Allowed

Shri Kundanmal Dabriwala v. Haryana Financial Corp. and Anr.

Punjab & Haryana HC8 Nov 2011CWP/2713/2009

Case brief

AI extract

What is this about?

The court examined whether a court-sanctioned company revival scheme constituted a statutory compound that discharged a guarantor's liability. It held that such a scheme extinguishes the principal debt, thereby discharging the surety who cannot be held liable for the extinguished amount.

What did the court decide?

The challenge to the show cause notice and the consequent order under Section 32(G) of the State Financial Corporation Act, 1951, allowed and impugned notice is quashed with no order as to costs.

Shri Kundanmal Dabriwala Vs Haryana Financial… — Company and Corporate | Punjab & Haryana HC (2011)

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IN THE HIGH COURT OF PUNJAB AND HARAYANA AT CHANDIGARH

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Civil Writ Petition No.2713 of 2009 (O&M) Date of Decision: December 20, 2011

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Shri Kundanmal Dabriwala ….Appellant

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Versus

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Haryana Financial Corporation and another ….Respondents

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CORAM: HON’BLE MR. JUSTICE HEMANT GUPTA HON’BLE MR. JUSTICE G.S. SANDHAWALIA

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Present: Shri Anand Chhibbar, Advocate, and S/Shri Lalit Thakur and Rakesh Kumar, Advocates, for the petitioner.

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Shri Kamal Sehgal, Advocate, for respondent No.1.

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Shri Arjun Pratap Atma Ram, Advocate, for respondent No.2.

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HEMANT GUPTA, J.

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The challenge in the writ petition is to a show cause notice dated 7.10.2008 (Annexure P.1) served upon the petitioner to pay a sum of Rs.83,58,671/- under Section 32(G) of the State Financial Corporation Act, 1951 (for short `the SFC Act’). The challenge is on the basis that once the principal debtor has settled its loan account with the Corporation, the petitioner, who is a guarantor, cannot be made liable to pay any amount over and above the amount paid by the principal debtor. It is the case of the petitioner that the liability of the guarantor is co-extensive with that of the principal debtor and not exceeding the liability of the principal debtor. Once the Corporation has settled its loan account with the principal debtor, the guarantor cannot be saddled with any additional liability.

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The facts leading to the issuance of the said show cause notice are that the petitioner is a Promoter Director of M/s Dabriwala Steels and

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Civil Writ Petition No.2713 of 2009 (O&M) [2]

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Engineering Company Ltd. The aforesaid Company had set up a mini steel plant at Faridabad. The Company was owner of two plots i.e. Plot No. 136, Sector 24, Faridabad and Plot No.142, Sector 24, Faridabad. The company stopped its production on 27.4.1985 due to financial constraints. The Company invoked the provisions of the Sick Industrial Companies (Special Provisions) Act, 1985 (for short the SICA’). The Board for Industrial and Financial Reconstruction (for short the BIFR’), constituted under the aforesaid Act, recommended the winding up of the Company on 25.5.1993. The appeal against such recommendation of the BIFR was dismissed by the Appellate Authority Industrial & Financial Reconstruction (for short `the AAIFR’) on 6.12.1994. The challenge to the aforesaid order before the Delhi High Court remained unsuccessful when the writ petition was dismissed on 16.12.1996. On the recommendation of the BIFR, this Court passed an order of winding up on 24.2.1995 in CP No. 31 of 1995. The Official Liquidator attached to this Court was directed to take into his custody or control all the properties and effects and all papers and books of the Company.

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The Haryana Financial Corporation (for short ‘the Corporation’) sought permission of this Court to sell the land, building, fixtures, plants and machinery of the Company situated at Plot No 136, Sector 24, Faridabad as a secured creditor having first charge over the said plot, which was allowed on 21.7.1995. The State Bank of India was holding second charge against the said property. In pursuance of such permission, all movable and immovable assets lying at Plot No.136, Sector 24, Faridabad was sold with the sale being affirmed by this Court on 17.9.2004 for the total sum of Rs.4.10 crores.

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The State Bank of India sought sale of plot No. 142, Sector 24, Faridabad, mortgaged to it to realize its dues. This Court permitted the Official Liquidator to sell plot No. 142, Sector 24, Faridabad in association with the secured creditors vide order dated 9.2.2006.

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Civil Writ Petition No.2713 of 2009 (O&M) [3]

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The petitioner along with the other share holders of the Company filed a petition under Sections 391 and 394 of the Companies Act, 1956 before this Court for revival of the Company by submitting a Rehabilitation Scheme. The majority share holders in the Company in liquidation proposed to the State Bank of India for settlement in terms of One Time Settlement Scheme, as per the guidelines issued by the Reserve Bank of India. The Bank agreed to accept Rs.4,85,00,000/- as against the total claim of Rs.22,96,34,254/-. This Court directed the Official Liquidator vide order dated 02.11.2007 to disburse an amount of Rs.4,05,00,000/- to State Bank of India as full and final payment i.e. out of sale proceeds of plot No.136, Sector 24, Faridabad. Balance Rs.80 lacs were to be pumped in by the ex-management. On account of One Time Settlement in the total sum of Rs.4,85,00,000/-, which the Bank received, the Bank satisfied its claim. The petitioner also approached the Corporation for a settlement but the settlement proposal was rejected. In the aforesaid order dated 02.11.2007, the Official Liquidator was also directed to adjudicate the claim of creditors and file his report before this Court. It was in pursuance of such direction, the Corporation submitted its claim. The Official Liquidator submitted his report to the High Court relying upon the report of the Chartered Accountant (Annexure P.10). The Official Liquidator adjudicated such claim and found that a sum of Rs.13,92,223/- is due and payable as against the total claim of Rs.60,69,525/- of the Corporation. It was observed that no amount of interest can be charged by the financial institution after the date of winding up i.e. 24.02.1995. Such report was accepted on 08.05.2008 by this Court. This Court granted liberty to any creditor aggrieved of adjudication of the claims by the Official Liquidator to prefer an appeal. No appeal was preferred by the Corporation. But on 29.07.2008, the counsel for the Corporation made a statement that it has no objection for the revival of the Company. This Court passed the following order:-

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Civil Writ Petition No.2713 of 2009 (O&M) [4]

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“Mr. Kamal Sehgal, counsel for respondent No.4 (HSIDC) states that the Corporation’s liability has been discharged and the Corporation has no objection to the scheme of revival and withdrawal of the order of liquidation.

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As per the report of the Official Liquidator bearing No. OLR No. 10 of 2008 filed in CP No. 740 of 2007 dated 12.4.2008, it is clearly mentioned that Shri Ashok Gupta, Assistant General Manager of the Haryana Financial Corporation and Rakesh Kumar, L.O. Head, who were present informed the Official Liquidator that the amount due on the date of winding up order was Rs.2,41.044/- as principal outstanding, Rs.4,41,843/- as misc. expenses and interest of Rs.7,10,969/- i.e. a total of Rs.13,93,856/-. The Official Liquidator, after considering the claim held that an amount of Rs.13,92,223/- was due to the Haryana Financial Corporation, as an unsecured creditor. It is not denied that the aforementioned amount has been received by the Haryana Financial Corporation under orders of this Court.

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Mr. Puneet Gupta, counsel for the Haryana Financial Corporation, states that the Haryana Financial Corporation, has no objection to the revival of the Company, but reserves its right upon revival to seek satisfaction of the mortgage deed, in accordance with law.

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At the request of counsel for the parties, adjourned to 30.7.2008.”

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The revival petition came up for final hearing on 19.3.2009 before this court and in a judgment reported as 2009(3) PLR 159 Shri Kundanmal Dabriwala and others v. M/s Dabriwala Steels and Engineering Company Limited (In Liqn.), the claim of the creditor including that of Corporation was adjudicated upon. The basic challenge was that the procedure prescribed i.e. the meetings of the secured and other creditors have not been held. In respect of the claim of the Financial Corporation, it was observed as under:-

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“ XII Answers as regards objection from HFC and in respect of all other sundry claims:

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The objection coming from HFC, who is the third respondent, is with regard to the disbursement of Rs.4.05 crores to the State Bank of India as including the claim by the State Bank of India against yet another company, even apart the amount due by the company in liquidation to the State

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Civil Writ Petition No.2713 of 2009 (O&M) [5]

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Bank of India. The contention by the Ex-Directors of the company that the HFC had itself admitted to OTS at Rs.2.50 lacs was specifically denied. HFC had made a demand for Rs.85,57,600/- with further interest w.e.f. 01.10.2007. The HFC was itself the first secured creditor in respect of the Plot No.136 and the State Bank of India was only a second secured creditor.

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The report of the Official Liquidator records the fact that the Court had directed the disbursement of Rs.4.05 crores to the State Bank of India as full and final payment of the claims against the company and Rs.10,82,255/- as the amount payable in satisfaction of the award of the claims of the workmen by virtue of order of the Industrial Tribunal/Labour Court-II. Drawing help from the report of the Chartered Accountant M/s A.K. Chadda & Co., the Official Liquidator has examined the claims of HFC vide its claim dated 26.05.2005, Income Tax Department vide its claim dated 23.03.2006, Excise Taxation Office vide its claim dated 31.03.2008 and HSEB vide its claim dated 27.05.1996. The claim adjudicated has been tabulated as follows:-

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Name of the creditor Amount claimed Claim Adjudicated Haryana Financial Rs.60,69,525/- Rs.13,92,223/Corporation

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XIV.Final Disposition:

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(i) to (iii) xx xx xx

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(iv) The amounts as adjudged by the Official Liquidator and found expressed in the report are approved and the amounts detailed in the report shall become payable by the company.”

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The Corporation has not challenged the aforesaid order though the said order is subject matter of challenge by other aggrieved persons including the auction purchaser, who was the highest bidder of plot No.136, Sector 24, Faridabad.

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The factual position, as asserted by the petitioner in the writ petition is not controvered by the counsel for the Corporation, but it is asserted that the Specified Authority has adjudicated that an amount of Rs.83,55,421/- with future interest from 15.4.2008 is recoverable and that the recovery certificate has been rightly issued. It is inter-alia pleaded to the following effect:-

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Civil Writ Petition No.2713 of 2009 (O&M) [6]

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“…..It is further submitted here that even at the time when revival order was passed the counsel for the respondent Corporation stated that the Corporation has no objection to revival, but the Corporation reserves its right upon revival to seek satisfaction of mortgage deed in accordance with law. Since the respondent-Corporation was not paid the entire loan amount recoverable from the company, the respondent Corporation issued notice dated 7.10.2008 under Section 32 (G) of the State Financial Corporation Act, 1951 against the promoters/guarantors/directors of the Company in liquidation.”

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xx xx xx

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“……It is further submitted here that the debt of guarantee executed by the petitioner with the respondent Corporation is a separate independent contract. Hence the petitioner cannot take the benefit of a separate contract with the Company. The petitioner has not brought the above stated facts before this Hon’ble Court hence the present writ petition deserves dismissal.”

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We have heard learned Counsel for the parties and with their assistance gone through the provisions of Statute and the law applicable. We find that the question requires to be examined is:-

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“Whether the revival scheme submitted by the Petitioner under Section 391 and 394 of the Companies Act, 1956 and accepted by court amounts to compounding with the principal debtor leading to the discharge of the surety within the meaning of Section 134 and 135 of the Contract Act, 1872?”

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To consider the above question, the following are the relevant provisions of the Indian Contract Act, 1872 (for short “the Act”):-

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“126. ‘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’, the person in respect of whose default the guarantee is given is called the ‘principal debtor’, and the person to whom the guarantee is given is called for ‘creditor’. A guarantee may be either oral or written.

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Civil Writ Petition No.2713 of 2009 (O&M) [7]

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128. Surety’s liability – The liability of the surety is coextensive with that of the principal debtor, unless it is otherwise provided by the contract.

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134. Discharge of surety by release or discharge of Principal Debtor - The surety is discharged by any contract between 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.

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135. Discharge of surety when creditor compounds with, gives time to, or agrees not to sue, principal debtor – 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.

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The Petitioner has sought revival of the Company- principal debtor under Sections 391 & 394 of the Companies Act. Section 391 of the Companies Act, relevant for the present case, reads as under:

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“391. Power to compromise or make arrangements with creditors and members – (1) Where a compromise or arrangement is proposed -

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(a) between a company and its creditors or any class of them; or

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(b) between a company and its members or any class of them,

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The Court may, on the application of the company or of any creditor or member of the company or, in the case of a company which is being wound up, of the liquidator, order a meeting of the creditors or class of creditors, or of the members or class of members, as the case may be to be called, held and conducted in such manner as the Court directs.

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(2) If a majority in number representing three-fourths in value of the creditors, or class of creditors, or members, or class of members as the case may be, present and voting either in person or, where proxies are allowed under the rule made under Section 643, by proxy, at the meeting, agree to any compromise or arrangement, the compromise or arrangement shall, if sanctioned by the Court, be binding on all the creditors, all the creditors of the class, all the members, or all the members of the class, as the case may be, and also on the company, or, in the case of a company which is being

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Civil Writ Petition No.2713 of 2009 (O&M) [8]

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wound up, on the liquidator and contributories of the company (emphasis supplied..).”

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As per Section 128 of the Contract Act, the liability of the surety is co-extensive with that of the principal debtor, unless it is otherwise provided by the contract. Section 134 of the Contract Act deals with discharge of surety by any contract between the creditors and the principal debtor, by which the principal debtor is released. The surety also discharged by an act or omission of the creditor. Section 135 of the Contract Act discharges the surety, when creditor compounds with the principal debtor.

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The Hon’ble Supreme Court in The Bank of Bihar Ltd. v. Dr. Damodar Prasad and another, AIR 1969 SC 297, held the surety has no right to dictate terms to the creditor and ask him to pursue his remedies against the principal in the first instance. In the absence of some special equity the surety has no right to restrain an action against him by the creditor on the ground that the principal is solvent or that the creditor may have relief against the principal in some other proceedings. Where the creditor has obtained a decree against the surety and the principal, the surety has no right to restrain execution against him until the creditor has exhausted his remedies against the principal. The court quoted with approval that a creditor is not bound to exhaust his remedy against the principal debtor before suing the surety and that when a decree is obtained against a surety, it may be enforced in the same manner as a decree for any other debt. The judgment of the Supreme Court in State Bank of India v. Messers. Indexpot Registered and others, AIR 1992 SC 1740, is also to the same effect.

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In Industrial Investment Bank of India Limited v. Biswanath Jhunjhunwala, (2009) 9 SCC 478, it was held to the following effect:

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“18. The term “co-extensive” has been defined in the celebrated book of Pollock & Mulla on Indian Contract and Specific Relief Act, 10th Edn., at p. 728 as under:

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Civil Writ Petition No.2713 of 2009 (O&M) [9]

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“Co-extensive.—Surety's liability is co-extensive with that of the principal debtor.

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A surety's liability to pay the debt is not removed by reason of the creditor's omission to sue the principal debtor. The creditor is not bound to exhaust his remedy against the principal before suing the surety, and a suit may be maintained against the surety though the principal has not been sued.”

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In Chitty on Contracts, 24th Edn., Vol. 2 at pp. 1031-32, para 4831 it is stated as under:

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“4831. Conditions precedent to liability of surety.— Prima facie the surety may be proceeded against without demand against him, and without first proceeding against the principal debtor.”

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In Halsbury's Laws of England, 4th Edn., Vol. 20, para 159 at p. 87 it has been observed that:

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“159. … It is not necessary for the creditor, before proceeding against the surety, to request the principal debtor to pay, or to sue him, although solvent, unless this is expressly stipulated for.”

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xxx xxx xxx

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The legal position as crystallized by a series of cases of this Court is clear that the liability of the guarantor and principal debtors is coextensive and not in alternative.”

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Learned counsel for the petitioner relies upon the provisions of Section 134 of the Act to contend that the petitioner stands discharged by the act and omission of the Corporation in terms of second part of Section 134 of the Act. It is also contended that in terms of Section 135 of the Contract Act, the petitioner also stands discharged, as the Corporation is deemed to have compromised with the principal debtor. The liability of the surety does not survive after the settlement with the principal debtor in proceedings under Section 391 and 394 of the Companies Act, 1956. Reference is also made to Syndicate Bank, Tangutur Branch, Tangutur, Prakasam District v. Pamidi Somaiah (died) and another, AIR 2002 Andhra Pradesh 12; Kurnool Chief Funds P. Ltd. v. Narasimha (P.) AIR 2008 Andhra Pradesh 38 and Union Bank of India v. Chairperson, Debts Recovery Appellate Tribunal and others, (2011)167 Company Cases page 1 (Allahabad).

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Civil Writ Petition No.2713 of 2009 (O&M) [10]

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In Syndicate Bank’s case (supra), the Andhra Pradesh High Court has examined the question as to whether the decree holder can proceed against the surety when the principal debtor’s liability stands discharged as the suit abated on account of non-impleading of legal heirs of deceased principal debtor. After considering the provisions of Section 134 of the Indian Contract Act, 1872, the Court held to the following effect:-

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“11. Though in all the above decisions, it was held that the liability of the surety is co-extensive with that of the principal Debtor and the creditor-Decree Holder need not proceed against the principal Debtor before proceeding against the surety, either by way of suit or against the principal Debtor before proceeding against the surety, either by way of suit or for the recovery of the decretal amount, but in none of the above decisions, the present position exists, where a suit against the principal Debtor had abated by an act of omission on the part of the creditor. As a result of the omission on the part of the creditor in bringing the legal representatives on record, the surety’s right that was provided under Section 140 of the Contract Act to proceed against the principal Debtor had been lost. Apart from that in terms of Section 134, the surety is discharged by the omission of the creditor in allowing the suit to abate against the principal Debtor and consequently in the discharge of the debt against the principal debtor.”

¶73

In M/s Kurnool Chief Funds (P) Ltd. ’s case (supra), the suit

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against the principal debtor was dismissed for default and the said decision became final. Thus, under law there was no liability surviving against the debtor for realization of the amount due to the creditor. It was held that once the liability of the principal debtor is extinguished, the surety’s liability gets automatically terminated. It was held to the following effect:

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“13. ….But in the present case, the suit against the principal debtor is dismissed for default and the decision became final. Therefore, under law, there is no liability surviving against D1 for realization of the amount due to the creditor. When once the liability of the principal debtor is extinguished, the sureties’ liability gets automatically terminated. Therefore, without making the principal debtor liable for payment of the amount to the creditor, the sureties cannot be made liable for recovery of the amount. When once the suit is decreed

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Civil Writ Petition No.2713 of 2009 (O&M) [11]

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against the principal debtor and the sureties with joint and several liability, it is the option of the decree holder to go against any one of them irrespective of the fact whether he is principal debtor or a surety….”

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In Union Bank of India’s case (Supra) the learned Single Judge of Allahabad High Court was considering almost the same question as in the present case that is consequences of discharge of a principal debtor by the Bank before the Official Liquidator. The Court found that such settlement discharges the surety. It was held to the following effect:

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“16. The second submission of learned counsel for the bank that discharge of the principal borrower by operation of the bankruptcy law, will not discharge the guarantors is also without any force and needs to be rejected. The bank had accepted the amount towards full and final settlement of its claim submitted before the Company Judge and the principal borrower did not stand discharged because of operation of law. The decision of the Supreme Court in Maharashtra State Electricity Board, AIR 1982 SC 1497, therefore, does not help the petitioner-bank. On the other hand, the submission of Sri R.P.Agarwal, learned counsel for the respondents that the liability of the surety gets automatically terminated when liability of principal debtor is extinguished, deserves to be accepted.”

¶80

Shri Kamal Sehgal, learned counsel for the Corporation argued that Sections 134 or 135 have no application in the present case, as the claim of the Corporation was slashed by an operation of law. It is argued that though the liability of the surety is co-extensive with the principal debtor, but such principle does not affect the right of creditor to recover the amount scaled down by operation of law such as bankruptcy laws. Therefore, the fact that the principal debtor stands absolved by virtue of an order passed by the Company Court, will not absolve the surety of its liability in terms of the fact that he stood as a guarantor. He relies upon Maharashtra State Electricity Board, Bombay v. The Official Liquidator, AIR 1982 Supreme Court 1497 and also on Industrial Finance Corporation of India Ltd. v. Cannanore Spinning and Weaving Mills Ltd and others, AIR

¶81

Civil Writ Petition No.2713 of 2009 (O&M) [12]

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2002 Supreme Court 1841, to contend that Corporation has a right to recover from the guarantor the amount due and payable by the principal debtor in terms of the gurantee executed by the petitioner. In Maharashtra State Electricity Board’s case (supra), the Hon’ble Supreme Court held that the rights of the creditor are not affected in the event of operation of laws. It was held to the following effect:

¶83

“The fact that the Company in liquidation i.e. the principal debtor has gone into liquidation also would not have any effect on the liability of the Bank i.e. the guarantor. Under section 128 of the Indian Contract Act, the liability of the surety is co-extensive with that of the principal debtor unless it is otherwise provided by the contract. A surety is no doubt discharged under S. 134 of the Indian Contract Act by any contract between 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, but a discharge which the principal debtor may secure by operation of law in bankruptcy (or in liquidation proceedings in the case of a company) does not absolve the surety of his liability (See Jagannath Ganeshram Agarwala v. Shivnarayan Bhagirath, AIR 1940 Bom 247. See also in re Fitzgeorge Ex parte Robson (1906) 1KB 462)…….”

¶84

In Cannanore Spinning and Weaving Mills Ltd. case (supra), reference was made to the Full Bench Judgment of the Madras High Court in A.L.S.P.PL. Subramania Chettiar (decd.) and another v. Moniam P. Narayanaswami Gounder AIR 1951 Madras 48. The said judgment was not found to be helpful in the said case for the reason that the exceptions therein relate to the release of the principal debtor’s liability under the law of limitation, bankruptcy law etc. It was held to the following effect:-

¶85

“But this passage will not, in my opinion, help the appellant in this case as the exceptions given there relate to the release of the principal debtor’s liability under the law of limitation, bankruptcy laws, etc. (which merely bar the remedy) and not to the extinction of the principal debtor’s liability, as hereunder the Madras Agriculturists’ Relief Act.”

¶86

Civil Writ Petition No.2713 of 2009 (O&M) [13]

¶87

In the said judgment, it was also held to the following effect:-

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“33. Adverting to the contract of guarantee be it noted that though it is not a contract regarding a primary transaction; but it is an independent transaction containing independent and reciprocal obligations. It is on principal to principal basis and by reason wherefor the Statute has provided both the creditor and the guarantor some relief as specified in this Chapter of Contract Act (between Sections 130 to 141). Section 141 thus involves an issue of a deliberate action on the part of the creditor and not a mere fortuitous situation beyond the control of the creditor. …..

¶89

In Halsbury’s Laws of England – Fourth Edition (para 335), it has been relying upon four rather old decisions of the Court of Appeal. Wheatley v. Bastow (1855) 7 De G M & G 261 at 279-280 per Turner LJ: Hardwick v. Wright (1865) 35 Beav 133; Polak v. Everett (1876) 1 QBD 669 at 675. C.A. per Blackburn J. Carter v. White (1883) 25 Ch D 666 at 670, CA., categorically stated “A transaction which causes no loss of securities or a loss not attributable to the fault of the creditor, will not discharge the guarantor.”

¶90

The counsel for the Corporation has made statement before this court on 29.07.2008 that the Corporation has no objection for the revival of the Company, but reserved its right upon revival, to seek satisfaction of the mortgage deed, in accordance with law. After the said statement was made, the petition under Sections 391 & 394 of the Companies Act was finally decided on 19.03.2009, whereby the claim of the Corporation was scaled down. The Corporation has not challenged the earlier order accepting the report of the Official Liquidator on 08.05.2008 and also the later order accepting the petition for revival on 19.03.2009.

¶91

The judgment in Maharashtra State Electricity Board’s case (supra), though deals with exception of surety being liable where the liability of principal debtor is extinguished by law, but in our view the said judgment is not applicable to the facts of the present case. In the aforesaid case, the principal debtor went into liquidation. Mere fact that the principal debtor was subject to bankruptcy laws, was found to be not sufficient to absolve the surety of its liability. Similar is the principle laid

¶92

Civil Writ Petition No.2713 of 2009 (O&M) [14]

¶93

down in Cannanore Spinning and Waving Mills Ltd. case (supra). Keeping such principal in view, the abatement of suit for not impleading the legal heirs of deceased principal debtor or dismissal of suit against the principal debtor will not absolve the surety.

¶94

In Jagannath Caneshram Aggarwala v. Shivnarayan Bhagirath and others AIR 1940 Bombay 247, it was held that the liability of a surety is co-extensive, but not alternative. The said finding was arising out of meeting of the creditors and the shareholders of the Company to consider a scheme of reconstruction under Section 153 of the Companies Act, 1913. As per the scheme every creditor was to receive half the sum in cash and other half in the shape of preferential shares. Having received the benefits under the scheme, the plaintiff sought to recover the deficient amount from the defendants. The Court considered Halsbury’s Laws of England (Edn.2), Vol.5; Jacobs (1875) 10 Chancery A 211; London Chartered Bank of Australia (1893) 3 Chancery 540 & Garner’s Motors Limited (1937) 1 Chancery 594 and held that the surety – defendant No.1 is liable to the creditor. In Garner’s Motor Limited case (supra), referred to by the Bombay High Court, there were two companies called Sentinel Waggon Works Limited and Garner’s Motors Limited, who were jointly liable to pay certain debts. One of the Companies i.e. Sentinel Waggon Works Limited defaulted and entered into a scheme of arrangement. The other debtor sought to rely upon the scheme of arrangement to absolve itself of liability. It was held to the following effect:-

¶95

“…The liquidators contend that Garner’s Motors, Ld., was discharged from its liability by the fact that on March 23, 1936, a scheme of arrangement between Sentinel Waggon Works, Ld., and its creditors was sanctioned by the Court under Section 153 of the Companies Act, 1929. It is settled law that accord and satisfaction between a creditor and one of several debtors, who are jointly and severally liable to the creditor, discharges the other debtors unless it appears from the terms of the agreement or the surrounding circumstances that the creditor intended to reserve his rights against them. The law is in my opinion correctly stated in Halsbury’s Laws

¶96

Civil Writ Petition No.2713 of 2009 (O&M) [15]

¶97

of England (second edition), Vol.7, P.237, para 324. But in my judgment a discharge of one of several joint debtors by operation of law does not discharge the other debtors. In my judgment the effect of Section 153 of the Companies Act, 1929, is to give to a scheme when sanctioned by the Court under the section a statutory operation. The scheme when sanctioned by the court becomes something quite different from a mere agreement signed by the parties. It becomes a statutory scheme. In my judgment, therefore, the discharge of Sentinel Waggon Works, Ld., from the debt to Temple Press, Ld., which was effected under clause 15 of the scheme sanctioned by the Court on March 23, 1936, did not have the effect of discharging Garner’s Motors, Ld., from its liability in respect of the debt. It is settled law that a discharge of one of several judgment-debtors by operation of law does not release the other debtors. But in my judgment the effect of Section 153 of the Companies Act, 1929, is to give a scheme when sanctioned by the Court a statutory operation. I think that the law is correctly stated in Buckley, 12^th ed., p.322, as in Halsbury, vol. 5, p.797, para 1366.

¶98

In my judgment, therefore, the scheme, which provides that “The unsecured creditors of the present company shall accept the provisions in their favour contained in this Scheme in full satisfaction and discharge of all their claims against the present company and the assets thereof-“ did not release Garner’s Motors, Ld., which was jointly liable with the company which was being released by clause 15 from the liability.”

¶99

A perusal of the judgment shows that it was a case of joint debtors and extinguishment of debt of one did not absolve the other. It recognized the fact that the scheme under the Companies Act, assumes statutory operation.

¶100

On the other hand, a Full Bench of Madras High Court in a A.L.S.P.PL. Subramania Chettiar (decd.)’s case (supra), has considered the provisions of Madras Agriculturists’ Relief Act. The liabilities of an agriculturist debtor were scaled down under the said Act. The argument that the scaling down debt against the principal debtor does not absolve the surety, did not find favour with the Court. It was held to the following effect:-

¶101

Civil Writ Petition No.2713 of 2009 (O&M) [16]

¶102

“6. Section 128, Contract Act, says that the liability of the surety is co-extensive with that of the principal debtor unless it is otherwise provided by contract. It is a settled principle of law that the surety's- liability is only accessory and secondary. Under the express provisions of Section 128 his liability is made only co-extensive with that of the principal debtor. That can only mean that his liability, is no less or no more than that of the principal debtor. If the amount payable by the principal debtor is discharged in part, the surety's liability also is pro tanto reduced. …. ….Section 140, Contract Act, says that the surety, on discharging a debt would only get all the rights which the creditor had against the principal, debtor. So, if the creditor could not recover any portion of the debt from the principal debtor, owing to scaling down under the Madras Agriculturists' Relief Act, it follows that the surety could not also recover that portion of the debt. That would be very unjust to the surety and would land him in unexpected and unmerited loss by the Madras Agriculturists' Relief Act intervening and Scaling down the debt. The Madras Agriculturists' Relief Act in our opinion, therefore, to prevent such injustice to the surety, intended to extinguish the portion of the debt affected by the scaling down and not merely; to bar the remedy. By doing so it did not confer any benefit on the non-agriculturist surety but only relieved him from an extra burden and loss which would have been thrown on him if the debt was not extinguished and he was made liable to bear the loss of the difference by virtue of Section 140, Contract Act.

¶103

xxx xxx xxx

¶104

Now we come to the second point, namely, assuming that the intention of the Madras Agriculturists' Relief Act is to extinguish the whole or portion of the debt affected by the scaling down, would such extinction of the debt as regards the principal debtor ensure to the benefit of his surety and extinguish his liability also regarding that portion of the debt so extinguished? I have absolutely no doubt that it will. Section 128, Contract Act, clearly enacts that the liability of the surety is co-extensive with that of the principal debtor unless it is otherwise provided by the contract. There is nothing in Section 133 etc., to alter this general proposition. In Sami Iyer v. Ramaswami Chettiar, A. I. R. 1923 Mad. 340 already referred to, it was held that the liability of a surety for a debt ceased to exist when his

¶105

Civil Writ Petition No.2713 of 2009 (O&M) [17]

¶106

principal's debt was extinguished, in that case by an act which caused the merger of the estate of the principal debtor and the creditor. It was observed there by Venkatasubba Rao J. at p. 177 :

¶107

"The debt due by the judgment-debtor having become extinguished, are the plaintiffs entitled to proceed against the surety ? They are not. To my mind, the question does not admit of any doubt. Cunningham and Shephard in their 'Indian Contract' quote the following passage from Pothiar when dealing with Section 134 : 'It results from the definition of a surety's engagement as being accessory to a principal obligation that the extinction of the principal obligation necessarily induces that of the surety, it being the nature of an accessory obligation that it cannot exist without its principal'. The learned Commentators add the rule may also be put upon the less technical ground that if the release of the surety did not follow from that of the debtor, the latter's release would be purely illusory because the consequence would be that the surety on being compelled to pay would immediately turn round on the debtor. I find it impossible to hold that the creditor can proceed against the surety although the debt has been recovered." .

¶108

Spencer J. remarks in the same case :

¶109

"Ordinarily the liability of a surety is co-extensive with that of the principal debtor unless it is otherwise provided for ..... An illustration of the effect of Section 128, Contract Act occurs in Shek Sulaiman v. Shivram Bhijai, 12 Bom. 71 where it was observed that if an amount recoverable by a plaintiff, from a defendant debtor is diminished in appeal, the surety's engagement, being one of indemnity, would dimmish in like proportion. So, if the sum recoverable became zero, owing to the decree being reversed, the surety's liability would also be reduced to nothing."

¶110

It is obvious that in a case like this, where the decree is amended under Section 19, Madras Agriculturists' Relief Act, and the amount recoverable by a plaintiff from the principal debtor is diminished in appeal, the surety's engagement, being one of indemnity, would diminish in like proportion; and if the sum recoverable from the principal debtor becomes

¶111

Civil Writ Petition No.2713 of 2009 (O&M) [18]

¶112

zero, under the amended decree the surety's liability would also be reduced to nothing.

¶113

Niyogi J. in Babu Rao v. Babu Manakkal, A.I.R. 1938 Nag. 413 lays down the principle in a different, though equally effective manner as follows :

¶114

"When the creditor seeks to enforce the debt against the surety, the latter is legitimately entitled to ask 'is the principal debtor himself liable? If not, he has committed no default and you cannot compel me to discharge an obligation which has no existence. If, on the other hand, I pay you, how can I recover it from the principal debtor whose liability, the debt itself having vanished, has ceased? ' When the surety seeks his remedy against the principal debtor, ho does it in respect of the same debt as the one owed by the principal debtor to the creditor. It is clear that the debt must exist."

¶115

So, it is clear that the debt must exist (and should not have been extinguished as under the Madras Agriculturists' Relief Act), if the creditor is to choose to enforce his remedy against the surety when the principal debtor stands discharged…..

¶116

10a …… .I am unable to agree with the view propounded therein or with the reasoning underlying it. The Bench relied on two main reasons, the first being that, Section 128, Contract Act, is not intended to govern all future changes in the liability of the parties, when there is no warrant in that section for any such conclusion. The second reason given; is that when a new statutory provision has had the effect of granting a partial discharge to the principal debtor, and the creditor has taken no part in releasing the principal debtor from his liability, the remedy of the creditor against the guarantor will not be affected. In other words, they held, like the Bench which decided the Nellore Co-operative Urban Bank Ltd. v. Mallikarjunayya, A.I.R.1948 Madras 252 (Patanjali Sastri and Thyagarajan JJ.) that a statutory discharge of the whole or any part of a principal debtor's debt will not discharge the surety pro tanto as the creditor has taken no part in releasing the principal debtor from his liability. But it is, obvious that this position will not be valid when the debt itself has been extinguished as regards the

¶117

Civil Writ Petition No.2713 of 2009 (O&M) [19]

¶118

principal debtor by the statute, as I have held to be the case under the Madras Agriculturists' Relief Act, and there is nothing; to be recovered from him, and so nothing to be recovered from the surety, who has only guaranteed the same debt, as was due from the principal debtor his engagement, being merely accessory to the principal obligation. It is clear to me therefore that the Bench ruling in Sami Iyer v. Ramasami Chettiar, A.I.R. 1923 Mad. 340 represents the correct state of the law regarding this matter and that Subramanian Chettiar v. Batcha Rowther, A.I.R. 1942 Mad. 145 was wrongly decided. I may add that the same Bench which decided Subramanian Chettiar v. Batcha Rowther, A. I. R. 1942 Madras 145 was a party to the decision in Satyanarayanamurti v. Sathiraju, A.I.R.1942 Madras 525 and that they decided therein that a non-agriculturist purchaser of mortgaged property was entitled to redeem the mortgage as a whole after having, the debt scaled down, They remarked:

¶119

"It is therefore not correct to say, as was argued for the appellant, that the Court, by allowing the mortgagors to redeem the mortgage as a whole, was conferring a benefit upon a non-agriculturist, contrary to the intendment of the Madras Agriculturist's Relief Act. On the other hand, if the purchaser in such circumstances is made to pay the entire sum reserved with him for payment under the sale-deed, which was executed before the passing of the said Act, the mortgagor would stand ultimately deprived of the benefit which as agriculturists they are undoubtedly entitled to claim under the Act."

¶120

The same reasoning would entitle a non agriculturist surety to claim the benefit of the scaling down in respect of the principal debtor as he must otherwise be allowed to recover what he has paid, and the principal debtor would stand ultimately deprived of the benefit which as an agriculturist, he was entitled to claim under the Act.

¶121

xxx xxx xxx

¶122

Unhampered by judicial decisions also, on a fair reading of the provisions of the Contract Act, I am inclined to hold that as the liability of the surety is co-extensive with that of the principal debtor, if the latter's liability is scaled down in

¶123

Civil Writ Petition No.2713 of 2009 (O&M) [20]

¶124

an amended decree, or otherwise extinguished in whole or in part by statute, the liability of the surety also is pro tanto reduced or extinguished. Paragraph 192 of Halsbury's Laws of England, Vol. 16, 1935 Edn., contains the following passage :

¶125

"Whatever expressly or impliedly discharges the principal debtor from liability usually discharges the surety also by implication, as his position is thereby altered without his consent, notwithstanding that the alteration is accomplished by operation of law. He is therefore discharged where he can establish that the alteration changes the nature of his liability, but not otherwise."

¶126

This shows that extinction of a debt in whole or in part by operation of law will do, and that the creditor need not take any part in realising the principal debtor from his liability. Mr. Ramachandra Aiyar relied on a passage in para. 195 which runs as follows:

¶127

"Though an alteration in the position of the surety by the principal debtor's discharge, or otherwise, accomplished by the operation of law, may discharge him this is not always the case."

¶128

But this passage will not, in my opinion, help the appellant in this case as the exceptions given there relate to the release of the principal debtor's liability under the law of limitation, bankruptcy laws, etc. (which merely bar the remedy) and not to the extinction of the principal debtor's liability, as here under the Madras Agriculturists' Relief Act.”

¶129

It may be noticed that in most of the cases, reference is made to the quotes from the Halsbury’s Laws of England, Second Edition. In Halsbury’s Laws of England, Fourth Edition, (Volume 20 reprint) in Para Nos. 610, it is said to the following effect:-

¶130

“ 610 Bankruptcy A contract is not a rule discharged by the bankruptcy of any of the parties to it. A mere declaration of insolvency by one of the parties does not entitle the other to treat the contract as being at an end, but if the declaration is

¶131

Civil Writ Petition No.2713 of 2009 (O&M) [21]

¶132

made under circumstances which show an intention not to carry out the contract or an inability to do so the position is different; and if one party gives notice to the other of his insolvency and does nothing to show that he intends to stand by the contract the other party may be entitled to assume repudiation of the contract and either to insist upon performance or to treat the contract as at an end.”

¶133

In Para No.590 it is said to the following effect:-

¶134

“590 Compositions with creditors: Although an agreement whereby a creditor accepts part of his debt in satisfaction of the whole does not generally discharge the whole debt, there is an important exception to this rule in relation to compositions with creditors. A composition may arise where there is more than one creditor and an agreement between the debtor and some or all of the creditors whereby the creditors agree with the debtor, and with each other, to accept from the debtor payment of less than the amounts due to them in full satisfaction of the whole of their claims. Such an agreement is binding on all parties to it, and, provided the debtor complies with his obligations thereunder, will effectively discharge the original debts.”

¶135

The aforesaid Full Bench of Madras High Court has held that if the creditor is to choose to enforce his remedy against the surety, the debt must exist and should not have been extinguished as under Madras Agriculturists Relief Act. The exception noticed relates to the release of principal debtor’s liability under the law of Limitation and Bankruptcy Laws etc. which merely bars the remedy and not to the extinction of the principal debtor’s liability as under Madras Agriculturists Relief Act.

¶136

Hon’ble Supreme Court in Hindustan Lever v. State of Maharashtra, (2004) 9 SCC 438 , held that:

¶137

“10. By virtue of provisions of Section 391 of the Companies Act a scheme sanctioned by the court is statutorily binding on all its shareholders and creditors including those who dissented from or were opposed to the scheme being sanctioned. Since by law a procedure has been prescribed by which every shareholder and creditor in the absence of individual agreement, gets bound by the scheme, which

¶138

Civil Writ Petition No.2713 of 2009 (O&M) [22]

¶139

would otherwise be necessary to give its validity, the two provisos have been introduced casting a duty on the court to satisfy itself that the affairs of the company were/are not being conducted in a manner prejudicial to the interest of its members or to the public interest. The basic principle underlying these provisos is none other than the broad and general principle inherent in any compromise or settlement entered into between the parties, the same being that it should not be unfair, contrary to the public policy, unconscionable or against the law.”

¶140

Present is a case, which leads to extinction of principal debtor’s liability in terms of scheme of arrangement sanctioned by this Court on 19.03.2009. Such scheme is binding on all the creditors including non consenting creditors such as the Corporation. Under Section 135 of the Act, a contract between the creditor and the principal debtor by which the creditor compounds with the principal debtor, discharges the surety. It shall include a binding arrangement sanctioned by the Court under Section 391 of the Companies Act. It is a case of a deemed and binding contract though by operation of law, but such contract extinguishes the liability of the principal debtor. With such extinction of the liability of the principal debtor, the surety cannot recover the amount of debt paid, from the debtor. Therefore, it cannot be said that the surety will continue to be liable for payment of debt due to the creditor prior to settlement.

¶141

The judgment of Bombay High Court is helpful to the argument raised by Shri Sehgal, but we prefer to follow the later Full Bench judgment of Madras High Court in A.L.S.P.PL. Subramania Chettiar (decd.) case (supra). Similar is the view of a Single Bench of Allahabad High Court in Union Bank of India case (supra).

¶142

Thus, we arrive at the following conclusion:-

¶143

i) The scheme of arrangement sanctioned by the Company Court in exercise of the jurisdiction under Section 391 of the Companies Act, 1956, is binding on all creditors including the

¶144

Civil Writ Petition No.2713 of 2009 (O&M) [23]

¶145

non consenting creditors. Such scheme extinguishes the remaining claim of the creditor.

¶146

ii) On such extinction of the claim of the creditor, the surety stands discharged inter-alia for the reason that he cannot step in the shoes of the creditor and sue the debtor for the recovery of the amount paid by the surety in terms of Sections 139 and 140 of the Indian Contract Act.

¶147

iii) The judgments whereby the surety has been made liable where the principal debtor cannot be permitted to sue, are in the cases where the principal debtor has gone into voluntary or compulsory winding up or where the suit against the debtor has failed either on account of abatement or dismissal. Such action bars the remedy against the principal debtor, but does not extinguish the debt against the principal debtor. This is keeping in view the principle that the liability of the surety is co-extensive, but not alternative. Thus, where the principal debtor cannot be sued for one or the other reason, the surety will still be liable, except in cases where the liability of the principal debtor stands extinguished.

¶148

iv) Though the judgment of the Division Bench of the Bombay High Court in Jagannath Caneshram Aggarwala’s case (supra), is in the context of arrangement in terms of Section 153 of the Companies Act, 1913, which is almost parimateria with the Companies Act, 1956, but the distinction between the bar of remedy and the extinction of debt, has been examined by a Full Bench of the Madras High Court in A.L.S.P.PL. Subramania Chettiar’s case (supra). Though in the said case, the liability was scaled down under the Madras Agriculturists Relief Act, but the principle of scaling down of liability under the aforesaid Act, stands on same footing as that

¶149

Civil Writ Petition No.2713 of 2009 (O&M) [24]

¶150

of scaling down of debt under Section 391 of the Companies Act. In the proceedings under Section 391 of the Companies Act, the majority of the creditors have to agree for the scheme which makes it squarely falling within the scope of Sections 134 and 135 of the Contract Act.

¶151

In view of the provisions of law, the show cause notice calling upon the petitioner to determine his liability as surety of the Company, is illegal, unwarranted and without jurisdiction. So is the consequent order passed by the Corporation under Section 32(G) of the Act. Consequently, the writ petition is allowed and the impugned notice Annexure P-1 is quashed with no order as to costs.

¶152

(Hemant Gupta) Judge

¶153

(G.S. Sandhawalia) Judge

¶154

December 20, 2011 ds/vimal

Shri Kundanmal Dabriwala v. Haryana Financial Corp. and Anr.

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Shri Kundanmal Dabriwala v. Haryana Financial Corp. and Anr.

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