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Insolvency and Bankruptcy on Guarantors of Corporate Debtor

Contract of guarantee:

A contract of guarantee is between the creditor, the principal debtor and the surety, where under, the creditor has a remedy in relation to his debt against both the principal debtor and the surety. The surety here may be a corporate or a natural person and the liability of such person goes as far the liability of the principal debtor.

As per section 128 of the Indian Contract Act, 1872, the liability of the surety is co-extensive with that of the principal debtor, unless it is otherwise provided by the contract.

Though this may be limited by the terms of the contract of guarantee, the general principle of such contracts is that the liability of the principal debtor and the surety is co-extensive and is joint and several (Bank of Bihar v. Damodar Prasad, AIR 1969 SC 297)

Various case laws on the guarantors:

In favour of creditors:

1.    In Alpha and Omega Diagnostics (India) Ltd. v. Asset Reconstruction Company of India (31st July, 2017), the personal properties of the promoters were given as security to the banks. The issue was whether properties that are not owned by the corporate debtor would come within the scope of moratorium under section 14 of the Code. The NCLAT held that section 14 only applies to assets of the corporate debtor and would not bar proceedings or actions against assets of third parties.  

2.    A similar issue came up in Schweitzer Systemtek India Private Limited v. Phoenix ARC Private Limited (9th August, 2017), and following its previous decision, the NCLAT noted that moratorium in Section 14 has no application on the properties beyond the ownership of the corporate debtor.

3.    the Ahmedabad Bench of NCLT in IDBI Bank Ltd. v. BCC Estate Pvt. Ltd.  held that "The liability of Guarantor is coextensive with that of the Principal Borrower. It is for the creditor to choose against whom he wants to proceed. There is thus, no bar in the law which prevents any creditor to proceed against both, the Principal Borrower and Guarantors".

In favour of Guarantor:

4.    The Allahabad High Court subsequently took a differing view in Sanjeev Shriya v. State Bank of India (6th September, 2017) by applying moratorium to enforcement of guarantee against personal guarantor to the debt. The rationale being that if a CIRP is going on against the corporate debtor, then the debt owed by the corporate debtor is not final till the resolution plan is approved, and thus the liability of the surety would also be unclear. The Court took the view that until debt of the corporate debtor is crystallised, the guarantor’s liability may not be triggered.

5.    In State Bank of India v. V. Ramakrishnan and Veeson Energy Systems (28th February, 2018), the NCLAT took a broad interpretation of section 14 and held that it would bar proceedings or actions against sureties. It was held that proceedings against guarantors would affect the CIRP and may thus be barred by moratorium.

6.    The Kolkata Bench of NCLT also passed a decision in the case of ICICI Bank v. Vista Steel Ltd, holding that, "In this case, insolvency petition has already been admitted under Section 7 against the principal borrower. Therefore, another insolvency proceeding against the corporate guarantor is barred on account of moratorium order passed under Section 14 (1)(a) of the Code against the principal borrower"

Latest Relevant case law:

1.    State Bank of India Vs D.S. Raj Kumar (NCLAT - 18th April, 2018) - order of ‘Moratorium’ will be applicable only to the proceedings against the ‘Corporate Debtor’ and the ‘Personal Guarantor’, if pending before any court of law/Tribunal or authority, but the order of ‘Moratorium’ will not be applicable for filing application for triggering ‘Corporate Insolvency Resolution Process’ under Sections 7 or 9 or 10 of the Insolvency and Bankruptcy Code, 2016, against the ‘Guarantor’ or the ‘Personal Guarantor’ under Section 60(2).

2.    Appellate Tribunal is of the view that Part-III of ‘I&B Code’ has not been given effect but Part-II Section 60(2) having come into force, if ‘Corporate Insolvency Resolution Process’ has been initiated against the ‘Corporate Debtor’, the Insolvency and Bankruptcy Resolution Process against the ‘Personal Guarantor’ can be filed under section 60(2) before the same Adjudicating Authority (National Company Law Tribunal) and not before the Debt Recovery Tribunal (DRT).

Changes in the Code:

Views of Insolvency Law Committee on Moratorium on proceedings of surety to corporate debtor:

since many guarantees for loans of corporates are given by its promoters in the form of personal guarantees, if there is a stay on actions against their assets during a CIRP, such promoters (who are also corporate applicants) may file frivolous applications to merely take advantage of the stay and guard their assets. The Committee concluded that section 14 does not intend to bar actions against assets of guarantors to the debts of the corporate debtor and recommended that an explanation to clarify this may be inserted in section 14 of the Code. The scope of the moratorium may be restricted to the assets of the corporate debtor only.”

Relevant Sections under Insolvency and Bankruptcy, Code, 2016, on amendment of Code:

To remove the ambiguity in implementation of the Code, on considering the recommendations of Insolvency Law Committee along with the recommendations received from various stakeholders, the provisions of IBC were amended, with effect from 6th June, 2018.

1.    Section 60 of Insolvency and Bankruptcy, Code, 2016, enables filing of application relating to the insolvency resolution or liquidation or bankruptcy of a corporate guarantor or personal guarantor, as the case may be, of such corporate debtor before the same National Company Law Tribunal.

“such corporate debtor” -  is the corporate debtor where a corporate insolvency resolution process or liquidation proceeding of a corporate debtor is pending before a National Company Law Tribunal.

Prior to Insolvency and Bankruptcy Code (Amendment) Act, 2018, section 60 was referring to only personal guarantors, now with amended code, even the corporate guarantors are included.

2.    With the Insolvency and Bankruptcy Code (Amendment) Act, 2018, Section 14 on Moratorium, is not applicable to a surety in a contract of guarantee to the corporate debtor.

Conclusion:

The interpretation of various cases and the provisions of the Insolvency and Bankruptcy, Code, 2016, enable the possibility of dragging the insolvency process against the guarantors, even while the CIRP / liquidation of corporate debtor is on.

The insolvency process for individuals falls under the Part III of the code which is still to be notified.  Inspite of that, Appellate Tribunal State Bank of India Vs D.S. Raj Kumar (NCLAT - 18th April, 2018)  viewed that if ‘Corporate Insolvency Resolution Process’ has been initiated against the ‘Corporate Debtor’, the Insolvency and Bankruptcy Resolution Process against the ‘Personal Guarantor’ can be filed under section 60(2) before the same Adjudicating Authority (National Company Law Tribunal).

Hence, an application for insolvency process against personal guarantors, can be filed with NCLT (where CIRP/Liquidation of corporate debtor is pending) and the process for the same may be determined, either (a) with the aid NCLT or NCLAT or (a) with notification of Part III to personal guarantors.