Ashutosh Gupta and Gaurav Rana

Moot Question VIII, Whether The Approval of Resolution Plan Extinguishes The Guarantor’S Liability And His Subrogation Right

Post enactment of Insolvency Bankruptcy Code, 2016 of India (IBC or Code) rights and liability of guarantors, has been the most engrossing subject. One of the moot questions on the said subject is, whether approval of resolution plan by Adjudicating Authority extinguishes the guarantor’s liabilities and lender right to recover hair cut suffered in resolution plan (“Moot Question”). Said question came before the High Court of Calcutta (“High Court”) in the matter Gouri Shankar Jain Vs. Punjab National Bank and Ors. MANU/WB/2684/2019 (“Judgment”). High Court considered various facet of IBC vis-à-vis Contract Act, 1872 (“CA” or “Contract Act”) while adjudicating the Moot Question.

In this article we will be discussing aforesaid Moot Question, and consciously examine the impact of approval of the Resolution Plan on guarantor’s subrogation right i.e. right of indemnification from principal debtor as well. We will also be discussing various judgments of National Company Law Appellate Tribunal (“NCLAT”), other High Courts and Supreme Court of India, which would be relevant for shedding some light on the aforesaid conundrum.

FACTS OF THE CASE :

Petitioner is a guarantor of credit facilities enjoyed by Divya Jyoti Sponge Iron Private Limited (“Corporate Debtor” or “Company”), from the first respondent i.e. Punjab National Bank (“Bank” or “Financial Creditor”). The Corporate Debtor faced proceedings before the Adjudicating Authority, Kolkata Bench, at Kolkata (“Adjudicating Authority”) under the IBC in Company Petition (IB) No. 363/KB/2017. By an order dated March 13, 2018, the Adjudicating Authority approved a Resolution Plan in respect of the Corporate Debtor in said proceedings (“Resolution Plan”).

Resolution Plan envisaged payment of Rs. 34.25 crores to the financial creditors against their entire outstanding claim amount of Rs. 76.21 crores in full and final settlement of all the dues. Further, the resolution applicant had paid the secured financial creditors in terms of the Resolution Plan. Interestingly, the Resolution Plan does not deal with the personal guarantee given by the Petitioner (“Guarantor” or “Surety”) to the Financial Creditor.

Thereafter, Financial Creditor (First Respondent) issued a notice dated March 26, 2019 under Section 13(2) of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (“SARFAESI”) to the Guarantor on the basis of the guarantee. The Guarantor (Petitioner) thereafter came to learn that, the Guarantor was posted with CIBIL for an alleged default of Rs. 12,62,11,278/- towards the Financial Creditor. Petitioner has sought for a direction upon the Financial Creditor, to remove the name of the petitioner from the list of defaulters maintained by Credit Information Bureau (India) Limited (CIBIL) presently known as Trans Union CIBIL Limited.

SUBMISSIONS OF THE PARTIES :

The liability of the Guarantor is co-extensive with that of the Corporate Debtor/ Principal Debtor. The Corporate Debtor not having any liability to the Bank, subsequent to acceptance & approval by the Financial Creditor the payment in terms of the Resolution Plan as full and final settlement of its total claim and thereafter on approval of Adjudicating Authority same become final. Guarantor submitted on approval of Adjudicating Authority, petitioner, has no liability towards the Bank in view of the provisions of section 128 of the Contract Act, the liability of the petitioner stood extinguished. Accordingly, the personal guarantee given by the Guarantor stood extinguished upon such Resolution Plan being approved. Guarantor also submitted that, even if the first respondent has not agreed or assented to the Resolution Plan, then also it shall be binding onto the first respondent, and therefore no amount can be claimed from the Petitioner as a guarantor. According to Guarantor, the creditor having made a composition of the debt due from the principal debtor, the same discharged the surety/Guarantor. He also submitted that once a Resolution Plan is sanctioned by the Adjudicating Authority under the provisions of the Code, then such plan takes care of such guarantee. Such guarantee cannot be enforced dehors the provisions of the Resolution Plan sanctioned under the Code.

In support of such contentions, Guarantor has relied upon Sections 133 to 135, 139 and 145 of the Contract Act. Guarantor also relied on Shri Kundanmal Dabriwala v. Haryana Financial Corporation & Anr. MANU/PH/3320/2011; Commercial Bank of Tasmania v. Jones and Anr1893 Appeal Cases page 313 and Webb. Vs. Hewitt 1957 (3) Kay and Johnson page 438 in support of his contentions.

Correspondingly the Financial Creditor (First Respondent) submitted that, sanction of a Resolution Plan under the Code, ipso facto does not discharge the liability of a guarantor towards a creditor in respect of a guarantee given by such guarantor to secure the claim of a creditor. Sanction of a Resolution Plan by the Adjudicating Authority, does not wipe away the liability of a guarantor. According to him, the Resolution Plan is an involuntary act on the part of the creditor. Therefore, the Resolution Plan by itself cannot be said to have discharged the contract of guarantee. He has relied upon Sections 128, 133, 134 and 135 of the Act of 1872 as well as Sections 2(e), 5(5A), 5(22), 14(3), 30(4), 60(2) and 238 of the Code of 2016 in support of his contentions. He has also relied upon Maharashtra State Electricity Board Bombay v. Official Liquidator High Court, Ernakulum and Anr. MANU/SC/0024/1982, United Bank of India v. Modern Stores (India) Ltd. MANU/WB/0004/1988  and Industrial Finance Corporation of India Ltd. v Canonnore Blending and Weaving Mills Ltd. and Ors. MANU/SC/0317/2002.

Financial Creditors, draws attention to Section 14(3) of the Code of 2016 provides that, there will be no moratorium in respect of proceedings against a guarantor during the Corporate Insolvency Resolution process of a corporate debtor while a moratorium against a corporate debtor is in operation. He has also relied upon Section 60 (2) of the Code of 2016 to submit that, proceedings against guarantors may be instituted even when an Insolvency Resolution process or liquidation process against the corporate debtor is pending before the National Company Law Tribunal.

FINDING :

On prima facie High Court held that the liability of the guarantor stood extinguished upon the creditor making a compromise with the principal debtor.

Thereafter, High Court referred the operative portion of the Adjudicating Authority order approving the Resolution Plan under Section 31(1) of the Code, same is reiterated below:

…… “Accordingly, the Resolution Plan submitted by CP Ispat Private Limited is hereby approved upon the following directions:

1. It shall be binding on the corporate debtor and its employees, members, creditors, guarantors, and other stakeholders involved in the Resolution Plan.

2. The Resolution Plan of the corporate data shall come into force with immediate effect.

3. The moratorium order passed under Section 14 shall cease to have effect.

4. The Resolution Professional shall forward all records relating to the conduct of the Corporate Insolvency Resolution Process and the Resolution Plan to the Insolvency and Bankruptcy Board of India to be recorded on its data base.

5. A copy of this order is to be forwarded to IBBI…….”

Before adverting to its finding High Court analysed the relevant provisions of the CA, 1872 which are as follows:

“128. Surety’s liability.- The liability of the surety is coextensive with that of the principal debtor, unless it is otherwise provided by the contract.

……………..

133. Discharge of surety by variance in terms of contract.- Any variance, made without the surety’s consent, in the terms of the contract between the principal debtor and the creditor, discharges the surety as to transactions subsequent to the variance.

134. Discharge of surety by release or discharge of principal debtor.-The surety is discharged by any contract between the creditor and the principal debtor, by which the principal debtor is released, or by any act or omission of the creditor, the legal consequence of which is the discharge of the principal debtor.

135. Discharge of surety when creditor compounds with, gives time to, or agrees not to sue, principal debtor.-A contract between the creditor and the principal debtor, by which the creditor makes a composition with, or promises to give time to, or not to sue, the principal debtor, discharges the surety, unless the surety assents to such contract.

……………

139. Discharge of surety by creditor’s act or omission impairing surety’s eventual remedy.-If the creditor does any act which is inconsistent with the right of the surety, or omits to do any act which his duty to the surety requires him to do, and the eventual remedy of the surety himself against the principal debtor is thereby impaired, the surety is discharged.

……………..

145. Implied promise to indemnify surety.-In every contract of guarantee there is an implied promise by the principal debtor to indemnify the surety; and the surety is entitled to recover from the principal debtor whatever sum he has rightfully paid under the guarantee, but no sums which he has paid wrongfully.”

High Court also considered the relevant provisions of the Code, which are as follows:

“2 (e) personal guarantors to corporate debtors;

5. (5-A) “corporate guarantor” means a corporate person who is the surety in a contract of guarantee to a corporate debtor;

5. (22) personal guarantor means an individual who is the surety in a contract of guarantee to a corporate debtor;

14. (3) The provisions of sub-section (1) shall not apply to-

(a) such transaction as may be notified by the Central Government in consultation with any financial regulator;

(b) a surety in a contract of guarantee to a corporate debtor.”

High Court opined that, right to apply for insolvency does not arise out of a contract between the parties. It is a statutory right Section 6 of the Code specifies the persons who may initiate Corporate Insolvency Resolution process in respect of a corporate debtor. It cannot be said that, the financial creditor when it applies under Section 7 of the Code, does so with the view to enter into any compromise or composition with the corporate debtor in respect of the claim. In a given situation, the Resolution Plan submitted with the resolution professional and accepted by the committee of creditors and ultimately approved by the Adjudicating Authority, may provide for payment of the entirety of the claim or part thereof of the financial creditor applying for initiation of the Corporate Insolvency Resolution process. In neither of the two situations, can it be said that, the financial creditor entered into a voluntary compromise with the corporate debtor with regard to the quantum of the claim.

High Court also considered a scenario wherein the Resolution Plan may be approved by the financial creditor in the meeting of the committee of creditors and would such an approval mean that, the financial creditor entered into a composition with the corporate debtor, thereby impairing the right of the financial creditor to recover the balance amount from the guarantor of the corporate debtor. As per High Court such approval even wont impact the right of the financial creditor and consequently the liability of the Guarantor.

High Court also referred relevant portion of the citation referred by the parties, namely Maharashtra State Electricity Board, Bombay (supra) wherein it was held that, a discharge which the principal debtor may secure by operation of law in bankruptcy or in liquidation proceedings in the case of a company does not absolve the surety of his liability.

Further, High Court critically examined the case of Kundanmal Dabriwala (supra) and held that ratio in said case is not applicable in the present case and further same is not binding precedent on the court.

ORDER

High Court held that ratio of Maharashtra State Electricity Board (supra) being binding precedents and the factual scenarios obtaining therein being same as that obtaining in the present case, the ratio laid down therein are applied in the facts of the present case.

High Court further held that, the Corporate Debtor in a proceeding under Section 7 of the Code may stand discharged of its liability to its creditors. Such discharge being had in a proceeding for bankruptcy and insolvency, the same does not absolve the surety of the liability as has been held in Maharashtra State Electricity Board, Bombay (supra). When an application under Section 7 of the Code is admitted by the Adjudicating Authority, the steps taken subsequent thereto flows out of the statute.

In view of the discussions above, High Court answered first Moot Question in the negative and against the writ petitioner. Further next Moot Question was left open for further consideration by the High Court.

ANALYSIS

On a fair reading of the provisions of the Contract Act, it is evident that as the liability of the surety is co-extensive with that of the principal debtor, if the latter’s liability is scaled down in an amended decree, or otherwise extinguished in whole or in part by statute, the liability of the surety also is pro tanto reduced or extinguished. Paragraph 192 of Halsbury’s Laws of England, Vol. 16, 1935 Edn., contains the following passage : Whatever expressly or impliedly discharges the principal debtor from liability usually discharges the surety also by implication, as his position is thereby altered without his consent, notwithstanding that the alteration is accomplished by operation of law. He is therefore discharged where he can establish that the alteration changes the nature of his liability, but not otherwise.

Contract Act has defined liabilities of the guarantors as well as its subrogation right i.e.to recover the same from principal debtor. Further subrogation right is expounded under Section 145 of the CA, 1872. Succinctly, it is the right of the guarantor to recover from the principal debtor, the amount paid on his behalf to the creditor. Legally speaking, the concept of Subrogation provided under the Contracts law of India states that the rights of one person can be transferred to another person provided the latter person is instrumental in extinguishing the debt of the former-borrower. The guarantor becomes the creditor of the borrower as he is now succeeds to the right (including the right to realize debt amount) of the previous creditor.

An exemplary case of this is Amrit Lai Goverdhan Lalan v. State Bank of Travancore 1968 AIR 1432 in which the apex court has stated that principle of subrogation is not only subject to the contract of guarantee but also the principle of natural justice.

Further in addition to Section 145, Section 140, CA. 1872, also dealt with right of the guarantor, which stated that the surety, on discharging a debt would get all the rights which the creditor had against the principal debtor. So, if the creditor could not recover any portion of the debt from the principal debtor, owing to scaling down under any statute it follows that the surety could not also recover that portion of the debt. Thus, it would be very unjust to the surety and would land him in unexpected and unmerited loss, if creditor is allowed to recover the scaling down amount or hair cut.

Another contention which would rise, whether two parties (corporate guarantor and the resolution applicant) should be permitted to take away the rights of a third party (personal guarantor) who is not even a party to the contract. The issue appears to be far from being settled and, therefore, the stand of the Apex Court is eagerly awaited

Going further, even Companies Act, 2013 provide similar mechanism under Section 230-231, whereby debt of a company can be reduced or hived off, by consent of specified number creditors, under a scheme of arrangement and thereafter by approval of the National Company Law Tribunal same can be confirmed. Further, the test enunciated in deciding the right of subrogation/indemnification of guarantor in cases wherein debt has been reduced under Section 230-231 of the Companies Act, 2013 same can be referred and used in present conundrum. Similar question under arose before Hon’ble High Court of Punjab and Haryana in Shri Kundanmal Dabriwala v. Haryana Financial Corporation & Anr. MANU/PH/3320/2011 it was held that,

Present is a case, which leads to extinction of principal debtor’s liability in terms of scheme of arrangement sanctioned by this Court on 19.03.2009. Such scheme is binding on all the creditors including non consenting creditors such as the Corporation. Under Section 135 of the Act, a contract between the creditor and the principal debtor by which the creditor compounds with the principal debtor, discharges the surety. It shall include a binding arrangement sanctioned by the Court under Section 391 of the Companies Act. It is a case of a deemed and binding contract though by operation of law, but such contract extinguishes the liability of the principal debtor. With such extinction of the liability of the principal debtor, the surety cannot recover the amount of debt paid, from the debtor. Therefore, it cannot be said that the surety will continue to be liable for payment of debt due to the creditor prior to settlement.

Thus, we arrive at the following conclusion:-

i) The scheme of arrangement sanctioned by the Company Court in exercise of the jurisdiction under Section 391 of the Companies Act, 1956, is binding on all creditors including the non consenting creditors. Such scheme extinguishes the remaining claim of the creditor.

ii) On such extinction of the claim of the creditor, the surety stands discharged inter-alia for the reason that he cannot step in the shoes of the creditor and sue the debtor for the recovery of the amount paid by the surety in terms of Sections 139 and 140 of the Indian Contract Act.

iii)….This is keeping in view the principle that the liability of the surety is co-extensive, but not alternative. Thus, where the principal debtor cannot be sued for one or the other reason, the surety will still be liable, except in cases where the liability of the principal debtor stands extinguished.”

However said ratio was not accepted by the High Court in the Judgement; though High Court opined that finding in Shri Kundanmal Dabriwala (Supra) require further consideration.

Interestingly same question initially come before Adjudicating Authority, Delhi, in Davinder Ahluwalia and Ors. v. Sumit Aviation IB No. (IB)-229 (ND)/2017 where the personal guarantors of the defaulter company paid 1.05 crores to Punjab National Bank. The principle of subrogation placed the guarantor in the shoes of the creditor. The company again defaulted in paying the guarantors the amount paid towards absolution of the debt created in exchange of paying the amount owed by MS Sumit Aviation(SUPRA). The guarantors then approached NCLT under Section 7 of the IB Code. The Tribunal then allowed the Corporate Insolvency Resolution Proceedings against the principal debtor as the debtor did commit a default by not paying an amount.

Further this issue was dealt by the NCLAT as well in the case of Lalit Mishra and Others v Sharon Bio Medicine Limited, wherein it was observed that a guarantor cannot enjoy subrogation rights under the IBC as the proceedings thereunder are not recovery proceedings. The aim of the IBC is to revive the company and not to make certain that credit is available to all stakeholders. Moreover, it should also be considered that allowing the exercise of subrogation right will mean that the debt remains as it is and this will act as an obstruction in the revival of the corporate debtor. Though ratio laid down under Shri Kundanmal Dabriwala (Supra) was not discussed by the NCLAT.

Be that as it may, in view of Judgment of High Court and NCLAT order in Lalit Mishra (Supra), creditors can recover hair cut in the resolution plan from the guarantors and guarantor’s right of subrogation does not survive post approval of the resolution plan.

Authors are advocate at New Delhi and Managing Partner and Partner respectively at Indo Legal Services a boutique law firm in New Delhi.

DISCLAIMER: This article is for information purposes only. Nothing contained herein is, purports to be, or is intended as legal advice and you should seek legal advice before you act on any information or view expressed herein. Although we have endeavoured to accurately reflect the subject matter of this article, we make no representation or warranty, express or implied, in any manner whatsoever in connection with the contents of this article. No recipient or reader of this article should construe it as an attempt to solicit business in any manner whatsoever.

Author Bio

Qualification: LL.B / Advocate
Company: Indo Legal Services LLP
Location: New Delhi, New Delhi, IN
Member Since: 18 Feb 2020 | Total Posts: 8
MR. GAURAV RANA(Advocate, CS) Mr. Rana, Advocate is a member of Bar Council Association of Delhi High Court, India and an Associate member of Institute of Company Secretaries of India. He has extensive experience in commercial litigation, arbitration and regularly argues at various fora. He advises View Full Profile

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