CHAPTERS ON CHANGING FACETS AND DYNAMISM OF LAW 2019

EFFECT OF RESOLUTION PLAN ON GUARANTORS

ABSTRACT:

The research paper aims at providing an overview of the liability of Guarantee/Guarantor under a
Corporate Insolvency Resolution plan. The paper will discuss a plethora of judgments by the
NCLT, NCLAT, High Courts and Supreme Court on this topic and how the same has perplexed
the legal fraternities and general public. This paper also briefly covers the basic concepts
relevant to a contract of guarantee, key issues relating to awareness of a lender in making a
demand for payment against the principal and the Personal Guarantor, obtaining a judgment
following a demand for payment where the demand has gone unpaid by the Guarantor and
enforcing the judgment against the Guarantor. The paper is of much importance since financial
institutions require guarantees to hedge their investment in case a borrower defaults on regular
repayments. This research paper also highlights the lack of guarantor’s knowledge with regards
to their legal responsibility to the borrower. This paper further extends to discuss about the
implications of guarantees given by individuals and companies and aims to increase public
understanding on guarantees. The research paper is shaped in the view of suggesting the liability
of guarantee/guarantor under Corporate Insolvency Resolution plan that remains a grey area in
the evolving Insolvency and Bankruptcy Code, which has the potential of leading to dangerous
and erroneous consequences if not properly and precisely addressed.

INTRODUCTION:

A company, firm, partnership etc. are bound to hit highs and lows. When the debt of a Company
is more than the income, then the Company declares it to be Bankrupt after initiating the
necessary steps. Insolvency and Bankruptcy Code (here after, IBC) is the Law of Bankruptcy in
India.The Code, 2016 provides for the process of insolvency/ bankruptcy resolution of
Corporates and Individuals, and where no resolution is possible it provides for liquidation or
bankruptcy. The position and liabilities of guarantors is not specifically dealt with under the
Code. As such there has been a considerable debate on the issue as to whether a guarantor can be
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proceeded simultaneously with the principal debtor or not. Section 60 of the Code deals with
guarantors but only to a limited extent.

KEY POTENTIALS OF IBC, 2016:

The insolvency and bankruptcy code 2016 was introduced in the Lok Sabha on 31st December
2015 by Late Finance Minister Arun Jaitley.1The code received assent from Former President
Pranab Mukherjee on 28 of May and was notified in the Gazette of India on 28 May 2016.2It is
accommodated as Entry 9 of List III (Concurrent List) in our Constitution.

The code3 applies to:4

 Companies incorporated under the Companies Act, 2013;

 Company governed by any other Special Act;
 Limited Liability Partnership Firm;
 Body Corporate, incorporated under any Act;
 Individuals.

However, except the above, the Code does not state much regarding the substantive rights and
liabilities arising out of a guarantee. These rights and liabilities are provided under the Indian
Contract Act, 1872. Therefore, in order to ascertain the rights of the creditor and liability of a
surety with regard to a guarantee, one will have to make reference to the Indian Contract Act,
1872.

The very first insolvency resolution orders under this code were passed by National Company
Law Tribunal (here after, NCLT) in the cases of Synergies Dooray Automotive Limitedand the
Prowess International Private Limited.5The code outlines separate insolvency resolution process
for individuals companies and partnership firms.

1
PRS| Bill Track| the insolvency bankruptcy code 2015 www.prsindia.org retrieved on 20 February 2018
2
http ://www.indiacode.nic.in/acts-in- PDF/2016/201631. PDF
3
Insolvency Bankruptcy Code, 2016.
4
https://taxguru.in/corporate-law/insolvency-bankruptcy-code-2016-dawn-new-era-part-i.html
5
"NCLT okays first insolvency resolution scheme under the IBC",Livemint, 16 August 2017

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The key features of IBC insolvency resolution are Insolvency Regulator, Insolvency
Professionals, Bankruptcy and Insolvency Adjudicator.6

The implementation of IBC has marked the beginning of a new era. The IBC unified a variety of
legislations such as Sick Industrial companies Act, Security Interests Act, The Recovery of Debt
Due to Banks & Financial Institution Act, etc, .7 It is also often considered as the Guarantor
friendly law, as it protects them unlike the previous legislations.

There exists a Debtor, Creditor and a Guarantor in forming a Company or Business organization.
The Insolvency Bankruptcy Code focuses on a mechanism by which creditors could wholly or
partly recover their dues from a company which is unable to pay back the debt. This code is
likely to improve transparency and reduce litigation over business failures, further this is an
efficient way to deal with business during crucial economy, thereby, optimising its allocation of
resources.8

THE CONCEPT OF CORPORATE INSOLVENCY RESOLUTION PROCESS:

The concept of Corporate Insolvency Resolution Process (here after, CIRP) is recognized by the
IBC. Under this concept, once a default is established, the tribunal initiates CIRP following the
consultation with Creditors of the Company.

During this, the concerns related to Guarantors arises. The concept of Guarantee is introduced
and explained U/S 126 of the Indian Contract Act, 1872, which obligates on surety to honour the
promise of the Principal Debtor’s present of future Debt, provided to him by a creditor.9

Once the resolution plan is approved it will be binding on all the stakeholders including the
guarantors.10

It was held that the Guarantor cannot exercise the power of subrogation as the proceedings under
IBC are not recovery proceedings.11

6
"Legislative Brief Of The Code " ( PDF). PRS India. retrieved On 18 August 2016.
7
Supra Note 4
8
https://www.civilsdaily.com/story/insolvency-and-bankruptcy-code/
9
Lord Chorley, Law of Banking , 2nd Edition, Pitman 1947
10
SBI v. V. Ramakrishnan 2018 SCC Online SC 963

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RELATIONSHIP BETWEEN BORROWER & GUARANTOR:

Liability of a borrower is co extensive with guarantor, thus when borrower is unable to clear off
the debt, the creditor is empowered to proceed against the guarantor.12The term "co-extensive"
has been defined as under:13

“Co-extensive. - A surety's liability to pay the debt is not removed by reason of the
creditor's omission to sue the principal debtor.”

This liability is independent as the contract of Guarantee is independent contract by itself. 14 The
creditor need not necessarily exhaust his remedy against the debtor before approaching the
Guarantor.15 “It is not necessary for the creditor, before proceeding against the surety, to request
the principal debtor to pay, or to sue him, although solvent, unless this is expressly stipulated
for”.16 In State Bank of India v. M/s. Indexport Registered & Ors,17 the Supreme Court held
that the decree holder bank can execute the decree against the Guarantor without proceeding
against the Principal Borrower.

CONTRACT OF GUARANTEE:

A contract of Guarantee means a contract to perform the promises made or discharge the
liabilities of the third Person in case of his failure to discharge his liabilities.18A contract of
guarantee19 is a contract between Creditor, Principal Debtor and Guarantor.

o Creditor has a remedy in relation to his debt against both the Principal Debtor and the
surety,
o Surety can be corporate or natural person.

11
Lalit Mishra & Ors v. Sharon Bio Medicine Ltd., [Company Appeal Insolvency no. 164 of 2018, dated
14.11.2018]
12
Subankhan v. Lalkhan AIR 1947 Nag. 643
13
Pollock &Mulla on Indian Contract and Specific Relief Act, Tenth Edition, at page 728
14
http://www.mondaq.com/india/x/767846/Insolvency+Bankruptcy/Personal+Guarantor+Has+No+Right+Against+
Corporate+Debtor
15
Supra note 12
16
Halsbury’s Laws of England, Fourth Edition., Volume 20, paragraph 159 at page 87
17
State Bank of India v. M/s. Indexport Registered & Ors 1992 AIR 1740
18
Nagpur Nagarik Sahakari Bank Ltd. V. Union Of India & Anr 1984 55 CompCas 677 AP
19
D. S. Constructions Limited v. Rite Limited & Anr AIR 2006 Delhi 98

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A person who gives Guarantee is also called as surety.20 The corporate Surety is known as
Corporate Guarantor and individual surety is called as Personal Guarantor. The person in respect
of whose default the guarantee is given is called the ‘principal debtor’ and the person to whom
guarantee is given is called the ‘creditor’.21 A guarantee may be either oral or written.22 A
corporate guarantee is an agreement in which one party, the Guarantor, takes on the payments or
responsibilities of a Debt if the Debtor defaults on the loan.23

Further, it is held that in case of an insolvency proceeding or liquidation proceeding is initiated

against the principal debtor, the claim of insolvency or bankruptcy against the guarantor is to be
initiated in the NCLT.24

The presence of 3 parties in the contract extends the privity of contract to tripartite of contract.25

According to Indian Contract Act, 1872, the liability between the surety and the debtor is co-
extensive Liability, thus in case a proceeding is initiated against the principal debtor, Guarantors
conduct will be governed by it. An exception to this was laid down in “EG. Bankruptcy:
Jagannath v. Shivnarayan”26, wherein the court said that “discharge of surety by discharge of
law doesnot discharge the surety”.27

Through Sanjeev Shriya v. State Bank of India, the court interpreted Section 60(2), reaffirming
the right of creditor to proceed against the Guarantor of corporate debtor.28 Unless and until the
outstanding is repaid, the Contract of Guarantee shall be continued to be in existence.29

Thus, Corporate guarantors are also known as,30

o Third party guarantee

20
D. S. Constructions Limited v. Rite Limited & Anr AIR 2006 Delhi 98
21
Nagpur Nagarik Sahakari Bank Ltd. V. Union Of India & Anr 1984 55 CompCas 677 AP
22
M/s. Bharat Heavy Electricals Limited v. M/s. Hyderabad Iron Steel Works , D.V.S.S.SOMAYAJULU,J Date:
16.07.2018 KLP
23
https://www.upcounsel.com/corporate-guarantee
24
Sanjeev Shriya v. LML Industries Writ- C No. – 30285 of 2017
25
S N Gupta, Law relating to Guarantees with Proformus of Bank Guarantees and Indemnity Bonds, 6 th edition,
Pitman 1947.
26
E G. Bankruptcy: Jagannath v. Shivnarayan AIR 1940 Bombay 380
27
Ibid
28
Sanjeev Shriya v. LML Industries Writ- C No. – 30285 of 2017
29
M/s Anik Industries Limited v. IDBI Bank on 17– 01 – 2019
30
https://www.upcounsel.com/corporate-guarantee

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o Guaranty
o Guarantee
o Guaranteed Loan.

Section 60(2) of the IB Code gives the power to the creditor to initiate a “corporate insolvency
process” against the Guarantor.31

RIGHTS & SCOPE OF GUARANTOR:

During the period of Morotorium, “any action to foreclose, recover or enforce any security
interest created by the corporate debtor in respect of its property” is prohibited.32 In lieu of the
same, it’s vital to point out that whenever the Guarantor pays the corporate debtor’s debt, he
himself acquires a right against the principal Debtor.33 Hence, a guarantor is also a creditor of
varied degree34 and the rights of the surety is co- extensive with that of the Principal Debtor35.

‘In a Resolution Plan under IBC, personal guarantors cannot step into the Creditor’s shoes’. 36

In Bombay High Court Case of Alpha & Omega Diagnostics (India) Ltd. V. Asset
Reconstruction Company Of India Ltd & Ors37dealt with the question, “whether a creditor
under the insolvency regime can sell the assets of the personal Guarantor?”. The court examined
the word “it” contained in Section 14 of the IBC, 2016 and said that the benefit of moratorium is
not available to the personal guarantors of the corporate debtors. Hence, a personal guarantor’s
assets can be disposed of in order to satiate the debt. NCLAT in the case of Schweitzer
Systemtek India Pvt. Ltd. V. Pheonix ARC Pvt. Ltd & Ors,38 gave a judgement based on similar
lines.

31
The Insolvency Bankruptcy Code, 2016
32
Section 14 (1)(c), Insolvency and Bankruptcy Code, 2016
33
The New Conundrum: Guarantors in Insolvency Regime, Namrata Dubey ILNU Ahemedabad, IBC. PDF
34
United Nations Commission on International Trade, Legislative Guide on Insolvency Law (New York, 2005),
para1.
35
Sanjeev Shriya v. LML Industries Writ- C No. – 30285 of 2017
36
Lalit Mishra & Ors v. Sharon Bio Medicine Ltd. [Company Appeal Insolvency No.164/2018, dated: 14.11.2018]
37
Alpha & Omega Diagnostics (India) Ltd. V. Asset Reconstruction Company of India Ltd. & Ors Company Appeal
(AT) (Insol.) No. 116/2017
38
Schweitzer Systemtek India Pvt. Ltd. V. Pheonix ARC Pvt. Ltd & Ors Company Appeal (AT) (Insolvency) No.
129/2017

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Recovery of money by anyone is a very critical task, especially when a Guarantor has to collect
back his money paid in rescue of the Debtor. Therefore, the Guarantor becomes the creditor of
the Borrower as he now holds the right of the previous Creditor (including the right to realize
debt amount).39

The present condundrum is that:40

a. The prohibition of taking a recourse to guarantor and to realize debt from that end makes
it implicit that the proceedings against the Guarantor in Insolvency and Bankruptcy Code
is very restricted, hence this is defying the principles of contract and as a result of this a
scarcity of trust is created in matters pertaining to guarantee contracts.
b. If one is allowing the selling off of the Guarantor’s assets than the same would go against
the objectives of IBC, 2016.

In the case of ChokalingaChettiar v. DandayuthapaniChettiar,41 the High Court of Madras held

that, “...The creditor can pursue his remedies concurrently against both the principal debtor and
the surety and obtain a decree against both in the same suit, provided, as I find in this case, that
the surety is also at the date of the suit liable for the amount due by the principal debtor...”.
Further, in accordance with law, the liabilities of the principal debtor and the guarantor are joint
and several. The Bombay High Court held in Sicom Ltd. v. Co-Nick Alloys (India) Ltd42
that“...It is also well settled that the liability of the principal debtor and guarantors is joint and
several. Thus it is open to the creditor to even sue the guarantor without suing the principal
debtor altogether...”

In the instant case43, few lines are unfinished relating to Personal Guarantee, since the IB Code
has not opened up its wings to the fullest. The issues that have evolved are:

 Whether the right of a personal guarantor to step into the shoes of a creditor against
the corporate debtor is case of an IBC resolution?
 Whether such situation would only be for a promoter based personal Guarantee?

39
S N Gupta, “ Law Relating to Guarantees wit Pro-formas of Bank Guarantees and Indemnity Bonds” (6 th edition,
Pitman 1947)
40
The New Conundrum: Guarantors in Insolvency Regime, Namrata Dubey ILNU Ahemedabad, IBC. PDF
41
Chokalinga Chettiar v. Dandayuthapani ChettiarAIR 1928 Mad 1262
42
Sicom Ltd. v. Co-Nick Alloys (India) Ltd 2005 (4) BomCR 653
43
Lalit Mishra & Ors v. Sharon Bio Medicine Ltd. [Company Appeal Insolvency No.164/2018, dated: 14.11.2018]

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 Whether such right of subrogation is automatically taken away once a resolution plan
is passed?
 Whether it is a matter that needs to be declared in terms of the resolution plan and the
Committee of Creditors (here after, COC)?

“Any right of a personal guarantor (at least in case of a promoter personal guarantee) can be
withdrawn as part of the Resolution Process”44.

The major concern raised, with respect to Corporate Guarantor, is that, when one company is the
guarantor of the other, than both companies would wind in the CIRP/ liquidation process. Thus,
the essence of DRT directing the creditor to seek Prayer as “instituting an Insolvency Resolution
Process” instead of “recovery of dues” is diluted and is felt necessary. Debt recovery is seen as
by product of the insolvency process.45 In Morgan v. Saymore, the court held that after disposing
off the obligations of the principal debtor the guarantor acquires the right to stand in the shoes of
the creditor.46

The NCLT, Principal Bench, New Delhi, in the matter of Rave Scans Pvt. Ltd.47has 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. Thus, it is clear that CIRP does not bar the creditor from
proceeding against the Guarantors.48

In G.K. Investments Limited v. Vistra Itcl (India) Limited49, it was held that CIRP cannot be
initiated against two Corporate Guarantors simultaneously for the same set of debt and default.

The Appellate Authority in the matter of Dr. Vishnu Kumar Aggarwal v. M/s. Piramal
Enterprises Limited50 held that Section 7 Application against the Corporate Guarantor is not

44
https://www.thehindubusinessline.com/money-and-banking/in-a-resolution-plan-under-ibc-personal-guarantors-
cant-step-into-creditors-shoes/article25821235.ece#
45
The New Conundrum: Guarantors in Insolvency Regime, Namrata Dubey ILNU Ahemedabad, IBC. PDF
46
Morgan v. Saymore (1638) 1 Rep Ch 120
47
[IB No. 01/2017, decision dated 9th May 2019]
48
Rave Scans Pvt. Ltd. [IB No. 01/2017, decision dated 9th May 2019]
49
G.K. Investments Limited v. Vistra Itcl (India) Limited on 28 November, 2018
50
Dr. Vishnu Kumar Aggarwal v. M/s. Piramal Enterprises Limited (Company Appeal (AT) (Insolvency) No. 347 of
2018.

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maintainable in cases where the CIRP has already been admitted against the other Corporate
Guarantor for the same very claim and default.

What will come as a major drift in the concept of guarantee/guarantor under the Code is the
judgment of the Hon’ble Supreme Court in the case of State Bank of India vs
V.Ramakrishnan51, wherein the Court has elaborately felt the need of the hour in the concept of
guarantee/guarantor under CIRP. The Hon’ble Apex Court observed that the period of
moratorium does not extend to personal guarantors and that the object of the Code was to not
allow guarantors, who in the case of corporate debtors were mostly Directors in management of
the company, to escape from an independent and co-extensive liability to pay off the entire
outstanding debt.

CONCLUSION:

Thus, the research paper is concluded with an opinion that the Law of IBC is a new born
legislation. The actual potential and scope of the same is still a puzzle to us. Many interpretations
are provided for every aspect of the legislation, by various courts and tribunals. The position of
Guarantors is strengthened by the Code, with new dimensions, rights and liabilities. Thus, a
Guarantor plays the role of creditor, debtor and Guarantor under the Code, along with the co -
extensive liability with the borrower.

51
(2018) 17 SCC 394

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REFERENCES:

 Lord Chorley, Law of Banking , 2nd Edition, Pitman 1947

 Pollock & Mulla on Indian Contract and Specific Relief Act, Tenth Edition

 Halsbury’s Laws of England, Fourth Edition., Volume 20, paragraph 159 at page 87

 S N Gupta, Law relating to Guarantees with Proformus of Bank Guarantees and

Indemnity Bonds, 6th edition, Pitman 1947.

 The New Conundrum: Guarantors in Insolvency Regime, Namrata Dubey ILNU Ahemedabad,
IBC. PDF

 United Nations Commission on International Trade, Legislative Guide on Insolvency

Law (New York, 2005)

 "Legislative Brief Of The Code " ( PDF).

 "NCLT okays first insolvency resolution scheme under the IBC", Livemint.

 “BETWEEN THE LINES…” January 2019, Vaish Associates, Advocates, Pdf.

 INSOLVENCY ROUND UP, Volume III Issue I, Manoj K. Singh, Daisy Chawla, Jatin
Kapoor & Rishub Kapoor, SINGH & ASSOCIATES, Pdf.

WEBLIOGRAPHY:

 www.thehindubusinessline.com

 https://www.upcounsel.com/corporate-guarantee

 www.indiacode.nic.in

 www.civilsdaily.com

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 https://taxguru.in/corporate-law/insolvency-bankruptcy-code-2016-dawn-new-era-part-
i.html

 www.prsindia.org

 https://www.ibbi.gov.in/orders/nclt?title=&date=2019-05-09&nclt=25

 http://www.mondaq.com/india/x/767846/Insolvency+Bankruptcy/Personal+Guarantor+H
as+No+Right+Against+Corporate+Debtor

 https://indiacorplaw.in/2019/02/corporate-insolvency-creditor-guarantor-dilemma.html

 https://ibclaw.in/the-corporate-guarantees-given-by-the-guarantor-can-be-invoked-only-
in-the-event-of-a-default-on-the-part-of-the-principal-borrower-export-import-bank-of-
india-vs-chl-limited-nclat/

 http://vinodkothari.com/2019/02/liability-of-guarantor-and-principal-debtor-is-co-
extensive-and-not-in-alternativ/

 www.inidankanoon.org

 https://www.toppr.com/guides/business-laws-cs/indian-contract-act-1872/contract-of-
guarantee/
 https://www.bloombergquint.com/insolvency/ibc-why-creditors-double-dipping-has-
guarantors-at-the-edge-of-their-seats

 http://www.mondaq.com/india/x/834608/Insolvency+Bankruptcy/Liability+Of+Guaranto
rs+After+Approval+Of+Resolution+Plan+Under+The+Insolvency+And+Bankruptcy+Co
de+2016
 https://ezresolve.in/blog/2018/7/4/insolvency-and-bankruptcy-on-guarantors-of-
corporate-debtor

 https://economictimes.indiatimes.com/blogs/et-editorials/only-lenders-should-initiate-
bankruptcy/

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LEGISLATIONS:

 INSOLVENCY AND BANKRUPTCY CODE, 2016

 THE INDIAN CONTRACT ACT, 1872

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