[Aayush Mitruka is a lawyer based in Delhi]
The latest ruling of the National Company Law Appellate Tribunal (Appellate Tribunal) in the case of State Bank of India (SBI) v V Ramakrishnan and another has evoked another controversy touching upon the Insolvency and Bankruptcy Code, 2016 (Code) that serves as a major setback to creditors. The moot question was whether a financial creditor can proceed against the assets of a personal guarantor while the corporate debtor is undergoing a corporate insolvency resolution process (CIRP).
Brief facts
Mr. V. Ramakrishnan, the managing director and promoter of Veesons Energy Systems Limited had given personal guarantee against the loan secured by Veesons from SBI. Veesons (i.e. the corporate debtor) was sent for insolvency resolution by the lender and accordingly a moratorium was declared. SBI invoked the personal guarantee against the personal guarantor and, following that, the bank issued a possession notice and took symbolic possession of the secured assets in accordance with the provisions of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI Act). The personal guarantor filed an application before the National Company Law Tribunal, Chennai (Tribunal) for halting of the proceedings under the SARFAESI Act initiated against him in his capacity of a personal guarantor.
NCLT – Chennai’s Decision
The Tribunal ruled in Mr. Ramakrishnan’s favour and held that in this case he, as guarantor, will substitute the lenders and as a result fresh security interest will be created on the corporate debtor’s property. Such an interest will naturally be created during the moratorium period. The Tribunal reasoned that creation of such an interest will affect the liability of the borrower and therefore cannot be permitted. The Tribunal placed reliance on sections 14 and 31 of the Code, which has been reproduced below:
14. Moratorium: (1) Subject to provisions of sub-sections (2) and (3), on the insolvency commencement date, the Adjudicating Authority shall by order declare moratorium for prohibiting all of the following, namely:— ….
(b) transferring, encumbering, alienating or disposing of by the corporate debtor any of its assets or any legal right or beneficial interest therein; ..
31. Approval of resolution plan: (1) If the Adjudicating Authority is satisfied that the resolution plan as approved by the committee of creditors under sub-section (4) of section 30 meets the requirements as referred to in sub-section (2) of section 30, it shall by order approve the resolution plan which shall be binding on the corporate debtor and its employees, members, creditors, guarantors and other stakeholders involved in the resolution plan.…
Further, in this connection, the Tribunal also placed its reliance on section 140 of the Indian Contract Act, 1872. Under section 140, where a guarantor has paid the whole or part of the liability which he guaranteed, the guarantor enters into the shoes of his creditor and gets all the rights which he had against the principal debtor. For the aforesaid, the Tribunal allowed the application filed by the personal guarantor and consequently restrained SBI from proceeding against him till the moratorium period is over.
Appellate Tribunal’s Decision:
SBI, being aggrieved by the decision of the Tribunal approached the Appellate Tribunal. The Appellate Tribunal concurred with the decision of the Tribunal and ruled that a creditor cannot invoke personal guarantee while the borrower is undergoing CIRP. In other words, the moratorium on sale of assets applies not only to those of corporate debtor but also to the personal guarantors’ assets.
Inconsistent views?
This issue of promoter guarantee has been highly debatable and a contentious one. The decision has evoked mixed response from the legal fraternity and added more confusion. At the outset, it must be pointed out that the Appellate Tribunal in its earlier decisions in the cases of Alpha & Omega Diagnostics v Asset Reconstruction of Company India Limited (Alpha & Omega) and Schweitzer Systemic India Private Limited v Phoenix ARC had held that the moratorium provision will only affect the assets of the insolvent borrower. In these decisions, much emphasis was laid on the term “its” employed in section 14(a) of the Code. The Appellate Tribunal neither discussed nor did it take into consideration sub section (b) of section 14 while arriving at its earlier decision.
Interestingly enough, the Appellate Tribunal did categorically make the following observation in its decision in the case of Alpha & Omega:
5. However, we are not inclined to accept such submissions as Appellant-Corporate Applicant has sought for “its” own insolvency resolution process that will include only the assets of the Corporate Debtor and not any assets, movable or immovable of a third party, like any director or other. In so far as ‘guarantor’ is concerned, we are not expressing any opinion, as they come within the meaning of ‘Corporate Debtor individually’, as distinct from principal debtor who has taken a loan.”
[Emphasis supplied]
In spite of the observation set out above, one would find it extremely difficult to reconcile the two sets of decisions. The Appellate Tribunal in the present decision (at least) ought to have taken the two earlier decisions into consideration (and possibly distinguished) to arrive at the present finding. There is absolutely no discussion of the prior decisions by the Appellate Tribunal. Quite to the contrary, the Appellate Tribunal in the Ramakrishnan decision concludes by holding:
18. In view of the aforesaid provisions, we hold that the ‘Moratorium’ will not only be applicable to the property of the ‘Corporate Debtor’ but also on the ‘Personal Guarantor’.
The absolute statement made by the Appellate Tribunal makes the situation more complicated and throws open a can of worms. It strongly suggests that no recovery proceedings can be initiated or continued against the personal guarantors during a CIRP. It must be appreciated that one may argue that, if looked contextually, this judgment will suggest that rights cannot be exercised against the guarantors only when they affects the liability of the corporate debtor. However, it remains to be seen how this finally turns out.
Some Observations
It is debatable whether the subrogation of a guarantor to the position of the creditor will actually lead to creation of any fresh encumbrance. One may argue (and rightly so) that this does not lead to creation of any fresh encumbrance on the assets of the borrower as it merely leads to replacement of the encumbrance from the lender to the guarantor.
Secondly, the whole idea behind protecting any asset under section 14 of the Code is so that it can be used while drawing a resolution plan. In a situation (like the present one) where the asset is not owned by the corporate debtor, that will anyway be precluded from being a part of the plan. Thus, in such a situation, it is absurd to protect it under section 14 of the Code. Section 14 is as clear as it can be.
Pertinently, section 22 of the erstwhile Sick Industrial Companies (Special Provisions) Act, 1985 (SICA) provided very limited protection to the guarantors. In absence of any such protection in section 14 of the Code, it can be argued that this would go to establish that the guarantor would not get any protection or benefit (limited or otherwise) under an order of moratorium that has been passed in favour of the corporate debtor.
Conclusion
It is well known that the protection provision under SICA was subjected to large scale abuse. The present interpretation adopted by the Appellate Tribunal will lead to rampant misuse of the provision by the personal guarantors. Note that personal guarantors in most cases are the promoters of the company. Besides, I must add that the underlying principle by extension will also be applicable to corporate guarantors. Undoubtedly, the decision is bound to make it difficult for the creditors to recover their dues.
The curtains have not been dropped on this issue. The Supreme Court is yet to consider this critical and pivotal issue and the final word has to come from it. Further the committee currently reviewing the Code to suggest changes in order to iron out various wrinkles identified so far is reported to consider this significant issue.
Aayush Mitruka
