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Guarantees under the IBC Regime: A Settled Conundrum

Guarantees, or ‘Contract of Guarantees’ play an important role in the present commercial world. Since the enforcement of Insolvency and Bankruptcy Code, 2016 (‘IBC’), the status of Guarantees has remained ambiguous. Various contradictory judicial decisions have further added to this ambiguity. The objective of this article is to understand the confusion that existed on this aspect and analyse the evolving jurisprudence.

The basic issue fuelling the ambiguity has been invocation of a Guarantee during the moratorium imposed on a Corporate Debtor under Section 14 of IBC.

In order to understand and analyse this issue, it is important to first scrutinize it from the point of view of a Contract of Guarantee[1]. Any Contract of Guarantee is a tripartite agreement between a ‘surety’, ‘principal debtor’ and ‘creditor’, in which the surety guarantees payment to the creditor in the event of default of the principal debtor. From this point of view, in a scenario where a moratorium has been imposed on a Corporate Debtor, three (3) alternatives are possible:

 

  1. Where the Corporate Debtor is a creditor:
  2. Where the Corporate Debtor is a surety; and
  3. Where the Corporate Debtor is a principal debtor.

In a case where the Corporate Debtor is a surety, the Adjudicating Authority in its early decisions[2] held that the Guarantee could not be invoked against the Corporate Debtor once the moratorium has been imposed as the invocation resulted in foreclosure, recovery or enforcement of any security interest created by the Corporate Debtor in respect of its property. In another case[3], it was also held that the Guarantee which has not been invoked by the creditor prior to initiation of the Corporate Insolvency Resolution process (‘CIRP’), the proof of claim with respect to that Guarantee cannot be filed by the creditor with the IRP/RP.

However, these issues were sought to be settled by the National Company Law Appellate Tribunal (‘NCLAT’) in the case of Export-Import Bank of India vs. Resolution Professional JEKPL Pvt. Ltd.[4] The Hon’ble NCLAT differentiated between the terms ‘default’ and ‘claim’ and held that any person who has a right to claim payment can file a claim under IBC irrespective of whether it has matured or not. In other words, after moratorium has been imposed on a Corporate Debtor, Guarantee given by such Corporate Debtor as a surety can be invoked by filing a claim with the IRP/RP of that Corporate Debtor.

There have been conflicting decisions with respect to the last scenario where the Corporate Debtor is a principal debtor and Guarantee has been given by a third party to the creditor. While in some cases[5], it was held that the moratorium is applicable on the property of personal guarantors as well, in others[6], it was held that moratorium was applicable only to the property of the Corporate Debtor.

Finally, the conflict was resolved by the Hon’ble Supreme Court in the case of State Bank of India vs. V. Ramakrishnan & Anr.[7] where it was held that moratorium period shall not apply to a personal guarantor of a Corporate Debtor. The Court observed that the object of the IBC was not to allow personal guarantors to escape from an independent and co-extensive liability to pay off the entire outstanding debt, which is why Section 14 is not applied to them. This decision of the Hon’ble Supreme Court has also been followed by the Adjudicating Authority in Levcon Valves (P) Ltd. vs. Energo Engineering Projects Ltd.[8]

The IBC was also thereafter amended in 2018 wherein clause 3 of Section 14 was substituted to read that the provisions of sub-section (1) shall not apply to “a surety in a contract of guarantee to a corporate debtor”. Accordingly, it has now been safely rested that a creditor can invoke a Guarantee (whether personal, corporate or performance guarantee) against the surety even when moratorium has been imposed under Section 14 with respect to the Corporate Debtor. In other words, the assets of a surety will not be covered by the moratorium imposed on the Corporate Debtor.

In our view, this seems to be the correct approach since it gives effect to the well-established legal principle of independence of contract between the creditor and the surety in a Contract of Guarantee.[9]

 


[1] Refer Section 126 of the Indian Contract Act, 1872.

[2] Refer Axis Bank Limited vs. Edu Smart Services Private Limited, NCLT, New Delhi Bench, Order dated October 27, 2017; also refer RBL Bank Limited vs. MBL Infrastructures, NCLT Kolkata Bench, Order dated December 18, 2017.

[3] Refer Bank of Baroda vs. Binani Cements Ltd., NCLT Kolkata Bench, Order dated November 17, 2017.

[4] Company Appeal (AT) (Insolvency) No. 304 of 2017, Order dated August 14, 2018.

[5] Refer State Bank of India vs. D.S. Rajendra Kumar, Company Appeal (AT) (Insolvency) No. 87 of 2018 (clubbed with other company petitions), Order dated 18.04.2018.

[6] Refer Alpha & Omega Diagnostics (India) Ltd. vs. Asset Reconstruction Company of India Ltd. & Ors., Company Appeal (AT) (Insolvency) No. 116 of 2017, Order dated 31.07.2017; also refer Schweitzer Systemtek India Pvt. Ltd. vs. Pheonix ARC Pvt. Ltd. & Ors., Company Appeal (AT) (Insolvency) No. 129 of 2017, Order dated 09.08.2017.

[7] (2018) 17 SCC 394

[8] C.A. No. 453(PB) of 2017 in C.P. (IB) No. 160(ND) of 2017, Order dated August 24, 2018.

[9] Refer Industrial Finance Corporation of India Ltd. vs. Cannanore Spg. and Wvg. Mills Ltd., (2002) 5 SCC 54.

[10] Refer Industrial Finance Corporation of India Ltd. vs. Cannanore Spg. and Wvg. Mills Ltd., (2002) 5 SCC 54.

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