Home » Between The Lines » NCLAT: Liability of the corporate debtor towards the promoter-personal guarantor can be waived by the resolution plan

Disclaimer: While every care has been taken in the preparation of this Between the Lines to ensure its accuracy at the time of publication, Vaish Associates Advocates assumes no responsibility for any errors which despite all precautions, may be found therein. Neither this bulletin nor the information contained herein constitutes a contract or will form the basis of a contract. The material contained in this document does not constitute / substitute professional advice that may be required before acting on any matter. All logos and trademarks appearing in the newsletter are property of their respective owners.

The National Company Law Appellate Tribunal (“NCLAT”) in Lalit Mishra and Others v. Sharon Bio Medicine Limited and Others (decided on December 19, 2018) held that a resolution plan that discharged the liability of the corporate debtor to pay off its personal guarantors who were also the promoters was not discriminatory in nature.

By way of order dated February 28, 2018, the National Company Law Tribunal, Mumbai (“NCLT, Mumbai”) approved the resolution plan approved by the committee of creditors of Sharon Bio Medicine Limited (“Corporate Debtor”). The dispute arose when the promoters of the Corporate Debtor (“Appellants”) felt short changed as the resolution plan did not provide for their dues, as personal guarantors, to be paid off.

The resolution plan stated that the personal guarantee provided by the existing promoters of the Corporate Debtor shall result in no liability towards the Corporate Debtor or the successful resolution applicants and all the securities of the Corporate Debtor would be released. Further, the resolution plan also envisaged a selective reduction of the share capital of the Corporate Debtor more particularly (i) the entire shareholding of the promoter group and secured lenders; and (ii) up to 90% of the equity shares held by the public shareholders. This resulted in the Appellants challenging the order of the NCLT, Mumbai approving the resolution plan on two counts:

  1. The resolution plan did not envisage paying off the Appellants who were the promoters of the Corporate Debtor.
  2. The resolution plan was discriminatory towards the Appellants who were also the personal guarantors of the Corporate Debtor.

Whether NCLT, Mumbai should have approved the resolution plan in light of the personal guarantors excluded from being paid off?

The Appellants submitted that the payment terms provided in the resolution plan were in contravention to the applicable provisions of law. They also submitted that the successful resolution applicant had arbitrarily reduced or written off substantial liabilities of the Appellants without any legal basis. It was further pleaded that the lenders had not been treated similarly and restructuring for its entire claims of the Corporate Debtor was against the provisions of the Insolvency and Bankruptcy Code, 2016 (“Code”).

The Appellants argued that the security interest which includes the personal guarantees of the Appellants had been reduced to ‘nil’ under the resolution plan. Therefore, the resolution plan was contrary to Section 133 and 140 of the Indian Contract Act, 1872 (“Contract Act“). Section 133 of the Contract Act provides that if any change is made in the terms of the contract between the principal debtor and the creditor without the surety’s consent, it will discharge the surety from transactions subsequent to the change.

Further, Section 140 of the Contract Act deals with the right of subrogation to the surety, which provides that when the surety has paid the guaranteed debt or performed a guaranteed duty, it steps into the shoes of the creditor and all rights of the creditor start to vest with the surety.

The submissions of the Respondent were not recorded in the judgement.

The NCLAT observed that one of the primary objects of the Code is maximization of the value of the assets of the Corporate Debtor and then to balance the interest of all the creditors. Further the Code prohibits the promoters from gaining, directly or indirectly, control of the Corporate Debtor, or benefiting from the corporate insolvency resolution process or its outcome. The Code seeks to protect creditors of the Corporate Debtor by preventing promoters from rewarding themselves at the expense of creditors and undermining the insolvency processes. This is evident from the fact that powers of the promoters as the members of the board of directors of the Corporate Debtor are suspended once the resolution process begins and the promoters and shareholders have no right of representation, participation or voting in the meeting of the committee of creditors.

The NCLAT also observed that the personal guarantors who had filed the appeal in the present matter were the promoters, who contributed to the insolvency of the Corporate Debtor. Therefore, a resolution plan that does not envisage a payment of dues to the Appellants in their capacity as promoters /personal guarantors or discharges the liability of the Corporate Debtor as well as successful resolution applicant would not be discriminatory in nature.

The NCLAT also held that the liability of guarantors is co-extensive with the borrower. Also, it was not the intention of the Code to benefit the personal guarantors by excluding exercise of legal remedies available in law to the creditors, to recover legitimate dues by enforcing the personal guarantees, which are independent contracts.

The NCLAT held that resolution plan does not discriminate against the promoters/shareholders/personal guarantors and therefore dismissed the appeal filed by the Appellants.

Vaish Associates Advocates View
The NCLAT held that the resolution plan can effectively deny a personal guarantor the right of subrogation enshrined in the Contract Act. It is trite to mention that promoters or related parties are usually the ones who provide personal guarantees to the corporate debtors. It has been observed in some cases, that the promoters are the ones driving a company to insolvency and in such cases, providing a less favourable payment arrangement or, no payment at all under a resolution plan for such promoters compared to other creditors or even shareholders would be far from discriminatory.

This is in line with the spirit of the judgement in case of J.R. Agro Industries Private Limited v. Swadisht Oils Private Limited (decided on July 24, 2018) where the National Company Law Tribunal, Allahabad (“NCLT Allahabad”) ordered a modification of a resolution plan that gave priority to the related party financial creditors over the operational creditors. The NCLT Allahabad applied the principle enshrined in paragraph 55 of the UNCITRAL Legislative Guide which specifies that when an organisation owes debts to more than one creditor, the priority scheme established under the applicable law may provide for subordination of certain types of claim: for example, the determination of the priority of related party claims.

Further, the doctrine of equitable subordination also provides that a court can permit the subordination of a controlling shareholder’s claims upon debt to those of other bona fide creditors in bankruptcy, if the controlling shareholder has behaved unfairly or wrongly towards the company and its outside creditors. In line with the aforementioned decision of the NCLT Allahabad and the doctrine of equitable subordination, this judgement acts equitably by differentiating the promoters from other creditors and shareholders.

For more information please write to Mr. Bomi Daruwala at [email protected]