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CS Professional · Banking and Insurance - Laws and Practice · Advances, Securities and Documentation

Union Bank sanctions a construction loan to Deccan Builders, payable in stages as work reaches set milestones, on the guarantee of Farid for proper completion. Without telling Farid, the bank releases the last two stage payments to Deccan Builders in advance, before the milestones are reached. Deccan later abandons the work. What is the effect on Farid's guarantee?

Farid is discharged. Paying the final instalments before the milestones were reached was an act inconsistent with the surety's rights, and it impaired his eventual remedy against the principal debtor. Under the Contract Act, that discharges the surety whatever the bank's intentions.

  1. AFarid remains fully liable because the bank acted in good faith
  2. BFarid is liable only for the advance payments
  3. CFarid is liable if the bank proves actual loss
  4. DFarid is discharged, as the bank's act was inconsistent with his rights and impaired his eventual remedyCorrect

Explanation

If the creditor does an act inconsistent with the surety's rights and the surety's eventual remedy against the principal debtor is impaired, the surety is discharged. Releasing the last stage payments early removes the safeguard the milestones gave, so Farid is discharged. Good faith is not a defence, so option 1 is wrong.

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