Remedies available to the Creditor against Guarantors under IBC

[By Amay Bahri]

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

Like any new legislation which is introduced, even the Insolvency and Bankruptcy Code 2016 (hereinafter ‘IBC’ or ‘the code’) has been marred by litigation since its inception. One of the more recent discussions on IBC is regarding the power of the creditor against guarantors of a corporate debtor. This discussion becomes all the more relevant after the introduction of new rules and regulations for governing the insolvency of personal guarantors. These new rules and regulations allow the creditor to initiate insolvency proceedings against the personal guarantor, however, there are still unresolved issues regarding the powers of the creditor to have legal recourse against the guarantor when the principal debtor is unable to pay debts. To iron out these unresolved issues, we refer to the already established precedents relating to corporate guarantors. Though corporate and personal guarantors are different to the extent of their liability, there appears to be no distinction or any reason for the distinction in their treatment within the code; thus the developed jurisprudence surrounding the rights against corporate guarantors can be applied to the personal guarantor.

One of the objectives mentioned in the preamble to the Insolvency and Bankruptcy Code is that the code seeks to balance of interest of stakeholders. The code marks a paradigm shift from a regime of unaccountable corporates to adopting a realistic approach where commercially unviable companies would close shop. Upon such shift, the code has adopted a creditor centric approach, wherein wide powers to institute the insolvency proceedings are vested with the creditors. The concept of a guarantee is rooted in the Indian Contract Act, thus the powers of the creditor under IBC are to be exercised keeping in mind the principles of guarantee under the Indian Contract Act. There are two distinct issues that arise here, first regarding the power of the creditor to recover after acceptance of the resolution plan; and second regarding the power of the creditor to proceed against the guarantor when insolvency proceedings against corporate debtor have been initiated but the resolution plan has not been accepted. Against this backdrop, the author seeks to discuss the recovery mechanisms available to the creditor against the guarantor a) after the acceptance of the resolution plan and b) when the corporate debtor is under CIRP. The author shall then provide his own conclusion as to the flaws in the recovery mechanism and the way forward.

Power of the creditor to recover after Acceptance of Resolution Plan

According to the IBC, the acceptance of the resolution plan by the Committee of Creditors (CoC) and approval of the same by the adjudicatory body brings the insolvency proceedings to an end. As per section 31 of the IBC, such an accepted resolution plan determines the full and final liability of the principal debtor. The IBC does not directly deal with the liabilities of a guarantor; neither does it bar the creditor to institute proceedings against the guarantor of the debt.

Guarantors seek to protect themselves from the claims of recovery of debt amount by applying the provisions of the Indian Contract Act. These provisions are Section 133 and 134 of the Indian Contract Act. Section 133 provides that a surety is discharged of the debt if there is variance in the terms of the contract without the consent of the surety. The resolution plan can be seen as a variance of terms without the consent of the guarantor, thus the guarantor should be absolved from its liability. However, section 31(1) of the IBC makes the resolution binding on the guarantor, thus countering such claims of the guarantor and making the guarantor liable to bear the liability.

Turning to section 134 of the Contract Act, the provision provides that any act which relieves the principal debtor of its obligation to pay will also discharge the surety of its obligation for such a debt. Applying section 134 would be erroneous since a crucial ingredient to satisfy the requirements of this section is that the agreement to discharge the principal debtor of the debt was reached through their own volition and not due to any operation of law. By approval of the resolution plan, the corporate debtor is discharged of its obligations to make a payment, but this discharge is due to the application of the law. Since the crux of section 134 is not satisfied, the said section cannot be invoked to discharge the guarantor of their obligation to pay. Hence, the guarantor is bound to pay the unpaid amount of debt, after the acceptance of the resolution plan and the creditor can take legal actions against the guarantor.

One complication that arises out of this arrangement is whether the right to subrogation survives after acceptance of the resolution plan. This was answered in negative, in the case of Essar Steel case but this does not seem to be the final position of law. The right to subrogation would entitle the guarantor to recover the amount of debt paid to the creditor as the guarantor would then step into the shoes of the creditor to claim the amount paid. The holding of Essar Steel is a huge blow to the rights of the guarantor as the judgment has done away with a right to subrogation, which is not only a statutory right under the Indian Contract Act, but also a principle of natural justice. Considering this decision not only impacts the inherent rights of guarantors, but also has adverse impacts on the market economy; the decision of Essar Steel relegating subrogation right requires reconsideration.

Power of the creditor to proceed against the guarantor when the debtor is under CIRP

As per the Indian Contract Act, the liability of a guarantor and that of the principal debtor are co-extensive, thus a creditor is not obligated to expend the legal remedies against the principal debtor before making a claim against the guarantor and can sue either of them for the debt in no particular order.[i] Further with the amendment to section 14, it is now settled that the moratorium period is not applicable to guarantors, thus section 14 does not prohibit the initiation of insolvency proceedings against the guarantor when the principal debtor is facing insolvency. In addition to this, section 60 of the code allows the creditor to proceed against the guarantors during insolvency of the principal debtor.

These provisions and principles point to a clear position that CIRP against the guarantor can be initiated during the CIRP of the principal debtor; however, the confusion is caused due to the decision of the NCLAT in Piramal Enterprises Ltd case. In this case the NCLAT held that though nothing in the code prevents a creditor from initiating insolvency against the guarantor and principal debtor, a creditor cannot proceed against both of them based on the same claim at the same time, thus if an application against either is admitted, then the creditor would be unable to proceed against the other. The reasoning of the NCLAT was that allowing a right to claim against both guarantor and debtor was giving rise to parallel proceedings. The approach of the NCLAT is contrary to the legislative intent of the code as seen by the amendment to section 14 in 2018, and also fails to consider the binding decision of the Supreme Court in the case of V. Ramakrishna where the court gave wider remedies to the creditor by allowing the creditor to proceed against the guarantor for recovering debt amount, during the pendency of insolvency of the principal debtor. Further, the decision of Piramal Enterprises disregards the established principle of co-extensive liability of guarantor and debtor under contract of guarantee.

Conclusion

The above analysis shows that the legal position regarding remedies with creditors, after the conclusion of CIRP against the principal debtor is largely settled; however, the same when CIRP is still in the process remains uncertain. The decision in Piramal Enterprises is a glitch in the systematic network of IBC, and its appeal presents a golden opportunity for the Supreme Court to streamline the intent of the legislature and the approach of the courts. In my opinion, the concern of parallel proceedings and the multiplicity of litigation is valid, but it cannot be the sole reason for ruling against the express intent of the legislature and a binding decision of the Supreme Court. Additionally, the code provides that the proceeding against the guarantor shall be brought before the same NCLT bench where the proceedings against the debtor are instituted, thereby solving the issue of multiple proceedings. Hence, with the stage set, it is clear what the Supreme Court should do in the appeal.

Endnotes:

[i] Pollock & Mulla, The Indian Contract and Specific Relief Act (15th edn. Lexis Nexis 2018)

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