report finds the diverse points of convergence among several laws relating to pledges. First, for the pledge to be valid as against third parties, it must be in writing and entered in an official register. Second, the pledge acquires priority over other creditors (who had the notice of the pledge) and the assignee in bankruptcy in respect of the goods pledged. Third, in the event of default of the pledgor, the pledgee may sell for the account of the pledgor. Finally, as a general rule the pledge is valid only if it secures the transaction specifie by the relevant law.101

Floating charge The Secretary-General's Report indentifies the Common law institu-

99. For various iorms of pledge without dispossession, see UN Doc, A/CN. 9/20/Add. 1, p. 3, footnote 6, see also Folsum, Supra note 10 at 477 ff.

100. Robert Charles Kelso, International Law of Commerce 152-53 (Buffalo, N.Y., 1961). 101. For Commercial pledges under French law, see Jacques M. RafHn, The Conmercial

Law of France, in the Digest of Commercial Laws of the World60 (Dobbs Ferry, N.Y., 1966).


tion of "floating charge" as a security device. Floating charge on lien is a legal concept whereby the indebtedness is secured by a charge or lien on the assets of the debtor. The assets may be either present or future goods The security attaches to any specific property when the "floating" charge settles itself down and crystalizes.102 In other legal systems, it is noted, the floating charge forms a specific type of lien.

Fiduciary transfer of property Under German law, it has been pointed out by one authority, pledge

as a security device (although it has received elaborate treatment in the Civil Code) "is without significance, in business practice because the code prescribes that the possession of the chattel which shall be subject to the pledge be transfered by the pledgor to the pledgee." Moreover a chattel mortgage as a security device, it is further noted, is also unknown to German law. However, the German Courts have developed another device akin (at least functionally) to the Common law chattel mortgage, which is known as the "sucherungsuebereignung". Under this device, an express agreement is concluded whereby a debtor transfers to the creditor the title to the goods as security for the payment of a debt due from him to the transferee creditor, the possession of the goods usually remaining with the debtor.103 This device is chiefly known as fiduciary transfer of property or fiduciary-ownership. It is chiefly put into use by financial institutions in loan operations. The flexible nature of the device lies in the fact that there are no rigid formal requirements to be observed. The security interest of the creditor, of course, is his title to the goods. It is widely in use in Germany, the Netherlands and Indonesia. However, as the Secretary-General's Report notes, the absence of publicity has evoked severe criticism of the device, especially in Germany and the Netherlands, and a system of registration of the agreements has been recommended.

Conditional sale Conditional sale envisages an agreement between the seller and the

buyer to sell goods on credit on the condition that the seller retains the title to the goods until the buyer pays of his dues. Witholding by the seller of the title to the goods produces the desired result to have the debt properly secured. For, the seller will also have the right to repossess the goods upon default of the buyer, such repossession entailing the termination of the contract. The device prevents third parties (with notice) from acquiring the goods from the debtor buyer. Though essentially a Common law institution, the device has found acceptance, of course, with necessary variations in several continental legal systems such as Austria, Germany,

102. Halsbury's Laws of England, 275 (London, 3rd (Simons; ed., 1957). 103. Dres Pfluger, Schon, Parn, Schnitter and Rabe, The Commercial Laws of

Germany in Digest and Commercial Laws oj the World 29 (Dobbes Ferry, N.Y., 1966).


Switzerland, Denmark, the Netherlands, and Sweden.

The Uniform Commercial Code of the United States The Uniform Commercial Code of United States is a unique piece of

legislation in that it attempts under section 9 to codify all security devices supplanting them with a broad definition of security interest.104

Mentschikoff finds that in addition to its attempt at simplification and classifications, it has been based on three basic policies: first, it recognizes the importance of protecting the ongoing or current secured financing as an element in expansion of trade and business; second, it attempts to prevent monopoly of a debtor by a single lender; and finally, it endeavours to prevent the overreaching of a debtor by a secured lender. The chief advantage of the Uniform Commercial Code lies in the fact that thanks to its codification, all security interests operate essentially the same way, although there are certain variations to accommodate special requirements. It recognizes the debtor's right to redeem and the right to the surplus on sale of the collateral upon his default, while the creditor is given the right to foreclose without judicial process the right to claim the defciency after sale and the right to priority. A security instrument is "perfected" usually by filing with the appropriate authorities or by taking possession of the property. If imperfect, the instrument holds good as between the parties to the transaction but superceded by a perfected instrument, and defeated by a lien creditor without notice, by the debtor's trustee in bankruptcy, and by a good faith transferee who gives value. A buyer in the ordinary course of business can, however, defeat even a perfected security interest. The Code also recognizes a heirarchy of priorities among competing perfected security interests in the same property.

C Indian law There are several security devices under Indian law and practice.

But the important security devices used in business transactions include (1) pledges, (2) lien, and (3) conditional sale.

Pledges :—(a) Pledges without dispossession The Indian Contract Act, 1872, does not contain any specific pro

vision to govern pledges without dispossission exclusively. Section 172 of the Act defines a "pledge" as the bailment106 of goods as "security for payment of a debt or performance of a promise". However, Indian law is familiar with pledges without dispossession through the institution of 104. See, for instance, Calvin W. Comman, Sales and Secured Financing : Conditional

Sale Financing 483. See also Sria Mentschikoff, Commercial Transactions 901 If (Boston, 1970).

105. A "bailment", under section 148 8f the same Act, is delivery of goods by one person to another for some purpose upon a contract that they shall, when the purpose is accomplished, be returned or otherwise disposed of according to the directions of the person delivering them.


"hypothecation". Hypothecation, not accompanied by possession by the pledgee, is a kind of pledge. It confers a good title upon the person in whose favour it is made. The transaction is regarded as "security" and equity gives effect to it.106 It has been held107 that in the absence of fraud, there is no inherent illegality, immorality or opposition to public policy in the nonpossession hypothecation of movables, and therefore, a contract for such a hypothecation is a valid contract, for it is a transaction which has become customary throughout the country and is suited to the circumstances and business intercourse of the people.

The difference between "pledge" under the Act and hypothecation lies in the requirement that in the case of the former the possession of goods is actually delivered to the person for whose benefit the pledge is made,108 while in the case of the latter the goods are retained by the owner. It is only certain rights in them that are transferred to the creditor.109 In order to determine whether a particular transaction of the type of a pledge constitutes a hypothecation without dispossession from the pledgor, one should find whether there was an intention to create a security. If such an intention is evident, equity gives effect to it.110 Indian Courts have also endorsed the English view that hypothecation may be done not only of the movables existing at the time of the transaction, but also of those movables which may be subsequently acquired or bought.111

The Indian law maintains a distinction between a hypothecation and a hire purchase agreement. In the latter case, the test is whether the transaction constitutes a bailment with an option to purchase. If it is does, it is a hire-purchase agreement.112

The peculiar nature of hypothecation under Indian law becomes all the more prominent in a case where a person accepts hypothecation of movable property without obtaining possession, after which a subsequent encumbrance obtains possession of the property. It has been held that the former cannot claim priority over the latter if the latter had no notice of the charge to which the former was entitled.113

106. Pramatha Nath Talukdar v. Maharaja Probirendra H. Tagore, A.I.R. 1966 Cal. 405 at 408; K. M. Ramaswami Chetty and Others v. P.K. Lakshmamma, A.I.R. 1963 Andh. Pra. 201 at 203.

107. (1911) 2 Nag. L.R. 72 at 77. 10S. Simla Banking and Industrial Co. Ltd. v. M/s. Pritamas, A.I.R. 1960 Punj. 42 at 43. 119. Bank of Maharashtra Ltd. v. Official Liquidator, A.I.R. 1969 Mys. 280 at 284. 110. See also Sri Harish Chandra and Others v. Punjab National Bank, A.I.R. 1958 All.

264 at 265; Haripada Sadhukhan v. Anath Nath Dey and Others, A.I.R. 1918 Cal. 165 at 166.

111. H.V.Low&Co.Ltd.,v.PulinbihariLalSingha and Others, A.I.R. 1933 Cal. 154 at 159.

112. V. Dakshina Murthi Mudaliar and Other v. General and Credit Corporation India Ltd., A.I.R. 1960 Mad. 328 at 330, 331.

113. Moosa Abdul Halib v. Maung Tun Kyaing, 131 I.C. 723,


H. Pledges with dispossession The Indian law relating to pledges closely follows its English counter

part.114 The legal basis for pledges with dispossession is section 172 of the Indian Contract Act of 1872, which provides that the bailment of goods as security for payment of a debt or performance of a promise is called "pledge". This is, of course, the Anglo-Saxon conception of pledge as a security device. It is said that under the English law there are three classes of securities: a simple lien, a mortgage passing the property out and a security intermediate between a lien and a mortgage. The third category covers a pledge where by a contract, a deposit of goods is made a security for a debt, and the right to the property vests in the pledgee so far as is neeessary to secure the debt.116 As section 172 defines a pledge as a "bailment" of goods, it clearly means that a transaction to be identified as a pledge should involve delivery of goods by the pledgor to the pledgee.116

A pledge is niether a mortgage nor a lien. It passes no title to the goods but only the right to retain possession till payment.117 The onus is on the pledgee to prove that his possession of anothet's property is by way of a 'pledge' within the meaning of section 172.118

The Indian Contract Act makes a clear distinction between a lien and a pledge properly so called. Under section 171, bankers, for instance, may, in the absence of a contract to the country, retain, as a security for a general balance of account, any goods bailed to them.

As has already been pointed out, delivery is essential to identify a transaction as a pledge within the meaning of section 172. The delivery may be either actual or symbolic (or constructive). It has been held by the English courts that "in order to complete the pledge it is not necessary that there should be an actual delivery of the chattel to the pledgee, it is sufficient...if there be a constructive delivery". The reason is that the property in goods may pass, even though they remain in the possession of the pledgor, provided, of course, that "they do so by virtue of a contract between the parties which makes the custody of the pledgor the custody of the pledgee.119 The English ruling has been followed by Indian Courts.120

Another characteristic of the Indian law—which is identical with the English law—is that it is difficult to apply the law concerning powers such as the one laid down in the Indian Contract Act to cover all classes of pledges. Thus it is not exhaustive and does not cover documents like deeds and government and company securities. These documents require endorsement. In Joyti v. Mukhi, the Calcutta High Court held that a 114. HaUiday v. Holgóte, L.R. 3 Ex. 299. 115. See, Lallan Prasad v. Rahmat AH, A.I.R. 1967 S.C. 1322. 116. See, section 148 which defines a "bailment"; see also Jyoti v. Mukhi, 22 C.W.N.

297. 117. Krishna v. Kannarutra, I.L.R. 1941. Mad. 394. 118. Ram Krishendas v. Jasumal, 61 l.C.P. 305. 119. See, Meversteim v. Barber, L.R. 2 C.P. 38 at 51. 120. Narasiah v. Venkataramiah, I.L.R. 42 Mad. 59.


pledge to a bank of government securities was to be made by endorsement and delivery.121

There can be a pledge of company shares in India.122 However, the transaction is always subject to the provisions of the Indian Companies Act, 1956.123 For section 82 of that Act provides that the shares or other interests of any member in a company shall be movable property, transferable in the manner porvided by the articles of the company. The term "securities", in this context, merely indicates a group of security devices devices of security interest. The Indian Capital Issues (Control) Act, 1947, is the law on the point. The Act. under section 2(e), defines "securities" as meaning any of the following instruments issued or to be issued, or created or to be created, by or for the benefit of a company, namely :— (1) shares, stocks and bonds; (2) debentures,124 (3) mortage deeds, instruments of power, pledge or hypothecation and any other instruments creating or evidencing a charge or lien on the assets of the company; and (4) instruments acknowledging loan to or indebedness of the company and guaranteed by a third party or entered into jointly with a third party. The Act purporting to regulate the general use of securities in transactions specifically provides, under section 5 paragraph (i), that no person shall accept or give any consideration for any securities in respect of an issue of capital125 made or proposed to be made in the states or elswhere unless the consent or recognition of the Central Government has been accorded to such issue of capital.

In Mercantile Bank of India v. Central Bank of India Ltd.,12* the Privy Coucii laid down that a railway receipt was a document of title, and that a pledge of a railway receipt should operate as a pledge of the goods. What is a "document of tittle to goods" has been defined by section 2 (4) of the Sale of Goods Act, 1930, as including a bill of lading, dock-warrant, warehouse-keeper's certificate, wharfinger's certificate, railway-receipt, warrant or order for delivery of goods and any other documents used in the ordinary course of business as proof of the possession or control of goods, or authorizing or purporting to authorize, either by endorsement or by delivery the possessor of the document to transfer or receive goods

121. 22C.W.N. 297! 122. Arjun PraSad and others v. Central Bank of India Ltd., A.I R. 1950 Pat. 32 at 37. 123. Nagabhushandm Tadepathi and others v. Siram Rama Chandra Rao and others,

A.I.R. 1923 Mad. 241 at 244. 124. The "debentures" under the Indian Companies Act, 1956, are only instruments

under seal evidencing a debt. It is not capital. Therefore it has been held that the definition of "securities" in the Capital Issues (Control) Act, 1947, does not govern the Companies Act. Sse Madan Lai Fakir Chand Dudhediya v. Changdeo Sugar Mills, A.I.R. 1958 Bombay 491 at 498.

125. The Act, under section 2(b) defines "issues of capital" as the issuing or creation of any securities whether for cash or otherwise, and it also includes the capitalization of profits or reserves for the purpose of converting partly paid-up shares into fully paid-up shares or increasing the paid value of shares already issued.

126. 172 I.C. 745 (PC).


thereby represented. Explanation to section 137 of the Transfer of Property Act, 1882, gives almost an indentical definition for a "mercantitle document of title to goods."

Use of promissory notes as a security device is also well established in Indian law. In T. Radhakrishna Chettiar v. Official Liquidator, Madras People's Bank Ltd.,127 a bank, being unable to pay the amount due to a fixed depositor, offered to endorse certain promissory notes to him as security for its indebtedness. The lender was to be at liberty to collect the amounts due on the notes and credit net realization towards the amounts due by the bank, and on payment by the lender of any balance due to him, he should transfer to the bank such of the notes as might be outstanding. It was held by the court that the transaction amounted to a bailment of the promissory notes security for a debt, and that all requirements for a valid pledge had been fulfilled.

C. Pledgee's rights under Indian law The Indian Contract Act, 1872, confers upon the pledgee three impor

tant rights. First, it recognizes the pledgee's right of retainer. He may retain the goods pledged not only for payment of the debt or the performance of promise, but for the interest of debt, and all necessary expenses incurred by him in respect of the possession or for the preservation of goods pledged.128 It has been held by the Supreme Court that the pledgee cannot maintain a suit for recovery of debt and at the same time retain the pledged, property.129 The right of retainer is limited by the prescription under section 174 of the Act, that the pledgee cannot, in the absence of a contractual stipulation, retain the goods pledged for any debt or promise other than the debt or promise for which they are pledged, but such contract, in the absence of anything to the contrary, shall be presumed in regard to subsequent advances made by the pledgee. In the view of the High Court of Bombay, the pledge and subsequent advances raise a presumption that there is a contract to hold the pledge for such advances. Where, however, the later advance is separately secured, such presumption does not arise.130 In the second place, the pledgee has a right to claim expenses. Under section 175, he is entitled to receive from the pledgor extraordinary expenses incurred by him for the preservation of the goods pledged to him.

The most important right of the pledgee is his right to sue the pledgor or sell the pledged property on default by the latter. Recognizing this right, section 176 provides that if the pledgor makes default in payment of the debt, or performance, at the stipulated time of the promise, in respect of which the goods were pledged, (1) the pledgee may bring a

127. 1943 Comp. Cases 21, 128. Section 173. 129. Lallan Prasad v. Rahmat AH and Another, A.I.R. 1967 S.C. 1322 at 1326. 130. Cowsji Muncherji Banaji v. Official Assignee of Bombay, A.I.R. Bom. 507 at 508.


suit against the pledgor upon the debt or promise and retain the goods pledged as a collateral security; or (2) he may sell the thing pledged on giving the pledgor reasonable notice of the sale. If the proceeds of such sale are less than the amount due in respect of the debt or promise, the pledgor is still liable to pay the balance. If the proceeds of the sale are greater than the amount due, the pledgee shall pay over the surplus to the pledgor. This right of the pledgee to sue the pledgor or to put the goods on sale must be read with the pledgor's right under section 177 to redeem at any time after the stipulated time, but before the actual sale of the goods on payment of his dues plus any additional expenses accrued on his default. Sections 176 and 177 have been designed to prevent any clog in the way of redemption and they cannot be overridden by mutual agreement of parties.131

The pledgee's rights either to sue on debt or to sell the goods are concurrent.132 In Surajmal v. Fulchand,133 the Nagpur High Court held the view that the case of an unpaid vendor who exercises a right of sale in pursuance of his lien is not on par with that of pledgee exercising similar right of sale. If the property fetches at the sale more than the amount due, the vendee cannot claim the excess. But the pledgee sells the goods pledged as the property of the pledgor. The notice of sale must be reaso-able, having regard to the circumstances in each case.134 The object of the notiee is to provide the pledgor with a reasonable opportunity to exercise his right to redeem under section 177.13S

Section 178 permits, for faciliating business transactions, pledge by a mercantile agent136 provided the pledgee acts in good faith and has not at the time of the pledge any notice of any defect of the pledgor's authority.

Lien The Indian law relating to mercantile transactions introduces the

Common law concept of lien into the provisions of the Indian Sale of Goods Act, 1930, and therefore a study of it seems to be relevant, as it may be considered as one of the security devices through which business transactions are secured in India. Indian law has borrowed the concept

131. Ningthoujan Tompak Singh, v. Moirangthen Kali Singh A I.R. 1962 Mmipur 1 at 2. 132. Jyoti Prokash Nanc/e v. Muti Prokash Nande and others A.I.R. 1918 Cal. 947 at

949; sse also Maridas Mundhra v. National and Grind/ay's Bank Ltd'., A.I.R. 1963 Ca!. 132 at 134.

133. A.I.R. 1951 Nag. 264. 134. Sankra Naiayana Iyer Saraswatty Ammalv. The Kotayyani Bank Ltd., A.I.R. 1950

Trav-co. 66 at 69; see also Hulas Kunwar v. Allahabad Bank Ltd., A.I.R. 1958 Cal. 644 at 649.

135. Bharat Bank v. Sheoji Prasad, A.I R. 1955 Pat. 288 at 290. J36. A mercantile agent, under section 2 of the Sale of Goods Act, 1930, is an agent,

having in the customary course of business as such agent, authority either to sell the goods, or to consign goods for the purpose of sale, or to buy goods, or to raise money on the security of goods.


of seller's lien from the English Sale of Goods Act, 1893.13' The English law contemplates "lien" in two senses.128 In its primary sense, lien is a legal right in one man to retain the property of another until the present and accrued claims of the person in possession are satisfied. In its secondary sense, the word "lien" may be applied to a right subsisting in a person who has no possession of the property concerned but who, nevertheless, has a right against the owner analogous to a legal lien. This right may arise (1) in equity, (2) by statute or, (3) under a court order.

The Indian Sale of Goods Act, 1930, through section 46(l)(a), provides that, subject to the provisions of the Act and of any law for the time being in force, notwithstanding that the property in the goods may have passed to the buyer, the unpaid seller of goods, as such, has by implication of law, "a lien on the goods, for the price while he is in possession of them". Elaborating this provision, the subsequent section of the Act states that, subject to the provisions of the Act, the unpaid seller139 of goods who is in possession of them until payment or tender of the price, in three cases, such as : (1) where the goods have been sold without any stipulation as to credit; (2) where the goods have been sold on credit, but the term of credit, has expired; and (3) where the buyer becomes insolvent.140 This right of lien is available to the seller notwithstanding the fact that he is in possession of goods as agent or bailee for the buyer.

The lien, as is clear both from section 46(l)(a) and section 47, is based on the unpaid sellers' possession of the goods and not on title, and it has been held by the Privy Council that unless there is possession there is no lien.141 The lien can be taken advantage of only by an unpaid seller. Jt necessarily follows, therefore, that where the seller is estopped by his own conduct from denying that he had received payment for the goods to which the delivery order relates he cannot exercise the lien under this section,142 The Act requires that the unpaid seller, to be entitled for the lien, should have possession of and no title to the goods he is holding as against the buyer. In other words, existence of the lien pre-supposes that the property in the goods has already passed. The simple reason is that a person cannot have a lein on his own goods.143

137. See !he Statement of Objects and Reasons to ihe Indian Sale of Goods Bill, 1929, Gazette of India, 1929, Part V, p. 163. See also Chalmers' (Paul Sieghart, ed.), Sale of Goods Act, 1893, 128 IT (London, 14th ed.).

138. 24 Hatsbury's Laws of England 124-125 (London, 3rd ed., 1958). 139. Seciicn 45 deems the seller of goods as an "unpaid seller" (a) when the whole of

the price has not been paid or tendered, or (b) when a bill of exchange or other negotiable instrument has been received as conditional payment, and the condition on which it was received has not been fulfilled.

140. Compare section 41 of the English Sale of Goods Act, 1893. 141. Maneckjee v. Wadilal, A.I.R. 1926 P.C. 38 at 40. 142. Anglo-Indian Jute Mills Co, v. Omademull, 10 I.C. 879. 143. Nippon Yusen Kaisha v. Ramjiban, A.I R. 1938 P,C. 152.


Indian courts have given a broad interpretation to section 47 in their attempt to determine as to when the unpaid seller's lien begins. Tn Kalka Prasad Ram Charan v. Harish Chandra1**, the Allahabad High Court was confronted with a contention that the seller's exercise of the right of lien began when a demand for delivery was made from him by the buyer and was followed by a refusal by him. Rejecting the contention as ill-founded, the Court viewed it as putting "a very narrow interpretation" on the language of section 47. "The result of accepting this interpretation", according to the Court, "will be that by simply keeping quiet the buyer could deprive the seller of his exercise of the right of lien. This could never have been the intention of law." "Thus, where the goods are ascertained by the buyer and are in a deliverable state", found the court, "the property in goods passes to the buyer under section 20 as soon as the contract was made; If the sailer is allowed to retain possession of the goods till the payment of price and no period of credit is given to the seller in respect of them, the case falls under sub-section (l)(a) of section 47 and the seller's lien commenced from the time of the making of the contract".145

Even where the unpaid seller had made part delivery of the goods, he may, under section 48, exercise his right of lien on the remainder, unless such part delivery has been made under such circumstances as to show an agreement to waive the lien. The mere fact that the unpaid seller has obtained a decree for the price of the goods, does not divest him of his right of lien. This principle has been recognized under section 49(2).

The Indian law, under section 49(1) of the Act, envisages three different situations effecting termination of the lien of the unpaid seller. First, the unpaid seller loses his lien when he delivers the goods to the carrier or other bailee for the purpose of transmission to the buyer without reserving the right of disposal of the goods. Second, his lien is teimi-nated when the buyer or his agent lawfully obtains possession of the goods. And finally, he waives the lien either expressly or by necessary implication. His waiver may be taken to be implied by his conduct.1'16 There has, however, been an Indian ruling to the effect that the mere taking of a personal security is not tantamount to abandonment of the lien147

3. Conditional sales The term 'conditional sale' is chiefly the contribution of the American

law. The idea behind the conditional sale is that a contract for sale may be concluded under which possession of property is delivered to the buyer

144. A.I.R. 1957 AH. 25. 145. Id. at 27. 146. Jones v. Cliff, (1833) I C . & M. 540; Gun v. Cuthbert, (1843) L.J. 12 Ex. 309;

Boardmanv. Sill, (1808) 1 Comp. 410 ( K ) ; Yiuigmmm v. Briesemann, (1893) 67 E.T. 642 (C.A.).

147. Morion v. Wood fall, A.I.R. 1927 Lah. 103.


and the property in the goods is to vest in the buyer at a subsequent time upon the payment of part or all the price, or upon performance of any other condition or the happening of any contingency.148 The rules relevant under the Indian Sale of Goods Act, 1930, are those relating to the passing of property.

Section 4 of the Act distinguishes between a sale and an agreement to sell. Where under a contract of sale the property in the goods is transferred from the seller to the buyer, the contract is called a sale. But where the transfer of the property in the goods is to take place at a future time or subject to some condition thereafter to be fulfilled subject to which the property in the goods is to be transferred, the transaction is an agreement to sell. An agreement to sell becomes a sale when the time lapses or the conditions are fulfilled subject to which the property in the goods is to be transferred. It has been held in Sahodeo Singh v. Kular Nathl·19, that the distinction between a contract for sale and a contract to sell is that between an executed contract and an excutory contract. Sale creates a jus in rent as it passes ownership immediately when it has been exceuted, said the Allahabad High Court, while a contract to sell is jus ad rent, for it only creates an obligation attached to the ownership of property not amounting to an interest therein. The criterion to decide whether there is a sale or merely a contract to sell is whether another deed would be required to pass the title or ownership. Daya Shanker Mehrotra v. Union of Indiauo was a case where there was a purported sale (gram) to the Government at quoted rates, property in the goods passing to the buyer only after the goods were inspected and approved. Notification by the Government fixing it price of dal was issued before the goods were inspected, approved and accepted. It was held that the transaction was an agreement to sell and that it did not constitute a sale, for the passing of property was arrested till the goods were approved.

Whether a contract amounts to sale or an agreement to sell also depends on the intention of the parties. Section 19 of the Act provides clearly that property passes when intended to pass. The section prescribes three rules. First, where it is a contract for the sale of specific or ascertained goods, the property in them is transferred to the buyer at such time as the parties to the contract intend it to be transferred. Second, for the purpose of ascertaining the intention of the parties regard should be had to (1) the terms of the contract, (2) the conduct of the parties, and (3) the circumstances of the parties. And finally, unless a different intention appears, the rules contained in sections 20 to 24 of the Act are the rules for ascertaining the intention of the parties as to the time at which the property in the

148. See Uniform Conditional Sale Act (of the United States), section 1 which defines a "conditional sale"

149. A I R . 1950 All 632. 150. (1968) Punj. L.R. 57 (Delhi Division).


goods is to pass to the buyer.151

The B.K. Wadeyar v. M/s. Daultram Rameswarlal1*2 was a leading case involving an f.o.b. export contract. In that case the respondent firm claimed exemption from sales tax under Article 286(l)(b) of the Constitution of India, 1950, in respect of sales made by them of cotton and castor oil on the ground that the sales were f.o.b. contracts, under which they continued to be the owners of the goods till those crossed the customs' barrier and entered the export stream. They also contested the purchase tax for which they were assessed under section 10-B of the Bombay Sales Tax Act. The Bombay High Court upheld the first contention, but found that they were liable to pay the purchase tax. Both parties went on appeal to the Supreme Court. The Supreme Court, dismissing the appeals, held that sales in which the goods remain the sellers' property till they have been brought on board the ship are exempt from sales tax under Article 286(l)(b) of the Constitution of India. "The law is now well settled", declared the Court, "that if property in the goods passes to the buyer after they have, for the purpose of export to a foreign country, crossed the custom's frontier, the sale has taken place "in the course of the export" out of the territory of India. The normal rule in the f.o.b. contracts is that, in the absence of special agreement, the property in the goods does not pass until the goods are actually put on board the ship".

4. Effect of Indian law relating to foreign exchange regulations on use of security devices Indian law relating to foreign exchange regulations focusses its atten

tion mainly on one single category of security devices. The term "security" is used in the Indian Foreign Exchange Regulations Act, 1947, in a special sense, which is commonplace in the modern business transactions. Section 2(k) of the Act defines "security" as meaning shares, stocks, bonds, debentures, debenture stock and Government securities, savings certificates, deposit receipts in respect of deposits of securities, and units and sub-units of unit trusts and including certificate of title to securities. "Securities" do not, however, include bills of exchange or promissory notes other than Government Promissory notes.

(a) Foreign Securities: "Foreign security", under section 2(e) of the Act, means (a) any securities referred to in section 2(k) created or issued 151. Section 20 provides that in a contract for the sale of specific goods in a deliverable

state, the property in the goods passes to the buyer when the contract is made. Under section 21 where the seller is required to do some hing to the goods to put them to the deliverable state, property does not pass until such thing is dons and the buyer is given notice thereof. Where the seller is required to do something for the purpose of ascertaining the price, under section 22, property does not pass until such act is done and the buyer is given notice thereof. Section 22 provides for the sale of unascertained goods and appropriation, and section 24, for goods sent on approval or "on sale or return".

152. A.I.R. 1961 S.C. 311.


elsewhere than in India and (b) any security, the principal of or interest on which is payable in any foreign currency elsewhere than in India.

(b) Import of Securities : There are no restrictions on the import into India of any securities whether Indian or foreign.

(c) Dealings in Securities: Domestic dealings in rupee securities are not subject to any restrictions. Persons resident in India may deal in the shares of sterling companies which are operating extensively in India and which maintain two registers, one in India and the other in the United Kingdom provided payment is made in rupees and the shares are on the Indian register. Transactions in the shares of companies which do not maintain registers in India require the prior approval of the Reserve Bank of India. Persons resident in India who are or have become owners of foreign securities are permitted to hold or retain such securities provided they have been acquired in a manner not involving a breach of the Indian Exchange Control Regulations. The prior approval of the Reserve Bank of India is necessory before such securities can be sold, transferred or otherwise disposed of by the holder. Permission will be granted on application through an authorised dealer for the sale of securities for re-investment or for sale and repatriation of the proceeds to India.

Export or Transfer of Securities: The taking or sending out of India of securities (including life or endowment insurance policies) is prohibited under section 13 of the Foreign Exchange Regulation Act except with the prior approval of the Reserve Bank. Persons, intending to send their securities to their banker or agents abroad for sale, transfer, etc., should apply to the Reserve Bank of for a licence through an authorised dealer in foreign exchange.

(e) Transfer of securities to non-residents: The transfer of any security or the creation or transfer of any interest in a security to or in favour of a person resident outside India is prohibited except with the general or special permission of the Reserve Bank of India. Similarly, the transfer of securities from one register in India to another outside India and the issuing whether in India or elsewhere, of securities which are registered or to be registered in India to persons resident outside India, is also prohibited except with the permission of the Reserve Bank of India.

( / ) Application for permission to hold foreign securities: All persons resident in India (other than foreign nationals not domidled in India) holding foreign securities, i.e., currency expressed to be payable in any currency other than Indian rupees are required to apply to the Reserve Bank of Tndia for permission to hold them. A foreign national resident in India is, however, not required to make any application as he has been granted general permission to continue to acquire, hold or dispose of any foreign security if such security is acquired by him or his own property or is held by lien for or on behalf of any other person not domiciled in India.

(g) Acquisition by the Government of foreign securities: The Foreign


Exchange Regulation Act, 1947, through section 16 empowers the Government of India (a) to order the transfer to itself of foreign securities specified in the official notification at a price which according to that Government is not less than the market value of the securities on the date of the notification; or (b) to direct the owner of such foreign securities to sell or procure the sale of securities and thereafter to offer the foreign exchange to the Government of India or to the Reserve Bank at such price as may be fixed by the Government not less than the market rate of the foreign exchange. The Indian Government may act under this section only "if it is of opinion that it is expedient so to do for the purpose of strengthening its foreign exchange position."

CHAPTER VIII The Indian Law of Guaranties and Securities

Documents

Transcript of CHAPTER VIII The Indian Law of Guaranties and Securities