Court-sanctioned composition extinguishing principal debt discharges the surety and defeats recovery against the guarantor.

A court-sanctioned scheme of arrangement under the Companies Act, 1956 binds all creditors and may extinguish the principal debtor's remaining liability. Where the sanctioned composition finally reduces and extinguishes the debt, the surety cannot be proceeded against for that same extinguished liability because the surety's obligation is co-extensive with the principal debt. On that basis, a recovery notice issued against the guarantor under the State Financial Corporations Act, 1951, is without jurisdiction and cannot stand. Cases where only the remedy was barred, rather than the debt itself extinguished, were distinguished.

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Issues: Whether a scheme of arrangement sanctioned under sections 391 and 394 of the Companies Act, 1956, which scales down and extinguishes the remaining liability of the principal debtor, amounts to a composition with the principal debtor so as to discharge the surety under sections 134 and 135 of the Indian Contract Act, 1872, and render a recovery notice under section 32G of the State Financial Corporations Act, 1951, against the guarantor illegal.

Analysis: A scheme sanctioned by the company court under section 391 of the Companies Act, 1956, binds all creditors, including dissenting creditors, and has statutory force. Where such a scheme results in extinction of the creditor's remaining claim against the principal debtor, the legal position is not merely that the creditor's remedy is barred; the debt itself stands extinguished to the extent covered by the sanctioned arrangement. In such a situation, the surety cannot be fastened with an independent liability for the same extinguished debt, because the surety's liability is co-extensive with that of the principal debtor and the surety cannot be required to pay a debt that no longer survives against the debtor. The cases dealing with liquidation, abatement, dismissal, or other situations where only the remedy is barred were distinguished on this basis.

Conclusion: The sanctioned revival scheme constituted a binding composition that extinguished the remaining claim against the principal debtor, and the petitioner as surety stood discharged. The notice issued under section 32G of the State Financial Corporations Act, 1951, was without jurisdiction and could not be sustained.

Final Conclusion: The guarantor could not be proceeded against after the company court-sanctioned settlement had finally reduced and extinguished the principal debt, and the recovery action was quashed.

Ratio Decidendi: A court-sanctioned composition or arrangement that extinguishes the principal debtor's liability also discharges the surety, because the surety's liability cannot exceed a debt that no longer survives against the principal debtor.

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