THE HON'BLE MR JUSTICE L.NARASIMHA REDDY WRIT PETITION No.23103 of 2002 ORDER: M/s.Ayyappa Pulverisers and Allied Services (Private) Limited, the second respondent herein, intended to establish an industrial unit in Plot Nos.126 and 127, I.D.A., Kondapalli, Krishna District. It applied for loan to the State Financial Corporation, the first respondent herein, and accordingly, a sum of Rs.19/- lakhs was sanctioned and released. The land and machinery of the industrial unit was mortgaged to the first respondent. In addition to that, the petitioner stood as surety for repayment of the loan. The second respondent committed default. Therefore, steps were initiated by the first respondent under Section 29 of the State Financial Corporations Act, 1951 (for short ‘the Act’). The plant and machinery of the second respondent were seized and were put to sale. On the ground that satisfactory offers were not received, the first respondent sought to proceed against the properties of the petitioner, offered as security. Thereupon, she filed W.P.No.17616 of 2000. This Court disposed of the writ petition directing that the petitioner shall be put on separate notice before any action is initiated against her. The first respondent made a second attempt to sell the assets of the second respondent. At that stage, the latter came forward with a request to extend the benefit of One Time Settlement (OTS). On the basis of the arrangement that was agreed to between respondents 1 and 2, seized unit was handed over and the second respondent paid a sum of Rs.6/- lakhs. On the ground that the second respondent did not pay the balance of the amount, the first respondent issued a notice to the petitioner proposing to proceed against her properties. The petitioner challenges the action of the respondents. She contends that there is no justification for the first respondent to proceed against her properties, without taking any steps vis-à-vis the primary assets. She also states that the arrangement in the form of OTS took place without notice to her and in that view of the matter, her surety ceased to exist. The first respondent filed a counter-affidavit referring to various facts, which are matters of record. It is admitted that initially the plant and machinery of the second respondent were brought to sale and when satisfactory offers were not received, attempts were made to proceed against the properties of the petitioner. They admit the factum of extension of benefit of OTS to the second respondent. It is, however, pleaded that the second respondent did not fulfil the terms of OTS and thereby, the necessity has arisen to proceed against the properties of the petitioner. Heard Sri M.S.Prasad, learned counsel for the petitioner, and Sri M.Vidya Sagar, learned Standing Counsel for the first respondent. The petitioner figured as a surety in the loan transaction between respondents 1 and 2. There is no dispute that the second respondent committed default in repayment of the loan. Therefore, the first respondent exercised its power under Section 29 of the Act and seized the primary assets. Alleging that the response in the auction was not encouraging, steps were initiated to proceed against the properties of the petitioner. This Court intervened in W.P.No.17616 of 2000 and held that before any steps are taken against the properties offered as surety, separate notice must be issued. Certain developments have taken place thereafter, and now, the first respondent intends to proceed against the properties of the petitioner. One thing, which needs to be mentioned, at this stage, is that the first respondent cannot proceed directly against the properties of the petitioner under Section 29 of the Act. I n Karnataka State Financial Corporation v. N.Narasimahaiah[1], the Supreme Court held that a State Financial Corporation does not have the power to invoke Section 29 of the Act against the properties of a surety and that it has to initiate proceedings either under Section 31 or 32-G of the Act. Admittedly, no such steps were initiated in the instant case. A creditor can proceed against the principal debtor or a surety to recover the debt. His option, in this regard, is unqualified. However, if any arrangement or composition takes place between creditor, on the one hand, and the principal debtor, on the other hand, without the knowledge of the surety, the obligation of the surety ceases to exist. Section 135 of the Indian Contract Act, 1872 (for short “the 1872 Act”) is clear, on this aspect. “Discharge of surety when creditor compounds with, gives time to, or agrees not to sue, principal debtor:- A contract between the creditor and the principal debtor, by which the creditor makes a composition with, or promises to give time to, or not to sue, the principal debtor, discharges the surety, unless the surety assents to such contract.” It is not dispute that an arrangement in the form of OTS has taken place between respondents 1 and 2. The petitioner was not put on notice, nor her consent was obtained in the transaction. The OTS has brought into existence what is known as a composition contemplated under Section 135 of the 1872 Act. The terms and conditions of loan transaction have undergone radical and substantial change without the participation of the surety. Thereby, the obligation of the surety ceases to exist by operation of Section 135 of the 1872 Act. Viewed from any angle, the respondents cannot proceed against the petitioner. Therefore, the Writ Petition is allowed as prayed for. There shall be no order as to costs. _______________________ Dt.28.11.2008 L.NARASIMHA REDDY, J GJ [1] (2008) 5 Supreme Court Cases 176