Liability of Personal Guarantors under IBC: Critical Study - by Nikita Johri
Liability
of Personal Guarantors under IBC: Critical Study
Author:-
Nikita Johri
5th
year law student at
University
of Petroleum and Energy Studies,
Dehradun
Abstract
This paper proposes to encompass the
definition of corporate guarantor, contract of guarantee and its essentials,
definition of financial creditor and the relevant provisions of the contract
act which concerns the contract of guarantee and position of the guarantor.
Furthermore, I’ll be discussing the relevant case laws and judgments in
conclusion with my own analysis regarding the matter. Since, the corporate
guarantor acts as a surety for the debtor in case of default, it’s important
that their interests are secured and protected in a justifiable way. As
Insolvency and Bankruptcy code stands on one of these pillars of protecting the
interests of all the stakeholders, the interest of guarantors/surety should not
be left unnoticed.
Glossary of
terms
1. Corporate guarantor- Section 5(5A) of Insolvency Code
which states “Corporate Guarantor” means a corporate person who is the surety
in a contract of guarantee to a corporate debtor.[1]
2. Contract of guarantee- Section 126 of Indian Contract Act
defines contract of guarantee which means a contract to perform the promise or
discharge the liability of a third person in case of his default.
3. Personal guarantor- In terms of Section 5(22) of the IB
Code, 'personal guarantor' is an individual who is a surety in a contract of
guarantee to the corporate debtor.
4. The person who gives the guarantee is
called “surety”.
5. The person of whose default the
guarantee is given is called the “Principal debtor”.
6. The person to whom the guarantee is
given is called the creditor.
7. Financial creditor- “A person who owes a financial
obligation, including anybody to whom such debt has been legitimately assigned
or transferred.”
Introduction
The provisions pertaining to the
Contract of Guarantee are covered by Chapter VIII of the Indian Contract Act,
1872 ("ICA"). The provisions relating to personal guarantors are
provided under Part III of the Insolvency and Bankruptcy Code, 2016
("IBC"), which states that "The liability of the surety is coextensive
with that of the principal debtor is coextensive with that of the principal
debtor unless the contract otherwise provides" (Section 128 of the ICA).
But since the IBC's implementation, a number of circumstances have led to
ambiguity and confusion regarding the scope of guarantor obligation, which
eventually led to the creation of a smokescreen. By deciphering authoritative
case law on the responsibility of personal guarantors under IBC, this paper
aims to cut through the fog.[2]
Subsections (e), (f), and (g) were
added to Section 2 of the Code by way of an amendment in 2018. The
classification of entities to which the Code would apply is provided in Section
2. According to Section 2(e) of the Code, personal guarantors to corporate
debtors are exempt from Section 2(g) provisions regarding individuals
because the code applies to them.[3]
Prior to now, creditors could only
begin insolvency proceedings against a corporate debtor under Chapter II
(Corporate Insolvency Resolution Process) of the Insolvency and Bankruptcy
Code. However, creditors are now able to begin insolvency proceedings against a
corporate debtor's personal guarantor as well, and they can do so concurrently.
The open questions about how to handle a variety of legal actions, the extent to
which a creditor can recover money from a personal guarantor (especially in
situations where they have already taken a haircut and discharged the principal
debtor), and the practical difficulties involved in pursuing both parties for
recovery make the tasks of advisers less straightforward despite such
notification.[4]
Essentials
to a contract of guarantee
- Consideration- It is an essential element of a contract of guarantee.
The consideration can be monetary, a future act, personal property, etc.
that largely benefits the principal debtor.
- Not made in good faith- A contract of guarantee is not an uberrimae fides
contract, that is, a contract made in good faith. But there is an
obligation to disclose all the material facts to the surety so he can make
an informed decision. Therefore, a guarantee obtained by concealment or
misrepresentation is invalid.
- Either oral or written- The contract can either be oral or written according
to Section 126 of the Indian Contract Act, 1872.
Conformity
to contract law
The petitioners argued that the
Contract Act, 1872[6]'s
protection of guarantors will be superseded by the applicability of IBC to
solely personal guarantors. Section 128[7] of
the Contract Act of 1872, which states that the surety's liability is
co-extensive with the primary debtor's liability and that if the latter's
liability is discharged, the former's liability also would be, was relied upon.
Therefore, the personal guarantor's liabilities must also be eliminated since
the corporate debtor is released from all obligations once a resolution plan is
approved. Therefore, the notification deprives the personal guarantors of their
essential statutory rights by permitting creditors to independently pursue them
before the NCLT.
The Supreme Court rejected this
argument and made it clear that the approval of a resolution plan and its
finality under Section 31[8] IBC
do not, by themselves, release the guarantor from liability. The Court
determined that, under the terms of Section 128 of the Contract Act, in the
case of an unequivocal promise, the guarantor's liability persists since there
is no discharge under Section 134[9] of
the Contract Act, citing Maharashtra SEB v. Official Liquidator[10].
As a result, the creditor may pursue the guarantor because the principal debtor
is dismissed by an involuntary legal process, not by the conduct or inaction of
the creditor.
The Supreme Court's ruling in SBI v.
V. Ramakrishnan[11], which
said that a guarantor may not request a discharge of duty upon acceptance of a
resolution plan that could include clauses allowing the continuation of the
guarantors' debt, was also cited. Furthermore, because the personal guarantor's
duty results from a separate contract, the provisions of that contract will
determine the liability's character and scope. Finally, creditors have the
option of taking legal action against both the corporate debtor and its
personal guarantor at the same time or in any sequence.
Principle
of double dip
There is a genuine worry about double
recovery when a creditor's claim against the guarantor is still active. In the
Lalit Kumar case[12], the
Solicitor General argued against this by citing the double-dip rule, which
states that a creditor may recover the same amount from both the principal
debtor and any co-debtors or guarantors. Thus, until the complete amount is
paid, the creditor may pursue a claim against both or either of the entities.
If a portion has already been paid by one, however, the other would still be
responsible for the balance due because their liabilities are joint and
several. The
availability of concurrent remedies against the principal debtor and the
guarantor does not permit the creditor to recover more than the total amount
due. This is something that is reinforced in the report of the Insolvency Law
Committee. Safeguards against double recovery are ingrained in contract law. [13]Additional
precautions are included in the IBC provisions themselves. For instance,
Section 14[14] allows
the adjudicating authority to put a moratorium on new lawsuits or the
continuation of ongoing lawsuits or processes against a corporate debtor.[15]
The Solicitor General in the Lalit
Kumar case[16] argued
that the latter is concerned with the claim of recovery of the same debt
against the same estate twice, resulting in double payment out of one estate,
and contrasts the principle of double dip with the principle of double proof.
The former, on the other hand, involves a claim for the recovery of the same
debt against two different estates, which is allowed by the insolvency laws.
The UK Supreme Court had ruled in Kaupthing Singer & Friedlander Ltd., (No.
2), In re[17] that
the principle of double proof does not prevent creditors from benefiting from
the principle of double dipping and that creditors can claim the same debt
against two different estates. The Supreme Court cited this decision in
accepting the Solicitor General's arguments. Further clarification provided by
the UK Supreme Court stated that either or both of the principal borrower and
guarantor may be sued by creditors. The creditor can pursue either for the
whole amount, but they cannot recover more than the full amount combined if
both are insolvent. Because
of this, the Supreme Court acknowledged the double dip principle and permitted
the recovery of only the agreed-upon debt amount, regardless of who the
creditor chooses to pursue and in what sequence.
In a previous ruling, Vishnu Kumar
Agarwal v. Piramal Enterprises Ltd.[18],
the Nclat held that once an application has been admitted against one of the
corporate debtors, such as the principal debtor or corporate guarantor(s), the
same creditor cannot submit a second application for the same set of claims and
default against the other corporate debtor. Additionally, it was decided that
the same creditor may not submit a claim for the same set of debt in two
different corporate insolvency resolution processes (CIRP) for the principal
borrower and corporate guarantor. Rakhecha's argument, however, is that this is a form of
double dipping that is legal because it complies with the reasoning in the
Kaupthing Singer case[19],
which states that if both the principal borrower and the guarantor are
insolvent, the creditor may pursue each for the full amount but cannot recover
more than the full amount. [20]An
appeal of the ruling is still pending before the Supreme Court due to the clear
violation of the principle of co-extensive liability, which applies to both the
principal borrower and the guarantor under Section 128 of the Contract Act. By
preventing creditors from pursuing any corporate debtor, it violates their
statutory right to do so.
Given that Piramal judgment[21]
only addresses corporate guarantors—rather than personal guarantors—the Supreme
Court in the Lalit Kumar case[22]
offered much-needed clarity for personal guarantors. In the Lalit Kumar case[23],
the Supreme Court also decided that, in contrast to corporate guarantors, only
personal guarantors are covered by the exception to the moratorium contemplated
by Section 14. This gives personal guarantors the potential of moratorium
protection. IBC still has an urgent need to resolve these gaps in the law,
particularly when it comes to the unequal treatment of personal and corporate
guarantors.
Right of
subrogation
By granting the guarantee the ability
to reclaim the sum paid on behalf of the principal debtor after obligations
have been discharged, Section 140[24]
of the Contract Act puts the guarantor in the position of the creditor. A
crucial issue is whether a resolution plan that permits creditors to recover
debts owed by guarantors can also be used to eliminate the statutory right of
subrogation of the guarantors. The IBC does not view this entitlement as an
absolute one because it would make the insolvency process worthless by further
limiting the corporate debtor's assets.[25]
The petitioners in the Lalit Kumar
case argued that the promoters (who are typically personal guarantors) are
prohibited from filing a resolution plan against the corporate debtor under Section
29-A[26]
IBC, and that this right would be included in the creditors' rights enjoyed by
the guarantor after the resolution process. The petitioners therefore
criticised the contested notification for the personal guarantor's failure to
recoup funds from the corporate debtor.
The Court just made a cursory mention
of this problem without going into detail. The Kaupthing Singer &
Friedlander Ltd. case[27]
was cited once more, in which the UK Supreme Court reaffirmed that the
principal debtor has a first commitment to the creditor and only a secondary
one to defend the guarantor in the event that the principal debtor's liability
is discharged. Similar to this, the guarantor only has a secondary right of
recovery against the principle debtor but is still obligated to pay the
creditor on the principal debtor's behalf. The UK Supreme Court stated in the Kaupthing case that if the
major debtor is already bankrupt, the guarantor may not assert its secondary
right in competition with the creditor. The Supreme Court, however, left the
argument at an ambiguous note.
Thus, it might be obliquely inferred
that the Court's evaluation is skewed in favour of achieving the single goal of
debt recovery. The Court's acceptance of Arcelor Mittal's resolution plan,
which provided for the deemed extinguishment of all claims of guarantors based
on subrogation under the guarantee,[28]
clearly demonstrated the superiority of resolution plans over the contractual
rights of the personal guarantors. Essar Steel (India) Ltd. Committee of Creditors
v. Satish Kumar Gupta. Such a corporate debtor-granted right to denial is
unfair since it encourages the suppression of one group of guarantors' rights
in order to serve the interests of creditors. Therefore, it is necessary to
implement strong protections to stop contractual rights from being superseded.
Landmark
judgement
The National Company Law Tribunal
("NCLT"), Kolkata Bench, comprising of Shri Rohit Kapoor (Judicial
Member) and Shri Harish Chander Suri (Technical Member), while adjudicating a
petition filed in Orbit Towers Pvt. Ltd. v Sampurna Suppliers Pvt. Ltd., has
held that if a Guarantor pays the debt on behalf of the Principal Borrower,
then it steps into the shoes of the Creditor and can initiate Corporate
Insolvency Resolution Process ("CIRP") against the Principal
Borrower. The order was passed on 27.06.2022.
Background
Facts :
In 2011, Sampurna Suppliers Pvt. Ltd.
("Corporate Debtor") had availed a loan of Rs.10,00,00,000/- from the
Indian Bank. Upon the request of Corporate Debtor, Orbit Towers Pvt. Ltd.
("Financial Creditor") had given corporate guarantee for the said
Loan and had also created an equitable mortgage of its property situated in
Kolkata in favour of Indian Bank. The Corporate Debtor was obligated to repay
the loan amount of Rs.10,00,00,000/- along interest and to obtain release of
the Financial Creditor's property at Kolkata. However, the Corporate Debtor
failed to do so and the Financial Creditor paid Rs.8,45,19,907/- to the Indian
Bank in capacity of a Corporate Guarantor. Thereafter, the Corporate Debtor
paid Rs.2,60,00,000/- to the Financial Creditor towards part discharge of its
liability and a sum of Rs.5,85,19,907/- remained due and payable. The liability
of Principal Borrower (Corporate Debtor) was discharged by the Guarantor
(Financial Creditor).
The Financial Creditor filed a
petition under Section 7 of the Insolvency and Bankruptcy Code, 2016
("IBC") before NCLT Kolkata Bench, seeking initiation of CIRP against
the Corporate Debtor.
Issue :
When the Surety has repaid the amount
of financial debt owed by the Corporate Debtor to the Indian Bank, would it
make the Surety a "Financial Creditor", eligible for proceeding
against the Corporate Debtor (Principal Borrower) without there being any
agreement between the two?
Analysis By
The NCLT Bench :
The NCLT Bench observed that Sections
140 and 141 of the Indian Contracts Act, 1872 talk of "right of
subrogation", which entails the substitution of another person in place of
the Creditor, so that the person substituted will succeed to all the rights of
the creditor with reference to the debt. "The guarantor's right to be
placed in the creditor's position on the discharge of the principal debtor's obligation,
to the extent that the Guarantor's property or funds have been used to satisfy
the Creditor's claim and to effect such discharge is called the Guarantor's
right of subrogation."
It was further observed that Section
140 provides that rights of surety of payment or performance, where a debt has
become due on default of the Principal Debtor to perform, the surety upon
making payment or performance of all that, is eligible for and is invested with
all the rights which the Creditor had against the Principal Debtor. The
Creditor had the rights to sue the Principal Debtor. The Creditor had the
rights to sue the Principal Debtor. The Guarantor may therefore, sue the
Principal Debtor, having got invested with all rights of the Creditor.
Therefore, under the provisions of the Indian Contract Act, 1872, all the
rights of the then Creditor i.e. the Indian Bank, would automatically become
the rights of the Surety (Financial Creditor).
On the issue of absence of any
agreement between Corporate Debtor and Financial Creditor, it was held that:
"Any agreement of guarantee
between the Indian Bank and the Guarantor is sufficient for the purpose of
bestowing all the rights of the Bank/creditor upon the Financial Creditor
herein once the Financial Creditor has discharged all the liability of the
Corporate Debtor towards Indian Bank. There may or may not be any agreement
between the Financial Creditor and the Corporate Debtor. It does not make any
difference at all. The Law is very clear that once the Guarantor/surety
discharges the liability of the Principal borrower towards the creditor, all
the rights of the Creditor to recover that money would automatically be
transferred in favour of the surety/ Guarantor. This is exactly the right of
subrogation.”
Decision of
the NCLT Bench
Thus the Bench held that the
Financial Creditor was eligible and entitled to proceed against the Corporate
Debtor for recovery of the dues and file the petition under Section 7 of the
IBC before Adjudicating Authority or before any other Forum of competent
jurisdiction. The petition was admitted and CIRP was initiated against the
Corporate Debtor.
Conclusion
It should be noted that a
surety/guarantor to the corporate debtor as and when discharges its duty to the
creditor should get to exercise the right to subrogation given under law. For
the system to work in a fair manner, its necessary that justice should be done
for all. As there have been numerous disputing cases on the problem at hand,
the latest recent judgment given in the Orbit towers case settles down the dust
as to the confusion regarding the recoverability of debts by the guarantor from
the corporate debtor. The paper highlighted major provisions and acts which
states the liability and remedies available to the guarantor so as to safeguard
from any unjust practices which can be carried out because of the loopholes in
the regulatory framework and lack of clarity.
References
[1]
https://www.indiacode.nic.in/handle/123456789/2154?sam_handle=123456789/1362
[2]Vikas
Dutta, Liability of Personal Guarantors under IBC: Clearing the Smokescreen,
2 October, 2021,
https://ibclaw.in/liability-of-personal-guarantors-under-ibc-clearing-the-smokescreen-by-mr-vikas-dutta-ms-mansi-sachdeva/
[3]
Siddharth Pandey, Liability Of Personal Guarantors Under IBC, 12 August
2021,
https://www.mondaq.com/india/insolvencybankruptcy/1101410/liability-of-personal-guarantors-under-ibc
[4]
Kirti Tandon, liability of personal guarantor under ibc,
https://rplegalindia.com/blog-detail/2/LIABILITY-OF-PERSONAL-GUARANTOR-UNDER-IBC
[5]
Rishika Verma, Contract of Guarantee and its Essential Elements, LAW
COLUMN, (05 April, 2021),
https://www.lawcolumn.in/contract-of-guarantee-and-its-essential-elements/
[6]
Contract Act, 1872.
[7]
Contract Act, 1872, S. 128
[8]
Insolvency and Bankruptcy Code, 2016, S. 31.
[9]
Contract Act, 1872, S. 134.
[10]
(1982) 3 SCC 358
[11]
(2018) 17 SCC 394.
[12]
(2021) 9 SCC 321.
[13]
Ministry of Corporate Affairs, Report of the Insolvency Law Committee (February
2020).
[14]
Insolvency and Bankruptcy Code, 2016, S. 14.
[15]
Sirhaan Seth, Principle of Double Dip: A Contentious Issue before the
Supreme Court, https://www.ijlmh.com/paper/principle-of-double-dip-a-contentious-issue-before-the-supreme-court/#:~:text=The%20Insolvency%20Law%20Principle%20of,before%20the%20Indian%20Supreme%20Court.
[16]
(2021) 9 SCC 321.
[17]
(2012) 1 AC 804 : (2011) 3 WLR 939 : 2011 UKSC 48.
[18]
2019 SCC OnLine NCLAT 81.
[19]
(2012) 1 AC 804 : (2011) 3 WLR 939 : 2011 UKSC 48.
[20]
Shradha Rakhecha, “Double Dip under IBC — A Tough Choice for Lenders —
Contracts and Commercial Law — India” (Mondaq.com, 2019)
.
[21]
2019 SCC OnLine NCLAT 81.
[22]
(2021) 9 SCC 321.
[23]
(2021) 9 SCC 321.
[24]
Insolvency and Bankruptcy Code, 2016, S. 140.
[25]
Gopal Gour, Right of Subrogation Under IBC: Impact on Market, THE CBCL
BLOG, (13, August, 2020), Right of Subrogation Under IBC: Impact on Market
[26]
Insolvency and Bankruptcy Code, 2016, S. 29-A.
[27]
(2012) 1 AC 804 : (2011) 3 WLR 939 : 2011 UKSC 48.
[28]
(2020) 8 SCC 531.
[29]
C.P (IB) No. 2046/KB/2019