Conundrum of Simultaneous Proceedings against Principal Borrower and Corporate Guarantor for the Same Debt

Introduction

In any financial transaction pertaining to granting loans to the corporates, one of the most conventional methods adopted by banks and financial institutions include obtaining a guarantee from either the promoter or the holding/group companies of such corporate. Such guarantees and related contracts are governed under the provisions of Indian Contract Act, 1872 under the principle of coextensive liability of the surety and the principal debtor.

However, after introduction of the Insolvency and Bankruptcy Code, 2016 (“Code”), one of the most highly debated issues concerning these guarantee contracts is related to the question as to whether a lender can make simultaneous claims against the corporate insolvency resolution processes against the principal borrower as well as the corporate guarantor.

The question on initiation of Corporate Insolvency Resolution Process (“CIRP”) against two Corporate Debtors (either Principal Borrower or Corporate Guarantor) for the same set of debt obligations arising out of the same loan agreements under the ambit of the Code initially arose in the matter of Dr. Vishnu Kumar Agarwal Vs M/s Piramal Enterprises Limited[1] (“Piramal Judgment”) before the Hon’ble National Company Law Appellate Tribunal (“NCLAT”) wherein the Hon’ble Tribunal observed and held in Para 32 of the judgment,

“There is no bar in the Insolvency and Bankruptcy Code, 2016 for filing simultaneously two applications under Section 7 against the ‘Principal Borrower’ as well as the ‘Corporate Guarantor (s). However, once for the same set of claim application under Section 7 by the financial creditor is admitted against one ‘Corporate Debtor’ i.e. ‘Principal Borrower’ or ‘Corporate Guarantor’, second application by the same financial creditor for the same set of claim and default cannot be admitted against the other ‘Corporate Debtor’ i.e. ‘Principal Borrower’ or ‘Corporate Guarantor’. Though there is no provision to file joint application under Section 7 of the Insolvency and Bankruptcy Code, 2016 by the Financial Creditors, no application can be filed by the Financial Creditor against two or more “Corporate Debtors” on the ground of joint liability ( ‘Principal Borrower’ and on ‘Corporate Guarantor’ or ‘Principal Borrower’ or two ‘Corporate Guarantors’ or one ‘Corporate Guarantor’ and other ‘Corporate Guarantor’ till it is shown that the ‘Corporate Debtors’ combinedly are joint venture company.”

The aforesaid judgment of the Hon’ble NCLAT led to a complete stir in the market considering the fact that even though the Hon’ble Tribunal agreed on the principle of co-extensive liability of principal debtor and surety, it disregarded the same principle within the ambit of the Code. This is the reason that many appeals against the Piramal Judgment are pending before the Hon’ble Supreme Court and as on date the Hon’ble Supreme Court has in the matter of Piramal directed maintaining of status quo.

Whilst the Piramal Judgment is in challenge before the Hon’ble Supreme Court, a twist in the tale has erupted in the form of one of the most recent judgments issued by Hon’ble NCLAT in the matter of State Bank of India Vs Athena Energy Ventures Private Limited[2] (“Athena Energy Ventures Case”) wherein the Hon’ble NCLAT has held and observed in Para 19 and 20 of the judgment,

“It is clear that in the matter of guarantee, CIRP can proceed against the Principal Borrower as well as Guarantor. The law laid down by the Hon’ble High Courts for their respective jurisdictions, and law as laid down by the Hon’ble Supreme Court in the whole country is binding. In the matter of Piramal, the Bench of this Appellate Tribunal “interpreted” the law. Ordinarily, we would respect and adopt the interpretation but for the reasons as discussed above, we are unable to interpret the law in the manner as it was interpreted in the Piramal matter. For such reasons, we are unable to uphold the judgment as passed by the Adjudicating Authority. The appeal is allowed.”

2. Relevant provisions of Law

Section 128 of the Indian Contract Act, 1872 which reads as under stipulates that the liability of the guarantor is co-extensive with that of the principal debtor unless it is otherwise provided by the contract. However, the onus is on the surety to establish that, the contract of guarantee provided for anything to diminish the liability of the surety under the contract of guarantee excepting the liability of the surety being co-extensive as that of the principal debtor or company.

“Surety’s Liability- The liability of the surety is co-extensive with that of the principal debtor, unless it is otherwise provided by the contract.”

Section 5(8) of the Code defines “financial debt” as a debt along with interest, if any which is disbursed against the consideration for the time value of money and includes, money borrowed against the payment of interest, any counter indemnity obligation in respect of a guarantee, bond, documentary letter of credit or any other instrument issued by a bank or financial institution and any amount of liability in respect of any such guarantee or indemnity. Thus, the Code treats the Principal Borrower and the Guarantor similarly.

Section 60 (2) and (3) of the Code allows filing of simultaneous application against the Borrower as well as Guarantor and states that the same could also be maintained.

3. Insolvency Law Committee Report Comments

The Insolvency Law Committee in its Report dated February 2020[3] under Para 7.3 noted and observed,

“while, under a contract of guarantee, a creditor is not entitled to recover more than what is due to it, an action against the surety cannot be prevented solely on the ground that the creditor has an alternative relief against the principal borrower. Further, as discussed above, the creditor is at liberty to proceed against either the debtor alone, or the surety alone, or jointly against both the debtor and the surety. Therefore, restricting a creditor from initiating CIRP against both the principal borrower and the surety would prejudice the right of the creditor provided under the contract of guarantee to proceed simultaneously against both of them.”

In addition to the above, as the right to simultaneous remedy is central to a contract of guarantee, the Committee suggested that in cases where both the principal borrower and the surety are undergoing CIRP, the creditor should be permitted to file claims in both the CIRPs. Since, the Code does not prevent this, the Committee has recommended that no amendments were necessary in this regard. In view of the above, the Committee observed that if a creditor is denied the right to proceed simultaneously against the Corporate Debtor and the Guarantor, the ability of the creditor to recover its debt may be seriously impaired.

4. Piramal Vs Athena: A Critical Analysis

It is worth noting that though the Piramal Judgment agreed with the principle of co-extensive liability of the debtor and the surety, it completely rejected the application of the same in consonance with the Code.

It is pertinent to mention here that the Hon’ble Supreme Court in the matter of Investment Bank of India Vs Biswanath Jhunjhunwala[4], has settled the law on guarantee and held,

“The very object of the guarantee is defeated if the creditor is asked to postpone his remedies against the surety. In the present case the creditor is a banking company. A guarantee is a collateral security usually taken by a banker. The security will become useless if his rights against the surety can be so easily cut down.”

Further, the Hon’ble Supreme Court in the matter of State Bank of India Vs Ramakrishnan[5] observed and affirmed in Para 22 of the judgment,

“Section 31 (1) of the Code, in fact, makes it clear that the guarantor cannot escape the payment of the Resolution Plan, which has been approved, may well include provisions as to payments to be made by such guarantor.”

The Hon’ble Supreme Court has re-emphasised again on its aforesaid view in the matter of Committee of Creditors of Essar Steel Vs Satish Kumar Gupta and Ors.[6]

The Hon’ble NCLAT in the Piramal Judgment observed and held the following:

1. It is always open for a financial creditor to initiate Corporate Insolvency Resolution Process against the Corporate Guarantor without first initiating the insolvency process against the Principal Borrower since the creditor is also the financial creditor qua the Corporate Guarantors.
2. However, admittedly, for the same set of debt, claim cannot be filed by same financial creditor in two separate Corporate Insolvency Resolution Processes. The Hon’ble Tribunal held the above basis the argument that if same claim cannot be claimed from Resolution Professionals of separate Corporate Insolvency Resolution Processes, for same claim amount and default, two applications under Section 7 of the Code cannot be admitted simultaneously. It means once for the same claim Corporate Insolvency Resolution Process is initiated against one of the Corporate Debtor, then, after such initiation, the financial creditor cannot trigger Corporate Insolvency Resolution Process against the other Corporate Debtor for the same claim amount i.e. debt.
3. There is no bar in the Code for filing two simultaneous applications under Section 7 against the Principal Borrower as well as the Corporate Guarantor (s) or against both the Guarantor (s). However, once for same set of claim application under Section 7 filed by the financial creditor is admitted against one of the Corporate Debtor i.e. Principal Borrower or Corporate Guarantor, second application by the same financial creditor for the same set of claim and default cannot be admitted against the other Corporate Debtor i.e. Principal Borrower or Corporate Guarantor.

On the other hand, the Hon’ble NCLAT in the Athena Energy Ventures Case, has taken note of the following:

1. The issue in the matter of Piramal was relating to question whether CIRP can be initiated against two Corporate Guarantors simultaneously for same set of debt and default.
2. The issue was not whether application can be filed against the Principal Borrower as well as the Corporate Guarantor. The observations made by the Appellate Tribunal in Para 32 of the Piramal Judgment that the second application for same set of claim and default cannot be admitted against the Corporate Guarantor or Principal Borrower was not an issue in the matter of Piramal.
3. Apart from the above, the Appellate Tribunal in the Piramal judgment do not appear to have noticed Sub-Sections 2 and 3 of Section 60 of the Code.
4. If the above provisions of Section 60 (2) and (3) are kept in view, it can be said that the Code has no aversion to simultaneously proceeding against the Corporate Debtor and Corporate Guarantor. If two applications can be filed, for the same amount against the Principal Borrower and the Guarantor, keeping in view the above provisions, the Applications can also be maintained. It is for such reason that Section 60 (3) \provides that if insolvency resolution process or liquidation or bankruptcy proceedings of a Corporate Guarantor or Personal Guarantor as the case may be of the Corporate Debtor is pending in any Court or Tribunal, it shall stand transferred to the Adjudicating Authority dealing with the insolvency resolution process or liquidation process of such Corporate Debtor. Apparently and for obvious reasons, the law requires that both the proceedings should be before the same Adjudicating Authority.
5. Under the Contract of Guarantee, it is only when the Creditor would receive amount, the question of no more due or adjustment would arise and it would be a matter of adjustment when the Creditor receives debt due from the Borrower/Guarantor in the respective CIRP that the same should be taken note of and adjusted in the other CIRP. This can be conveniently done, more so when IRP/RP in both the CIRPs is same. Insolvency and Bankruptcy Board of India may have to lay down regulations to guide IRP/RPs in this regard.
6. The Insolvency Law Committee has rightly held that provisions are there in the form of Section 60 (2) and (3) and no amendment or legal changes are required at the moment. It is, therefore, noted that simultaneously remedy is central to a contract of guarantee and where Principal Borrower and Surety are undergoing CIRP, the creditor should be able to file claims in both the CIRPs. The Code does not prevent this in any manner.
7. The Hon’ble NCLAT concluded that in the matter of guarantee, CIRP can proceed against Principal Borrower as well as Guarantor and observed that it would be unable to interpret the law in the manner as it was interpreted in the matter of Piramal and set-aside the judgment passed by NCLT and appointed the same Resolution Professional who was appointed for the Principal Borrower i.e. Athena Chhattisgarh Power Limited.

The Hon’ble NCLAT, emphasised the need for group insolvency and appointment of same IRP/RP where multiple entities of a single group go insolvent, their resolution can be consolidated in one court so that the combined assets can be utilised in the best interest of both the entities. The NCLAT, further, advised IBBI to lay regulations to guide IRP/RPs in this regard.

About the Authors:

1.  P Ravi Charan – Partner, Link Legal India Law Services
Ravi Charan is a Partner with Link Legal India Law Services and has over 16 years of experience. He has expertise in advising and representing various spectrum of clients in proceedings pertaining to litigation, arbitration, project finance, real estate and general corporate.

2. Ms. Neha Pathak – Associate, Link Legal India Law Services
Neha is a part of the Insolvency team at the firm with over 6 years of experience in the banking and finance industry with special focus on acquisition and resolution of financial assets including restructuring and insolvency resolution process.

References: