Insolvency: Lenders Score Another Win Against Guarantors
Does a recent NCLAT order on the status of guarantors run contrary to what Supreme Court and Section 14 (3) of the IBC laid down?
From the onset of the Insolvency and Bankruptcy Code, there has been evolving jurisprudence on the position of guarantors, in the event of a default where a guarantee has been provided.
Moratorium Against Guarantors
In the initial period of implementation of the IBC, there was a huge debate as to whether guarantors would be entitled to the benefit of a moratorium, as provided under Section 14, upon the commencement of insolvency proceedings against the borrower for whose benefit the guarantee had been obtained. One set of rulings (an Allahabad High Court judgment a case involving State Bank of India, the Chennai NCLT, and NCLAT judgments in the Veesons Energy Systems case) held that the benefit of the moratorium would be available to the guarantors. However, the order of the NCLAT in the Veesons Energy Systems matter was later set aside by the Supreme Court.
Another set of judgments pronounced by the Mumbai NCLT did not allow the moratorium to be extended to the guarantors of borrowers against whom insolvency proceedings had been initiated.
The amendment to Section 14 (3) of the IBC, effective from June 6, 2018, provided that the moratorium under Section 14 would not apply to a guarantor of a borrower against whom insolvency proceeding had already commenced. When ruling on a case involving State Bank of India, on Aug. 14, 2018, the Supreme Court held that the moratorium against a defaulting company would not apply to a surety in a contract of guarantee. In fact, the Supreme Court judgment, while analysing the amendment brought under Section 14(3), held that the amendment was clarificatory in nature and, as such, has retrospective effect.
By virtue of this Supreme Court judgment, financial creditors can pursue action against guarantors if insolvency proceedings against the borrower have commenced and the moratorium available to the corporate debtor would not extend to the guarantors.
Proceeding Against Guarantor Independent Of Action Against Borrower
On Jan. 8, 2019, ruling on a Piramal Enterprises case, the NCLAT held that it is not necessary to initiate insolvency proceedings against the borrower before initiating any such insolvency proceedings against the corporate guarantors who have provided guarantees for the benefit of such a borrower. Additionally the NCLAT even held that the financial creditor always has the option to initiate insolvency proceedings, under Section 7 of the IBC, against the corporate guarantors and the obligation of the guarantor is co-extensive with that of the borrower.
The NCLAT ruling further paves the way for financial creditors to proceed against corporate guarantors independent of any action against the corporate debtor.
No Simultaneous Proceedings Against Two Corporate Guarantors For Same Default
The NCLAT further held that there is no bar in the IBC for filing two simultaneous applications under Section 7 against the borrower as well as the corporate guarantor(s) or against two guarantors. However, the NCLAT also held that once, for the same set of claims if an application under Section 7 filed by the financial creditor is admitted against any one of the ‘corporate debtor’ [being ‘principal borrower’ or ‘corporate guarantor(s)’], a second application by the same financial creditor for the same set of claims and default cannot be admitted against the other ‘corporate debtor’ [being the corporate guarantor(s) or the principal borrower].
In the event there is more than one corporate guarantor, the financial creditor would have to make a choice as to whether the application under Section 7 ought to be filed against the corporate debtor being (a) the principal borrower; or (b) the corporate guarantor(s).
If there is more than one corporate guarantor, then the financial creditor would have to choose from any one of the corporate guarantors against whom the financial creditor wishes to file an application under Section 7.
Conclusion
One part of the NCLAT judgment, dealing with initiating proceedings against the corporate guarantor that are outside the scope of any action taken against the principal borrower, is spot on.
However, arguments could be raised against the NCLAT’s rationale on the other part, which deals with initiating insolvency proceedings against two corporate guarantors simultaneously for the same set of debt and default.
While NCLAT’s intention for deciding the second issue is well-intentioned, it may create uncertainty as to whether an insolvency proceeding which is being pursued against the corporate debtor, may prevent insolvency proceeding against the corporate guarantor(s) for the same debt.
The NCLAT judgment does not make any mention of the Supreme Court judgment, wherein it has been held that statutory moratorium applicable to the insolvent company/corporate debtor, may not be applicable to the personal guarantor of such insolvent company corporate debtor. By virtue of this Supreme Court Judgment, financial creditors were enabled from pursuing their action against the corporate guarantors even if the insolvency proceedings against the corporate debtor were ongoing. The NCLAT Judgment also does not make any reference to the amended Section 14(3) of the IBC.
It can be argued that the NCLAT judgment may be contrary to the Supreme Court judgment as well as the amended Section 14 (3) of the IBC.
It would be interesting to see if the aggrieved party in the NCLAT judgment carries the matter to the Supreme Court to have this controversy settled once and for all.
Nirav Shah and Ajay Shaw are Partners at DSK Legal.
The views expressed here are those of the authors and do not necessarily represent the views of BloombergQuint or its editorial team.