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GUARANTORS OF CORPORATE DEBTOR : TREATMENT

IN THE INSOLVENCY AND BANKRUPTCY CODE, 2016

Submitted to:
Ms. Navita Aggarwal
Assistant Professor, Law of Insolvency

Submitted by:
Abhimanyu Singh Rathore
Roll No.: 02
B.A. L.L.B. (HONS.)
Semester X
Section: B

Date of Submission: ___.10.2019

HIDAYATULLAH NATIONAL LAW UNIVERSITY


Uparwara Post, Abhanpur, New Raipur – 492002 (C.G.)
DECLARATION

I hereby declare that the project work entitled “Guarantors of Corporate Debtor : Treatment
in the Insolvency and Bankruptcy Code, 2016” submitted to Hidayatullah National Law
University, Raipur, is a record of an original work done by me under the able guidance of Ms.
Navita Aggarwal, Assistant Professor, Law of Insolvency, Hidayatullah National Law
University, Raipur.

Abhimanyu Singh Rathore

Roll No.: 02

Section: B

Semester: X

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ACKNOWLEDGEMENTS

I feel highly elated to work on the topic “Guarantors of Corporate Debtor: Treatment in the
Insolvency and Bankruptcy Code, 2016”. This research venture has been made possible due
to the generous co-operation of various persons. To list them all is not practicable, even to
repay them in words is beyond the domain of my lexicon.

May I observe the protocol to show my deep gratitude to the venerated Ms. Navita Aggarwal,
Assistant Professor, for her kind gesture in allotting me such a wonderful and elucidating
research topic. Her consistent supervision, constant inspiration and invaluable guidance have
been of immense help in understanding and carrying out the nuances of the project report.

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TABLE OF CONTENTS

DECLARATION ....................................................................................................................... 2

ACKNOWLEDGEMENTS ....................................................................................................... 3

1. INTRODUCTION .............................................................................................................. 5

Scope of Study .................................................................................................................... 6

Objectives ........................................................................................................................... 6

Research Methodology ....................................................................................................... 6

2. POSITION OF GUARANTORS VIS-À-VIS THE MORATORIUM ............................... 7

Understanding the ‘Moratorium’ under IBC ...................................................................... 7

Position under IBC.............................................................................................................. 7

3. LIABILITY OF GUARANTORS AFTER APPROVAL OF RESOLUTION PLAN ....... 9

4. WHETHER INSOLVENCY PROCEEDINGS CAN BE INITIATED AGAINST


CORPORATE GUARANTOR BEFORE PROCEEDING AGAINST THE PRINCIPAL
DEBTOR? ................................................................................................................................ 11

5. RIGHTS OF GUARANTOR VIS-À-VIS THE CORPORATE DEBTOR ...................... 13

6. CONCLUSION ................................................................................................................. 14

BIBLIOGRAPHY .................................................................................................................... 15

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1. INTRODUCTION

The Insolvency and Bankruptcy Code, 2016 (“Code” or “IBC”) was enacted by the
Parliament. This code is an act to consolidate and amend the laws relating to re-organization
and insolvency resolution of corporate persons, partnership firms and individuals in a time
bound manner for:
 maximization of value of assets of such persons;
 to promote entrepreneurship, availability of credit; and
 balance the interests of all the stakeholders including alteration

The principle objective behind the passage of IBC was to achieve a timely resolution while
maximizing the value of assets and ensuring higher recovery for creditors. With these
objectives in mind, IBC has also assisted financial institutions to initiate corporate insolvency
resolution process against guarantors. The concept of guarantee is governed by the Indian
Contract Act, 1872 ("ICA"), where under the contract of guarantee puts an obligation on a
surety to honour the promise of principal debtor by paying the principal debtor's present or
future debt, provided to him by a creditor in case of default by the principal debtor.
Crucially, the liability of a guarantor is co-extensive with that of the principal debtor.

It is a prevalent commercial practice for the promoters of an entity to provide personal


guarantees in respect of debts undertaken by the entity concerned. A separate agreement
known as the “Guarantee Agreement” is entered into between the lender (i.e. the financial
creditor, under the IBC regime) and the personal guarantor. The underlying understanding is
that in case the debtor fails to repay the debt, then, independent of the legal remedies
available to the financial creditor, the latter can, under the different legal remedies available
to it, institute an action involving sale of assets or invoke the personal guarantor to act upon
her guarantee in respect of the debts undertaken by the corporate debtor. In that sense, the
financing agreement between the corporate debtor and the financial creditor is quite
independent and distinct from the Guarantee Agreement between the financial creditor and
the personal guarantor.

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SCOPE OF STUDY
The scope of this project report is majorly limited to the study the role and position of
Guarantors of the Corporate Debtor under the IBC, 2016.

OBJECTIVES
 To analyse the role of guarantors and their position vis-à-vis the corporate debtor;

 To elucidate the judgments discussing the position of guarantors during the moratorium
period under the Insolvency and Bankruptcy Code, 2016.

 To discuss whether the Guarantors can still be held liable after the resolution plan is
approved.

 To explore whether the financial creditor can initiate insolvency resolution process
against the corporate guarantors before the principal debtor.

RESEARCH METHODOLOGY
This project report is doctrinal in nature. Secondary and Electronic resources have been
largely used to gather information and data about the topic. Books and other reference as
guided by Faculty have been primarily helpful in giving this project a firm structure.
Websites, dictionaries and articles have also been referred. Footnotes have been provided
wherever needed, to acknowledge the source.

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2. POSITION OF GUARANTORS VIS-À-VIS THE
MORATORIUM
UNDERSTANDING THE ‘MORATORIUM’ UNDER IBC
Moratorium, generally speaking, operates like a stay against certain action(s). Under the IBC,
on the insolvency commencement date, the Adjudicating Authority shall declare a
moratorium prohibiting the actions elucidated therein.1 It is basically a period wherein no
judicial proceedings for recovery, enforcement of security interest, sale or transfer of assets
or termination of essential contracts can be instituted or continued against the corporate
debtor.

POSITION UNDER IBC


One of the earliest decisions in this regard was the Allahabad High Court in the matter of
Sanjeev Shriya2. The factual matrix of the case was such that LML (the corporate debtor)
entered into a multi-party agreement with SBI to avail a loan with (ex) directors of LML,
namely, Sanjeev Shriya, Deepak Singhania and Anurag Kumar Singhania guarantors for this
loan. However, in 2007, LML was declared ‘sick’ by the Board for Industrial & Financial
Reconstruction (“BIFR”). SBI subsequently moved an application for recovery before the
DRT, Allahabad and LML, in the meanwhile, initiated an application under Section 10, IBC.
The Adjudicating Authority allowed the initiation of the corporate insolvency resolution
process and declared moratorium. DRT however, allowed continuance of proceedings against
the directors and this led to the appeal to the High Court. The Court opined that the
proceedings were in a “fluid stage” and for the same course of action, two split proceedings
i.e. before the DRT as well as the NCLT, should be avoided, if possible. The Court also held
went on to stay the proceedings against the guarantors before the DRT. 3 This judgment was
in contrast to earlier orders of the Adjudicating Authority under the IBC wherein personal

1
The Insolvency and Bankruptcy Code, 2016, No. 31 of 2016, Section 14.
2
Sanjeev Shriya v. State Bank of India, Civil Writ Petition No. 30285 of 2017, https://barandbench.com/wp-
content/uploads/2017/09/attachment-1.pdf (Last retrieved on 19/10/2019).
3
http://www.nishithdesai.com/information/news-storage/news-details/article/guarantors-and-the-moratorium-
under-the-bankruptcy-code-an-on-going-battle.html (Last retrieved on 19/10/2019).
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guarantors were excluded from the scope of the moratorium.4 The position regarding the
effect of moratorium on proceedings against personal guarantors was settled by the Supreme
Court in the judgment in State Bank of India v. V. Ramakrishna.5 The factual matrix of the
case was as follows:

 M/s. Veesons Energy Systems Private Limited ("Corporate Debtor”) availed credit
facilities from State Bank of India ("Financial Creditor"). Mr. V Ramakrishna, the
managing director of the company signed a personal guarantee in favour of State
Bank of India.6

 As the company did not pay its debts, the assets of the company were classified as
NPAs on July 26, 2015. The bank initiated proceedings under the SARFAESI Act,
2002 and issued notices to the corporate debtor and the personal guarantor. 7

 The corporate debtor subsequently filed an application under Section 10, IBC and the
same was admitted and moratorium declared. The personal guarantor approached the
Adjudicating Authority for stay of proceeding under SARFAESI Act.8

In light of this factual matrix, the Supreme Court proceeded to decide on the issues raised and
held as follows:

 Upon a plain reading of Section 14, IBC and observed that the term ‘personal
guarantors’ was conspicuous by its absence and thus a manifestation of the legislative
intention to exclude them from the scope of the moratorium;9

 The Court observed that Section 60(3) of the Code, which provided that the
adjudicating authority in relation to the insolvency resolution and liquidation of both

4
See Alpha & Omega Diagnostics (India) Ltd. v. Asset Reconstruction Company of India Ltd. & Ors.,
Company Appeal (AT) (Insolvency) No. 116 of 2017 (NCLAT); Schweitzer Systemtek India Pvt. Ltd. v.
Pheonix ARC Pvt. Ltd. & Ors., Company Appeal (AT) (Insolvency) No. 129 of 2017 (NCLAT).
5
State of Bank of India v. V. Ramakrishnan & Anr., Civil Appeal No. 3595 of 2018 [(2018) 96 taxmann.com
271 (SC)].
6
Ibid., ¶ 2.
7
Ibid., ¶ 3.
8
Ibid., ¶ 4.
9
Ibid., ¶ 23.
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corporate debtors and personal guarantors shall be the NCLT, is only clarificatory in
this regard.10

 Also, Sections 31, 96 and 101 of the IBC did not extend the scope of the moratorium
to the personal guarantors.

The aforesaid finding of the Hon'ble 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.

3. LIABILITY OF GUARANTORS AFTER APPROVAL OF


RESOLUTION PLAN

Once the CIRP is concluded and the resolution plan is approved by the adjudicating authority
under section 31 of the IBC, the debt owed by the corporate debtor is settled. No proceedings
can be initiated against the corporate debtor in relation to the debt that is settled. However,
proceedings can be initiated against the guarantor for the recovery of remaining debt
amount.11

Under the IBC, the debtor is discharged on approval and implementation of resolution plan.
The resolution plan is approved when the National Company Law Tribunal (NCLT) is
satisfied that the resolution plan is approved by the prescribed majority of the committee of
creditors and its contents are in accordance with the law. Therefore, the principal debtor is
discharged under the IBC not on the instance of a creditor but due to the operation of law,
i.e., approval of the NCLT after its satisfaction. The creditor may or may not be favor of the
resolution plan. However, once the same is approved by the NCLT, the debtor is discharged

10
Ibid., ¶ 21.
11
Corporate Insolvency and the Creditor-Guarantor Dilemma (22/02/2019) available at
https://indiacorplaw.in/2019/02/corporate-insolvency-creditor-guarantor-dilemma.html (Last retrieved on
19/10/2019).
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and the said decision is binding on the creditor. But the guarantor is not discharged of its
liability towards the creditor on the discharge of principal debtor’s liability under the IBC. 12

The Supreme Court while addressing this issue in the case of Re: SBI v. V. Ramakrishnan
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.

In the Report of the Insolvency Law Committee dated 26th March, 201813, the Committee has
also observed that the assets of a surety are separate from those of Corporate Debtor. The
enforcement of guarantee may not have a significant impact on the debt of the corporate
debtor and the proceedings against the Corporate Debtor may not be seriously impacted by
the actions against the assets of sureties. The contractual principles of guarantee are required
to be respected even during moratorium. The guarantor cannot take a defence that they will
not be liable for any remaining amount once the resolution plan is approved.

Recently, the NCLT, Principal Bench, New Delhi, in the matter of Rave Scans Pvt. Ltd.14 has
dealt with the same aspect and has dismissed the application filed by one of the guarantors
who had tried to challenge the proceedings initiated by the Financial Creditors against the
guarantor post the acceptance of the Resolution Plan.

From the above, it is clear that the conclusion of CIRP does not bar the creditor to proceed
against the guarantors. The rights of a creditor against a guarantor are independent.

12
Liability of Guarantors after approval of Resolution Plan under The Insolvency And Bankruptcy Code, 2016
(8/08/2019) available at
http://www.mondaq.com/india/x/834608/Insolvency+Bankruptcy/Liability+Of+Guarantors+After+Approval+
Of+Resolution+Plan+Under+The+Insolvency+And+Bankruptcy+Code+2016 (Last retrieved on 19/10/2019).
13
Report of the Insolvency Law Committee, available at
http://www.mca.gov.in/Ministry/pdf/ReportInsolvencyLawCommittee_12042019.pdf (Last retrieved on
19/10/2019)
14
IB No. 01/2017 dated 9th May 2019.
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4. WHETHER INSOLVENCY PROCEEDINGS CAN BE
INITIATED AGAINST CORPORATE GUARANTOR
BEFORE PROCEEDING AGAINST THE PRINCIPAL
DEBTOR?
This question arose before the Appellate Authority and was subsequently affirmed by the
apex court in the matter of Ferro Alloys Corporation Limited v. Rural Electrification
Corporation Limited.15 The factual matrix of the same was as follows:

 Rural Electrification Corporation Limited (REC), served as a financial creditor and


had sanctioned a loan amounting to Rs. 517.90 crores to FACOR Power Limited, the
principal debtor. Ferro Alloys Corporation Limited (Ferro Alloys) was the corporate
guarantor of the said loan and had, therefore, undertaken to guarantee all amounts
payable by FACOR Power Limited to REC. 16

 When FACOR Power Limited failed to repay the loan, REC invoked the corporate
guarantee on 27 October 2015. Thereafter, on the failure of REC to repay the loan,
REC filed an application before the adjudicating authority to initiate corporate
insolvency resolution proceedings against Ferro Alloys. The application was
admitted. 17

 Ferro Alloys filed an appeal against the adjudicating authority order. Thereafter, 2
other appeals were filed on behalf of a consortium of banks (Lenders Consortium) and
the shareholders and promoter of Ferro Alloys.

In appeal, the contention of the appellants was that while the Code includes the concept of a
'personal guarantor', it does not recognize the concept of a corporate guarantor. Therefore, an
insolvency proceeding cannot be initiated against a corporate guarantor. Without conceding
that a 'corporate guarantor' is subsumed within the definition of a 'corporate debtor', the
appellants further contended that an insolvency proceeding cannot be initiated against the

15
Ferro Alloys Corporation Limited v. Rural Electrification Corporation Limited, Comp. App (AT) (Ins) No. 92
of 2017.
16
Ibid., ¶ 22.
17
Ibid., ¶ 22, 24.
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corporate guarantor without proceeding and exhausting the relief provided against the
principal debtor.18 On the other hand, REC submitted that the corporate guarantee provided
by Ferro Alloys was unconditional, joint and several and co-extensive with that of the
principal debtor and could be invoked even without exhausting the remedies against the
principal debtor. It was further argued that a corporate guarantor becomes a corporate debtor
as soon as a guarantee agreement is invoked. It was subsequently held that:

 The Code does not exclusively delineate and/or prescribes any inter-se rights,
obligation and liabilities of a guarantor qua ‘financial creditor’. Thus, in absence of
any express provision providing for inter-se rights, obligation and liabilities of
guarantor qua ‘financial creditor’ under the Code, the same will have to be noticed
from the provisions of the Indian Contract Act, which exclusively and elaborately
deals with the same.19

 Without initiating any ‘Corporate Insolvency Resolution Process’ against the


‘Principal Borrower’, it is always open to the ‘Financial Creditor’ to initiate
‘Corporate Insolvency Resolution Process’ under Section 7 against the ‘Corporate
Guarantors’, as the creditor is also the ‘Financial Creditor’ qua ‘Corporate
Guarantor’.20

On 11th February, 2019, the Supreme Court affirmed the NCLAT judgment which held that
insolvency proceedings against the corporate guarantor may be undertaken without initiating
prior proceedings against the principal debtor under the Code.21 Thus a long line of
precedents under Indian and foreign contract and insolvency laws, which hold that a creditor
may proceed against the guarantor on failure of the principal debtor to repay the loan upon
demand by the creditor without exhausting his remedies against the principal debtor, has been
followed.

Also, in view of the Insolvency and Bankruptcy Code (Second Amendment) Act, 2018
amending the Code to bring in Section 5A (which defined 'corporate guarantor' as a corporate

18
Ibid., ¶ 7.
19
Ibid., ¶ 35.
20
Ibid., ¶ 39.
21
Supreme Court Upholds NCLAT Judgment Ruling That Insolvency Proceedings May Be Invoked Against
Corporate Guarantor Before Proceeding Against The Principal Debtor (27/02/2019) available at
http://www.mondaq.com/article.asp?article_id=784940&type=mondaqai (Last retrieved on 19/10/2019).
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person who is the surety in a contract of guarantee to a corporate debtor), the argument that
the Code does not recognize the concept of a “corporate guarantor” becomes redundant with
effect from 6th June 2018, i.e. the date the amendment came into force.22

5. RIGHTS OF GUARANTOR VIS-À-VIS THE


CORPORATE DEBTOR
A guarantor has a right of subrogation against the principal debtor under section 140 of the
Contract Act for the debt amount paid on behalf of the principal debtor. However, no such
right can be enjoyed when the payment is made by the guarantor after the CIRP in relation to
the debt for which the guarantee is provided is concluded.

This issue is squarely covered by the judgement of the National Company Law Appellate
Tribunal (NCLAT) in Lalit Mishra and Ors. v. Sharon Bio Medicine Ltd.23 The NCLAT 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 credit is available to all stakeholders. Thus, no such recovery can be made by
guarantor.

22
Id.
23
Company Appeal (AT) (Insolvency) No. 164 of 2018 (19/12/ 2018).
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6. CONCLUSION
The liability of the guarantor arises by virtue of default committed by the principal debtor
also known as corporate debtor under this insolvency regime. Thus, in light of the provisions
of the Indian Contract Act, 1872, the creditor is within his rights to seek remedies against the
guarantors in case of failure of principal debtor to repay the amount. This position has also
been fortified by the adjudicating authorities under the IBC who have now laid down the
position that guarantors of a corporate debtor can also initiate corporate insolvency resolution
process against the guarantors before initiating it against the principal debtor. The benefit of
moratorium under Section 14 is applicable only and only to the corporate debtor. Hence, the
Supreme Court, in the matter of Re:State Bank of India as mentioned above, has rightly
distinguished between moratorium under Section 14 and 101 of IBC. The underlying
rationale behind the exclusion of guarantors from the scope of the moratorium seems to be
that advanced by the apex court in Innoventive Industries, which proclaims the IBC as a
‘creditor-friendly’ law. The position of guarantors to a corporate debtor while raising
finances cannot be underestimated and due importance has been given to both their and other
stakeholders interests during the resolution process under the IBC.

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BIBLIOGRAPHY

STATUTES

 The Indian Contract Act, 1872.


 The Insolvency and Bankruptcy Code, 2016.

WEBSITES

 https://ibbi.gov.in/
 https://barandbench.com/
 http://www.nishithdesai.com/
 https://www.rbi.org.in
 http://www.mondaq.com/
 https://www.vantageasia.com/
 https://indiacorplaw.in/

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