[By Sushant Kumar and Vanshaj Dhiman]
The authors are students at the Dr. Ram Manohar Lohiya National Law University, Lucknow.
The contract of guarantee is an essential part of the restructuring process of the corporate debtor. It is a settled position in contract law that the guarantor’s liability arises as soon as the borrower defaults in making payment of the debt. However, the advent of the Insolvency and Bankruptcy Code, 2016 [hereinafter ‘IBC’ or ‘Code’] and some judicial pronouncements of National Company Law Tribunal (“NCLT”) and National Company Law Appellate Tribunal (“NCLAT”) have given rise to a catch-22 situation before the creditors. In this article, an attempt has been made to understand the law governing guarantees of a corporate debtor in the current insolvency regime. The confusion has arisen due to conflicting judicial pronouncements on the issue of maintainability of simultaneous insolvency proceedings in respect of the same debt and certain lacunae in the legislative framework of the Code.
Let us first understand the basic principle of a guarantee-contract. A contract of guarantee is entered into between the creditor, the principal debtor, and the guarantor. Here, the guarantor may be a body corporate or a natural person. It is said that the guarantors and corporate debtor sail in the same boat, and therefore, the very objective of securing the guarantee would be defeated if the creditor is forced to first exhaust its remedy against the principal debtor before proceeding against the guarantor. This right of the creditor is the hallmark of a guarantee-contract. It is a trite legal position that the guarantor’s liability is co-extensive with that of the principal debtor.
Guarantor’s Liability Before the Maturity of Corporate Insolvency Resolution Process
Before we delve into the discussion, it is important to note that the Committee of Creditors (“CoC”) drives the insolvency resolution process (“IRP”). Therefore, the guarantor(s) cannot be allowed to dictate the terms and manner of the proceedings under the Code or seek deferment of the proceeding initiated against them. Though the relationship between the corporate debtor and the guarantor originates from the same transaction, both are separate and independent entities. Since the guarantor’s liability is distinct and separate from that of the corporate debtor, the creditor can proceed against the guarantor and the corporate debtor simultaneously or alternatively.
Section 14(3)(b) of the IBC guides this aspect. It states that the moratorium will not apply to the surety in a contract of guarantee. In other words, only the estate of the corporate debtor will be protected by moratorium under Section 14 of the Code, and this benefit shall not extend to the assets of the surety.
Further, Sections 60(2) and 60(3) of the IBC reflect the Parliament’s intention to allow concurrent insolvency proceedings against the corporate debtor as well as the personal guarantor. The Parliament, intentionally, has made the personal guarantor to the corporate debtor equally liable to reduce the number of non-performing assets (NPA) for the speedy resolution of outstanding debt and make the promoters liable for their flawed decisions.
Besides, the Code does not prohibit the creditors from proving double proof of the same debt against two separate estates (also known as double-dipping). That means the creditor is entitled to prove its claim against both the principal debtor and the guarantor(s) but cannot claim more than the total debt. The NCLT, in ICICI Bank Ltd v CA Ritu Rastogi, permitted simultaneous initiation of IRPs against both the principal borrower and the guarantor.
In State Bank of India v V Ramakrishnan, the Supreme Court clarified that the moratorium does not extend to the surety’s assets thereby accepting the proposition that the IBC does not bar the filing of two insolvency proceedings simultaneously. However, the ratio of the NCLAT, in Vishnu Kumar Agarwal v Piramal Enterprises Ltd, seems to circumvent these decisions by holding that for the same debt, a claim cannot be filed, and proceedings maintained, by the same financial creditor in two separate IRPs simultaneously.
Arguably, the proceedings against the guarantors should not be initiated unless the corporate debtor’s liability is not crystallized in the resolution plan itself or until the CIRP has not been completed. However, the CIRP is not a recovery proceeding, but a means to resolve and restructure the corporate debtor’s debt. Having an independent and co-extensive liability, the guarantor cannot claim immunity in the garb of CIRP being underway because his liability is to pay off the entire outstanding debt subject to the guarantee contract.
Mostly, the promoters/directors of a corporate debtor furnish a personal guarantee for the sanctioning of a loan to the corporate debtor. If the proceedings against such personal guarantors are stayed during a CIRP, they may file frivolous applications with ulterior motives merely to escape from their liabilities until the CIRP is not completed. Besides, the IBC aims to protect the rights of the creditors and not to reward such personal guarantors by whose decisions the corporate debtor became insolvent in the first place.
A Hypothetical Scenario to Understand the Law
To better understand how the invocation of guarantee(s) before the CIRP of the corporate debtor matures should play out, let us take an example [hereinafter ‘the example’]. Say, the corporate debtor is CD, corporate guarantor to the corporate debtor is Gc, personal guarantor to the corporate debtor is Gp and that there exist four creditors of the corporate debtor, namely C1, C2, C3, and C4.
C1 has the corporate guarantee, C2 has the personal guarantee, C3 has both the corporate and the personal guarantee for the same debt from the same guarantors as C1 and C2, respectively, and C4 has no guarantees. C1 invoked the CIRP against CD. However, before the CIRP could be completed, C3 invoked both its guarantees but the guarantors (both Gc and Gp) defaulted on their respective guarantees. Consequently, C3 filed an application against Gc under Part II of the Code and Gp under Part III of the Code before the same NCLT overlooking the CIRP process due to the amended Section 60 of the Code.
As already discussed, the moratorium under Section 14 of the Code does not extend to the guarantor’s assets(s). Accordingly, IRP can be simultaneously initiated against them (see, State Bank of India v V Ramakrishna). However, in the example elucidated above, C3 may not be able to maintain simultaneous proceedings against both Gc and Gp in light of the Piramal judgment as the proceedings are for the same debt. Although Piramal was concerned with a corporate guarantor, the Tribunals are likely to hold the same for a personal guarantor when the same debt is in question.
Presently, no statutory mechanism exists as to how the three IRPs (according to the example) would be coordinated to reach a fair solution and avoid double dividends while ensuring that the process remains a time-bound affair.
The Way Forward
Ideally, in ‘the example’ elucidated, C3 should have been able to maintain simultaneous proceedings against the corporate guarantor and the personal guarantor while the CIRP of the corporate debtor to remain underway as well. The only caveat is that there must exist mandatory communication between the resolution professionals of the three IRPs, and satisfaction of the debt in whole or part in any of the three resolution processes be immediately communicated to the other resolution professionals to, appropriately, incorporate the changes in the debt left outstanding. Furthermore, the NCLT should be allowed to return the resolution plan for appropriate modification within a maximum stipulated time period, not exceeding 14 days if the plan presented has not incorporated the said changes. Additionally, the guarantors should be allowed to appraise the tribunal if a resolution professional fails to make such communication.
To facilitate the mandatory communication and coordination between resolution professionals of simultaneous IRPs, insertion of an appropriate provision in Part II and Part III of the Code is necessary. In the interim, relevant rules governing the conduct of the resolution professionals should be amended to facilitate and encourage such coordination. This is likely to reduce unwanted litigation and time delays at the final stage of the IRP.
Piramal has in effect circumvented the Supreme Court judgment in SBI v Ramakrishna concerning Section 14 and has made the 2018 amendment to Section 14 virtually ineffective since simultaneous proceedings by the same creditor for the same debt is currently non-maintainable. It would be logical to insert a provision explicitly allowing such proceedings to take place, as is the intent of the Code, thereby overturning the ruling in Piramal before it can have a more detrimental effect.
Currently, the NCLT may either accept or reject the resolution plan. An appropriate amendment is the need of the hour so that the tribunal may return the plan for modification under specific circumstances as elucidated above. This would also encourage the adjudicating authority to apply judicial mind before exercising their authority. Nonetheless, it must be remembered that the proceedings continue to remain a time-bound affair; otherwise, the objective of the Code would be severely undermined.