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Insolvency Law: Guarantors Lose The Right To Step Into Creditors’ Shoes

Personal and corporate guarantors, who’ve had to not only shoulder equal liability as the borrower under the insolvency law, now have also lost their right of subrogation.

Under the Insolvency and Bankruptcy Code, courts—by relying on the Indian Contract Act—have held that the liability of a guarantor and borrower is co-extensive, they have the same liability towards the creditor. If the creditor recovers some amount from the borrower, the liability of the guarantor reduces proportionately and vice-versa.

But also built in the Contract Act is the right of subrogation for the benefit of guarantors. This means that if a creditor recovers partial or full debt from the guarantor, the guarantor will then be able to step into the shoes of the creditor and recover this amount from the borrower at a later stage. In a recent order, the National Company Law Applellate Tribunal has denied this right to guarantors.

To simplify this, let’s say lender L loaned Rs 100 to borrower B which was guaranteed by G. Assuming that through the insolvency and bankruptcy code, L recovers Rs 70 from B. For the remaining Rs 30, courts have allowed L to go after G. Once L recovers Rs 30, the right of subrogation under the contract law kicks in to allow G to recover this amount from B. But in the case of Sharon Bio Medicine, the NCLAT held that this right of the guarantors—who happened to be the promoters—can be taken away if the resolution plan provides for it.

It has done so on grounds that the insolvency law prohibits promoters from benefiting, directly or indirectly, from the resolution process. The NCLAT has pointed out that the insolvency code is not a recovery suit and its objective is to maximise asset value of the insolvent company and balance the interests of the creditors.

Most resolution professionals make it a point to state in the plan that there won’t be any right of subrogation, Anshul Jain, regulatory practice head at PwC, pointed out. This, he explained, was done to give comfort to the resolution applicants that they won’t face any liabilities from guarantors going forward.

Bidders would argue that if today I’m paying Rs 70 to the lender and then being asked to pay Rs 30 to the guarantor, eventually I’ll end up paying Rs 100 for the asset. So, my cost is not Rs 70 but Rs 100. This prompted bidders to either state in their plans that there won’t be any right of subrogation or if it’s provided, the lenders would need to indemnify them.
Anshul Jain, Partner, PwC 

Technically speaking, the subrogation rights should be upheld because on the one hand you’re relying on contract law to allow creditors to go after guarantors and ensure recovery, Divyanshu Pandey, an insolvency law partner at J Sagar Associates, told BloombergQuint. On the other hand, he said that subrogation rights (if not waived) aren’t being upheld. “While NCLAT is saying IBC is not a recovery tool, it has permitted creditors to recover money under the guarantee by recognising creditors’ rights under the Contract Act but is denying guarantors their subrogation right under the same statute.”

Denying the subrogation right can be viewed as an inequitable treatment to guarantors’ claims. Be that as it may, the NCLAT seems to have taken a more practical approach. No resolution applicant will ever be interested in resolution of companies under corporate insolvency resolution process if the subrogation right is upheld because for him the liability will still be there.
Divyanshu Pandey, Partner, JSA

No resolution applicant will ever be interested in insolvent companies if this right is upheld because for him the liability will still be there, Pandey said.