A few words on the rule of ‘Contra Proferentem’ (Contract Law demystified)

The concept can be best explained through the facts of a recent case (which are fairly straightforward). Picture this:

  • A bank called – ‘No Bank’ lent various credit facilities to ‘X’ Company totalling to about 12 lakhs, on the security of moveables and raw material.
  • Later, ‘X’ Company’s directors (let’s call them Y and Z) gave a personal guarantee (on 30.08.1974) and became guarantors/sureties.
  • As on that date, the total outstanding that X company owed to ‘No Bank’ was about 8 lacs.
  • The Promissory notes, letter(s) of guarantee (together the “Guarantee Documents”) made no mention as to whether the guarantee was w.r.t monies already owed by X Company to the Bank or only for loans advanced subsequent to execution of the guarantee documents.
  • The Guarantee Documents (drafted by Bank draftsmen) were ambiguous in that regard.
  • The principal debtor Company ‘X’ defaulted and Bank proceeded to sue the Directors (Y and Z) for the outstanding debt of 8 lacs (as on 30.08.1974).
  • Directors refused to make payment on the premise that their liability can only be prospective, that is to say, for debts taken after they had stood guarantee for X Company.
  • The Bank argued that the creditor/Bank was under no obligation to apprise the sureties of the previous outstanding amount and is legally entitled to legitimately appropriate payments made by surety to the earlier debts.

Court decision: 

  • To resolve this controversy, the Court relied on the classic doctrine of  contra proferentem (which is Latin for : “against [the] offeror”). This doctrine stipulates  that whenever a promise, agreement or a term is ambiguous, the same has to be interpreted against the interests of its draftsman. (This is grounded in strong common-sense and logic, since the draftsman is naturally to be blamed more for shoddy drafting, if not downright malicious intent. Further, a person drafting a vague clause may have a vested interest in keeping things vague and uncertain, which cannot be incentivised by interpreting the clause in his favour). The doctrine is often applied to situations involving standardized contracts or where the parties are of unequal bargaining power. 
  • The Court’s observations in this regard are instructive :

5. So far as the factual matrix is concerned, the respondent Company was a constituent of the appellant Bank for a considerably long period and had availed of various facilities including cash credit, etc. It is not in dispute that of the limit of Rs 12 lakhs sanctioned by the appellant Bank in favour of the respondent Company, the balance on the close of the business on 29-8-1974 was Rs 7,68,853.39, and the latter stood indebted to the former for the aforesaid sum. The learned counsel for the appellant Bank had sought to rely on Montosh Kumar Chatterjee v. Central Calcutta Bank Ltd. [Montosh Kumar Chatterjee v. Central Calcutta Bank Ltd., 1952 SCC OnLine Cal 243 : (1952-53) 57 CWN 852] , the ratio of which appears to be that a creditor is not bound to volunteer to a surety information as to the state of the principal debtor’s account; and that a creditor is entitled to appropriate payments received subsequent to the execution of a guarantee bond, even so far as a pre-existing debt of which the surety had no knowledge; that there can be no presumption that the surety will be efficacious for prior as well as current and future debts. We note that in the case in hand, the letter of guarantee signed on 30-8-1974 by Respondents 2 to 4 makes no mention of any old transactions, although it specifically records that the liability of the guarantors cannot exceed Rs 12 lakhs. The letters of guarantee could easily have recorded the liabilities outstanding against the respondent Company on 30-8-1974 with an affirmation from Respondents 2 to 4 that they were guaranteeing these outstandings. Woefully for the appellant Bank, there is no such acknowledgment or assumption of liability in the subject guarantee. The High Court has pithily noted the statement of PW 1, Accountant of the appellant Bank, who has deposed to the effect that the deed of guarantee made no mention of any prior transactions. It appears to us that if any doubts in this regard still persisted, they stood dispelled by the testimony of DW 1, who has stated in his cross-examination that the appellant Bank obtained the guarantee deed on the understanding that it would be effective and relevant only with regard to debts subsequent to 30-8-1974. This very witness had also clarified that the guarantee arrangements made no mention whatsoever that they were effective in respect of prior debts.

6. The decision in Sita Ram Gupta v. Punjab National Bank [Sita Ram Gupta v. Punjab National Bank, (2008) 5 SCC 711] is of no advantage to the appellant Bank. That decision concerns the possibility of a guarantor revoking his continuing guarantee, with the objective of escaping his liability. This is not the case before us inasmuch as the defence of Respondents 2 to 4 is that they had agreed to stand surety only for transactions after 30-8-1974. Our attention was also drawn to B.G. Vasantha v. Corporation Bank [B.G. Vasantha v. Corporation Bank, (2005) 10 SCC 215] as also M.S. Anirudhan v. Thomco’s Bank Ltd. [M.S. Anirudhan v. Thomco’s Bank Ltd., AIR 1963 SC 746] but these decisions do not call for a detailed analysis. It is the appellant Bank which drafted the guarantee deed, and in case of doubt, the document would be read against it. This is the contra proferentem rule, which is of a vintage which brooks no contradiction.

7. In view of the foregoing discussion, there appears to be no controversy as to the fact that the guarantee deeds executed by Respondents 2 to 4 on 30-8-1974 rendered them personally liable for any transactions or advances made by the appellant Bank to the respondent Company after 30-8-1974. There is also no controversy whatsoever that the bank account lay dormant after this date, all dealings having been transacted much prior thereto. Such being the position, it is not open to the appellant Bank to pursue Respondents 2 to 4 for recovery of debts incurred by the respondent Company in favour of the appellant Bank. We may clarify that our decision is founded on the evidence that has been recorded in this suit. We should not be misunderstood to have held that a guarantor can, in no circumstances be fastened with liabilities which had been incurred in the past which the guarantor assumed liability for.

Facts borrowed from the SC decision in : Central Bank of India v. Virudhunagar Steel Rolling Mills Ltd., (2015) 16 SCC 207

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