Can Arbitration Proceedings Against a Director/Promoter Continue Even after Moratorium is Imposed on the Principal Debtor Company

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.