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Co-Extensive Liabilities and Subrogation Rights in Corporate Insolvency: The Supreme Court’s Stance

[Parth Birla is a fourth-year student at Hidayatullah National Law University, Raipur]

Recently, the Supreme Court, in BRS Ventures Investments Ltd. v. SREI Infrastructure Finance Ltd., had the opportunity to interpret the overlapping mechanisms of the concept of Guarantee in the Corporate Insolvency Resolution Process. This case delves into the intricacies of the Insolvency and Bankruptcy Code, 2016 (IBC) and the Indian Contract Act, 1872 (ICA), highlighting how the liabilities of corporate guarantors and debtors are addressed within the framework of insolvency laws. The decision underscores the co-extensive nature of guarantor and debtor liabilities, the impact of resolution plans, and the ability of financial creditors to pursue simultaneous proceedings against guarantor and debtor, providing important clarifications pertaining to long-standing doubts in the IBC regime. This post, firstly, demarcates the facts of the case and the arguments raised by the parties. Secondly, it outlines the findings and interpretation of the Supreme Court and finally, analyzes the Court’s observations in the context of relevant precedents.

Background of the Case

Insolvency of the Corporate Guarantor

SREI Infrastructure Finance Ltd. (Financial Creditor) granted a loan of Rs. 100 crores to Gujarat Hydrocarbon and Power SEZ Ltd. (Corporate Debtor), a subsidiary of Assam Company India Ltd. (ACIL), for setting up a Special Economic Zone project. This loan was secured by a corporate guarantee given by ACIL (Guarantor). Upon default by the Corporate Debtor, SREI invoked the corporate guarantee provided by ACIL. However, the guarantor was unable to repay the loan. An application under section 7 of the IBC was filed against ACIL, leading to the admission of the case by the NCLT in 2017. The financial creditor claimed Rs. 648.81 crores, which included the principal loan amount. A resolution plan by BRS Ventures Investments Ltd. (BRSVIL, Appellant) was approved, with them paying Rs. 38.87 crores in full and final settlement to the financial creditor.

Insolvency of the Corporate Debtor

In 2020, the financial creditor filed another application under section 7 of the IBC against Corporate Debtor, claiming Rs. 1428 crores as the outstanding balance from the initial loan facility of Rs.100 crores. This application was admitted by the NCLT, and pursuant to the admission, BRSVIL (for Guarantor’s Insolvency) and the suspended Director filed an appeal before the NCLAT which dismissed the appeals, prompting a further appeal to the Supreme Court.

Arguments Raised

Appellants

BRSVIL argued that in the Corporate Insolvency Resolution Process (CIRP) of the guarantor, their resolution plan, which included a payment of Rs. 38.87 crores to the financial creditor, was approved. This payment, deemed a full and final settlement, triggers section 140 of the ICA, allowing BRSVIL to assume the rights of the financial creditor. Consequently, they claimed subrogation rights over the financial creditor’s claims against the corporate debtor and cited Kadamba Sugar Industries Pvt. Ltd. v. Devru Ganapathi Hegde Bhairi and Economic Transport Organization, Delhi v. Charan Spinning Mills Pvt. Ltd. to argue that even partial payment can entitle the guarantor to subrogation rights.

Furthermore, it was contended that the payment discharged the entire debt owed to the financial creditor, preventing further claims against the corporate debtor under section 63 and section 41 of the ICA. Despite this, the financial creditor proceeded under section 7 of IBC against the corporate debtor, which was unjustified given the full discharge of debt and the BRSVIL’s right of subrogation.

Respondents (Financial Creditor)

The financial creditors highlighted that the NCLT approved the resolution plan for the corporate debtor and asserted that no payment was made against the guarantor’s claim since it was an unsecured financial creditor, while the liquidation value of the corporate debtor was significantly lower than the secured creditors’ total claims. BRSVIL’s main grievance was the approval of corporate insolvency against the corporate debtor, which allegedly included assets part of ACIL’s CIRP. The Financial Creditors clarified that under section 36(4) of the IBC, subsidiary assets cannot be included in liquidation estate assets. Furthermore, section 18 of the IBC indicates that the resolution process does not encompass the subsidiary’s assets. They cited Supreme Court decisions in Vodafone International Holdings BV v. Union of India and Jaypee Kensington Boulevard Apartments Welfare Association v. NBCC (India) Ltd., to argue that holding companies and subsidiaries are distinct legal entities, and ACIL’s resolution plan specifically excluded subsidiary assets, extinguished all ACIL’s assets, and stated no subrogation rights for existing guarantors.

The financial creditors referred to the Supreme Court’s decision in Lalit Kumar Jain v. Union of India, which states that creditors can proceed against personal guarantors under the IBC, and the approval of a resolution plan does not discharge guarantors of their liabilities. Since the entire outstanding amount was not recovered from ACIL, the financial creditor could still proceed against corporate debtor. The first financial creditors initially pursued remedies against the guarantor and then filed under Section 7 against corporate debtor. They concluded that partial recovery from the guarantor does not absolve the corporate debtor of financial obligations.

Findings of the Supreme Court

Liability of Guarantor and Principal Borrower

The Supreme Court emphasized the co-extensive liability of the surety (guarantor) and the principal debtor, as laid down under section 128 of ICA. The creditor has the right to proceed against either or both parties. The Court noted that any variance in the contract terms without the surety’s consent can discharge the surety for future transactions. However, settlements with the surety do not extinguish the principal debtor’s liability for the remaining amount.

Impact of Resolution Plans on Liability Guarantor and Principal Borrower

In the case of Lalit Kumar Jain v. Union of India, the Court established that the approval of a resolution plan for the principal borrower does not discharge the surety’s liability. The court applied the same reasoning in the present case and held that a resolution plan for the surety does not discharge the principal borrower’s liability. The resolution plan of a corporate debtor binds all stakeholders but does not affect the liability of the principal borrower to repay the remaining loan amount.

Simultaneous Proceedings Against Corporate Debtor and Guarantor

The Apex Court clarified that the IBC allows for separate or simultaneous insolvency proceedings against both the Corporate Debtor and the Corporate Guarantor. Section 60(2) of the IBC provides for this, and section 60(3) mandates the transfer of CIRP proceedings to the same Adjudicating Authority if they are pending before different authorities.

Subrogation Rights and Classification of Assets

The Court relied on section 140 of the ICA which provides that upon payment by the surety, they are subrogated to the rights of the creditor to the extent of the amount paid. In this case, BRSVIL, having paid Rs. 38.87 crores on behalf of the guarantor, acquired the right to recover this amount from the Corporate Debtor. However, the financial creditor retains the right to recover the remaining debt from the corporate debtor. The case once again crystallizes that the assets of a subsidiary company are distinct from those of the holding company. The Court reaffirmed that a holding company’s ownership of shares in a subsidiary does not equate to ownership of the subsidiary’s assets. Therefore, the assets of Gujarat Hydrocarbon were not included in ACIL’s resolution plan.

Analysis

The Supreme Court through its latest verdict has once again strengthened the position of the Financial Creditor in the IBC regime. Typically, haircuts result in a significant reduction in the amount owed to creditors. Generally, this reduction has been as much as 80%, and in rare situations, it has even reached as high as 95%. Thus, it was necessary to protect the loan advanced by the creditors to the extent which is possible, and the court, by sticking to the reasoning of Lalit Kumar, has provided a much-needed relief to the financial creditors.

As far as simultaneous proceedings are concerned, the NCLT in  ICICI Bank Ltd. v. CA Ritu Rastogi allowed the financial creditor to simultaneously proceed against the Corporate Debtor and Guarantor, while on the other hand the NCLAT in Dr. Vishnu Kumar Agarwal v Piramal Enterprises Ltd restrained the financial creditor from moving simultaneous proceedings. Thus, through the present case, the court has settled the contention by upholding the financial creditor’s right to move applications under section 7 of IBC simultaneously.

In the case of Orbit Towers Pvt. Ltd. v Sampurna Suppliers Pvt. Ltd., the NCLT observed that “Creditor had the rights to sue the Principal Debtor. The Guarantor may therefore, sue the Principal Debtor having got and invested with all rights of the Creditor.” In the present factual matrix as well, the court followed the same lines of reasoning and directed BRSVIL to recover the money paid by them for the overall settlement to the financial creditor. The judgment refers to the right of subrogation as an equitable right and, therefore, lays a foundation for dealing with such a factual matrix in the future course. The court once reiterated that subsidiary and holding companies need to be treated as separate legal identities and this observation becomes more pertinent when any subsidiary/holding company falls into the clutches of IBC.

Conclusion

The Supreme Court’s decision in the present case significantly impacts corporate insolvency jurisprudence, particularly regarding the co-extensive liabilities of guarantors and corporate debtors. By emphasizing the independent yet interlinked liabilities of both parties, the Court has reinforced the legal framework that allows financial creditors to pursue simultaneous insolvency proceedings under the IBC. This ruling not only upholds the financial creditors’ rights but also clarifies the interpretation of subrogation rights under ICA, ensuring that guarantors who fulfill their obligations are equitably entitled to recover their payments from the principal debtors.

Furthermore, the judgment provides much-needed clarity on the distinct legal identities of holding and subsidiary companies within the context of insolvency proceedings. By affirming that the assets of a subsidiary are separate from those of the holding company, the Court has drawn the boundaries of corporate entities, preventing the mingling of assets in resolution plans. This decision serves as a landmark precedent, protecting the interests of financial creditors while balancing the equitable rights of guarantors, and provides a thorough method for handling intricate insolvency situations in India’s changing legal landscape.

– Parth Birla

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