Position of Guarantors under IBC: A Quandary Untouched – By Rishika Sharma and Samarth Kapoor

Position of Guarantors under IBC: A Quandary Untouched

– By Rishika Sharma, 3rd Year law student at Maharashtra National Law University, Aurangabad and
Samarth Kapoor, 4th year law student at Maharashtra National Law University, Aurangabad

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INTRODUCTION

The Insolvency and Bankruptcy Code came into force to meet the international standards with regards to the insolvent companies. It was implemented with an objective to realise the debt owed in a much easier manner. The Code was enacted to address the shortcomings that existed in the insolvency laws at that time.

There are provisions in the Code that assist and help the Creditors to realise the debt owed by the debtors which come out to be a very effective tool for the Creditors. As the Code has not been notified fully and the legislature is taking their time to visit each part of the Code, the need to clarify certain moot points becomes necessary before it becomes too late to make the rectification. The Code was silent about the position of the Guarantors as one of the debtors of the Financial Creditor, however, the amendment which came into effect via 2019 notification by which the Part III of the Code has been notified and certain other amendments were introduced with regards to Personal Guarantors made some pointers very clear about the status of invocation of insolvency proceedings against the Guarantors.

While the Part III of the Code[1] determines the liability of the Guarantor and talks about separate insolvency proceedings to be invoked against the Guarantors, the same does not deal with the situation where the rights of the Guarantors are at stake. The position is still unsettled and there’s a need to introduce proper mechanism and procedure for the same to clear the air. The present article deals with the practical problems that exist currently with regards to the simultaneous proceedings against the debtor and the guarantor and the right to subrogation of the guarantor under IBC. Further, the article will take into consideration the situation under which the Guarantor will stand discharged from his/its liability and will later conclude on the suggestion to revisit the existing regime with regards to the Guarantors under insolvency law prevailing in India.

IS IT MANDATORY FOR THE CREDITOR TO EXHAUST OTHER REMEDIES BEFORE PROCEEDING AGAINST THE GUARANTOR?

The provisions of the Contract Act govern the principle of Guarantee according to which the Guarantor becomes liable for the defaults of the Debtor. Whether it is mandatory for the Creditor to exhaust the other remedies available at his disposal prior to initiating the insolvency proceedings against the personal guarantor is a question that needs to be answered. Time and again the Courts in India have tried to resolve this conundrum but the different views taken by the Courts are a matter of concern that baffles the whole story.

The code (IBC) has no provision that talks about the sequence to be followed by the Creditor when it comes to the realisation of the debt owed by the Corporate Debtor. As per the proviso of Section 128 of the Contract Act, the liability of the Guarantor is co-extensive with that of the Corporate Debtor hence, if we go by the literal interpretation of the provision then it directly talks about the concept of simultaneous liability, i.e., if the Corporate debtor failed to repay the debt then the liability of both the personalities (Corporate Debtor and the Guarantor) arises. So, what is the confusion in this concept? The confusion arises when the different opinions were put forth by the Courts in terms of understanding the provision of the Contract Act in light of the liability of the Guarantor under the Code.

The Hon’ble Supreme Court in the case of Bank of Bihar v. Damodar Prasad[2] held that liability of the surety as per Section 128 of the Contract Act is coextensive with that of the principal debtor and once the debtor failed to clear the debts then the surety will become liable and the liability will be immediate. The creditor doesn’t need to exhaust his remedies against the debtor first prior to going against the guarantor. It was stated that “In the absence of some special equity the surety has no right to restrain an action against him by the creditor on the ground that the principal is solvent or that the creditor may have relief against the principal in some other proceedings.

The liability of the Guarantor is coextensive unless something contrary is stipulated in the Contract. The Supreme Court in the case of Damodar Prasad[3] emphasised the condition wherein the creditor has to first avail the remedy against the debtor and then only he can move against the guarantor and that being the contrary clause in the Contract of Guarantee through which certain exceptions can be created at the time of execution of Guarantee with regards to the obligation of the Guarantor.[4] The “Burden of proof” is on the Appellant to establish that, the Contract of Guarantee provided anything to diminish the liability of the Petitioner under the Contract of the Guarantee accepting the liability of the Petitioner being coextensive as that of the Company.[5]

In the case of State Bank of India v. Indexreport Registered[6] the Supreme Court stuck to the same principle of co-extensive liability and held that the Creditor (Bank in that case) can execute the decree first against the guarantor without proceeding against the debtor. Similarly, in the case of Ferro Alloys Corporation Ltd. v. Rural Electrification Corporation Ltd.,[7] the NCLAT observed that u/s 7 of the Code it is always open for the creditor to initiate CIRP against the guarantor and it is the foremost duty of the tribunal to admit the same.

The NCLAT in the case of SBI, Stressed Asset Management Branch v. Mahendra Kumar Jajodia[8] was posed with the question of whether the initiation of CIRP is a prerequisite for initiating IRP against the Guarantor. In this case, the appeal was filed against the order passed by NCLT Kolkata which refused the Creditor to avail the remedy u/s 95 of the Code[9] for initiating IRP against the Personal guarantor. The appellate authority explored the wide arena of Section 60 of the Code[10] and pointed out the error in the order passed by the NCLT holding that the IRP application filed by the creditor is premature. The NCLAT while allowing the appeal held that Section 60(2) does not prohibit the filing of insolvency proceedings against the personal guarantor whether there is any pendency of proceedings against the Corporate Debtor or not.

The matter was sent to the Supreme Court and the Apex Court stayed the order passed by the NCLAT till the finalisation of this issue. However, as per the scheme of the code and the judgments already there regarding this, it is clear that the Creditor being the “Financial Creditor” of the Debtor as well as of the Guarantor has the liberty to seek his remedy against the Guarantor even prior to exhausting the remedy against the debtor. Now it will be in the interest of the concerned parties if the Supreme Court settles down this position with hard rock reasoning. The interpretation of Section 60 of the Code is a must and now it will be in the hands of the Apex Court to draw a perfect line having no flaws which can be used to set the right path to govern this issue of initiation of IRP against the guarantor.

Scope of Section 14 of the Code – Non-applicability of the moratorium on Guarantors

Section 14 of the Code[11] talks about the moratorium to be applicable on the proceedings with respect to the Corporate Debtor during the process of CIRP. The moratorium is imposed from the date of admission of the insolvency application against the corporate debtor which bars the institution of fresh suits or proceedings and suspends the continuation of the suits or proceedings already instituted. The import of this provision is very wide as it includes institution, continuation and execution of suits and proceedings. The aim of the moratorium is to prevent the CIRP and the Corporate Debtor from maximising the value of the assets without being burdened by additional debts.[12]

The Allahabad HC in the case of Sanjeev Shriya v. LML Industries and SBI[13] got the question of the scope of the moratorium and its applicability to guarantors. The HC held that Section 14 covers the guarantors as well and the reasoning given by the Court for this was that during the CIRP of the Corporate Debtor it is uncertain to recognize the debt owed by the CD hence, it will prejudice the rights of the guarantor as it will become unclear about the guarantor’s liability. The same view was reiterated by the NCLAT in the case of V. Ramakrishnan v. M/s Veesons Energy Pvt. Ltd. and SBI.[14] But if the same view is taken into consideration then it would definitely make the contract of guarantee infructuous as the guarantor will not be able to serve the purpose. The views presented by the forums may restrict the rights of the creditor if such a broad approach with regards to the moratorium has been accepted.

The Supreme Court in the case of State Bank of India v. V. Ramakrishnan[15] had the opportunity to resolve this conundrum where the question was posed before the Supreme Court whether the moratorium as u/s 14 is applicable to Personal Guarantors or not. The Supreme Court perused the provisions of the code with respect to the moratorium, i.e., Sections 14, 96 and 101 of the Code and held that if any insolvency proceeding is to be initiated against the guarantor then it can only be done in pursuance to the Part-III of the Code which contains separate moratorium provisions.[16]

NCLT Mumbai also dealt with the question of applicability of Moratorium in the case of Schweitzer Systemtek India Pvt. Ltd. v. Phoenix ARC Pvt. Ltd.[17] wherein the issue was whether the property belonging to the Guarantor comes within the ambit of Moratorium imposed on the Corporate Debtor or not. The NCLT while referring to Section 14 of the Code held that literal interpretation of the provision shows that the Moratorium has no application on the properties beyond the ownership of the Debtor. The order was also upheld by the appellate authority.[18]

The Insolvency Law Committee in the year 2018[19] submitted its report with regards to the scope of the moratorium and its applicability to the guarantors. The committee made certain recommendations with regards to the same including a suggestion to add an explanation in the provision which clearly depicts the applicability of Section 14. Presently, the position of law which stands by referring to the judgments and the provisions of the code is that the moratorium u/s 14 of the code has no applicability to the guarantor[20] and only the properties owned by the corporate debtor are covered under this provision. This clear inference is at par with the scheme of the code and the amendment after the V. Ramakrishnan judgement.[21]

Simultaneous proceedings against the Corporate Debtor and the Guarantor: The Conundrum untouched

While the provision of the Contract Act provides for co-extensive liability of the Guarantor with that of the Corporate Debtor unless any contrary clause has been mentioned in the Contract of Guarantee absolving the Guarantor from its liability. There have been a plethora of debates with regards to the Creditor’s right of initiating CIRP against the Corporate Debtor and Guarantor simultaneously because of which, confusion has arisen. Section 60 of the Code explores the area of initiating or transferring the proceeding against the guarantor in the same forum where the CIRP of the Corporate Debtor has already been initiated. The law regarding the same as per the literal interpretation of the provision that there can be simultaneous proceedings against the debtor and the guarantor, however, the judgments in this area are still not clear.[22]

The NCLAT in the case of Dr. Vishnu Kumar Agarwal v. M/s Piramal Enterprises Ltd.[23] had the opportunity to deal with this question wherein the Creditor had approached the NCLT to initiate the CIRP against the debtor and guarantor. The NCLAT while upholding the right of the Creditor to file two or more claims against the principal debtor and the Guarantor u/s 7 of the Code, however, the Creditor is not allowed to file the CIRP on the same set of claims. After this judgement, the question arises whether the reasoning given by the appellate Court was in favour of the aim of the Code and whether the fundamental principle of Co-extensive liability of the Guarantor has been eroded?[24]

In early 2018, the NCLT Delhi had this question of simultaneous proceedings in the case of ICICI Bank Ltd. v. CA Ritu Rastogi,[25] wherein the RP raised a plea before the NCLT that the applicant cannot raise its claim against the principal debtor and the guarantor which are under their respective CIRP as it will create deviation from the actual proceedings. Another important plea raised was that the applicant cannot act as a financial creditor in two different CIRPs and have voting rights in both the CIRPs as it will cause unjust enrichment to the applicant. NCLT in this case held that such remedy can be available to the creditor against both, the principal debtor and the guarantor and the plea of the guarantor not to go ahead with the CIRP cannot be taken into consideration if it is going against the terms of the guarantee contract.

Similarly, in the case of Edelweiss Asset Reconstruction Co. Ltd. v. Sachet Infrastructure Ltd.,[26] the NCLAT got the opportunity to settle the doubts of many with regard to the unjust enrichment of the creditor by initiating two CIRPs against the principal debtor and the guarantor. The NCLAT in this judgement cleared the air by allowing the simultaneous initiation of CIRPs in no particular order and held that if the claim of the creditor is accomplished in one proceeding then the same can be adjusted in another proceeding.

Another important judgement in this conundrum is the case of State Bank of India v. Athena Energy Ventures Pvt. Ltd.,[27] where the dispute before the NCLAT was to consider the appeal against the order of the NCLT by which it has declined to admit the application u/s 7 filed by the creditor after relying on the judgement passed in Piramal of NCLAT. The question was similar before the NCLAT as was there in the case of Piramal, however, the approach seems to be different in this case. NCLAT after perusing Section 60 of the Code, observed that there is no bar in the code against the simultaneous proceedings against the corporate debtor and the guarantor.

It was held that “Under the Contract of Guarantee, it is only when the Creditor would receive the amount, the question of no more due or adjustment would arise. It would be a matter of adjustment when the Creditor receives debt due from the Borrower/Guarantor in the respective CIRP that the same should be taken note of and adjusted in the other CIRP. This can be conveniently done, more so when IRP/RP in both the CIRP is the same. The Insolvency and Bankruptcy Board of India may have to lay down regulations to guide IRP/RPs in this regard.” However, it is to be pointed out that no such regulation has been put in place by the IBBI till now which can be pursued so as to prevent the creditor from receiving any kind of unjust enrichment.

Athena’s judgement didn’t take the decision given in Shadab Khan v. Nisus Finance and IFCI Ltd. v. M/s ACCIL Hospitality Ltd.[28] into consideration which supported the view of Piramal. However, both the judgments, i.e., the Athena and the Piramal are of NCLAT which means that there should be a ruling from an appellate authority to fix this loophole. Recently, in the case of State Bank of India v. Animesh Mukhopadhyay,[29] the NCLAT upheld the position that was decided in the Athena judgement. But the question still remains the same with regards to any ruling of the Hon’ble Supreme Court to fix this quandary.

Stage of Invocation of Rights against the Guarantors

Recently NCLT Mumbai Bench in the case of State Bank of India v. Ms. Savita Satish Gowda[30] held that the jurisdiction of the NCLT to entertain petitions against the personal guarantors will not be subsided even if the Corporate Debtor has been admitted to CIRP and the resolution plan has been approved by the adjudicating authority. The NCLT dealt with the contours of Section 60 upon which the guarantor put its reliance and contended that for initiation of IRP against the guarantors, it is necessary that the CIRP against the Corporate Debtor is pending or liquidation proceedings are pending. The NCLT rejected this contention and relied on the findings of the Supreme Court in the case of Lalit Kumar Jain v. Union of India,[31] wherein it was held that the same NCLT will entertain the petition against the guarantors which is seized of the matter with regards to Corporate Debtor.

Similarly, in the case of Rajnish Gupta v. Union Bank of India,[32] the NCLAT dealt with the question that whether the withdrawal of the Section 7 petition filed against the Corporate Debtor will bar the creditor to file a fresh application for initiation of IRP against the personal guarantor or not? The NCLAT held that the Creditor has independent access to the Guarantor and he is not bound to exhaust his remedy prior to going against the guarantor, hence, withdrawal of the application against the Corporate Debtor u/s 12A of the Code won’t affect the right of the Creditor to initiate IRP against the Guarantor.

In the case of E. Iqbal v. State Bank of India,[33] there was an issue of maintainability of initiation of IRP against the Guarantor u/s 95 of the Code when the application u/s 7 has already been filed against the Corporate Debtor. The NCLT pursued the provisions of the Code namely Section 60, 2(e) Rule 7 of the Insolvency and Bankruptcy (Application to Adjudicating Authority for Insolvency Resolution Process of Personal Guarantors to the Corporate Debtor) Rules, 2019 and came to the conclusion that since an application is pending against the Corporate Debtor, initiation of CIRP against the Corporate Debtor cannot be considered as a pre-requisite for initiation of IRP against the personal guarantor.

The Supreme Court in the case of Ferro Alloys Corporation Ltd. v. Rural Electrification Corporation Ltd.[34] countered with a position wherein the Creditor invoked a guarantee and upon failure of repaying the debt by the guarantor initiated the IRP against the Guarantor u/s 7 of the Code. The question raised before the Supreme Court was whether the NCLAT was correct in upholding the insolvency proceedings against the Guarantor without prior initiating the proceedings against the Corporate Debtor. While upholding the reasoning of NCLAT the Supreme Court observed that the Financial Creditor is also a creditor of the Guarantor as per the scheme of the Code, hence, the Creditor is at liberty to proceed against the Guarantor without exhausting his remedy against the Debtor.[35]

Referring to these judgments can give a brief idea as to at what stage the Creditor can approach the tribunal with regards to initiation of the IRP of the Guarantor as per the provisions of the Code. After perusing the provisions and their interpretation, it can be inferred that the Creditor has a very vast power when it comes to claiming the debt from the Corporate Debtor and for that matter, the Guarantor can be approached prior to exhausting the remedies against the Debtor itself. In this regard, the judgement of the Committee of Creditors, Essar Steel India Limited, Through Authorised Signatory v. Satish Kumar Gupta & Ors.,[36] wherein the Supreme Court relied on Section 31 of the Code and held that once the resolution is passed then there is no going back and it shall be binding on all the stakeholders including the Guarantors. The same view was taken by the Supreme Court in the judgement of State Bank of India v. V. Ramakrishnan[37] where the issue was related to exclusion of Guarantors from the garb of Moratorium u/s 14 of the Code.[38]

These judgments made it clear that Guarantors will come under the garb of the insolvency proceedings and that too without following any specific order as to at what stage the insolvency proceedings should be initiated against the Guarantor. Also, there is a need to explore the arena of the stage of invocation of rights against the guarantors as once the resolution plan is approved then deviation from the IBC regime and relying upon the Contract Act would bring out some inconsistencies in such a scenario.[39]

THE CLAIM OF CREDITOR AGAINST THE DEBTOR AND THE GUARANTOR: BIFURCATION REQUIRED

The Insolvency Law Principle of “Double-Dip’ is a globally accepted norm that allows a financial creditor to move against multiple estates for the same claim.

In Piramal Enterprises Ltd v. Vishnu Kumar Aggarwal,[40] the Hon’ble NCLT held that a financial creditor may pursue its claim simultaneously against a co-guarantor as the liability of the surety is joint and several. It went on to say that delaying the enforcement of claims against one creditor while proceedings against another are pending would be a violation of the contract of guarantee’s raison d’etre. Thus, for the first time in India, multiple claims for the same debt against different estates are recognized, and the ‘Principle of Double-Dip’ is recognised.[41]

As per the currently accepted regime, the Creditor does have an option of proceeding against two corporate debtors i.e. Principal Borrower or Guarantor for the same debt simultaneously.

In the recent case of Kunwar Raj Bhagwar v. Gujarat Hydrocarbons and Power SEZ Ltd.,[42] It was held that an application under section 7 of the Code against the corporate debtor for the same debt and default is maintainable in the light of the Athena Judgement. It was held that a Creditor can claim his remaining debt from the Principal Borrower which was not recovered from the CIRP of the Guarantor.

While allowing the creditor to file a claim as per his discretion contributes to the debacle of “Double Dipping of Claims”. The Creditor, despite filing a claim before a resolution professional of the Corporate Debtor or Guarantor, can proceed to file its claims against the complete debt in the CIRP of the Corporate Debtor or Guarantor. Double-dipping of claims has made it easy to take undue advantage of the situation. It has become mandatory to take into account the amount received by the Creditor and adjust it in other CIRPs.[43]

The need of the hour is that the resolution professionals of the Corporate Debtor and Personal Guarantor must coordinate to certify that there is no doubling of claims by the Creditor. To date, there haven’t been any steps by the judicial system where scrutinising the bifurcation of claims has been worked upon.[44]

Further, The Insolvency Committee Report dated February 2020 under Para 7.3 observed that A creditor, in the case of a contract of guarantee, is not entitled to recover more than what is due to it, an action against the surety cannot be prevented merely on the basis that the creditor has an alternative relief against the principal borrower. Also, as mentioned above, the creditor is allowed to proceed against either the debtor or the surety or jointly against both the debtor and surety. The committee has recognised this absurdity.  It was suggested by them that once the creator recovers its claim in one proceeding, there should be an equivalent revision in the claim filed in another proceeding. 

RIGHT TO SUBROGATION: CONTRACTUAL RIGHT OF THE GUARANTOR UNDER IBC

Ever since personal guarantors were made liable under the Insolvency and Bankruptcy Code by way of the notification dated 15 November 2019, their rights and liabilities under the Code have been extensively debated. This is primarily due to the disparity between the treatment of corporate guarantors under the scheme of the IBC and the well-established principles relating to contracts of guarantee under the Indian Contract Act.

Section 140 of the Contract Act[45] states that after paying the guaranteed debt or performing whatever he was obligated for, the surety steps into the shoes of the creditor. The surety’s right of subrogation is the ability of the surety to step in the shoes of the creditor. The abovementioned section is an essential ingredient of the law of guarantee as it makes it marketable. Conversely, on the other hand, this right has been denied to the personal guarantors under the IBC regime.  Initially, in the case of Lalit Mishra and Others v. Sharon Bio Medicine Ltd.,[46] the NCLAT has struck down the personal guarantor’s right of subrogation arising after the acceptance of the resolution plan. The rationale behind the judgement was that the Corporate Insolvency Resolution Process is focused on the revival of the Corporate Debtor and making the most of the present assets and that recovery of debt by personal guarantors is antithetical to the main enactment. This was again reiterated in the Committee of Creditors of Essar Steel Ltd. v Satish Kumar Gupta.[47] In this case, after obtaining the haircut amount under the Resolution Plan, the corporate debtor’s creditors attempted to invoke the guarantees offered for the rest amount. The Supreme Court in this decision cited SBI v. V. Ramakrishnan[48] and found that the guarantor’s liability continues even after the resolution plan is approved. Furthermore, the Court authorised a resolution plan that stripped the guarantors of their right of subrogation and left them with nothing significant, as evidenced by reasoning.

Further, the Supreme Court in Lalit Kumar Jain v. Union of India[49] held that in order to achieve the Code’s larger goal of reviving corporate entities, the personal guarantor’s right to recover the guarantee from the corporate debtor ceases to exist when the guarantee is invoked by a creditor. The bench upheld the constitutional validity of the notification dated 15 November 2019, which brought into effect specific provisions of the Code, concerning personal guarantors of corporate debtors. In doing so, the Supreme Court confirmed its ruling in SBI v. V. Ramakrishnan, holding that approval of a resolution plan under Section 31 of the Code does not relieve the personal guarantor’s responsibility since the involuntary conduct constituted liquidation or insolvency by operation of law. The Court did not explicitly consider the guarantor’s subrogation rights under Section 140 of the Indian Contract Act, 1972, because the issue was limited to the discharge of the responsibility.

The judgments in both Lalit Mishra and Lalit Kumar Jain contributed towards the extinguishment of the Right of Personal Guarantor as it does not serve the purpose of the Code to revive Corporate Bodies. Hence, it can be concluded that if the resolution plan (which is authorised by the creditors) includes the extinguishment of the personal guarantee’s right of subrogation, this basically renders the personal guarantor helpless. In the cases of State Bank of India v. Calyx Chemicals & Pharmaceuticals Limited[50] and IDBI Bank Ltd. v. EPC Constructions India Limited,[51] the NCLT and NCLAT respectively approved the resolution plan that did not give the guarantors of the Corporate Debtor on whose behalf the payment was made the right of subrogation.

The guarantors suffered a serious setback as a major principle of the law of guarantee was denied to them. Although the right of subrogation is not as fundamental as the principle of co-extensive responsibility, it is critical to the operation of guarantee contracts.[52] The guarantor’s right to stand in the shoes of the creditor and seek restitution in the case of the borrower’s repayment was harmed by the court’s interpretation.

Whether Approval of Resolution Plan Extinguished the Guarantor’s Liability and the Subrogation Right

The Rights and Liabilities of Personal Guarantees is one of the most debated topics of Insolvency and Bankruptcy legislation. The question “Whether Approval of Resolution Plan extinguishes the Guarantor’s Liability and the Subrogation Right” is one of the most intriguing issues. The same question was raised before the Calcutta High Court in the case of Gouri Shankar Jain v. Punjab National Bank.[53]

While deciding the issue the Hon’ble Court relied on the judgement given by the Apex Court in Maharashtra State Electricity Board Bombay v. Official Liquidator High Court, Ernakulam,[54] wherein it was decided that discharge secured by operation of law by the Principal Debtor in the case of liquidation or bankruptcy proceeding where a company does not absolve the surety of his liability. The same ratio was applied in United Bank of India v. Modern Stores (India) Ltd.,[55] where the Calcutta High Court held that the failure to sue the principal debtor or proceed against the principal debtor does not operate as the discharge of sureties’ liabilities.

The Hon’ble High Court also relied on the Supreme Court decision in Industrial Finance Corporation of India Ltd. v. Canonnore Blending and Weaving Mills Ltd.,[56] where it was decided that the creditor’s right of action against the surety stays preserved when the principal debtor is discharged of his liability by the consent of the surety/guarantor. At last, the Hon’ble Court relied on State Bank of India v. V. Ramakrishnan and Anr.,[57] where it was held that Section 14, IBC does not cover Personal Guarantors and the objective of IBC was not to let the Personal Guarantors escape from their independence and coextensive liability with the Corporate Debtor.

The essence of the judgement can be summarised in one sentence: Approval of a resolution plan in relation to a corporate debtor would not extinguish/reduce the liability of a guarantor of such corporate debtor.[58]

CIRCUMSTANCES UNDER WHICH THE GUARANTORS WILL BE DISCHARGED OF THEIR LIABILITY

There is no specific bar provided in the Code under which the Guarantor will stand discharged, however, the provisions of the Contract Act will be helpful in this regard when it comes to a no-fault theory applied to the Guarantor. As per the provisions of the Contract Act (Sections 130-135), the Guarantor will be discharged in case the conditions mentioned under these provisions have been fulfilled. Also, the rights of the Guarantor (as mentioned in Sections 138-145) will be applicable once the guarantor has fulfilled his/its part as per the Contract. But does this resolve the actual confusion with regards to the applicability of insolvency laws in Contact of guarantee? Now, this seems to be a question that needs to be addressed either by the legislature or by the judicial forums.

In the Cannanore Spinning & Weaving Mills Ltd. case,[59] the Supreme Court had the opportunity to determine the aspects of Section 141 and circumstances under which the guarantor can be stood extinguished from its liability. It was contended that due to the Nationalisation Act coming into effect, the Corporate Debtor failed to repay the loan amount and the Guarantor must be discharged on the grounds of variation of terms of the Contract as per Section 141 of the Contract Act.[60] The Apex Court while deciding the issue observed that the Contract of Guarantee is independent in itself and has no bearing on the Nationalisation Act, hence, the recourse u/s 141 was termed misplaced by the Supreme Court. While discussing the scope of liability of the Guarantor the Court observed that,

The surety contracts to pay if the debtor does not pay and the surety is bound by his contract. If the surety, perhaps less indolent or less well protected than the creditor, is worried that the mortgaged securities may decline in value then the surety may request the creditor to sell and if the creditor remains idle then the surety may bustle about, pay off the debt, take over the benefit of the securities and sell them. No creditor could carry on the business of lending if he could become liable to a mortgagee and to a surety or to either of them for a decline in value of the mortgaged property unless the creditor was personally responsible for the decline.”

The grounds of discharging the Guarantor from its liability are limited but the question here is upto what extent the degree of liability will be reduced and what will be the recourse available for the guarantor?

In the case of SCIL (India) Ltd. v. Indian Bank,[61] the Bombay High Court had a question as to what extent the guarantor will be liable. The High Court analysed the situation and held that suspension of the Contract between the Creditor and the principal debtor due to the default committed by the debtor will not act as a ground to absolve the guarantor from his liability. Under Section 134 of the Contract Act, the surety will be discharged on account of the discharge of the principal debtor, however, mere reason of winding up or the initiation of insolvency proceedings does not absolve the surety from his/ its liability.[62] The principle enshrined is clear but there are still some questions left that need to be answered in order to settle the whole confusion.

Bindingness of the Contract of Guarantee if Altered without the Consent of the Guarantor

Like any other Contract, the guarantor cannot be asked to do something for which he has not contracted. Now this means if the original parties, i.e., the Borrower/ Debtor and the Creditor have altered the terms of the Contract for which the Guarantor has not given his assent then he will not be liable for the obligation of the Debtor. Section 133[63] of the Contract Act states that where there is a variation in the terms of the Contract between the Debtor and the Creditor, the Guarantor will be absolved from the liability from the transactions made subsequent to such variance.

Section 133 of the Contract Act deals with the discharge of the Surety by variance in terms of the Contract and Section 139[64] of the Contract Act deals with the situation in which Surety will be discharged by Creditor’s act or omission impairing surety’s eventual remedy. Referring to the illustration of the provision a variation in terms of the Contract not by the acts of the parties but by the change in the legislature will have the effect of discharging the Guarantor from its liability.[65] The crux of the provision is that whenever there is any variance in the terms of the Contract without the consent of the Guarantor, the Guarantor will be discharged.

Now, it is questionable whether what variation of terms of the contract amounts to the discharge of the Guarantor? Whether there is anything to be looked upon while adjudicating the same? These questions are of prime importance as the jurisprudence of discharge is a very niche area wherein the Courts have tried to settle the dispute. The test of deciding whether the Guarantor is discharged or not is whether the variance has caused prejudice to the Guarantor or the risk that the Guarantor contracted for has been altered by such variation or not.[66] In the case of Perumal Reddiar v. Bank of Baroda,[67] the Madras High Court was of the view that there must be a material effect in the position of the Guarantor due to the variance in the terms of the contract and once it is established the Guarantor can be absolved from this liability. A similar view was taken by the Madras High Court in the case of M.R. Lakshmi Narayanan (Dead) v. Syndicate Bank,[68] wherein it was held that to attract Section 133 of the Contract Act there must be some substantial change in the original contract and prejudice must have been caused to the Guarantor.

As per the provisions of the Contract Act with regards to Guarantors, it is clear that any act which changes the course of the debt as included in the Contract of Guarantee without the consent of the Guarantor will ultimately discharge the Guarantor from his/its liability to that extent.[69] However, the scheme of the Code speaks something different by perusing Section 238[70] which defines the overriding effect of the Code over the other statutes. The provisions governing the Contract of Guarantee will be applicable but to the extent that they won’t affect the provisions of the Code. This principle should be looked upon while adjudicating the question of discharging the Guarantor from his/its liability.

It is very much clear that the Personal Guarantors are liable for the debts owed by the debtor and the liability is co-extensive with that of the Debtor. However, it is equally important to recognize the rights of the Personal Guarantors and treat them at par with the rest of the management of the Company.[71] There is a need to look for a way to maintain equilibrium when it comes to the realisation of debt otherwise the purpose of the Code will be relinquished which is to revive the Company and as the Personal Guarantors are a part of the whole process, they are entitled to due consideration.

CONCLUSION

It is quite interesting to see after perusing different authorities as discussed above how the rights of the Guarantors are being contravened by the provisions of the Code. Neither they are entitled to be discharged from their liabilities even if the Corporate Debtor stands discharged and nor they get a right to recover the amounts paid to the Creditors. The main aim of the Code is to look for a viable option for recovering the amount from the Debtor and to make the positioning of the Creditor clear as if to place the Creditor where it was standing before this havoc. However, in order to achieve this aim, the statute became a silent spectator to the conundrum faced by the Guarantors as to what should be the ultimate recourse for the Guarantors to get something substantial in the end.

The Code speaks nothing about the story of the Guarantors. All that is there is to realise the debt owed by the debtor and how to make the Guarantor accountable on this note. The common contention from the side of the Guarantors in cases where the Courts have dealt with the issue of simultaneous proceedings was that there should be a bar on applying for IRP of Guarantors when the CIRP of the debtor is still pending. The intention behind this point is to look after the principle of unjust enrichment, i.e., if there are two simultaneous proceedings against the debtor and the Guarantor then the Creditor can get what is not justifiable. This has been overlooked by the legislature when it comes to settling the dust around this moot question.

In some cases, the point of subrogation has been discussed as per the provisions of the Contract Act. While deciding this query, the Courts stick to the Creditor centric approach wherein the Creditor’s right to approach the forum, simultaneously initiating the insolvency proceedings against the debtor and the guarantor has been upheld. However, the Courts while deciding the issue of subrogation right of the guarantor to claim the amount back from the debtor that he paid on behalf of the debtor have upheld the intention of the Code which is to maximise the assets of the debtor which then help the Creditor to claim the debt owed. Every time when this question has been put up before the Court for consideration, it was decided in favour of the debtor and against the interest of the Guarantor which in some manner is right but if we see this from the perspective of the Guarantor then the right of the Guarantor has been infringed.

The Courts many a time have cited the provision of Section 238 of the Code which talks about the overriding power of the provisions of the Code if there is some sort of inconsistency with the provisions of the code. As the provision talks about the inconsistency of laws, it is pertinent to note that there is no provision in the Code that clearly states that the right of the Guarantor will be extinguished once the debt has been repaid, hence, this conundrum should be resolved by referring to the provisions of the Contract Act. However, the Courts haven’t explored this issue from a different perspective which will definitely come as a query before the Courts in near future and in that scenario, it will be extremely interesting to see what the Courts will look into while deciding and resolving this conundrum. Meanwhile, the contemporary judgments will hold ground for some more time and will be fascinating to see the approach of the Courts in the litigations to come.

 

Reference

[1] Insolvency & Bankruptcy Code, 2016, Part III, No. 31, Acts of Parliament, 2016.

[2] Bank of Bihar v. Damodar Prasad, [2017] ibclaw.in 21 SC.

[3] Ibid.

[4] Central Bank of India v. C.L. Vimla, (2015) 7 SCC 337.

[5] Rajnish Gupta v. Union Bank of India, (2022) ibclaw.in 178 NCLAT.

[6] State Bank of India v. Indexreport Registered, 1992 SCR (2) 1031.

[7] Ferro Alloys Corporation Ltd. v. Rural Electrification Corporation Ltd., [2019] ibclaw.in 17 NCLAT.

[8] SBI, Stressed Asset Management Branch v. Mahendra Kumar Jajodia, (2022) ibclaw.in 89 NCLAT.

[9] Insolvency & Bankruptcy Code, 2016, § 95, No. 31, Acts of Parliament, 2016.

[10] Insolvency & Bankruptcy Code, 2016, § 60, No. 31, Acts of Parliament, 2016.

[11] Insolvency & Bankruptcy Code, 2016, § 14, No. 31, Acts of Parliament, 2016.

[12] P. Mohanraj v. M/s Shah Brothers Ispat Ltd., (2021) ibclaw.in 24 SC.

[13] Sanjeev Shriya v. LML Industries and SBI, 2017 SCC OnLine All. 2717.

[14] V. Ramakrishnan v. M/s Veesons Energy Pvt. Ltd., [2018] ibclaw.in 94 NCLAT.

[15] State Bank of India v. V. Ramakrishnan, [2018] ibclaw.in 29 SC.

[16] Gaurav Juneja & Ayush Jain, Supreme Court Settles The Debate: No Moratorium For Personal Guarantors Under Section 14 Of The Insolvency Code, Mondaq (March 27, 2022, 9:45 PM), https://www.mondaq.com/india/insolvencybankruptcy/730990/supreme-court-settles-the-debate-no-moratorium-for-personal-guarantors-under-section-14-of-the-insolvency-code.

[17] Schweitzer Systemtek India Pvt. Ltd. v. Phoenix ARC Pvt. Ltd., [2017] ibclaw.in 13 NCLT.

[18] 2017 SCC OnLine NCLAT 235.

[19] Report of the Insolvency Law Committee, 2018.

[20] Alpha & Omega Diagnostics (India) Ltd. v. Asset Reconstruction Company of India, [2017] ibclaw.in 23 NCLAT.

[21] Supra Note 15.

[22] Palak Kumar, The Murky Waters of Simultaneous Initiation of Corporate Insolvency Resolution Process against both the Corporate Debtor as well as the Guarantor, Indian Corporate & Finance Law Review (March 27, 2022, 11: 10 PM)https://icflr.in/2021/05/10/the-murky-waters-of-simultaneous-initiation-of-corporate-insolvency-resolution-process-against-both-the-corporate-debtor-as-well-as-the-guarantor/.

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[26] Edelweiss Asset Reconstruction Co. Ltd. v. Sachet Infrastructure Ltd., (2019) ibclaw.in 477 NCLAT.

[27] State Bank of India v. Athena Energy Ventures Pvt. Ltd., (2020) ibclaw.in 344 NCLAT.

[28] IFCI Ltd. v. ACCIL Hospitality Ltd., II [2020] ibclaw.in 210 NCLAT.

[29] State Bank of India v. Animesh Mukhopadhyay, (2021) ibclaw.in 215 NCLAT.

[30] State Bank of India v. Ms. Savita Satish Gowda, (2022) ibclaw.in 103 NCLT.

[31] Lalit Kumar Jain v. Union of India, (2021) ibclaw.in 61 SC.

[32] Supra Note 5.

[33] E. Iqbal v. State Bank of India, (2022) ibclaw.in 116 NCLT.

[34] Supra Note 7.

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[37] Supra Note 15.

[38] Ravi Pentapati & Neha Pathak, Simultaneous CIRPs against Principal Borrower and Corporate Guarantor for the same debt, Mondaq (March 25, 2022, 10:45 PM), https://www.mondaq.com/india/insolvencybankruptcy/1016480/simultaneous-cirps-against-principal-borrower-and-corporate-guarantor-for-the-same-debt?type=mondaqai&score=83.

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[40] Piramal Enterprises Ltd v. Vishnu Kumar Aggarwal, Company Petition No. (IB) – 65(PB)/2018.

[41] Supra Note 38.

[42] Kunwar Raj Bhagwar v. Gujarat Hydrocarbons and Power SEZ Ltd., (2021) ibclaw.in 228 NCLAT.

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[45] Indian Contract Act, 1872, § 140, No. 9, Acts of Parliament, 1872.

[46] Lalit Mishra v. Sharon Bio Medicine Ltd., [2018] ibclaw.in 47 NCLAT.

[47] Supra Note 36.

[48] Supra Note 15.

[49] Supra Note 31.

[50] State Bank of India v. Calyx Chemicals & Pharmaceuticals Ltd., 2019 SCC OnLine NCLT 3854.

[51] IDBI Bank Ltd. v. EPC Constructions India Ltd., 2022 SCC OnLine NCLAT 43.

[52] Sonal Kumar Singh & Others, The precarious plight of a Guarantor under the Insolvency & Bankruptcy Code, 2016, Mondaq (March 29, 2022, 5;30 PM), https://www.mondaq.com/india/insolvencybankruptcy/1030860/the-precarious-plight-of-a-guarantor-under-the-insolvency-and-bankruptcy-code-2016.

[53] Gouri Shankar Jain v. Punjab National Bank, [2019] ibclaw.in 01 HC.

[54] Maharashtra State Electricity Board Bombay v. Official Liquidator High Court, Ernakulam, [2017] ibclaw.in 19 SC.

[55] United Bank of India v. Modern Stores (India) Ltd., (1990) 69 CompCas 697 Cal.

[56] Industrial Finance Corporation of India Ltd. v. Canonnore Blending and Weaving Mills Ltd., AIR 2002 SC 1841.

[57] Supra Note 15.

[58] Ashutosh Gupta & Gaurav Rana, Whether approval of Resolution Plan extinguishes Guarantor’s liability & his subrogation right?, Tax Guru (March 27, 2022, 8;45 PM), https://taxguru.in/corporate-law/approval-resolution-plan-extinguishes-guarantors-liability-subrogation-right.html.

[59] Supra Note 54.

[60] Indian Contract Act, 1872, § 141, No. 9, Acts of Parliament, 1872.

[61] SCIL (India) Ltd. v. Indian Bank, AIR 1992 Bom. 131.

[62] 12 Avtrar Singh, Law of Contract & Specific Relief 648 (EBC Publications 2018).

[63] Insolvency & Bankruptcy Code, 2016, § 133, No. 31, Acts of Parliament, 2016.

[64] Insolvency & Bankruptcy Code, 2016, § 139, No. 31, Acts of Parliament, 2016.

[65] Hazarimal v. Krishnarao, ILR (1981) 5 Bom. 647.

[66] Chatterton v. Maclean, 1951 1 All ER 761.

[67] Perumal Reddiar v. Bank of Baroda, (1981) 1 MLJ 419.

[68] M.R. Lakshmi Narayanan (Dead) v. Syndicate Bank, (2000) 99 CompCas 87 Mad.

[69] Supra Note 28.

[70] Insolvency & Bankruptcy Code, 2016, § 238, No. 31, Acts of Parliament, 2016.

[71] Simran Pahwa, Personal Guarantor – A Stakeholder?, IBC Laws (March 15, 2022, 4:35 PM), https://ibclaw.in/personal-guarantor-a-stakeholder-by-simran-pahwa/.

 

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