Dilemma of Guarantor’s Right to Subrogation under IBC Regime: Striking a Balance Between Revival and Equitable Principles
Introduction
In virtually all commercial transactions, the inclusion of a guarantee is deemed necessary to ensure the debtor’s ability to fulfil their obligations. It is customary for creditors to seek collateral or security prior to disbursing funds to borrowers. The utilization of guarantees plays a critical role in facilitating a substantial segment of the credit market. In commercial settings, this is commonly accomplished by obtaining a guarantee from the proprietors or affiliated entities of the principal debtor.
A guarantee is established through a promise to perform an action or refrain from it, and this alone is sufficient to confer its validity. Furthermore, the surety or guarantor takes on the rights of the creditors who have claims against the debtor or borrower, effectively taking on the position of the creditor and possessing the capacity to utilize all the assets of the creditor, as collateral against the borrower for whom the payment is being made. The issue of safeguarding the guarantor’s right to subrogation within the framework of the IBC regime has emerged from notable legal precedents such as the Essar Steel and Lalit Mishra cases. Nonetheless, there has been no explicit elucidation concerning the precise scope of the right to subrogation.
In specific circumstances, arguments have arisen suggesting that conferring the right to subrogation upon the guarantor would impede the central objective of the IBC. Conversely, some contend that the right to subrogation is an inherent entitlement of the guarantor and should be granted. Thus, this article aims to examine the stance on the right to subrogation within the IBC framework and analyse its implications for the market and the corporate debtor.
Defining the Right to Subrogation
Prior to exploring the advantages and disadvantages, it is necessary to clarify the concept of the right to subrogation and understand the fundamental prerequisites for assuming the role of a guarantor. In the case of Morgan v. Seymore[1], the court held that when the guarantor has fulfilled their responsibilities by repaying the debt or dues, they are entitled to assume the position of the creditors and exercise identical rights.
Section 128 of the Indian Contract Act establishes the co-extensive liability of debtors and guarantors, unless specified otherwise in the contract. As specified in Section 140, “Where a guaranteed debt has become due or default of the principal debtor to perform a guaranteed duty has taken place, the surety upon payment or performance of all that he is liable for, is invested with all the rights which the creditor has against the principal debtor”. “Fundamentally, subrogation takes place when the guarantor steps into the shoes of the creditor after fulfilling the outstanding amount.”
However, once the guarantor has discharged their responsibilities towards the creditors of the debtor, they forfeit the ability to initiate legal proceedings against the corporate debtor under the provisions of the Insolvency and Bankruptcy Code (IBC). Therefore, the main point of this discourse centres on the status of guarantors concerning their right to subrogation within the context of the Insolvency and Bankruptcy Code (IBC), along with the corresponding benefits and drawbacks.
Implications of Denying the Right to Subrogation under IBC
The guarantor, upon fulfilling the debt, assumes the position of the creditor and inherits all the obligations and rights associated with the creditor’s role. In the case of Amrit Lal Goverdhan Lalan v. State Bank of Travancore, the court underscored that this principle is in accordance with the fundamental notion of fairness and equity. As a result, the guarantor assumes all the obligations of the creditor with respect to the principal debtor. This indicates that the guarantor takes on the role of the creditor, thereby possessing the power to exert all the creditor’s assets as a means of redress against the borrower on whose behalf the payment was made.
In the event that a corporate debtor is released from its obligation to repay the guarantee, there exists the potential for unjust gain if the borrower experiences a significant improvement in their financial condition or if the financial burden is alleviated. Under such circumstances, the utilization of the guarantor’s funds to facilitate this improvement would result in an enrichment that comes at the guarantor’s expense.
“If the guarantor is not granted the right to subrogation”, the principal debtor would benefit from the funds provided by the guarantor, as the payment made to the creditor signifies the contribution made by the guarantor. Nevertheless, it is important to recognize that the surety holds a legitimate claim to be subrogated, as it possesses an equitable entitlement to assume the rights and responsibilities of the creditor.
It is important to acknowledge that within the framework of the Insolvency and Bankruptcy Code (IBC), there is a notable absence of provisions granting the guarantor the right of subrogation. As a result, the surety is precluded from initiating legal proceedings against the debtor in accordance with the IBC. Subrogation serves as a fundamental principle underlying the concept of guarantee, which holds significant importance with respect to any corporate transaction. Hence, it becomes necessary to carefully analyse the implications arising from the denial of the right of subrogation under the IBC.
Vigilant observation of the potential negative repercussions on the market is of utmost importance. The absence of recovery rights for guarantors would result in their hesitance to undertake the role of guarantors in transactions, consequently exerting a major impact on the commercial market, that heavily relies on the participation of guarantors. Moreover, it is imperative to acknowledge that the denial of the right to subrogation infringes upon the provisions outlined in Section 30(2)(e) of the IBC, as the exclusion of the right to subrogation conflicts with the provisions of “the “Indian Contract Act of 1872,” which is presently enforceable. The absence of this right within the plan is deemed non-compliant with the existing legal framework.
Furthermore, this refusal to grant the right to subrogation can be perceived as a violation of the principles of natural justice and equity. The guarantor, having fulfilled their obligations to the creditor, should not be deprived of their legitimate rights to seek redress from the principal debtor. Denying the guarantor’s right to subrogation under the IBC regime raises concerns regarding the potential violation of fundamental rights. Such denial may lead to a situation where the guarantor is left without any legal recourse, thereby infringing upon their rights to seek justice and fairness.
Challenges and Drawbacks of Granting the Right to Subrogation under IBC
Within the framework of the Insolvency and Bankruptcy Code (IBC), the right to subrogation has been denied to guarantors. This exclusion was initially implemented in the “Lalit Mishra & Ors. v. Sharon Bio Medicine Ltd. & Ors. case.” The rationale behind this decision stems from the concern that granting guarantors the right to subrogation would enable them to pursue claims against the “resolution applicant,” thereby undermining the primary objective of the applicant to revitalize the company. The resolution applicant would essentially be required to make the same payment that was originally owed.
The primary objective of the Corporate Insolvency Resolution Process (CIRP) is to optimize the worth of a company’s assets and effectively address its insolvency concerns through the careful management of creditor interests and the revitalization of the company. However, permitting guarantors to pursue reimbursement from the assets of the corporate debtor would reintroduce the vicious cycle of default and non-payment, leading to subsequent recovery, thereby imposing a hefty burden on the company’s assets. Such an allowance would run counter to the fundamental purpose of the CIRP, which strives to alleviate financial strain and ensure the sustainable recovery of the company.
The National Company Law Tribunal (NCLT) has ruled that, within the framework of proceedings governed by the Insolvency and Bankruptcy Code (IBC), the guarantor does not possess the right to exercise subrogation as stipulated in the Indian Contract Act. This determination is rooted in the recognition that IBC actions do not align with the classification of “recovery proceedings”.
“Section 238 of the IBC”, commonly known as the “non-obstante provision,” establishes the primacy of the Code over any conflicting laws. The aforementioned reasoning was also applied in the legal case of “Essar Steel India Ltd. Committee of Creditors v. Satish Kumar Gupta,” wherein the party requesting reimbursement invoked the right of “subrogation after” fulfilling “its obligations to the creditors”. Nevertheless, the SC dismissed the claim and upheld “that the guarantor” continues to be held accountable even following the approval of a resolution plan.
Conclusion & Suggestions
The issue of the guarantor’s right to subrogation under the Insolvency and Bankruptcy Code (IBC) requires careful deliberation and resolution. The absence of specific provisions granting this right creates uncertainties within the framework of the IBC. While subrogation is an inherent and equitable right that protects guarantors, its recognition could potentially hinder the primary objective of the IBC, which is to revive companies and maximize asset value. On the other hand, denying the right to subrogation may run counter to the principles of natural justice.
Striking a balance between the objectives of the IBC and the equitable principles of subrogation is crucial. To achieve this, it is recommended that the IBC be amended to explicitly acknowledge and safeguard the guarantor’s right to subrogation. This amendment would create a comprehensive framework that promotes a robust credit market while ensuring fairness and justice. By recognizing and preserving the guarantor’s right to subrogation, the IBC can establish a more equitable and effective legal environment for commercial transactions and debt resolution. It is imperative that all stakeholders carefully consider the implications and benefits of such an amendment to advance the objectives of the IBC while upholding principles of fairness and equity.
[1] “Morgan v. Seymore, (1638) 1 Rep Ch 120.”
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