K. Paramasivam v. The Karur Vysya Bank- Are Corporate Guarantors equivalent to Corporate Debtors

[By Keerthana Rakesh]

The author is a student at the Gujarat National Law University, Gandhinagar.

Introduction

Section 7 of the Insolvency and Bankruptcy Code (“IBC”) came under discussion due to the confusion that arose as to whether the proceedings can be initiated against the Corporate Guarantor under the Corporate Insolvency Resolution Process (“CIRP”). The apex Court in K. Paramasivam v. The Karur Vysya Bank Ltd. & Anr., has attempted to provide clarity on the same. Section 7(1) of IBC states that:

“(1) A financial creditor either by itself or jointly with other financial creditors may apply for initiating corporate insolvency resolution process against a corporate debtor before the Adjudicating Authority when a default has occurred.”

The appeal came before the Supreme Court challenging the decision of the National Company Law Appellate Tribunal (“NCLAT), whereby the tribunal admitted the application under Section 7 of IBC filed by the Financial creditor, Karur Vysya Bank Ltd. against Maharaja Theme Parks and Resorts Private Limited (“Maharaja Theme Parks and Resorts”). The ground for appeal was that Maharaja Theme Parks and Resorts is neither a Corporate Debtor according to Section 3(8) of IBC nor a Corporate Guarantor as per Section 5(5A) of IBC. They are excluded from the ambit of Section 7 of IBC since the borrowers were not Corporate Debtors. Through this post, the author seeks to analyze the above case law and to see whether the Supreme Court’s judgement aligns with the object behind IBC, which is to relieve distressed corporate entities and provide a means of recovery to creditors.

Factual Background

Maharaja Theme Parks and Resorts is a Company registered under the Companies Act, of 1956. The financial creditor, Karur Vysya Bank Ltd., had extended credit facilities to three entities: Sri Maharaja Refineries, Sri Maharaja Industries, and Sri Maharaja Enterprises. Maharaja Theme Parks and Resorts became the guarantor of the loans availed by the entities. The borrowers failed to repay their debts to the financial creditor, resulting in the Financial Creditor applying Section 7 of IBC before the National Company Law Tribunal (“NCLT”), Chennai, to initiate the CIRP proceedings against Maharaja Theme Parks and Resorts. The application was filed on the ground that Maharaja Theme Parks and Resorts, being the guarantor of the borrowers is liable to repay the debt.

Maharaja Theme Parks and Resorts objected to the contention of the Financial Creditor and argued that they do not fall within the purview of the Corporate Debtor as defined in Section 3(8) of IBC. Maharaja Theme Parks and Resorts also contended that they are not Corporate Guarantors according to Section 5(5A) of IBC since the borrowers are not Corporate Debtors. However, the adjudicating authority admitted the application under Section 7 of IBC and initiated the CIRP proceedings against Maharaja Theme Parks and Resorts.

They challenged the order of the NCLT and appealed before the NCLAT. The NCLAT upheld the position of the NCLT and dismissed the appeal. Aggrieved by the decision of NCLAT, Maharaja Theme Parks and Resorts filed an appeal before the Supreme Court under Section 62 of IBC against the order issued by the NCLT and NCLAT.

Issue

The issue which came before the Court was whether the liability of the Corporate guarantor is co-extensive with that of the Principal Borrower i.e., whether Maharaja Theme Parks and Resorts is a corporate guarantor as mentioned under Section 5(5A) of IBC and is responsible for the payment of debts to the Financial Creditor.

Ruling and Analysis

The court upheld the findings of NCLT and NCLAT and found no grounds to interfere with their decision to admit the application filed by the Financial Creditor and that Maharaja Theme Parks and Resorts is a Corporate Guarantor as per Section 5(5A) of IBC. While addressing the issue, the apex Court delved into the aspects of Corporate Debtor and Corporate Guarantor as defined in the IBC and took a liberal approach towards Section 7 of the IBC.

The Court mainly relied on its decision in the case of Laxmi Pant Surana v. Union Bank of India and Another (“Laxmi Pant Surana”) and emphasized that the financial creditor has the cause of action to proceed against the principal borrower as well as the guarantor in equal measure in the cases of default. The bench referred to Section 5(8)(i) of IBC which stated that the claim of the financial creditor also includes the liability of the person who gave the guarantee to the corporate debtor. The intention of this legislation was perceived by the apex court whereby the corporate guarantor is equally held liable as the corporate debtor for the failure of due payment to the financial creditor. It also looked into the contractual nature of the transaction and highlighted that the liability of the guarantor is coextensive as per Section 128 of the Contract Act. A broad approach was adopted by the Court where they extended the meaning of Corporate Debtor provided under Section 3(8) of the Act to include the Corporate Guarantor. This includes “corporate person” as defined under Section 3(7) of the Code. They further held that the principal borrower can be a Corporate or non-corporate entity, thus, giving a greater scope of relief to the financial creditor and preventing the Corporate guarantor or debtor to escape from its financial obligations.

Referring to the Laxmi Pant Surana judgement, the Court held that a financial creditor can directly apply to Section 7 of IBC for the initiation of CIRP proceedings against a corporate guarantor without previously suing the principal borrower. It can be inferred from the present case that the corporate guarantor steps into the shoes of the principal borrower regardless of whether the borrower is a corporate entity or not.

The Court held that the purpose of Section 7 is not to provide a remedy for financial creditors but to reorganise and provide insolvency resolution to the corporate debtor who is not in a position to repay the debt. However, the author contends that along with providing a resolution process for the corporate debtor, the procedure under Section 7 of IBC was drafted in such a way as to provide some relief to the financial creditor who was unable to retrieve the amount they paid to the corporate debtor. This position was adopted by the NCLAT in the judgement of Lalit Mishra and Ors. v. Sharon Bio Medicine Ltd.  (“Lalit Mishra”) in which it was held that the motive of IBC is to protect the creditors of Corporate Debtor by preventing them from rewarding themselves at the cost of the creditors, thereby undermining the insolvency processes. The Supreme Court refused to intervene in the position upheld by the NCLAT on appeal in that case and affirmed NCLAT’s stand.

Comments

Keeping the Laxmi Pant Surana judgement as the precedent and confirming the same position, in this case, the author can infer that the apex court thus, consistently upheld that the corporate guarantor is equivalent to the corporate debtor for Section 7 of the IBC. The Supreme Court rightly upheld the decision of the NCLT and NCLAT and therefore, admitted the application under Section 7 of IBC against the Corporate Guarantor, Maharaja Theme Parks and Resorts.

Further, the author agrees with the liberal approach of the Court which kept no limit on the width of Section 7 of IBC and included the Corporate Guarantors whose principal borrowers includes Corporate and non-corporate entity. Section 7, being an enabling provision permits the financial creditor to file CIRP proceedings with the corporate debtor, which in this case includes the corporate guarantor. The financial creditor must ensure that the above criteria are fulfilled.

The judgement does provide relief to the distressed corporate entities which are insolvent. Although the object of IBC is value maximization of the assets of the Corporate Debtor, the author thinks that the Court could have also outlined the remedies that Section 7 of IBC offered to the financial creditors, thus, creating a favourable situation for both parties.

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