New Delhi: The guarantor of a loan is liable to pay it if the debtor fails to clear it, the Supreme Court has ruled, while maintaining that financial institutions too cannot act like property dealers in recovering the debts.

A bench of justices B S Chauhan and Dipak Misra also said the guarantor cannot insist that the creditor must first exhaust all remedies against the principal debtor before recovering the debts from the surety holders.

"There can be no dispute to the settled legal proposition that in view of the provisions of Section 128 of the Indian Contract Act, 1872, the liability of the guarantor / surety is co-extensive with that of the debtor.

"Therefore, the creditor has a right to obtain a decree against the surety and the principal debtor.

"The surety has no right to restrain execution of the decree against him until the creditor has exhausted his remedy against the principal debtor for the reason that it is the business of the surety/ guarantor to see whether the principal debtor has paid or not," said Justice Chauhan, writing the judgement for the bench.

The apex court gave the ruling on an appeal by one Ganga Kishun, who had stood as a guarantor to a bank loan, raised by one Ganga Prasad, who had died without clearing it. Ganga Kishun had come to the apex court against the Uttar Pradesh government's decision to recover the loan arrears from him after the death of principal debtor Ganga Prasad.

While dismissing Ganga Kishun's appeal, the apex court, however, faulted the government's decision to auction Ganga Kishun's entire stretch of land for Rs 25,000 to recover an arrear worth Rs 8,500 only and not confining the auction to only 1/3rd of the land which could have fetched the arrears.

The apex court added the financial institutions cannot be allowed to act like property dealers to recover their loans.

"Undoubtedly, public money should be recovered and recovery should be made expeditiously. But it does not mean that the financial institutions which are concerned only with the recovery of their loans may be permitted to behave like property dealers and be permitted further to dispose of the secured assets in any unreasonable or arbitrary manner in flagrant violation of the statutory provisions.

"A right to hold a property is a constitutional right as well as a human right and a person cannot be deprived of his property except in accordance with the provisions of statute.

"Thus the conditions precedent for taking away someone's property or disposing of the secured assets is that the authority must ensure compliance of the statutory provisions," the bench said.

The court said the guarantor does not have a right to dictate terms to the creditor as to how he should make the recovery but said the liability should be shared by the co-sureties if there is more than one guarantor.

"Section 146 of the Contract Act provides that co-sureties are liable to contribute equally. Thus in case there are more than one surety /guarantor, they have to share the liability equally unless the agreement of contract provides otherwise," the bench said.

The apex court cautioned that in case the property is disposed of by a private treaty without adopting any other mode provided under the statutory rules etc, there may be a possibility of collusion / fraud; hence there should be proper valuation of the assets.

"And even when public auction is held, the possibility of collusion among the bidders cannot be ruled out.

"Therefore, it becomes a legal obligation on the part of the authority that property be sold in such a manner that it may fetch the best price. Thus essential ingredients of such sale remain a correct valuation report and fixing the reserve price," the bench said.


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