The Precarious Position of Personal Guarantors under the Insolvency and Bankruptcy Code, 2016

Akshata Timmapur



Since the inception of the Insolvency and Bankruptcy Code, 2016 (“Code”), the jurisprudence relating to personal guarantors has evolved leading to a determination in the rights and liabilities of such guarantors. This article seeks to shed some light on such jurisprudence which has emerged from various judgments relating to guarantors.


(A) Right of Subrogation of Personal Guarantors


The issue of right of subrogation first emanated in Mr. V. Ramakrishnan v. M/s. Veesons Energy Systems Pvt. Ltd. And State Bank of India (“Veesons”) before the Hon’ble NCLT, Chennai. Here, the court went into the question of the right of subrogation of a personal guarantor and its effect on Moratorium under Section 14. To put it succinctly, the right of subrogation embodies that upon the discharge of its liability under a contract of guarantee, a guarantor steps into the shoes of a creditor and can then recover the amount from the principal debtor. In essence, upon the discharge of its liability, a guarantor becomes a creditor of the principal debtor. It is the entire basis on which a contract of guarantee rests, and the same is also buttressed statutorily under Section 140 of the Indian Contract Act, 1872 (“ICA”).


With this said, the Hon’ble NCLT in the aforementioned case recognized this right of subrogation of a personal guarantor. In doing so it held that such right, in essence, would lead to the creation of fresh charge upon the assets of the corporate debtor during the subsistence of a moratorium which is clearly barred under Section 14(1)(b) of the Code. Therefore, it would not be possible to proceed against a personal guarantor once the moratorium was in force. This Order was upheld by the Hon’ble NCLAT vide Order dated 28.02.2018.


However, at the time, the general position was that moratorium would not be applicable to a personal guarantor’s assets. This view is evident from Hon’ble NCLAT judgements in Schweitzer Systemtek India Private Limited v. Phoenix ARC Private Limited and Alpha & Omega Diagnostics (India) Ltd. v. Asset Reconstruction Company of India Ltd. & Ors. Therefore, this conundrum led to an amendment being brought in, vide Insolvency and Bankruptcy (Second Amendment) Act of 2018 which was based on the recommendations of the Insolvency Law Committee Report dated 26.03.2018. This amendment introduced Section 14 (3) (b), clarifying that the moratorium would not be applicable to the contract of guarantee of the corporate debtor.


In retrospect, this amendment was necessary to mitigate a concerning practice adopted by promoters. Usually, it is the promoters, directors or some key connected persons that provide the guarantees for a corporate debtor’s debts. In cases like Schweitzer and Veesons, the corporate insolvency resolution process (“CIRP”) was initiated by the Corporate Debtor itself under Section 10 of the Code. Therefore, it wouldn’t be a far-fetched inference that the promoters were resorting to unscrupulous means- firstly by leading a company to its financial demise and thereafter seeking refuge under the Code from fulfilling their legal obligations. The amendment was a necessary step to curb such practice.


By the time, the Veesons case reached finality before the Hon’ble Supreme Court, the clarificatory amendment had already been introduced. Therefore, it was cemented in State Bank of India v. V. Ramakrishnan AIR (2018) SC 3876, that since the amendment merely clarified what was always envisaged by the statute, the amended Section 14(3)(b) would entail the exclusion of personal guarantors from the protection of the moratorium.

Interestingly, the contentions raised and adjudicated upon in Veesons, regarding the right of subrogation of a personal guarantor were not discussed in this case.


In that regard, the Hon’ble NCLAT in Lalit Mishra & Ors. v. Sharon Bio Medicine Ltd. (Company Appeal Insolvency no. 164 of 2018) (“Sharon Biomedicine”) upheld a resolution plan which took away the right of subrogation of a personal guarantor who also happened to be the promoter of the corporate debtor. A similar position was adopted by the Hon’ble Supreme Court under Committee of Creditors of Essar v. Satish Kumar Gupta wherein it was observed that an approved resolution plan which took away the right of subrogation of a promoter surety was valid and binding upon all stakeholders.


The aforementioned judgments have the effect of ratifying a Committee of Creditor’s (“CoC”) decision to take away subrogation rights of a guarantor. But what about a scenario where the resolution plan has not specifically taken away such rights? Would it then be open to the surety to stand as a financial creditor and participate in the resolution process once it discharges its liability?


The Hon’ble NCLAT in Sharan Biomedicine had observed that a promoter, being a related party to the corporate debtor, had no right to represent, participate or vote in a CoC. This would effectively mean that a surety who is a related party, is precluded from being subrogated under the Code. However, in P. B. Radhakrishnan & Ors. v. M/s Deleo Construction Private Limited (“Radhakrishnan”) and Mrs. Anita Kumaran v. KGS Developers which involved applications filed under Section 7 by aggrieved guarantors, the Hon’ble NCLT, Chennai Bench and Hon’ble NCLAT respectively, opined that guarantors could stand as financial creditors. In both cases, the guarantors standing as financial creditors were the related parties of the principal/corporate debtors. A distinguishing factor in these cases from Sharon Biomedicine was that the stage of the insolvency process differed. In Sharon Biomedicine the guarantor sought to challenge the resolution plan which was already approved by the CoC whereas in the latter cases, the guarantors themselves initiated the CIRP. It was observed in Radhakrishnan that a financial creditor who was an erstwhile director of the corporate debtor is not barred from invoking the provisions under the Code, as long as there is an existence of default and the debt falls within the definition of financial debt.


Therefore, it appears that while it is open to a guarantor to assume the role of financial creditor and initiate a resolution process against the principal debtor, it may not have much scope of being subrogated once a CIRP is already underway.


(B) Reduction/Extinguishment of Guarantor’s Liability


In Gouri Shankar Jain v. Punjab National Bank the Hon’ble High Court of Calcutta was posed with the issue of whether the liability of a guarantor can be reduced or extinguished, upon the secured financial creditor receiving payment as per the resolution plan. The court delved into the provisions relation to discharge of a surety under the ICA. It was observed that insolvency proceedings were a statutory, not contractual proceeding. Reliance was placed on Maharashtra State Electricity Board v. Official Liquidator to hold that while the principal debtor in a proceeding under Section 7 of the of Bankruptcy Code may stand discharged of its liability to its creditors, such discharge is secured by operation of law in bankruptcy or in liquidation proceedings and therefore does not absolve the surety of his liability. The Court held that the liability of a surety would not reduce or be extinguished upon the approval of resolution plan. Thus, it is available to creditors to proceed against the personal guarantors to recover the full amount guaranteed by them despite having received a haircut amount under the resolution plan.


(C) Parallel Proceedings Against Multiple Persons


An interesting point of contention arose in Dr. Vishnu Kumar Agarwal v. M/s Piramal Enterprises Limited. (“Piramal”) Here, it was argued that that for same set of claim amount and debt, two CIRPs cannot be initiated against two different ‘Corporate Guarantors/Corporate Debtors. To put it simply, the same debt was guaranteed by two different guarantors. Upon default by the principal borrower, the financial creditor initiated CIRP against both the guarantors simultaneously. The Hon’ble NCLAT held that while there in no bar in initiating CIRP simultaneously against two guarantors or guarantor and principal borrower, when one of such application gets admitted, the other one becomes non-maintainable.


The ramifications of this judgment are far-reaching. It effectively militates a creditor from double dipping i.e. pursuing recovery from two persons simultaneously. The contractual principles of guarantee stipulate that the liability of a borrower and a guarantor is co-extensive, meaning that a they are jointly and severally liable. Also, it has been observed in various other cases that a creditor can proceed against a guarantor, or multiple guarantors or debtors in no particular sequence. The Piramal judgment seems to dilute such right of the creditor.


Another aspect that the Piramal judgment does not consider is the recently notified Part III of the Code which provides for the initiation of CIRP against personal guarantors. So, supposing that a CIRP is already underway against a debtor under Part I of the Code, it would mean that another CIRP under Part III would not be admitted against a guarantor for the same debt. The matter is currently in appeal before the Hon’ble Supreme Court and it would clear many doubts raised by the NCLAT judgment.


Conclusion


The abovementioned judgments indicate that the personal guarantors have limited scope for reclaiming their dues from the principal debtor under the Code. This has reinstated the objective of the Code of maximisation of the value of the asset and provided a clear message that the Code is not to be used as a shield for escaping liability. In being a creditor friendly legislation, the Code perhaps has looked away from the issues of guarantors. This is also evident from the recent IBC Amendment Ordinance, 2020 which though suspends initiation of any CIRP against corporate debtors does not extend the same relaxation to personal guarantors under Part III of the Code. It remains to be seen how the Tribunals and Courts deal with the CIRP under Part III of the Code, moving forward.

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