Contract Act 1872

Op EdsOP. ED.

It is a trite law that when an insolvency order is passed, whereby the corporate insolvency resolution process (CIRP) is initiated against a company (corporate debtor), a moratorium is imposed under Section 14 of the Insolvency and Bankruptcy Code, 20161 (IBC) on all legal proceedings (including arbitration proceedings) pending against the corporate debtor.

Nowadays, it is a usual course in arbitrations that an entire arbitration proceeding comes to a halt when a moratorium gets imposed on a party to the dispute under IBC, as all legal proceedings against the principal debtor (party to the arbitral dispute) have to be paused till the completion of the CIRP proceedings. For instance, an arbitration proceeding is ongoing against multiple respondents which include a company and its directors/promoters. Would the arbitration proceeding still continue against such directors/promoters after a moratorium is imposed against the principal borrower i.e. the company? For careful analysis, let us see how the legislature and judiciary have interpreted the law on the same.

Prior to IBC

In Bank of Bihar Ltd. v. Damodar Prasad2, it was observed that the surety has no right to dictate terms to the creditor and ask him to pursue his remedies against the principal in the first instance. But the surety is a guarantee; and it is his business to see whether the principal pays, and not that of the creditor. 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. Where the creditor has obtained a decree against the surety and the principal, the surety has no right to restrain execution against him until the creditor has exhausted his remedies against the principal. Thereafter, the Supreme Court of India passed a judgment in Industrial Investment Bank of India Ltd. v. Biswanath Jhunjhunwala3, wherein a bank-initiated proceedings under Section 19 of the Recovery of Debts Due to Banks and Financial Institutions Act, 19934, in which stay of further proceedings was sought on the ground that the bank could not proceed against the guarantor till the rights of the bank against the principal borrower company were established. The Debts Recovery Tribunal dismissed the application. However, the High Court, in exercise of power under Article 227 of the Constitution of India5 allowed the objection and stayed further proceedings against the guarantor. The Bank appealed to the Supreme Court wherein the Supreme Court held that the liability of the guarantor and principal debtors is coextensive and not in alternative and the order of the High Court was set aside.

Post IBC

Even after the enactment of IBC in 2016, the legislature was not clear whether a moratorium could be imposed on a surety/guarantor. In the very important case of Sicom Investments and Finance Ltd. v. Rajesh Kumar Drolia6 Section 14 IBC came up for consideration, as well as the liabilities mentioned in Section 14, of the Bombay High Court. The High Court held that the moratorium under Section 14 applies to the corporate debtor; the benefits, as well as the liabilities mentioned in Section 14, are only that of the corporate debtor and corporate debtor alone and not a third party such as a guarantor, be it an individual or a corporate guarantor. The Court further approved the report of the Insolvency Law Committee wherein the Committee had held the following:

  1. all assets of guarantors of the corporate debtor shall be outside the scope of moratorium imposed under the Code;

  2. that surety’s liabilities being put on hold if a CIRP is going on against the corporate debtor, would lead to the contracts of guarantee being infructuous, and not serving the purpose for which they have been entered into;

  3. such a broad interpretation of the moratorium may curtail significant rights of the creditor which are intrinsic to a contract of guarantee;

  4. contractual principles of guarantee require being respected even during a moratorium and an alternative interpretation may not have been the intention of the Code, as is clear from a plain reading of Section 14.

The impugned order of the Tribunal taking the view that Section 14 would apply in favour of the personal guarantor as well and consequently restraining the proceedings against the personal guarantor was set aside.

The above view of the Bombay High Court has been approved by the Supreme Court in SBI v. V. Ramakrishnan7. In Ramakrishnan8, the Supreme Court of India held that the assets of the surety/guarantor can be distinguished from that of the principal debtor and hence the CIRP proceedings may not be affected adversely by the actions against assets of any third party like surety or guarantor. However, it is apposite to take note of Swiss Ribbons (P) Ltd. v. Union of India9, wherein the Court observed that the interest of the corporate debtor is bifurcated and separated from that of its promoters/those who are in management and the moratorium only preserves the assets of the corporate debtor during the resolution process. Furthermore, in IFCI Factors Ltd. v. Ramsarup Industries Ltd.10, a moratorium was imposed against the principal debtor company and the question was whether to continue the ongoing legal proceedings against the director or not. It was observed that the director had declared himself as a guarantor to the company and therefore it was held that legal proceedings will continue against the director being the guarantor.

However, in Paschim Gujarat Vij Company Ltd. v. Manibhadra Ispat Ltd.11, the plaintiff therein sought to seek recovery of dues payable by a company from its directors, the High Court observed that the directors of companies have been described as agents, trustees, or representatives of the company because of the fact vis-à-vis the company they act in a fiduciary capacity and perform acts and duties for the benefit of the company. Thus, the directors are the agents of the company to the extent they have been authorised to perform certain acts on behalf of the company; but the directors of a company owe no fiduciary or contractual duties or any duty of case to third parties who deal with the company. Therefore, by this observation it can be presumed that nothing entitles a third party to continue legal/arbitral proceedings against a director when a moratorium is imposed against the principal debtor company.

Amendment in IBC

Based on the report of the Committee, the IBC Insolvency and Bankruptcy Code (Amendment) Ordinance, 201912 was passed and an amendment was made in Section 1413 IBC wherein in sub-section (3), clause (a) was substituted (w.e.f. 28-12-2019). Section 14 reads as under:

14. Moratorium. — (1) Subject to provisions of sub-sections (2) and (3), on the insolvency commencement date, the Adjudicating Authority shall by order declare moratorium for prohibiting all of the following, namely—

(a) the institution of suits or continuation of pending suits or proceedings against the corporate debtor including execution of any judgment, decree, or order in any court of law, tribunal, arbitration panel or other authority;

(b) transferring, encumbering, alienating, or disposing of by the corporate debtor any of its assets or any legal right or beneficial interest therein;

(c) any action to foreclose, recover or enforce any security interest created by the corporate debtor in respect of its property including any action under the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002;

(d) the recovery of any property by an owner or lessor where such property is occupied by or in the possession of the corporate debtor.

* * *

(3) The provisions of sub-section (1) shall not apply to—

(a) such transactions, agreements or other arrangements as may be notified by the Central Government in consultation with any financial sector regulator or any other authority;

(b) a surety in a contract of guarantee to a corporate debtor.

* * *

Therefore, Section 14(3)(b) IBC clearly provides that the moratorium under Section 14(1) does not apply to surety or guarantor. The aforesaid provision can be complemented with Section 128 of the Contract Act, 187214 which provides as under:

128. Surety’s liability. —The liability of the surety is coextensive with that of the principal debtor unless it is otherwise provided by the contract.

An important observation was made in Lalit Kumar Jain v. Union of India15. In this case the Court took into consideration Section 31(1) IBC16, as also Sections 128 to 141 of the Contract Act, 187217 and held that Section 31(1) IBC in fact makes it clear that the guarantor cannot escape payment as the resolution plan which has been approved may well include provisions as to payments to be made by such guarantor; the moratorium is in relation to the debt and not the debtor; the object of the Code is not to allow such guarantors to escape from an independent and coextensive liability to pay of the entire outstanding debt, which is why Section 14 is not applied to them.

In the recent case of P. Mohanraj v. Shah Bros. Ispat (P) Ltd.18, the Supreme Court has held that a surety in a contract of guarantee of a debt owed by a corporate debtor cannot avail of the benefit of a moratorium as a result of which a creditor can enforce a guarantee, though not being able to enforce the principal debt during the period of moratorium.

Conclusion

It is now clear that a surety’s liability to pay the debt is not removed by reason of the creditor’s omission to sue the principal debtor, as the law recognises the same under Section 14(3)(b) IBC. The creditor is not bound to exhaust his remedy against the principal debtor before suing the surety/guarantor. Meaning thereby, an arbitral proceeding can be maintained against the surety even when the principal debtor has not been made party or is no longer a party in an arbitral proceeding. It is a settled law that a surety/guarantor’s liability is coextensive with that of the principal borrower. A guarantor can be proceeded against even without keeping the principal borrower as the party to the arbitral proceedings. Thus, where the liability of a person arises in its own capacity (as a guarantor/surety) separate from the corporate debtor, such person cannot seek the shelter of the moratorium imposed in relation to the corporate debtor. Indeed, courts have consistently rejected the defence that proceedings against guarantors cannot continue in view of the moratorium imposed against the principal debtor.19It is also observed that when a moratorium is imposed on the principal debtor, Court often allows the continuance of suit or arbitral proceedings against the promoters/directors of a company mostly in those cases wherein such surety/director has officially made themselves as the personal guarantors/sureties of the company20.

Therefore, arbitration proceedings can be continued against a director/promoter even after a moratorium is imposed against the principal borrower i.e. the company.

*Advocate. Author can be reached at <garimasharma97@gmail.com>.

1. Insolvency and Bankruptcy Code, 2016, S. 14.

2. AIR 1969 SC 297.

3. (2009) 9 SCC 478.

4. Recovery of Debts and Bankruptcy Act, 1993 [as amended], S. 19.

5. Constitution of India, Art. 227.

6. 2017 SCC OnLine Bom 9725.

7. (2018) 17 SCC 394.

8. (2018) 17 SCC 394.

9. (2019) 4 SCC 17.

10. 2019 SCC OnLine Del 9457.

11. 2019 SCC OnLine Guj 6933.

12. Insolvency and Bankruptcy Code (Amendment) Ordinance, 2019.

13. Insolvency and Bankruptcy Code, 2016, S. 14.

14. Contract Act, 1872, S. 128.

15. (2021) 9 SCC 321.

16. Insolvency and Bankruptcy Code, 2016, S. 31(1).

17. Contract Act, 1872, Ss. 128–141.

18. (2021) 6 SCC 258.

19. IFCI Factors Ltd. v. Ramsarup Industries Ltd., 2019 SCC OnLine Del 9457.

20. Vijay Kumar Jain v. Standard Chartered Bank, (2019) 20 SCC 455; Lalit Kumar Jain v. Union of India, (2021) 9 SCC 321.

Op Ed
Op EdsOP. ED.

Introduction

In its decision in Lalit Kumar Jain v. Union of India2, the Supreme Court allowed creditors like banks and other financial service providers to proceed against personal guarantors including promoters, MDs, and Chairmen of the corporate debtor for recovery of corporate loans under the Insolvency and Bankruptcy Code, 20163 (IBC). The common objection of the petitioners who had furnished personal guarantees was against the validity of the Central Government Notification dated 15-11-2019 (notification) which brought into force Part III of the IBC relating to insolvency and bankruptcy of individuals and partnership firms insofar as it is applicable to personal guarantors and corporate debtors. This piece seeks to examine the judgment in light of its consistency with Indian contract law and also analyse its impact on the sector.

Case outline

Post the release of the notification, several personal guarantees were invoked causing complications in insolvency proceedings at different stages since adjudication against both corporate debtor and personal guarantor were now clubbed under National Company Law Tribunal’s (NCLT) charge. The petitioners contended that the exercise of power by the Central Government conferred to it under Section 1(3)4 IBC was vitiated by excessive delegation, as it does not have the authority to impose conditions on the enforcement of the IBC. Thus, enforcing provisions of Part III only in relation to personal guarantors of the corporate debtors was a condition imposed by the Central Government which was ultra vires of its powers. Since it is not a compulsion under IBC for it to be applied to all individuals at the same time, the Supreme Court upheld the notification and held the exercise of power as intra vires. Another substantive question of law to be ascertained by the Supreme Court was whether the personal guarantor is also discharged of its liability on sanction of a resolution plan like the corporate debtor. The Court’s examination of the same is analysed in the following section.

Consistency with the contract law regime

A. Co-extensive liability

The petitioners urged that the application of IBC to only personal guarantors would override the protection of guarantors in contract of guarantee under the Contract Act, 18725 . Reliance was placed on the co-extensive principle under Section 1286 of the Contract Act, 1872, whereby, the liability of the surety is co-extensive with that of the principal debtor, and if the latter’s liability is discharged, so would the former’s. Thus, since the corporate debtor is discharged of any liability once a resolution plan is accepted, the personal guarantor’s liabilities must also be extinguished. Hence, by allowing creditors to separately proceed against the personal guarantors before the NCLT, the notification deprived them of their substantive statutory rights.

Rejecting this contention, the Supreme Court clarified that the sanction of a resolution plan and its finality under Section 317 IBC does not per se discharge the guarantor’s liability. Relying on Maharashtra SEB v. Official Liquidator8, the Court held that within the meaning of Section 128 of the Contract Act, in a case of an unequivocal guarantee, the liability of the guarantor continues as there is no discharge under Section 1349 of the Contract Act. It was observed that the principal debtor is discharged by an involuntary process of operation of law and not by an act or omission of the creditor and thus the creditor can proceed against the guarantor. Therefore, the discharge of liability of the corporate debtor due to an operation of law in liquidation proceedings does not ipso facto absolve the personal guarantor from its liability.

Reliance was also placed upon SBI v. V. Ramakrishnan10 wherein the Supreme Court held that a discharge of liability could not be sought by the guarantor upon approval of a resolution plan which could contain terms allowing continuation of debt of the guarantors. Moreover, since the liability of the personal guarantor arises from an independent contract, the nature and extent of the liability would depend on the terms under the contract. Therefore, conclusively, the creditors have the option to simultaneously proceed against the corporate debtor and its personal guarantor or they can choose to proceed in any order.

B. Principle of double dip

The continuation of a creditor’s claim against the guarantor does raise a legitimate concern over double recovery. The Solicitor General in Lalit Kumar case11 argued against this by relying on the principle of double dip, whereby the creditor can recover the same debt from two entities — principal debtor and guarantor or co-debtors or co-guarantors. Thus, until the creditor is paid the full amount, it can assert a claim for recovery against both or either of the entities or in case a portion is already paid by one, the other would be liable for the remaining amount as the liabilities of both are joint and several. Safeguards against double recovery are embedded in the contract law as also reiterated in the report of the Insolvency Law Committee that availability of simultaneous remedies against principal debtor and guarantor does not allow the creditor to recover more than the total debt due.12 Other safeguards can be found in IBC provisions itself. For example, Section 1413, under which a moratorium prohibiting institution of suits or continuation of pending suits/proceedings against the corporate debtor can be declared by the adjudicating authority.

Juxtaposing the principle of double dip with the principle of double proof, the Solicitor General in Lalit Kumar case14 contended that the latter is concerned with the claim of recovery of the same debt against the same estate twice, thereby leading to double payment out of one estate. On the other hand, the former involves claim of recovery of same debt against two separate estates, which is permissible under the insolvency laws. Accepting the arguments of the Solicitor General, the Supreme Court relied on Kaupthing Singer & Friedlander Ltd., (No. 2), In re15, wherein the UK Supreme Court had held that the principle of double proof does not prevent creditors to benefit from the principle of double dip and creditors can claim the same debt against two separate estates. The UK Supreme Court had further clarified that the creditors can proceed against either or both principal borrower and guarantor. However, if both are insolvent, then the creditor can proceed against each for the full amount but cannot recover more than the full amount in all. Therefore, the Supreme Court recognised the double dip principle and allowed the recovery of only the stipulated debt amount irrespective of who the creditor decides to proceed against and in which order.

In an earlier decision of Vishnu Kumar Agarwal v. Piramal Enterprises Ltd.16, the Nclat held that an application once admitted against one of the corporate debtors including principal debtor or corporate guarantor(s), the second application by the same creditor for the same set of claims and default cannot be admitted against the other corporate debtor. It was also held that a claim cannot be filed by the same creditor in two separate corporate insolvency resolution processes (CIRP) of principal borrower and corporate guarantor, for the same set of debt. However, advancing Rakhecha argument, this is a kind of double dip which is permissible in law as by following the rationale in Kaupthing Singer case17, if both the principal borrower and the guarantor are insolvent, then the creditor can proceed against each for the full amount but cannot recover more than the full amount.18 Pursuant to the evident violation of the principle of co-extensive liability of both the principal borrower and the guarantor under Section 128 of the Contract Act, an appeal against the decision is still pending before the Supreme Court. It infringes upon the statutory right of the creditors by restricting them to proceed against any corporate debtor.

The Supreme Court in Lalit Kumar case19 provided much needed clarity for personal guarantors, especially since Piramal judgment20 deals with corporate guarantors and not personal guarantors. The Supreme Court in Lalit Kumar case21 also held that the exception to moratorium envisaged under Section 14 extends to only corporate guarantors and not personal guarantors, thereby allowing a possibility of moratorium protection to personal guarantors unlike corporate guarantors. There is still an impending need for IBC to address such gaps in the legislation, especially in case of differential treatment of personal guarantors and corporate guarantors.

C. Right of subrogation

This statutory right under Section 14022 of the Contract Act puts the guarantor in the shoes of the creditor, allowing it to recover the amount paid on behalf of the principal debtor after the discharge of liabilities. A substantive question is whether a resolution plan allowing creditors to recover their dues from guarantors can, at the same time take away guarantor’s statutory right of subrogation. The IBC does not consider this right as an absolute right as it renders the process of insolvency pointless by further hampering the assets of the corporate debtor.

The petitioners in Lalit Kumar case23 argued that the creditors’ rights enjoyed by the guarantor would also include the right to file a resolution plan against the corporate debtor after the resolution process, which in the petitioners’ contention, the promoters (who are personal guarantors in most cases) are barred from filing under Section 29-A24 IBC. Thus, the petitioners criticised the impugned notification for the inability of personal guarantor to recover amounts from the corporate debtor.

The Court only briefly addressed this issue without delving into the fundamentals. Reliance was again placed on Kaupthing Singer & Friedlander Ltd. case25, wherein the UK Supreme Court had reiterated that the principal debtor has a primary obligation towards the creditor and only a secondary obligation to indemnify the guarantor if and so far, as it discharges the principal debtor’s liability. Similarly, the guarantor has an obligation to the creditor to pay on behalf of the principal debtor but has only a secondary right to recovery from the principal debtor. However, the Supreme Court in Lalit Kumar case26 left the argument at a vague note quoting UK Supreme Court’s observation in Kaupthing case27 that, if the principal debtor is already insolvent then the guarantor may not enforce its secondary right in competition with the creditor.

Thus, it can be modestly inferred that the Court’s assessment is biased towards the fulfilment of the sole purpose of debt recovery. In Essar Steel (India) Ltd. Committee of Creditors v. Satish Kumar Gupta28, the approval of Arcelor Mittal’s resolution plan providing deemed extinguishment of all claims of guarantors based on subrogation under the guarantee clearly indicated the prevalence of resolution plans over contractual rights of the personal guarantors. Such a right to denial vested with the corporate debtor is discriminatory as it advocates silencing of one set of guarantor’s rights to advance the rights of the creditors. Thus, effective safeguards need to be employed to prevent overriding of contractual rights.

Impact on the sector and concluding remarks

The judgment is beneficial to the creditors as it opens doors for them to access the asset pool of personal guarantors for debt recovery. However, it will also add to the already high bargaining power of the creditors against the corporate debtor leading to a concentration of powers with the creditors as now they have another route to recover loans besides the existing ones under Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 200229 and debt recovery proceedings among other civil remedies. This might lead to a rise in quantity of litigation between the three stakeholders, creditors, corporate debtors, and their personal guarantors. The judgment may be worrisome for the promoters who act as personal guarantors for companies burdened with debt as they are not off the hook even after the acceptance of the resolution plan. In Ramanujam’s view, this violates the principle of limited liability and disincentivises entrepreneurial risk-taking which is equally important as comforting lenders for keeping the sector afloat.30 Thus, it is agreed that the promoters do take an additional risk by offering personal guarantee, however, for further nourishment of the sector, the focus must be on diligence on borrowing over giving additional comfort support to the creditors.

The unification of proceedings under NCLT will not only allow the adjudicating authority and committee of creditors to consider the complete picture while evaluating the nature of assets and framing of an optimal resolution plan, respectively, but also help in avoiding unnecessary delays in the recovery process. During the hearings, Attorney General K.K. Venugopal contended in support of the notification that roping in guarantors would incentivise them to pay off the debt faster in view of obtaining a quick discharge. However, the decision of non-discharge of personal guarantors even after acceptance of resolution plan would evidently disincentivise them to respond quickly, thereby leading to delays.

Overall, there is no doubt that the judgment is more inclined towards the debt recovery aspect of insolvency proceedings as opposed to encouragement of the prime objective of IBC i.e. rescue of corporate debtors in distress. Without concretising the boundaries of right to subrogation after the recovery of debt by invocation of the personal guarantee puts the already debt-laden corporate debtor in a more uncertain position vis-à-vis repayment to the personal guarantor. With the possibility of extinguishing this right of the guarantors in the aftermath of Essar decision31, the corporate debtors would increasingly rely on the assets of the personal guarantor which may result in an increased risk appetite for taking loans, owing to the added cushioning. On the other hand, some also contend that the inclusion of the personal guarantor’s assets to mitigate the corporate debtor’s liabilities might lower the total debt servicing of the corporate debtor.32

Post Supreme Court’s favourable decision, the creditors have invoked personal guarantees worth of Rs 34,000 crores in view of Rs 37,861 crores as the total debt default by companies.33 Thus, evidently, the majority of the burden is falling on the personal guarantors as lenders try to recover the total debt. Although this will improve the financial health of the banking sector, but the interests of the personal guarantors need to be the top priority in order to keep it afloat in the future.

† BBA LLB (Hons.), Jindal Global Law School, O.P. Jindal Global University, Haryana, India. Author can be reached at <muskaangarg2018@gmail.com>.

2. (2021) 9 SCC 321.

3. Insolvency and Bankruptcy Code, 2016.

4. Insolvency and Bankruptcy Code, 2016, S. 1(3).

5. Contract Act, 1872.

6. Contract Act, 1872, S. 128.

7. Insolvency and Bankruptcy Code, 2016, S. 31.

8. (1982) 3 SCC 358.

9. Contract Act, 1872, S. 134.

10. (2018) 17 SCC 394.

11. (2021) 9 SCC 321.

12. Ministry of Corporate Affairs, Report of the Insolvency Law Committee (February 2020).

13. Insolvency and Bankruptcy Code, 2016, S. 14.

14. (2021) 9 SCC 321.

15. (2012) 1 AC 804 : (2011) 3 WLR 939 : 2011 UKSC 48.

16. 2019 SCC OnLine NCLAT 81.

17. (2012) 1 AC 804 : (2011) 3 WLR 939 : 2011 UKSC 48.

18. Shradha Rakhecha, “Double Dip under IBC — A Tough Choice for Lenders — Contracts and Commercial Law — India” (Mondaq.com, 2019) <https://www.mondaq.com/india/contracts-and-commercial-law/864448/double-dip-under-ibc–a-tough-choice-for-lenders>.

19. (2021) 9 SCC 321.

20. 2019 SCC OnLine NCLAT 81.

21. (2021) 9 SCC 321.

22. Insolvency and Bankruptcy Code, 2016, S. 140.

23. (2021) 9 SCC 321

24. Insolvency and Bankruptcy Code, 2016, S. 29-A.

25. (2012) 1 AC 804 : (2011) 3 WLR 939 : 2011 UKSC 48.

26. (2021) 9 SCC 321

27. (2012) 1 AC 804 : (2011) 3 WLR 939 : 2011 UKSC 48.

28. (2020) 8 SCC 531.

29. Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002.

30. S. Ramanujam, “Double Whammy for Personal Guarantors to Corporate Debtors” (Lawstreetindia.com, 2021) <http://www.lawstreetindia.com/experts/column?sid=571>.

31. (2020) 8 SCC 531.

32. Utkarsh Anand, “Personal Guarantors Accountable in IBC:  SC” (livemint.com, 2021) <https://www.livemint.com/news/india/personal-guarantors-accountable-in-ibcsc-11621618103236.html>.

33. Dev Chatterjee, “Banks Invoke Rs 34K-Crore Personal Guarantees in 200 Cases So Far” (Business-standard.com, 2021) <https://www.business-standard.com/article/finance/lenders-rush-to-invoke-personal-guarantees-of-promoters-121090701089_1.html>.