Corporate Insolvency and the Creditor-Guarantor Dilemma

[Akash Santosh Loya is a final year student of the 5-year B.A. LL.B. (Hons.) course at the National University of Advanced Legal Studies]

Introduction

There have been a number of decisions dealing with the rights of a creditor vis-à-vis guarantor under the Insolvency and Bankruptcy Code, 2016 (IBC). The adjudicating authorities have provided sufficient clarity on myriad issues ranging from whether the moratorium under section 14 of the IBC applies to the assets of guarantor to whether the corporate insolvency resolution process (CIRP) can be initiated against the guarantor even before the same is initiated against the corporate debtor.[1] However, there has not been much discussion on the rights of creditor vis-à-vis the guarantor after the conclusion of the CIRP. In this post, the author intends to analyse the same. Further, the rights of guarantor in relation to the corporate debtor in such a scenario are also discussed.

Right of creditor vis-à-vis the guarantor

Once the CIRP is concluded and the resolution plan is approved by the adjudicating authority under section 31 of the IBC, the debt owed by the corporate debtor is settled. No proceedings can be initiated against the corporate debtor in relation to the debt that is settled. However, proceedings can be initiated against the guarantor for the recovery of remaining debt amount because of the following reasons.

(a) That the contract of guarantee is an independent contract

The liability of guarantor is co-extensive with that of principal debtor. Therefore, upon the default of principal debtor, a right is accrued in favor of creditor against both the principal debtor and the guarantor. This liability is independent in itself as the contract of guarantee is an independent contract.[2] The guarantor becomes liable towards the entire debt amount for which the guarantee is provided and can be proceeded against irrespective of whether any proceedings have been initiated or are pending against the principal debtor.[3] The right of the creditor to proceed against the guarantor is one which is independent of its right to proceed against the principal debtor.[4] Therefore, the proceedings against the principal debtor cannot act as a bar to proceedings against the guarantor. The creditor can always recover the due amount from the guarantor which it was not able to recover from the principal debtor. In fact, the Supreme Court has also recognized this right of creditor in State Bank of India v. V. Ramakrishnan[5] by observing that the object of the IBC is not to allow the guarantor to escape its liability to pay the debt.

(b) That there is no discharge of guarantor under the Indian Contract Act, 1872

Under the Indian Contract Act, 1872, there are various circumstances provided in which the guarantor may be discharged of its liability towards the creditor. The two circumstances that require sufficient consideration are as follows:

i. An act of creditor, the legal consequence of which is discharge of the principal debtor.

A guarantor is discharged of its liability towards the creditor if the creditor on its own instance discharges the principal debtor.[6] The essential element that needs to be satisfied is that the discharge of the debtor should be through a voluntary act of the creditor. If the discharge of debtor is not through a voluntary act of the creditor but due to operation of law, then the guarantor is not discharged and can be held liable.[7] Any scheme or plan that is approved by a court or tribunal becomes a statutory scheme and is an act in operation of law.[8]

Under the IBC, the debtor is discharged on approval and implementation of resolution plan. The resolution plan is approved when the National Company Law Tribunal (NCLT) is satisfied that the resolution plan is approved by the prescribed majority of the committee of creditors and its contents are in accordance with the law.[9] Therefore, the principal debtor is discharged under the IBC not on the instance of a creditor but due to the operation of law, i.e., approval of the NCLT after its satisfaction. The creditor may or may not be favor of the resolution plan. However, once the same is approved by the NCLT, the debtor is discharged and the said decision is binding on the creditor. Thus, the guarantor is not discharged of its liability towards the creditor on the discharge of principal debtor’s liability under the IBC.

ii. Any variance in terms of the debt

If the contract between the principal debtor and the creditor is varied without guarantor’s consent, the guarantor is relieved from its liability to pay off the debt.[10]  One such variance can be a change made to the debt owed by the principal debtor. If such a change is made without the consent of guarantor, the guarantor is relieved from making any payment. Such a situation may arise in the context of IBC proceedings wherein a reduced return for the debt may be granted by the resolution plan. This issue has been dealt with by the Supreme Court in V. Ramakrishna. The Court, while addressing this issue, placed strong reliance on section 31 of the IBC which states that once the resolution plan is approved it will be binding on all stakeholders including the guarantors. On the basis of the said provision, it held that the guarantor cannot be relieved from making payment by virtue of section 133 of the Contract Act even if the debt is varied under the resolution plan as the resolution plan is binding on the guarantor as well.[11]

Rights of guarantor vis-à-vis the corporate debtor

A guarantor has a right of subrogation against the principal debtor under section 140 of the Contract Act for the debt amount paid on behalf of the principal debtor. However, no such right can be enjoyed when the payment is made by the guarantor after the CIRP in relation to the debt for which the guarantee is provided is concluded. The same is due to the following reasons.

(a) The proceedings under the IBC are not recovery proceedings

This issue is squarely covered by the judgement of the National Company Law Appellate Tribunal (NCLAT) in Lalit Mishra and Ors. v. Sharon Bio Medicine Ltd.[12] The NCLAT held that the guarantor cannot exercise its right of subrogation under the Contract Act as proceedings under the IBC are not recovery proceedings. The object of the proceedings under the IBC is to revive the company and focus on maximization of value of its assets and not to ensure that credit is available to all stakeholders. Thus, no such recovery can be made by guarantor.

(b) In any case, IBC will prevail over Contract Act

As already stated above, once the resolution plan is approved under section 31 of the IBC, the same is binding on all stakeholders including the guarantor. No further claims can be raised by anyone including the guarantor against the principal debtor after such approval. In contrast to the same, under the Contract Act the guarantor has a right of subrogation[13] and the right to be indemnified[14] against the principal debtor. Both these provisions under the contract law basically provide that the guarantor can file a claim against the principal debtor to recover the proceeds it has paid to the creditor. Therefore, there arises a clear inconsistency between the provisions of the Contract Act and section 31 of the IBC because the former grants a right to raise a claim against the principal debtor whereas the latter prohibits any such claims.

The solution to resolve this inconsistency has been provided under section 238 of the IBC. It states that if there is inconsistency between IBC and any other law, the IBC will prevail. This view has also been upheld by the Supreme Court in PR Commissioner of Income Tax v. Monnet Ispat and Energy Ltd.[15] and Innoventive Industries Ltd. v. ICICI Bank and Ors.[16]

Therefore, the IBC will prevail over the Contract Act, thereby denying the guarantor of its rights under the Contract Act.

Akash Santosh Loya

[1] Ferroy Alloys Corpn Ltd. v. Rural Electrification Corpn. Ltd., (2019) 1 taxmann.com 283, ¶ 39 (CIRP can be initiated against the guarantor even before the same is initiated against the debtor); State Bank of India v. V. Ramakrishnan, (2018) 96 taxmann.com 271 (SC), ¶19 (moratorium under section 14 does not extend to guarantor’s assets).

[2] BMD (P) Ltd. v. SVL Ltd., [2018] 98 taxmann.com 61 (NCLT-Chennai), ¶7.

[3] Bank of Bihar Ltd. v. Damodar Prasad, A.I.R. 1967 S.C. 297.

[4] Bank of India v. Gupta Infrastructure (India) Ltd., [2018] 91 taxmann.com 117 (NCLT – Mum.), ¶34.

[5] [2018] 96 taxmann.com 271 (SC), ¶ 23.

[6] Indian Contract Act, 1872, section 134.

[7] Maharastra State Electricity Board, Bombay v. Official Liquidator, High Court of Ernakulam, A.I.R. 1982 S.C. 1497, ¶ 7; See also Jagannath Ganeshram Aggarwala v. Shivnarayan Bhagirath, A.I.R. 1940 Bom. 247, ¶ 5.

[8] Garner’s Motor Ltd, In re (1937) 1 Ch. 594, 598.

[9] Insolvency and Bankruptcy Code, 2016, section 31.

[10] Indian Contract Act, 1872, section 133.

[11] Note 3 above, at ¶ 22.

[12] Company Appeal (AT) (Insolvency) No. 164 of 2018 (Date of Judgement: December 19, 2018), ¶ 9.

[13] Indian Contract Act, 1872, section 140.

[14] Indian Contract Act, 1872, section 145.

[15] SLP(C) Nos. 6483/2018 (Date of Order: August 10, 2018).

[16] A.I.R. 2017 S.C. 4084, ¶ 55.

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1 comment

  • REACTION (provoked by simple commion sense)

    After the coming into force of the ‘IBC’. and under its regime,for obvious reasons, the principal ‘debtor’ happens to have been pushed behind; and virtually, for all practical purposes – especially for debates and discussions of this kind, – with ‘GUARANTOR’ having come to occupy the center stage / to face the lime light .

    Impliedly does that mean, for all such future transactions of lending and borrowing , by / with financing institutions, ‘guarantor’ is a necessary party. In other words, imaginably, no lending should – or would be permitted , without a guarantor, – or more prudently more than one- qualifying /competent, as such, to TAKE OVER and become answerable to lender, in respect of the loan liability on default by the principal debtor.

    ANYone with brainy ideas on the foregoing mindblowing lines, to entertain; if not to enlighten !
    courtesy

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