Between The Lines | NCLT: Guarantor cannot enjoy ‘right of subrogation’ after corporate insolvency resolution process against the principal debtor gets concluded August 23, 2022
Published in: Between The Lines
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The National Company Law Tribunal, Hyderabad (“NCLT/Adjudicating Authority”) has in its judgement dated July 7, 2022 (“Judgement”), in the matter of State Bank of India v. Shri Ghansham Surajbali Kurmi [CP (IB) 297/95/HBD/2021] held that the guarantor cannot enjoy the ‘right of subrogation’ after corporate insolvency resolution process against the principal debtor gets concluded under the provisions of the Insolvency and Bankruptcy Code, 2016 (“IBC”).
Apex Drugs Limited (“Corporate Debtor”) had been granted various credit facilities amounting to INR 2,08,21,65,555.24 from the State Bank of India (“Financial Creditor”). The Corporate Debtor was the principal borrower and Shri Ghansham Surajbali Kurmi (“Personal Guarantor”) stood as a guarantor so as to secure the repayment of the financial assistance availed by the Corporate Debtor.
After availing the credit facilities offered by the Financial Creditor, the Corporate Debtor failed to adhere to sanction terms and neglected to operate loan accounts as per the terms and conditions of the restructuring package sanction. As a result, the accounts of the Corporate Debtor were classified as Non-Performing Assets (“NPA”) on June 30, 2013.
Consequently, the Financial Creditor had also exercised its rights and remedies under the provisions of the Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (“SARFAESI Act”), against the Corporate Debtor and the Personal Guarantor before the Debt Recovery Tribunal-II, Hyderabad, in order to recover the outstanding amounts from the Corporate Debtor and the Personal Guarantor.
The Financial Creditor had also filed a petition before the Adjudicating Authority under Section 9 of the IBC as a result of which the Company Petition was admitted into and Corporate Insolvency Resolution Process was initiated against the Corporate Debtor on September 6, 2018 (“CIRP”).
Pursuant to the framing of the Insolvency and Bankruptcy (Application to Adjudicating Authority for Insolvency Resolution Process for Personal Guarantors to Corporate Debtor) Rules, 2019 (“Personal Guarantors Insolvency Rules”), which came into effect from December 1, 2019, the Financial Creditor issued a demand notice dated August 16, 2021 to the Personal Guarantor, demanding payment of the amount in default and subsequently filed a petition under Section 95(1) of the IBC (Application by creditor to initiate insolvency resolution process) read with Rule 7(2) of the Personal Guarantors Insolvency Rules (“Petition”), seeking initiation of the Insolvency Resolution Process (“IRP”) against the Personal Guarantor.
The NCLT by its order dated November 29, 2021, granted interim-moratorium and appointed Shri Kanchinadham Ravi Kumar as the resolution professional (“Resolution Professional”) directing the Resolution Professional to file his report within ten (10) days of his appointment.
Accordingly, the Resolution Professional filed his report stating that the amount of debt as on July 31, 2021 stood at INR 2,08,21,65,555.24 Crores and that the Personal Guarantor had confirmed that no payment had been made to the Financial Creditor towards the default committed by the Corporate Debtor and a lack of resources to pay the said amount. Hence, the Resolution Professional recommended the admission of the Petition filed by the Financial Creditor under Section 95 of the IBC.
Whether a guarantor can enjoy the ‘right of subrogation’ even after conclusion of CIRP against the principal debtor.
Contentions raised by the Personal Guarantor:
The Personal Guarantor submitted that the Financial Creditor was part of the Committee of Creditors (“CoC”) having a voting share of 70.10%. The CoC initially approved the resolution plan of the successful resolution applicant with 100% voting, which was further approved by the Adjudicating Authority under Section 31 of the IBC (“Resolution Plan”).
Clause F (Reliefs and Concessions) of the Resolution Plan read as follows:
“Once the consideration as envisaged in the resolution plan is paid, all rights, security and interest including but not limited to mortgage, pledge, guarantee and hypothecation created shall stand satisfied in lieu of the said payment.”
The Personal Guarantor contended that as per Clause F of the Resolution Plan, once the consideration as envisaged in the said resolution plan is paid, all rights, security and interest including but not limited to mortgage, pledge, guarantee and hypothecation created shall stand satisfied in lieu of the said payment. Hence, by virtue of Clause F of the Resolution Plan, the liability of the Personal Guarantor to pay the Financial Creditor towards the default committed by the Corporate Debtor was discharged.
The Personal Guarantor further submitted that the Financial Creditor, despite knowing the fact that the Resolution Plan discharges the Personal Guarantor from future liabilities, has filed the Petition, without paying heed to the provisions of the Resolution Plan.
Therefore, any rights of the Financial Creditor against the Personal Guarantor stand forfeited after the Financial Creditor gave its approval to the said Resolution Plan.
Lastly, the Personal Guarantor contended that the Financial Creditor had not only filed the Petition by suppressing essential facts, with an intention to unlawfully hold the Personal Guarantor liable for past and settled dues, but also to harass and cause irreparable harm to the Personal Guarantor, whose liability was discharged after approval of the Resolution Plan.
In view of the above, the Personal Guarantor prayed for dismissal of the Petition filed by the Financial Creditor.
Contentions raised by the Financial Creditor:
The Financial Creditor denied the contentions put forth by the Personal Guarantor and submitted that the Financial Creditor being part of the CoC did not in any manner bar initiation of insolvency proceedings qua the Personal Guarantor. Further, the approval of the Resolution Plan by the CoC and subsequent approval of the said plan by the Adjudicating Authority, in no way affects the proceedings before the NCLT.
With regard to the contention of the Personal Guarantor that his liability to pay the Financial Creditor gets discharged by virtue of Clause F of the Resolution Plan, the Financial Creditor submitted that Clause F dealt with Reliefs and Concessions, whereby the resolution applicant sought certain reliefs/concessions from the Adjudicating Authority for smooth functioning of the Corporate Debtor. Interpreting the said Clause as an extinguishment of the guarantee provided by the Personal Guarantor creates a scenario which would have adverse cascading effects. The Financial Creditor vehemently denied that Clause F of the Resolution Plan discharges the Personal Guarantor from any future liabilities.
The Financial Creditor further submitted that even after the Resolution Plan of Corporate Debtor is approved, the Financial Creditor continues to be at liberty to initiate IRP against the Personal Guarantor by filing an application under Section 95 of the IBC. The IBC does not bar a financial creditor to initiate appropriate insolvency proceedings against personal guarantors. Rather, it provides for a mechanism specifically for insolvency and bankruptcy of the personal guarantors. It is a settled position of law that the liabilities of guarantors are co-extensive with that of the principal debtor/borrower.
Moreover, as per the provisions of Section 134 (Discharge of surety by release or discharge of principal debtor) of Indian Contract Act, 1872 (“Contract Act”), a guarantor is discharged of its liability towards the creditor only if the creditor on its own instance discharges the principal debtor. Therefore, the main ingredient of the said section is discharge of the principal debtor through voluntary act of the creditor and not due to operation of law.
A scheme or plan that is approved by a court/tribunal becomes a statutory scheme and thereby, in its nature, is an act of operation of law. Therefore, under the IBC, the corporate debtor is discharged by the operation of law, that is, by approval of the resolution plan by the adjudicating authority on its satisfaction and not at the instance of a creditor, irrespective of whether the creditor is in favour of a resolution plan. In other words, the Personal Guarantor cannot be said to be discharged of its liability towards the Financial Creditor as a consequence of discharge of the Corporate Debtor’s liability under the IBC.
The Financial Creditor categorically stated that after the CIRP has concluded, a guarantor cannot enjoy a right of subrogation when the payment is made by the guarantor with respect to the debt for which the guarantee is provided. In order to support its submissions, the Financial Creditor placed reliance on the judgment in the case of Lalit Mishra and Others v. Sharon Bio Medicine Limited [Company Appeal (AT) (Insolvency) No. 164 of 2018], wherein it was held that the guarantor cannot exercise its right of subrogation under the Contract Act, as proceedings under the IBC are not recovery proceedings and that the object of IBC is to revive the company and focus on maximisation of its assets, not to ensure that credit is available to all stakeholders.
The Financial Creditor also placed reliance on Lalit Kumar Jain v. Union of India [Transferred Case (Civil) No. 245/2020)] (“Lalit Kumar Case”), wherein the Hon’ble Supreme Court held that approval of a resolution plan does not ipso facto discharge a personal guarantor of his/her liabilities under the contract of guarantee. Moreover, the release or discharge of a principal borrower from the debt owed by it to its creditor, by an involuntary process, that is, by operation of law or due to liquidation or insolvency proceeding, do not absolve the surety/guarantor of his/her liability, which arises out of an independent contract.
On account of the foregoing, the Financial Creditor prayed that its Petition be allowed and IRP be initiated against the Personal Guarantor.
Observations of the NCLT
The NCLT affirmed the view of the Financial Creditor and observed that as per the provisions of Section 134 (Discharge of surety by release or discharge of principal debtor) of the Contract Act, a guarantor is discharged of its liability towards the creditor only if the creditor on its own instance discharges the principal debtor through voluntary act of the creditor and not due to operation of law.
Further, Clause F (Reliefs and Concessions) of the Resolution Plan clearly depicts the intention of the resolution applicant for seeking reliefs and concessions as far as the Corporate Debtor is concerned only, which is not only in line with the clean slate theory but also in line with the objectives of the IBC. Interpreting the contents of the said clause as an extinguishment of the guarantee provided by the personal guarantor would create a scenario that would have an adverse cascading effect.
The NCLT further observed that conclusion of CIRP does not bar the Financial Creditor to proceed against the Personal Guarantor and that the Financial Creditor can always approach the Adjudicating Authority as envisaged under the provisions of the IBC.
The NCLT observed that the submissions made by the Personal Guarantor lacked merit.
Decision of the NCLT
The NCLT asserted that the celebrated judgement in the Lalit Kumar Case, was squarely applicable to the instant case and held that after conclusion of CIRP, a guarantor cannot enjoy a right of subrogation against the corporate debtor when the payment is made by the guarantor with respect to the debt for which the guarantee is provided.
Moreover, by virtue of approval of the Resolution Plan, the Personal Guarantor is not discharged of its liability and the Financial Creditor is entitled to initiate IRP against the Personal Guarantor.
Therefore, the NCLT admitted the Petition filed by the Financial Creditor and initiated IRP against the Personal Guarantor, by declaring him insolvent.
This Judgement provides much needed clarity on guarantor’s subrogation rights and re-emphasizes the principle laid down in the Lalit Kumar Case that the release or discharge of a principal borrower from the debt owed by it to its creditor due to liquidation or insolvency proceeding does not absolve the guarantor of his/her liabilities, which arises out of an independent contract and that a personal guarantor would not be discharged by virtue of a resolution plan of a corporate debtor being approved under the IBC.
For any query, please write to Mr. Bomi Daruwala at [email protected]DOWNLOAD NEWSLETTER