IBC: Why Creditors’ Double Dipping Has Guarantors At The Edge Of Their Seats
It is quite common in business for a group company or a promoter to guarantee a loan. The implementation of the Insolvency and Bankruptcy Code, 2016 has raised several interesting questions about the fate of guarantor in case the borrowing company is admitted to insolvency resolution proceedings.
Legally, a creditor has the rights to recover his debt from the borrower AND the guarantor, in case of partial payments. But imagine that both entities are under insolvency. Can the creditor claim his dues and have a say in the committee of creditors of both insolvent entities?
That may seem like double dipping but experts say it is in fact legally permissible. Although, it does lead to some abstruse legal situations.
The very question of a creditor filing simultaneous claims under insolvencies of the borrower and guarantor came up before the National Company Law Tribunal in the ICICI v Ritu Rastogi case. The NCLT permitted the creditor to join the insolvency processes of the borrower and the guarantor, in accordance with the terms agreed to in the underlying guarantee agreement.
The tribunal relied on the Indian Contract Act, which states that the liability of a guarantor and borrower is co-extensive; which means that they have the same liability towards the creditor. If one of them pays back the creditor, the liability of the other towards the creditor reduces by a corresponding amount.
Following the NCLT judgement the Supreme Court and the legislature clarified that the moratorium (the period between the acceptance of insolvency application till conclusion of the insolvency proceedings, where no legal proceedings can be initiated against the insolvent entity) will not apply to the guarantor. This means, even if the borrower is in insolvency proceedings, the creditor can in parallel file claim or recover dues from the guarantor.
But the situation is more complicated than it appears.
1. Fluctuating Claims?
Kumar Saurabh Singh, partner at law firm Khaitan & Co told BloombergQuint that the issue of simultaneous insolvencies of borrower and guarantor is likely to come up in several insolvency proceedings, including Aircel Ltd. and Videocon Industries Ltd.
Typically, a group company guarantees the payment obligation of the borrower - this serves as a security for the lender. The IBC and subordinate regulations recognise the beneficiary of a guarantee as a financial creditor. They recognise that the claim of a financial creditor may vary during the insolvency process and allow for the Committee of Creditors (CoC) to be reconstituted accordingly. So if the creditor recovers some amount from the guarantor, its representation in the CoC will reduce proportionately.
However, under the amended Regulation 12, a creditor can submit a claim only up till 90 days after initiation of insolvency. This means that beyond the 90 day period, it is not clear yet on how the liabilities of the borrower or the guarantor will be adjusted once resolution plan for either one of them has been accepted while the other is still undergoing insolvency, Divyanshu Pandey, partner at law firm JSA told BloombergQuint.
2. Statutory Vs Contractual Rights
Another issue that arises is in relation to the confluence between IBC and contract laws. As per the principles of Contract Act, a guarantor is to be freed from his obligation under the guarantee agreement if there is any variance in the terms of the debt between the borrower and creditor, to which the guarantor is not a party.
Simply put that indicates if a resolution plan is achieved for the borrower, should the guarantor stand discharged of the liability?
Under contractual laws, it emerges that a guarantor is to be treated as discharged when the terms of the loan are varied, such as by a resolution plan of the borrower. However, there has been judicial debate on whether this can be contracted away, or whether this principle applies to a discharge by the operation of law, which would be the resolution process in this case.Amir Arsiwala, Insolvency Lawyer, Bombay High Court
Pandey points out that the borrower can ensure protection against such a scenario in the resolution plan.
A resolution plan typically has a provision that states that if a payment is made to the financial creditor pursuant to the resolution plan, any claim against the corporate debtor for such debt amounts stands satisfied, he explained.
A guarantor’s liability is co-extensive with the corporate debtor. Therefore, if a financial creditor wishes to have recourse against the guarantor for any unrecovered amounts then he or she should consider expressly carving out such right to recourse against the guarantor in the resolution plan.Divyanshu Pandey, Partner, JSA
3. A Subrogation Dilemma
Another principle of contract law that may have guarantors perplexed is the right of subrogation.
According to that - If the guarantor pays the debt amount, either partially or in full, it will have the right to recover this amount from the borrower, i.e., the guarantor replaces the original lender as the creditor of the borrower.
Pandey explains this issue with an example.
Suppose the creditor had extended a Rs 100 loan to the borrower. Subsequently, from the resolution plan for the borrower the creditor receives Rs 40 and the resolution plan of the guarantor repays the creditor Rs 30, for this Rs 30 the guarantor can come after borrower by exercising subrogation rights (as provided under the Contract Act), Pandey said.
But can the guarantor be thwarted by the bidder who acquired the corporate debtor?
To protect oneself from future claims arising out of exercise of subrogation rights, a prudent bidder may either chose to provide for extinguishment of such claims as a term of the resolution plan (given that a resolution plan binds the guarantor) or may seek the right to claim the money back from the creditors if the creditors are able to recover such amounts, Pandey added.
In a situation of insolvency, it is unlikely that there would be any value left in the corporate debtor for the guarantor to recover its dues, while exercising its subrogation rights, Singh told BloombergQuint. Alternatively, the successful bidder would usually seek indemnity from the lenders for any claim from the guarantor, he agreed.
But this presumes that the guarantor has the right of subrogation, Arsiwala argued.
The main conflict is whether the guarantor will be entitled to the securities of the creditor - a right given to the guarantor under the Contract Act, 1872, but possibly limited by provisions of the IBC.Amir Arsiwala, Insolvency Lawyer, Bombay High Court
The Fate Of Guarantors
The Supreme Court has clarified that the guarantors do not have the benefit of borrower’s moratorium, but they have not yet dealt with the effect of pursuing a guarantor during the insolvency proceedings of the borrower or any of the issues raised in this story so far. It may look at these very differently , said Arsiwala.
The aim of the IBC is to resolve the insolvency of a corporate debtor, not recover the amounts owed, and it follows from this that a resolution plan will restructure the existing debts of an insolvent companies into either completely new debt - or, as in most cases, a settlement of all existing debt, he noted. Accordingly, if the liability of a corporate debtor comes to an end, the liability of a guarantor cannot continue, Arsiwala contended.
What then would be the fate of guarantors? Given that this issue crops up in many IBC cases, the courts and tribunals are likely to adjudicate on it sooner than later, experts say.