The Supreme Court (“SC”) has in its judgment dated September 6, 2022 in the matter of K. Paramasivam v. The Karur Vysya Bank Limited and Others [Civil Appeal No. 9286 of 2019] held that the Corporate Insolvency Resolution Process (“CIRP”) can be initiated against the corporate debtor without proceeding against the principal borrower.

Facts

Mr. K. Paramasivam (“Appellant”) is the promoter, shareholder and suspended director of Maharaja Theme Parks and Resorts Private Limited (“Corporate Debtor”), which had stood as guarantor for the credit facilities granted by Karur Vysya Bank (“Financial Creditor/ Respondent”) to three entities, namely, (i) Sri Maharaja Refineries, a Partnership Firm; (ii) Sri Maharaja Industries, a proprietary concern of K. Paramasivam; and (iii) Sri Maharaja Enterprises, a proprietary concern of P. Sathiyamoorthy.

Upon failure on part of the principal borrowers to repay the loan, the Financial Creditor filed an application under Section 7 (Initiation of corporate insolvency resolution process by financial creditor) of the Insolvency and Bankruptcy Code, 2016 (“IBC”) for initiation of the CIRP of the Corporate Debtor, on account of the corporate guarantee(s) extended by the Corporate Debtor to secure the loans availed by each of the above-named borrowers. In view thereof, the National Company Law Tribunal, Chennai (“NCLT/ Adjudicating Authority”) admitted the Corporate Debtor under CIRP, by order dated April 8, 2019.

Thereafter, the NCLT order dated April 8, 2019 was challenged before the National Company Law Appellate Tribunal, New Delhi (“NCLAT”), which came to be dismissed, by order dated November 18, 2019. Aggrieved by the impugned order dated November 18, 2019 passed by the NCLAT, the Appellant preferred an appeal before the SC.

Issue

Whether an action under Section 7 (Initiation of corporate insolvency resolution process by financial creditor) of the IBC can be initiated by a financial creditor, against a corporate person, in relation to a corporate guarantee, given in respect of a loan advanced to the principal borrower, who is not a corporate person?.

Arguments

Contentions raised by the Appellant:

The Appellant submitted that the Corporate Debtor does not fall within the definition of ‘corporate guarantor’ in terms of Section 5(5A) of the IBC, wherein ‘corporate guarantor’ is defined as a corporate person who is the surety in a contract of guarantee to a corporate debtor. As such, the Appellant contended that it has not stood as guarantor in respect of a loan, which was granted to a corporate person. In order to substantiate the aforesaid contention, the Appellant referred to the definition of ‘corporate person’ provided under Section 3(7) of the IBC:

“(7) “corporate person” means a company as defined in Clause (20) of Section 2 of the Companies Act, 2013 (18 of 2013), a limited liability partnership, as defined in Clause (n) of Sub-section (1) of Section 2 of the Limited Liability Partnership Act, 2008 (6 of 2009), or any other person incorporated with limited liability under any law for the time being in force but shall not include any financial service provider;”

The Appellant submitted that on a conjoint reading of Section 5(5A), Section 3(7) and Section 3(8) of the IBC, it is clear that a corporate guarantor is the surety in a contract of guarantee to a corporate debtor. However, the principal borrowers herein, not being corporate debtor; as such, the Corporate Debtor is not a corporate guarantor as defined under Section 5(5A) of the IBC.

Contentions raised by the Respondent:

The Respondent submitted that the question of law as to whether an action under Section 7 of the IBC can be initiated by a financial creditor, against a corporate person, in relation to a corporate guarantee, given by that corporate person, in respect of a loan advanced to the principal borrower, who is not a corporate person; has already been settled by the Supreme Court in the recent judgment of Laxmi Pat Surana v. Union Bank of India and Another [Civil Appeal No. 2734 of 2020] (“Laxmi Pat Surana”). Hence, the position of law is clear that CIRP can be initiated against a corporate entity who has stood as guarantor to secure the dues of a non-corporate entity as a financial debt, which accrues to the corporate person, in respect of guarantee given by it, once the borrower commits default.

Observations of the Supreme Court

The SC examined the terms “financial creditor” as defined under Section 5(7) of the IBC, “creditor” as defined under Section 3(10) of the IBC, “financial debt” as defined under Section 5(8) of the IBC, “debt” as defined under Section 3(11) of the IBC and “claim” as defined under Section 3(6) of the IBC.

Upon examination of the above-mentioned terms, the SC observed that undoubtedly, a right or cause of action arises on part of the lender (financial creditor) to proceed against the principal borrower, as well as the guarantor in equal measure, in case of any default in repayment of debt. Further, even if the principal borrower fails to discharge its obligation in respect of the debt, it would still be deemed as if the default was committed by the guarantor itself. In this regard, SC referred to Section 128 of the Indian Contract Act, 1872 which clearly provides that the obligation of the guarantor is coextensive and coterminous with that of the principal borrower. The SC further observed that as a consequence of such default, the status of the guarantor metamorphoses into a debtor or a corporate debtor if it happens to be a corporate person, within the meaning of Section 3(8) of IBC. Further, the term “default” as defined under Section 3(12) of the IBC would mean non-payment of debt when whole or any part or instalment of the amount of debt has become due or payable and is not paid by the debtor or the corporate debtor, as the case may be.

Hence, SC observed that this argument on part of the Appellant could not be accepted that since the principal borrower is not a corporate person, the financial creditor could not have invoked remedy under Section 7 of the IBC against the corporate person who had merely stood as a guarantor to secure such loan account. The financial creditor can still proceed against the guarantor being a corporate debtor, consequent to the default committed by the principal borrower.

SC further observed that if the contentions raised by the Appellant were to be accepted, it would lead to diluting or narrowing the purview of the term “corporate debtor” occurring in Section 7 of IBC, which means a corporate person, who owes a debt to any person. It was further observed that the term “debt” as defined under Section 3(11) of the IBC is broad enough to include liability of a corporate person on account of guarantee extended by it to secure a loan by any person including not being a corporate person in the event of default committed by the latter. It would still be a “financial debt” of the corporate person, arising from the guarantee extended by it, within the meaning of Section 5(8) of the IBC.

SC arrived at the conclusion that upon harmonious and purposive construction of the relevant definitions and provisions of the IBC, it is not possible to extricate the corporate person from the liability (of being a corporate debtor) arising on account of the guarantee extended by it in respect of loan given to a person other than corporate person. Hence, the liability of the guarantor is coextensive with that of the principal borrower.

Further, in the Laxmi Pat Surana judgment, SC had made it clear that CIRP can be initiated against the corporate guarantor without proceeding against the principal borrower.

Decision of the Supreme Court

The SC held that in view of the issues raised in the present appeal having been already settled in the Laxmi Pat Surana judgment, it is clear that liability of the guarantor is co-extensive with that of the principal borrower. Hence, Financial Creditor can proceed against the guarantor without first suing the principal borrower.

The SC held that there is no reason to interfere with the concurrent findings of the NCLT and NCLAT, and therefore dismissed the appeal.

VA View:

The SC has put this question to rest that under Section 7 of the IBC, CIRP can be initiated against a corporate entity who has given a guarantee to secure the dues of a non-corporate entity as a financial debt accrues to the corporate person in respect of the guarantee given by it once the borrower commits default. In such a scenario, the guarantor would be the corporate debtor.

Further, the SC has reiterated its recent decision in Laxmi Pat Surana, whereby it was held by a three-judge bench that the liability of the guarantor is co-extensive with that of the principal borrower and that the financial creditor can very well proceed against the guarantor without first proceeding against the principal borrower.

For any query, please write to Mr. Bomi Daruwala at [email protected]

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