EVOLUTION OF PERSONAL GUARANTORS: AN UNSETTLED DILEMMA
Authors: Samkeet Surana
Samyak Dalal (co – author)
BBALLB (Hons.)
RESEARCH QUESTIONS
1. What is the Position and Liability of Guarantors during the Moratorium Period?
2. Whether separate proceedings can be initiated or continued against the guarantors of a corporate debtor undergoing a CIRP?
3. Whether the period of moratorium under section 14 of Insolvency and Bankruptcy Code is applicable to Personal Guarantor?
STATEMENT OF PROBLEM
The initial position of law is unsettled regarding the position and liability of the guarantors during the moratorium period and also the problem regarding separate proceedings and usage of the properties of the guarantor. The qualitative study will explore the problem and specify the need for a particular solution which could also be a suggestion for certain amendments or changes for the specific purpose.
OBJECTIVES/ STATEMENT OF PURPOSE
· The research pertaining to the area of personal guarantors is unclear and the various precedents give out different view in furtherance of the same. So therefore, the main research objective is to determine position and liability of guarantors during the moratorium period and also whether separate proceedings can be initiated or continued against the guarantors during the CIRP.
· The analysis on the topic would establish the differences between the position of the guarantor under the Indian Contract Act and Insolvency and the Bankruptcy Code, the paper would also showcase various judicial pronouncements to support in answering the research question and main thrust of the paper is establish thoroughly the liabilities and the rights of personal guarantor before, during the CIRP.
LIMITATION OF THE STUDY
· The scope of the research limits to the country of India and its jurisdiction.
· The paper also limits to using only the primary sources for references of the research.
LITERATURE REVIEW
1. Guarantors under Bankruptcy Code: the curious case of confusing precedents Sahil Kanuga and Arjun Gupta[1]
The article focuses and emphasizes on the aspect of the guarantors wherein they form the bedrock of loans and also provide the requisite guarantees to the lender or the creditor. The article also seeks to focus upon the interplay between the lender, guarantor and the debtor through the role of various precedents. The article also states that the Code envisages a brand-new regime for consolidating the laws pertaining to the reorganisation and insolvency resolution of corporate entities and partnership firms, as well as individuals, in a time-bound manner, with a view to maximising value and balancing the interests of all stakeholders. The most landmark case of State Bank of India v Mr V Ramakrishnan & Anr, The NCLT thereby determined that the moratorium was not only applicable to the property of the Corporate Debtor but also to the Personal Guarantor. Consequently, the NCLAT suspended the SARFAESI proceedings against the Personal Guarantor. The article also deals with other variety of cases along the same line and also lays down the differences of opinion in the various quoted judgments. In the latter part of the article, the author also states that the purpose of the guarantee agreements is for the recovery of the loans and the code is designed more or less for the creditors and the objective is such that to maximize the recovery for creditor without being unfair to or trampling on the rights of the debtor.
2. After the Guarantor Pays: The Uncertain Equitable Doctrines Of Reimbursement, Contribution, And Subrogation Brian D. Hulse[2]
The Article addresses the equitable doctrines of reimbursement, contribution, and subrogation as they apply to guarantors. Specifically, it explores in detail guarantors’ rights after they make payment under the guaranty and then seek to recover some or the entire amount paid from the borrower, other guarantors, or the collateral for the primary obligation. The article also discusses the inconsistencies in the case law on these subjects, which can create unpredictable results. The Article also elucidates upon the case of Honey v. Davis, the most famous American case wherein the Washington Supreme Court was not able to determine and give a clear about the context of Personal guarantor as there were about three different opinions but the majority of the judges stated that the landlord was not a surety and did not have a right of reimbursement. The dissenting opinion, joined by three justices, argued that the landlord was a surety and entitled to reimbursement. The latter part of the paper concludes that, when multiple parties are liable on a common debt, in whatever capacity, they should enter into appropriate reimbursement and contribution agreements at the outset of the transaction to avoid litigation and unpredictable outcomes. The article also states that Guarantors and other sureties that pay have well-recognized equitable rights of reimbursement against the principal obligor, contribution from other co-sureties, and subrogation to the rights of the creditor.
3. Corporate Insolvency: Its Operations and Emerging Problems – Navin K. Pahwa[3]
One of the major operational problems the article elucidates upon is the fixation of the liability of the guarantors. Although the Code is facing such challenges, the author is of the view that with correct judicial and legislative interference, it may grow into a mature and effective piece of legislation and improve the ease of doing business as well as the economic scenario in India. The author also deals with the NCLAT in its recent judgment in SBI v. V. Ramakrishnan (‘SBI’) held that the moratorium will apply both to the property of the Corporate Debtor and the personal guarantor. This ratio raises issues on deviation from well-settled concept of coextensive liability of the guarantor and the principal debtor as contemplated under Sec. 128 of the Contract Act, 1872. SBI is contemplating challenging this decision of the NCL AT. The author also suggests some of the new suggestions that has to be incorporated in the code with relation to the property of the corporate debtor wherein the author recommends that it should also provide for protection of the propert
ies of the personal guarantor during the moratorium period. The liability of the guarantor cannot be completely de-linked with the liability of the principal debtor. In the concluding part of the article states that the IB Code, a conglomerate of various legislations, has brought sea changes in the concept of bankruptcy and insolvency and also is refurbishing the confidence of creditors such that their rights are protected through the same processes.
ies of the personal guarantor during the moratorium period. The liability of the guarantor cannot be completely de-linked with the liability of the principal debtor. In the concluding part of the article states that the IB Code, a conglomerate of various legislations, has brought sea changes in the concept of bankruptcy and insolvency and also is refurbishing the confidence of creditors such that their rights are protected through the same processes.
4. Liability of Personal Guarantors vis a vis their Rights under the IBC: A Legal Conundrum – Pinak Parikh[4]
The Article begins with the introduction of the case of Essar Steel wherein Section 31(1) of IBC clears the smoke stating that the liability of personal guarantors stands extinguished upon approval of the resolution plan under IBC since the resolution plan is binding on the personal guarantors. However the same view is not been recognized and is untenable in law, wherein in the case of State Bank of India v. V. Ramakrishnan, observed that liability of the personal guarantors is not extinguished upon approval of the resolution plan. The author also states that The IBC is silent on the liability of personal guarantors to pay off the debts of corporate debtor following the approval of resolution plan. Such a situation is problematic because: (1) the resolution plan for the corporate debtor, which is a contract, discharges the principal debtor and, consequently, the guarantor (section 128 of the Contract Act); and (2) even though the guarantor is not discharged and is allowed to exercise the right of subrogation (section 140 of the Contract Act), it will bring the corporate debtor back to where it was prior to passing of a resolution plan, which was clearly not the intention of the legislature. The article also emphasizes on the aspect of liability of the guarantor under the scope of the Indian Contract Act, 1872. The author also provides with exploring the ambit of Sections 128, 135, 139 etc. and in the concluding part the author states that the time is ripe for the Supreme Court to conclusively determine liability of the personal guarantors as well as rights of the personal guarantors in respect of the corporate debtor following the approval of the resolution plan.
5. Liability of Personal Guarantors of a Corporate Debtor during the Corporate Insolvency Resolution Process – Param Pandya[5]
The author gives the case analysis of Sanjeev Shriya v. State Bank of India, wherein the court has decided the question pertaining to the question of the liability of personal guarantors of a company where moratorium under Section 14 of the Insolvency and Bankruptcy Code, 2016 (“IBC“) is in force. The Allahabad High Court has answered the above question in the negative stating that a personal guarantor of an insolvent company is not liable to pay the debt. The author seeks to protect the rights and the interest of the creditor by stating that, liquidation of the principal debtor does not by itself affect the creditor’s rights against the guarantors. The creditor may prove in liquidation the full balance due to it under the principal debt and may at the same time proceed against the guarantors for any sums due under the guarantee, obtain judgment against the guarantor for any sum outstanding at the date of the judgment, and then proceed to enforce its judgment until it is paid in full, from all sources. The creditor is entitled to prove in the liquidation of the principal debtor, irrespective of its ability to recover against the guarantor. The author in the latter part seeks to make IBC as a creditor-friendly law.
RESEARCH ANALYSIS
INTRODUCTION
Corporate guarantees form the bedrock of loans. They ostensibly provide the lender with comfort that the monies it has lent are sufficiently protected and, should the debtor find itself in a position where it is not able to repay the principal and interest, there is a fallback available to the lender. With the promulgation of the brand new Indian Insolvency and Bankruptcy Code, 2016 (the ‘Code’), the interplay between the lender, debtor and guarantor, has been called into question. There have been a number of cases where the issue of rights of a creditor against a guarantor (corporate as well as individual) under the
Insolvency and Bankruptcy Code, 2016 has been raised. Before, delving into answering and analyzing the research questions we need to understand the process of how CIRP work through.
Insolvency and Bankruptcy Code, 2016 has been raised. Before, delving into answering and analyzing the research questions we need to understand the process of how CIRP work through.
WORKING OF THE CORPORATE INSOLVENCY RESOLUTION PROCESS (CIRP)
As per the scheme of IBC, once the resolution plan is accepted by the Committee of Creditors (CoC) and the same is approved by the Adjudicating Authority, the CIRP comes to an end. Once the CIRP is concluded and the plan gets approved by the Adjudicating Authority as per Section 31 of the IBC, the debt which was owed by the Corporate Debtor is settled. No proceedings against the Corporate Debtor can be initiated in relation to the debt that has been settled. The resolution plan so approved is binding on the corporate debtor, its employees, members, creditors, guarantors and other stakeholders involved in the resolution plan. So therefore, in simple terms once the resolution plan is approved the liabilities of the corporate debtor come to an end and further there is no such role of them.
ROLE AND DEFENCES OF PERSONAL GUARANTOR
Sec 5 (22) of the Act define personal guarantor as ‘covers only individuals who are sureties to a contract of guarantee to a corporate debtor’. It is therefore also to be stated that the creditor has the right and also retain such right to proceed against the guarantor of the corporate debtor. Therefore, if the borrower is unable to clear the debt, then the right is accrued in favour of the creditor to proceed against the guarantor. But, the guarantors on the other hand can use some of the defences in their favour as enshrined under the Indian Contract Act, 1872 i.e., Section 133, 134, 140 etc. wherein, 134 deals with a guarantor is discharged of its liability towards the creditor if the creditor on its own instance discharges the Principal Debtor. Whereas, Section 140 which provides for right of subrogation. But all these defences stand no place and role in the Code as the position under IBC is different from that of the contact Act.
The role and the position of IBC is different and therefore the guarantor cannot be said to be discharged of its liability towards the creditor on the discharge of Principal Debtor’s liability under the IBC. The Supreme Court in the case of SBI v. V. Ramakrishnan[6], while addressing this issue placed strong reliance on Section 31 of the IBC which states that once the resolution plan is approved it will be binding on all the stakeholders including the guarantors. On the basis of the said provision, it held that the guarantor cannot be relieved from making payment by virtue of Section 133 of the Contract Act even if the debt is varied under the resolution plan as the resolution plan is binding on the guarantor as well. Also, the second defence has been clearly clarified by Lalit Mishra & Ors. v. Sharon Bio Medicine Ltd.[7], wherein it has been held that the guarantor cannot exercise its right of subrogation under the Contract Act as proceedings under the IBC are not recovery proceedings. The object of the proceedings under the IBC is to revive the company and focus on maximization of value of its assets and not to ensure that the credit is available to all stakeholders. Thus, no such recovery can be made by guarantor.
LIABILITY OF THE PERSONAL GUARANTOR
The High Court of Calcutta in Gouri Shankar Jain v. Punjab National Bank[8] was faced with the similar question, i.e., whether liability of the personal guarantor is extinguished upon approval of the resolution plan. The Calcutta High Court observed that liability of the personal guarantor is not extinguished upon approval of the resolution plan. The court also observed that, according to section 128 of the Contract Act, liability of the guarantor is co-extensive with that of the principle debtor. Therefore, the Court observed that in case of discharge by operation of law, the liability of the surety is not extinguished[9].
The Supreme Court in Committee of Creditors of Essar Steel India Limited v. Satish Kumar Gupta[10] had the occasion to deal with the issue of liability of the personal guarantors towar
ds financial creditors following the approval of resolution plan under IBC. However, the Supreme Court, instead of giving a decisive decision on the aforesaid issue, observed: “So far as the present case is concerned, we hasten to add that we are saying nothing which may affect the pending litigation on account of invocation of these guarantees”. In view of colossal amount of debt still unpaid, it appears that the Supreme Court has clearly failed to come to the rescue of either personal guarantors or financial creditors.
ds financial creditors following the approval of resolution plan under IBC. However, the Supreme Court, instead of giving a decisive decision on the aforesaid issue, observed: “So far as the present case is concerned, we hasten to add that we are saying nothing which may affect the pending litigation on account of invocation of these guarantees”. In view of colossal amount of debt still unpaid, it appears that the Supreme Court has clearly failed to come to the rescue of either personal guarantors or financial creditors.
TREATMENT OF PROPERTIES UNDER MORATORIUM PERIOD
In the case of Alpha & Omega Diagnostics (India) Ltd. v. Asset Reconstruction Company of India Ltd. & Ors.[11], on an appeal from the NCLT to NCLAT, the National Company Law Appellate Tribunal (NCLAT) settled the question with regard to treatment of properties of the guarantors during a moratorium under section 14 of the Code. The question put forth before the NCLT Mumbai was whether such properties that are not owned by the corporate debtor would fall within the ambit of a moratorium under the Code. The NCLT answered the question in positive stating that the strict interpretation of the term “its” under section 14(1)(c) of the Code refers to the property of the corporate debtor undergoing a CIRP. Accordingly, the property not owned by the corporate debtor would not fall within the ambit of the moratorium imposed under the Code. Upholding the decision of the NCLT, the NCLAT held that the moratorium would not be applicable to any assets, movable or immoveable, that do not belong to the corporate debtor.
Therefore, both the NCLT and the NCLAT had decided the issue strictly interpreting the Code and holding that it is only the property of the corporate debtor that would fall within the shadow of the moratorium imposed under section 14(1)(c) and no other properties shall be covered thereunder. The same has also been reiterated in Schweitzer Systemtek India Private Limited v. Phoenix ARC Private Limited[12]. In the case of Sanjeev Shreya v. State Bank of India[13], the Allahabad High Court held that proceedings against guarantors of the corporate debtor cannot be continued while the moratorium issued under section 14 of the Code is in force.
The most landmark judgment pertaining to the granting of the moratorium period as enshrined under Section 14 is applicable to personal guarantors or not is decided in the case of State Bank of India v. Ramakrishnan and Ors.[14], On Feb. 14, M/s. Veesons Energy Systems Private Limited (“Corporate Debtor”/ “Company”) availed credit facilities from State Bank of India (“Financial Creditor”/ “Bank”). Mr. V Ramakrishna, the managing director of the company signed a personal guarantee in favor of State Bank of India. The company was not able to pay its debt therefore the company filed an application under Section 10 of IBC before the NCLT. The Tribunal admitted the application and passed an order of Moratorium under section 14 of the IBC. But the main issue arised wherein the bank even after his declaration of moratorium period proceeded against property of personal guarantor under SARFAESI Act. `
NCLT order- The Tribunal by its order dated September 18, 2018, prohibited the Bank from proceeding against the property of personal guarantor during moratorium period.
On Appeal to NCLAT (order) – The NCLAT relying upon section 60 and section 31 of the Code, held that moratorium under section 14 will apply to personal guarantor as well.
Supreme Court- The court held that the personal guarantor is not entitled to moratorium period under the Insolvency and Bankruptcy Code. The court relied upon report of Insolvency Law Committee which clarified that Section 14 Section 14 would not apply to the guarantors and also the proviso to amended section 14 clearly states that the moratorium period envisaged in section 14 is not applicable to personal guarantor to a corporate debtor.
CONCLUSION AND SUGGESTIONS
The issue regarding the position and liability of guarantors under the guarantee during the moratorium period is brought through various judicial precedents.
It is to be noted that the understanding of the code should be such that, creditors must be protected in all such acts which is legal in nature and also the code must be a creditor friendly one. From the above judgments it is clear fact that since an action against the properties of a guarantor are not covered under the moratorium imposed on the corporate debtor, the proceedings against the guarantor for recovery of guarantee amount can be initiated or continued, despite the moratorium on legal proceedings in other forums against the corporate debtor during its CIRP. But this position has been altered through the recent judgment wherein, the proceedings against guarantors of the corporate debtor cannot be continued while the moratorium issued under section 14 of the Code is in force. By that the creditors would not have the right to proceed for recovery against the guarantors of a corporate debtor undergoing a CIRP, until the time the moratorium (under section 14) of the Code is in place. This position of law is therefore unsettled. According to the authors understanding the court which is developed and made through over time must be more of creditor-friendly, as the risk that is bourne by the creditor that is the non-surety of return of the money must be repaid in time by either the debtor of his guarantor. Therefore, according to my understanding there must be some amendments or changes brought into the code such that there is some imposition of liability of the guarantor and there must also be separate proceedings which must take place even though moratorium period is announced by the authorities in order to recover the amounts that belong to the creditor as such. The time is ripe for the Supreme Court to conclusively determine liability of the personal guarantors as well as rights of the personal guarantors in respect of the corporate debtor following the approval of the resolution plan.
It is to be noted that the understanding of the code should be such that, creditors must be protected in all such acts which is legal in nature and also the code must be a creditor friendly one. From the above judgments it is clear fact that since an action against the properties of a guarantor are not covered under the moratorium imposed on the corporate debtor, the proceedings against the guarantor for recovery of guarantee amount can be initiated or continued, despite the moratorium on legal proceedings in other forums against the corporate debtor during its CIRP. But this position has been altered through the recent judgment wherein, the proceedings against guarantors of the corporate debtor cannot be continued while the moratorium issued under section 14 of the Code is in force. By that the creditors would not have the right to proceed for recovery against the guarantors of a corporate debtor undergoing a CIRP, until the time the moratorium (under section 14) of the Code is in place. This position of law is therefore unsettled. According to the authors understanding the court which is developed and made through over time must be more of creditor-friendly, as the risk that is bourne by the creditor that is the non-surety of return of the money must be repaid in time by either the debtor of his guarantor. Therefore, according to my understanding there must be some amendments or changes brought into the code such that there is some imposition of liability of the guarantor and there must also be separate proceedings which must take place even though moratorium period is announced by the authorities in order to recover the amounts that belong to the creditor as such. The time is ripe for the Supreme Court to conclusively determine liability of the personal guarantors as well as rights of the personal guarantors in respect of the corporate debtor following the approval of the resolution plan.
With the rollout of a brand new regime across a jurisdiction as large as India, there will always be some degree of teething issues. As can be seen, there exists some confusion, ambiguity and uncertainty in respect of the overall interplay and relationship between the lender, debtor and guarantor in various potential factual situations. The second part of the question is also interpreted through the judicial precedents, wherein the most important landmark judgment of State Bank of India v. Mr V Ramakrishnan & Anr, where the Supreme Court has given much needed clarity as to the application of period of moratorium to surety of corporate debtor. If there is stay on proceedings against assets of personal guarantor during corporate insolvency resolution proceeding, then the surety may file frivolous application to safeguard their assets. The apex court has remedied this situation by clarifying that Section 14 does not intend to bar actions against assets of guarantors. According to the understanding of the authors, the same must be upheld because when such guarantee has been provided by the guarantor then such guarantee must be upheld in respect of the same and the actions against them must take place. The role of guarantor is that of the surety and such guarantee provides some amount of satisfaction to the creditor and a confidence so that in future no contingencies happen to provide certain amount of loan again, therefore the guarantors must provide the remedies even if the CIRP have begun and the action against must sustain.
The Supreme Court in Innovative Industries v ICICI Bank[15]has hailed the Code to be a ‘creditor-friendly’ law. Mostly, creditors enter into a guarantee agreement as a means of securing their debt and reducing their risk exposure. If a creditor is deprived of its right to move against a guarantor because it is already proceeding against the principal debtor, then this goes against the spirit and intention behind guarantee agreements. There is a requirement to iron out the procedural difficulties that will be caused if a creditor exits the process after settling its claims through the guarantor. Ultimately, the goal of interpreting and implementing the Code should be to maximize the recovery for a creditor without being unfair to or trampling on the rights of the debtor.
To conclude, the paper seeks to establish and answer the research questions and also suggest the required changes or certain amendments which must be brought under the Insolvency and Bankruptcy code such that the unsettled dilemma is settled and there is an established position of the guarantor such that the right and liability of the personal guarantor is established.
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[1] Sahil Kanuga & Arjun Gupta, Guarantors under Bankruptcy Code: The Curious Case of Confusing Precedents, 12 Insolvency & Restructuring Int’l 19 (2018).
[2] Brian D. Hulse , After The G
uarantor Pays: The Uncertain Equitable Doctrines Of Reimbursement, Contribution, And Subrogation, American Bar Association, Vol. 51, No. 1 (SPRING 2016), pp. 41-74
uarantor Pays: The Uncertain Equitable Doctrines Of Reimbursement, Contribution, And Subrogation, American Bar Association, Vol. 51, No. 1 (SPRING 2016), pp. 41-74
[3] Navin K. Pahwa , Corporate Insolvency: Its Operations and Emerging Problems, National Law School of India Review , Vol. 30, No. 2 (2018), pp. 111-118
[4] Pinak Parikh, 4. Liability of Personal Guarantors vis a vis their Rights under the IBC: A Legal Conundrum, IndiaCorp Law, https://indiacorplaw.in/2020/01/liability-personal-guarantors-vis-vis-rights-ibc-legal-conundrum.html, Last accessed on 16th Feb, 2020.
[5] Param Pandya, Liability of Personal Guarantors of a Corporate Debtor during the Corporate Insolvency Resolution Process, IndiaCorp Law, https://indiacorplaw.in/2017/09/liability-personal-guarantors-corporate-debtor-corporate-insolvency-resolution-process.html Last accessed on 16th Feb, 2020.
[6] State Bank of India v. Mr. V Ramakrishnan &Anr, Company Appeal (AT) (Insolvency) No 213 of 2017.
[7] Lalit Mishra & Ors. v. Sharon Bio Medicine Ltd., [Company appeal Insolvency no. 164 of 2018]
[8] Gouri Shankar Jain v. Punjab National Bank, W.P. No. 10147 (W) of 2019
[9] Maharashtra State Electricity Board, Bombay v. Official Liquidator, High Court, Ernakulam, 1983 SCR (1) 561
[10] Committee of Creditors of Essar Steel India Limited vs. Satish Kumar Gupta and Ors. Civil Appeal No. 8766-67 of 2019
[11] Alpha & Omega Diagnostics (India) Ltd. v. Asset Reconstruction Company of India Ltd. & Ors ,Company Appeal (AT) (Insol.) No. 116 of 2017
[12] Schweitzer Systemtek India Private Limited v. Phoenix ARC Private Limited, Company Appeal (AT) (Insolvency) No. 129 of 2017
[13] Sanjeev Shreya v. State Bank of India, (2018) 2 All LJ 769
[14] Supra 1
[15] Innovative Industries v ICICI Bank, Civil Appeal Nos 8337-8338 of 2017.
