KARNATAKA BANK LTD. v. GAJANAN SHANKARARAO — 1976 DIGILAW 92 (KAR)

VENKATACHALAIAH, J, J. ( 1 ) THIS appeal by the plaintiff in O. S. 10 of 1967 on the file of the Civil judge at Hubli is directed against that part of the judgment and decree dated 25-2-1972 by which the Court-below, while granting a decree against the principal-debtor, the first defendant in the suit for the sum of Rupees 32,757 negatived the claim against the sureties, defendants 2 and 3 who are respondents 1 and 2 respectively in this appeal. ( 2 ) APPELLANT claiming to be the successor-in-interest of Bank of karnataka Ltd, Hubli, instituted the suit from which this appeal arises, for the recovery of the sum. of Us. 32, 757 against the first defendant as the principal debtor in enforcement of the pronote for Rs. 25,000, Ext. P1, and the hypothecation bond, Extp2, relating to the Truck MYG 3031 and against defendants 2 and 3, on the basis of the surety bond, Ext. P3; the said transactions under Exts. P1, P2 and P3 having been entered into by the defendants with the Bank of Karnataka Ltd, Hubli. Appellant claims that the assets and liabilities of the said Bank of Karnataka are taken over by the appellant on 29-12-1966. ( 3 ) THE defence urged by respondents 1 and 2 in the Court below, inter-alia, was that appellant was not the holder in due course of the negotiable instrument, Ext. P1 and was not competent to maintain the the action thereon; and that the appellant and the Bank of Karnataka from which appellant derives title having allowed the security under the hypothecation bond, Ext. P2, to be impaired and lost owing to their own negligence and defaults and having thereby rendered themselves disabled from, giving to the sureties the benefit of the security, the liability of respondents 1 and 2 as sureties has had to be reduced to the extent of the value of the security so impaired. ( 4 ) ON these pleadings, the Court-below framed the following issues: (1) Whether the Bank of Karnataka Ltd, Hubli with its assets and liabilities, has on 29-12-1966 merged with the plaintiff Bank as alleged? (2) Whether the plaintiff is not entitled to enforce the, suit pronote as alleged by 3rd defendant? (3) Whether the suit is not maintainable as alleged by the defendant? (4) To what reliefs are the parties entitled? (2) Whether the plaintiff is not entitled to enforce the, suit pronote as alleged by 3rd defendant? (3) Whether the suit is not maintainable as alleged by the defendant? (4) To what reliefs are the parties entitled? additional Issue (5) Whether Defts 2 and 3 are discharged for the reasons mentioned in paras 5 of their respective written statements? Having recorded its findings in the affirmative on issues 2 and 5, the Court-below while granting the decree as prayed for against the principal-debtor dismissed the suit as against the said sureties. ( 5 ) BEFORE we proceed to consider the contentions urged and the propositions arising for consideration in this appeal, it is necessary to advert to certain facts which are not in dispute. The relevant and undisputed facts are that on 30-5-1964, the first defendant borrowed Rs. 25,000 executing the pronote, Ext. P1, in favour of the Bank of Karnataka; that the said loan was secured by the hypothecation of the truck MYG 3031 then owned by the first defendant in favour of the said Bank under the hypothecation-bond, Ext. P2 dated 30-5-1964 and that on the same day defendants 2 and 3, the respondents in this appeal, executed the instrument of guarantee and constituted themselves sureties for the obligations of the principal-debtor. Ext. P2 contemplated re-payment of the loan of Rs. 25,000 along with the stipulated interest thereon in certain instalments, the first of which fell due on 1-7-1964. Cl (6) of Ext. P2, inter-alia, empowers the creditor-Bank to take possession of and sell the security-in this case the Truck - in the event of there being a failure on the part of the borrower to pay 'any one' instalment. It is not in dispute that by the time the suit came to be filed all the instalments had become overdue: and that neither the Bank of Karnataka nor the appellant which claims under the former did anything to exercise their power of seizure of the Truck which was the primary security. It is not in dispute that by the time the suit came to be filed all the instalments had become overdue: and that neither the Bank of Karnataka nor the appellant which claims under the former did anything to exercise their power of seizure of the Truck which was the primary security. It is not also disputed that in the meanwhile the truck so deteriorated in value that it was reduced to a mere scrap ( 6 ) SRI B. P. Holla, learned Counsel for the appellant assailed the findings recorded by the Court below on issues 2, 3 and 5 on the following grounds: (a) The omission or inaction on the part of the creditor to enforce the primary security under Ext. P2 amounts only to a "mere forbearance" which does not have the effect of discharging the sureties; (b) Under the express terms of Ext. P3 the sureties had 'waived' and 'contracted out' of the benefit of S. 141 of the Contract Act and that therefore the liability of the sureties which was co-extensive with that of the principal-debtor subsisted; and, (c) The security under Ext. P2 was not in the possession of the "creditor and that therefore the question of impairment or loss of the security at the instance of the creditor does not arise at all. ( 7 ) SRI V. Krishnamurthi, learned counsel for the respondents, how ever, sought to sustain the decree of dismissal as against the sureties, his principal contentions being that the hypothecation of a moveable was merely an extended concept of a pledge; that the right to the possession of the chattel, in the context of the statutorily recognised obligations of the creditor towards the sureties in the matter of preservation of the security for the benefit of the sureties, is equivalent to actual possession; that the obligation to preserve the collateral security extends not merely to the security the creditor has, but also to what the creditor ought to have had; tiiat the appellant by allowing the security under Ext. P2 to be lost or impaired, had put it out of its power to handover the security to the sureties; and that therefore the sureties are entitled to have their liability as such sureties jettisoned in proportion to the value of the collateral security so lost or impaired by or at the instance of the creditor. P2 to be lost or impaired, had put it out of its power to handover the security to the sureties; and that therefore the sureties are entitled to have their liability as such sureties jettisoned in proportion to the value of the collateral security so lost or impaired by or at the instance of the creditor. In support of these propositions, Sri. Krishnamurthi relied upon certain passages in the decisions in Craythorne v. Swinburns, ( (1807) 14 Ves. 160) and Wulff and Billing v. Jay, (1872) 7 QB. . 756) referred to, with approval by the Supreme Court in Amrit Lal goverdhan Lalan v. State Bank of Travancore (AIR. 1968 SC. 1432 ). ( 8 ) THE question, therefore, that arises for decision in this appeal is whether the failure on the part of the appellant to proceed against the security under Ext. P2 with the attendant circumstance that the security lost its value, has had the effect of discharging the liability of the sureties tc the extent of the value of the security lost. The principle underlying the rule -hat the surety is entitled, on payment of the debt or performance cf all that he is liable for, to the benefit of the rights of the creditor against the principal-debtor and to be put in the same position in which the creditor stands in relation to the principal- debtor, is one of equity and rests not upon contract but on a principle of natural justice. In Craythorne v. Swinburne (I) referred to above, the court of Chancery accepted this rule of equity expounded by Sir Samuel romilly as counsel and stated the principle thus :"the surety will be entitled to every remedy which the creditor has against the principal debtor; to enforce every security and all means of payment; to stand in the place of the creditor; not only through the medium of contract, but even by means of securities entered into without the knowledge of the surety having a right to have those securities transferred to him, though there was no stipulation for that; and to avail himself of all those securities against the debtor. This right of a surety also stends, not upon contract but upon a principle. of natural justice. "this rule of equity is embodied in S. 141 of the Indian Contract Act, 1872. This right of a surety also stends, not upon contract but upon a principle. of natural justice. "this rule of equity is embodied in S. 141 of the Indian Contract Act, 1872. The said section states :" A surety is entitled 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 of the existence of such security or not; and, 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. "it is plain that the expression, is invested with all the rights which the creditor has against, the principal debtor in the section brings about even without the necessity cf a transfer and by operation of law, the vesting in the surety of all the security held by the creditor against the principal debtor. The rule of English Law is however modified in the Indian Statutory formulation of the rule by limiting the entitlement of the surety only to the security held by the creditor as at the date of the contract of suretyship. Sri V. Krishnamurthi invited our attention to the exposition of this principle of equity in Rees v. Barrington , which was referred to with approval by Hannen, J in Wulff and Billing v. Jay. The passage relied upon by Sri V. Krishnamurthi reads thus :". . . That doctrine is very clearly expressed in the notes in Rees v. Harrington (2 White and TL. C. (4th Ed.) at p. 1002 ). As a surety, on payment of the debt, is entitled to all the securities of the creditor, whether he is aware of their existence or not even though they werei given after the contract of suretyship, if the creditor who has had, or ought to have had, them in his full possession or power, loses them or permits them to get into the possession of the debtor, or does not make them effectual by giving proper notice, the surety to the extent of such security will be discharged. A surety, moreover, will be released if the creditor, by reason of what he has done, cannot on payment by the surety, give him the securities in exactly the same condition as they formerly stood in his hands. A surety, moreover, will be released if the creditor, by reason of what he has done, cannot on payment by the surety, give him the securities in exactly the same condition as they formerly stood in his hands. " ( 9 ) WHITE and Tudor's Leading Cases (4thed,) at p. 1002. it is the contention of Sri V. Krishnamurthi that in the present case the creditor by reason of what it has done, cannot, on payment by the sureties, give them the security in exactly the same condition as it formerly stood in its hands, and that therefore the liability of the sureties are, pro-tanto, reduced. ( 10 ) S. 137 of the Contract Act provides that '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 guarantee to the contrary, discharge the surety. What emerges from a reading of the provisions in Ss. 137 and 141 together is that while a 'mere forbearance' to enforce the security against the principal debtor will not discharge the surety, any act by which the creditor loses, or, without the consent of the surety, parts with the security, has the effect of discharging the surety to the extent of the value of the security. Whether any particular act on the part of the creditor constitutes 'mere forbearance' without more or constitutes an act by which the creditor puts it out of his power to handover the security to the surety, will depend upon the facts and circumstances of the particular case. While the principles are clear, the difficulty arises in their practical application to a given situation. The contention of Sri B. P. Holla is that the security 'in the hands' of the creditor in this ease is in the form of a document, Ext. P2 and that the creditor not having been in physical possession of the subject-matter of the security, cannot be said to have lost or parted with it in any sense of those expressions within the meaning of S. 141 of the Contract Act. P2 and that the creditor not having been in physical possession of the subject-matter of the security, cannot be said to have lost or parted with it in any sense of those expressions within the meaning of S. 141 of the Contract Act. But, Sri V. Krishnamurthi maintains that hypothecation of goods is an extended idea of pledge and that the obligation to preserve the security enjoined by law upon a creditor extends not merely to the security the creditor has 'in his hands' but also to what the creditor 'ought to have'. ( 11 ) AFTER a careful consideration of the matter, we are of the opinion that having regard to the nature of the security in the present case, the sureties cannot make an appeal to the provisions of S. 141 of the Contract act. In our opinion, the true principle governing the matter is stated in american Jurisprudence (Vol. 50; page 978, para 114) in terms following:" 114. Failure to enforce Security.-while the authorities appear ' to be in entire agreement on the proposition that a surety is discharged, at least to the extent of the value of the security lost, where the creditor, without the surety's consent, affirmatively releases collateral security, there seems to be some difference of opinion where a loss is claimed to have occurred through the inactivity of the creditor. The general rule, however, is that in the absence of an express agreement to use diligence, or a special request to act, or such peculiar circumstances as to render prompt action of the creditor an absolute duty , mere inaction or passive negligence on the part of the creditor in failing to take steps to secure the collection of his debt from collateral security given to him by the principal debtor is not sufficient of itself to discharge or release a surety from his obligation to pay the debt, the reason for this rule is that a surety is amply protected against the inaction or passive neglect of the creditor by virtue of the fact that if he desires to expedite payment, he may himself pay the debt, acquire all the securities held by the creditor, and become subrogated to all the rights of the creditor. Thus, as respects collateral secure ties, the rule is the same as respects the collection of the debt of the principal debtor. Thus, as respects collateral secure ties, the rule is the same as respects the collection of the debt of the principal debtor. The creditor is under no obligation of active dili- gence for the protection of the surety, so long as the surety himself remains inactive. Until the surety moves in the matter, it is enough that the creditor holds himself in readiness to transfer to him, when he applies, all the securities he holds, that he may have the benefit of such securities in aid of his own responsibility. The mere failure of a creditor to sell or fore-close against collateral in his hands will therefore not ordinarily discharge the surety. In general, sureties are not released by the failure of a creditor to enforce a mortgage or other lien which he has taken to secure the payment of his debt. Where, however, there is an agreement or understanding between the creditor and the surety, with reference to the enforcement of the security, the creditor is bound to active diligence, and ff by his negligence the property held as collateral is lost or destroyed, or surrendered, the surety will be exonerated to the extent of the loss, for the reason that the understanding or agreement to look after the security and see that the property pledged as security shall be applied to the debt destroys the duty of the surety to be vigilant and produces a false confidence, but for which he might take security for his own indemnification. Also, of course, if the creditor undertakes to enforce the collection of the collateral and is negligent in the manner of enforcing it, the surety is discharged to the extent of the loss thereby resulting. "what emerges from this enunciation is that a mere passive inactivity or passive negligence on the part of the creditor by failing to realise the debt from the collateral security is not sufficient, in itself, to discharge the surety for the reason that the surety can himself avoid consequences of such passivity by himself paying the debt and becoming subrogated to the rights of the creditor. In the absence of a contract to the contrary, the creditor is under no obligation of active diligence for the protection of the surety, so long as the surety himself remains inactive. In the absence of a contract to the contrary, the creditor is under no obligation of active diligence for the protection of the surety, so long as the surety himself remains inactive. Thus tested, the inaction on the part of the appellant or the Bank of Karnataka from which it derives title will not, of itself, mitigate sureties' liability. ( 12 ) WE will now consider the decisions cited by Sri V. Krishnamurthi for the respondents. They are the following : (i) Rainbow and wife v. Juggins ( (1879) 5 QB Division 138) was a case where defendant was surety for the repayment of a sum of money advanced by the plaintiff to the principal debtor. As a further security for the advance, the principal debtor deposited with the plaintiff a policy of life insurance. The principal debtor having subsequently become bankrupt and the advance remaining unpaid, the plaintiff proved the full debt against the estate in bankruptcy without valuing the security, which consequently, came to be claimed by the trustee in bankruptcy. The liability of the surety, in the circumstances, was held to be discharged to the extent of the value of the policy. (ii) In wulff and Billing v. Jay ( (1879) 5 QB Division 138), defendant became surety for the repayment of moneys lent by the plaintiffs to B and P who were traders. At the time of the loan the borrowers assigned, in favour of the plaintiffs, as security for the debt, the lease of their business premises, plant and fix- tures. The deed provided for repayment of the loan by 25th of August 1871 and of the interest by 5th of February 1871, and that until default in payment of either the principal or interest, borrowers should continue in possession of the property assigned to, the plaintiffs, and upon such default the plaintiff should not sell without giving the borrowers one month's notice in writing. The deed was not registered. The borrowers failed to pay interest, but the plaintiffs did not er. ter into possession. The plaintiffs received nctice a week prior to 25th of August that the borrowers were insolvent, but they allowed them tp continue in possession and on the 5th of August, the borrowers filed a, petition for liquidation under the Bankruptcy Act and were adjudicated. The trustee in bankruptcy seized and sold the goods and chattels assigned by the deed. The plaintiffs received nctice a week prior to 25th of August that the borrowers were insolvent, but they allowed them tp continue in possession and on the 5th of August, the borrowers filed a, petition for liquidation under the Bankruptcy Act and were adjudicated. The trustee in bankruptcy seized and sold the goods and chattels assigned by the deed. It was held that plaintiffs, by their omission both to register the deed and to seize the property assigned to them on default of payment of the interest, had deprived themselves of the power to assign the security to the surety, and that owing to their laches the surety was discharged to the amount that the goods were worth. (iii) The next case is the State of M. P. v. Kaluram (AIR. 1867 SC, 1105), where one jagatram purchased, at an auction of timber held by the Divisional Forest officer, Hoshangabad on 20th July 1954 and the appellant along with one nathuram stood surety for him for any sum which may become payable by jagatram to the Governor. Under the provisions of the Contract which invoked the provisions of the Forest Contract Rules and under the provisions of the Indian Forest Act the State had a charge over the goods sold as well as the right to remain in possession till payment of the instalments of price by the contractor. In those circumstances, the fact that Jagatram was permitted by the authorities to remove the goods without pre-payment was held by the Supreme Court to be an act which under S. 141 of the contract Act, had the effect of discharging the liability of the surety pro-tanto. (iv) In the case of Amrit Lal Goverdan Lalan (3) the appellant had executed a letter of guarantee in favour of the Travancore Forward Bank Ltd, respecting the liability of the borrowers who had agreed to open in the books of the Bank a Cash Credit Account to the extent of Rs. 1,00,000 to be secured by goods pledged, one of the conditions of that contract being that borrowers had to remit the advance value or make a substitution of goods of equal value before withdrawing any of the pledged goods from the custody of the Bank. 1,00,000 to be secured by goods pledged, one of the conditions of that contract being that borrowers had to remit the advance value or make a substitution of goods of equal value before withdrawing any of the pledged goods from the custody of the Bank. The pledged goods were verified by the employees of the Bank and on 18-4-1957 when an inventory was taken, there was a shortage of goods to the value of Rs. 35,690. In the suit against the sureties filed by the State Bank of Travancore as the successor-in-interest of the, lending Bank, the Supreme Court held that in the facts and circumstances of the case, provisions of 9. 141 of the Contract Act were invoked and the liability of the sureties stood mitigated to the extent of Rs. 35,690 being the value of the goods lest from the custody of the Bank. In the three cases referred to in sub-paras (1) and (iii) and (iv), the creditor had the physical custody of the security and the security was lost owing to the negligence of the creditor. They were cases where the act or omission held proved against the creditor were, demonstrably acts not of mere forbearance', but something more. In Wullf and Billing v. Jay ( (1872) 7 QB. 756) referred to above, the circumstance that the omission on the part of the creditor in securing legal efficacy and enforceability for the security by getting the deed registered and the inaction, despite the notice of bank- ruptcy a week before the traders, in fact, filed a petition under the Bank ruptcy Act, in taking possession constituted acts of the creditor, which were not acts of mere forbearance' and in the circumstances made a difference of degree a difference of kind. The cases cited by Sri V. Krishnamurthi , therefore, are clearly distinguishable from the position obtaining in the present case. ( 13 ) WE ought, perhaps, to notice here another argument addressed by sri B. P. Holla, which, proceeding as it does upon the construction of cl (5) of the surety bond, Ex. P3, was to the effect that, in any event, the sureties had waived and contracted out of the benefit of S. 141. In the said cl (5) of Ext. P3, it is stipulated that the creditor would be at liberty, inter-alia, to release any other security held or to be held. P3, was to the effect that, in any event, the sureties had waived and contracted out of the benefit of S. 141. In the said cl (5) of Ext. P3, it is stipulated that the creditor would be at liberty, inter-alia, to release any other security held or to be held. It was contended by Sri Krishnamurthi that the expression 'other' obtaining in that clause would only refer to security other than the one held under Ext. P2, and that therefore, the argument of Sri Holla in this behalf is not tenable. It is unnecessary to go into this question in the view we have taken that even if there is no such surrender and contracting out, the sureties could not appeal to the provisions of S. 141 which in the facts and circumstances of the case was not attracted. ( 14 ) THE foregoing discussions dispose of all the contentions urged by both the parties before us in this appeal. However, we asked the learned counsel for the appellant to clarify whether the assignment of the debt under the pronotee-Ext. P1 by the Bank of Karnataka Ltd, in favour of the appellant would also operate to assign, the benefit of the security under extp3. Sri B. P. Holla, learned Counsel for the appellant took time and filed an application under Or. 41, R. 27 CPC seeking to produce a letter dt. 25-6-1976 from ths Reserve Bank of India, Dept of Banking Operations and Development, Bombay, on the basis of which he contends that the scheme of transfer of the assets and liabilities of the Bank of Karnataka Ltd, in favour of the appellant attracts the provisions ot S. 44a (6) of the Banking regulation Act, 1949, and that the assignment of the benefit of the security is also effectuated by operation of law. He also sought to rely upon the provisions of S. 8 of the Transfer of Property Act. ( 15 ) THE additional evidence sought to be produced by the appellant requires to be admitted as being required to enable this Court to pronounce judgment and the said letter of the Reserve Bank of India whose authenticity is not disputed is marked as a part of the documentary evidence in this case. ( 15 ) THE additional evidence sought to be produced by the appellant requires to be admitted as being required to enable this Court to pronounce judgment and the said letter of the Reserve Bank of India whose authenticity is not disputed is marked as a part of the documentary evidence in this case. By the said letter, the Reserve Bank of India has confirmed that the agreed assets and liabilities of the Bank of Karnataka Ltd, were transferred to the Karnataka Bank Ltd, the appellant, with effect from the close of business on the 29th of Decr 1966 with prior approval of the Reserve bank of India. This prima facie shows that the sanction of the Reserve bank of India for a scheme for transfer of the assets and liabilities of the bank of Karnataka Ltd, to the appellant has been granted by the Reserve bank of India. That apart, in the present case, the pronote Ext. P1 has been duly negotiated by the endorsement by the Bank of Karnataka Ltd, in favour of the appellant. This fact is not disputed before us. In regard to the proposition whether upon an assignment of the debt, the security therefore also stands assigned, the following passage from Halsbury's Laws of england-3rd Ed. Vol. 8 p. 260 may be referred :" 454. Assignment of Securities. The assignment of a debt may perhaps imply the assignment of the securities therefor, on the other hand, securities may be assigned with the intention of assigning debt but without the necessary formalities for the assignment of the debt, and in such case, though the assignee cannot recover the debt, yet neither the assignor nor his representative can recover the securities, and the result may be that no one can recover the debt. " ( 16 ) HAVING regard to all the circumstances, including the fact that this question was not raised by the respondents, we consider it proper in this case to proceed on the basis that the appellant is entitled to the benefit of the security under Ext. PS and that it is not necessary for us to pronounce on the question of law as to the matter. PS and that it is not necessary for us to pronounce on the question of law as to the matter. ( 17 ) IN the result, we allow this appeal and in reversal of the decree of dismissal of the suit as against respondents 1 and 2 by the Court below, we decree plaintiff's suit as against respondents 1 and 2 for the sum of rs. 25,000. Respondents 1 and 2 shall, however, not be liable to interest prior to: the date of the suit as no demand as contemplated in Ext. P3 had come to be made on them. So far as interest from the date of suit till date of realisation is concerned, having regard to ail the circumstances of the case including the circumstance that the benefit of the security under Ext. P2 wag not available to them, we consider it inequitable to impose on respondents 1 and 2 a liability towards pendente lite and future interest at a rate in excess of 3 per cent per annum and accordingly we direct that the said sum of Rs. 25,000 decreed against respondents 1 and 2 shall carry interest at 3 per cent per annum from the date of suit till date of payment. We also direct that the appellant and respondents 1 and 2 will bear and pay their own costs both here and below. --- *** --- .