ABSTRACT
The recent development in India’s corporate insolvency regime has brought into the limelight the issue of the treatment of corporate guarantors as per the Insolvency and Bankruptcy Code, 2016 (IBC). It becomes imperative for the lenders and creditors to make proper use of corporate guarantors to ensure smooth recovery of their assets from the borrowers. There is increased apprehension concerning the fair treatment of such corporate guarantors when the liabilities under their guarantees are enforced along with the liabilities of the principal borrower. According to the provisions of the Indian Contract Act, 1872, the liability of a guarantor is co-extensive with the liability of the principal debtor. However, in the current context of insolvency, the corporate guarantors are subject to rigorous corporate insolvency resolution processes (CIRPs) simultaneously. The objective of this article is to focus on the interpretation of the provisions of the IBC with regard to issues related to the maximisation of creditor’s wealth and ensuring fairness towards the guarantor corporations.
INTRODUCTION
Given the dramatic reforms introduced in India’s debt-recovery processes, the Insolvency and Bankruptcy Code, 2016, presently serves as the main legislative framework for corporate defaults. In complex borrowing set-ups, a corporation may agree to act as a corporate guarantor to secure the debt of the original borrower. On the one hand, creditors favourably view such guarantees as critical elementary risk management options that, by their implementation, bring about the flow of institutional capital. On the other hand, legal advisors and advocates suggest that the initiation of insolvency against a guarantor – sometimes even before the remedies offset against the debtor – may adversely impact the crucial economic state of the guarantor business.
The debate within the law concerning corporate guarantors goes beyond debt recovery in a conventional manner. There are bigger questions related to important aspects like statutory interpretation, the IBC and the Indian Contract Act, and the concept of going concerns. The moment a corporate guarantor enters the insolvency scenario, it suffers severe operational and reputational consequences. The interaction of contractual liability and statutory insolvency requires a very rigorous legal process to prevent the debt recovery process from resulting in disproportionate commercial losses.
STATUTORY INTERPRETATION AND CO-EXTENSIVE LIABILITY
The basic premise of the law on sureties in India is contained in Section 128 of the Indian Contract Act, 1872, which clearly states that the liability of the surety is co-extensive with that of the principal debtor unless otherwise provided for by the contract. According to this principle, the lender is not legally required to exhaust every option available to him against the principal debtor before taking action against the surety.
The IBC framework mirrors this principle in its definitions of “financial debt” and “corporate debtor.” The moment that a corporate guarantor defaults in its obligation to pay after the guarantee is invoked, the lender can invoke Section 7 of the IBC and initiate the CIRP process. If some people do not agree with this approach, they argue that putting both the principal borrower and the guarantor in simultaneous insolvency proceedings leads to a duplication of claims and prejudices the interests of the stakeholders of the guarantor company.
THE INDIAN POSITION: SIMULTANEOUS PROCEEDINGS
Before the appellate courts shed light on the pertinent legal questions, issues abounded on whether a financial creditor may initiate more than one corporate personal insolvency proceeding concerning one and the same debt against the principal borrower and the corporate guarantor. Initial approaches yielded contradictory court decisions at the level of the National Company Law Tribunal (NCLT), resulting in a somewhat disparate manner of tackling insolvency problems.
Eventually, the need for a comprehensive interpretation of the relevant law emerged. Several important judicial decisions, including those made by the National Company Law Appellate Tribunal (NCLAT) in the case of State Bank of India v. Athena Energy Ventures Pvt. Ltd., 2020 SCC OnLine NCLAT 774, allowed for simultaneous hearings on the topic. Courts ruled that rigidity inherent in the IBC made it impossible for a creditor to file its claims in both CIRPs; however, the escalation of proceedings is restricted by the fact that the creditor is entitled to recover only the total amount of the debt. Thus, creditors are strongly protected under the new approach working in conjunction with the guarantee institution.
RECENT DEVELOPMENTS AND JUDICIAL PRECEDENTS
Lately, the Supreme Court of India has been scrutinising the provisions applicable to guarantors. One key issue is the guarantor’s right to be subrogated. As a general rule, when a guarantor fulfils its obligation, it acquires the status of the creditor.
However, after the introduction of the IBC, the Supreme Court has indicated that, if a resolution plan permits the discharge of the principal borrower’s liability, the corporate guarantor will not have the right to institute any claims against the resolved entity. The Supreme Court relies on the fact that the IBC is intended to give the principal borrower a “clean slate,” which means that the law intends neither to discharge all obligations of the principal borrower nor to oblige the successful resolution applicant to face the claims of previous guarantors.
In addition, the courts are evaluating the possibility of proceedings against individuals providing personal guarantees and companies even once a resolution plan is approved for the main borrower. One of the leading legal arguments is that the approval of a resolution plan per se does not absolve the guarantor of its independent contractual obligations to execute its duties according to the contract and the Code in great detail.
CREDITOR PROTECTION, FAIRNESS, AND THE LIMITS OF LAW
Scholars and those in charge of implementing the law are divided when it comes to whether the current IBC mechanism is able to guarantee justice while also ensuring effective debt collection. While advocates of the current situation argue that it allows creditors to act duly and honour various agreements to get the maximum recovery, they also stress that restricting the liberties of such institutions can decrease their effectiveness and cause their market to collapse. Therefore, this perspective highlights the importance of applying the principles of justice in a strict way.
However, the opponents argue that the current interpretation of the concept of justice is biased towards banks. After all, there are numerous corporate guarantors acting as independent companies with their own personnel and stakeholders. Furthermore, there are concerns that the process of CIRP initiation of companies that are able to fulfil obligations based on the secondary liability might lead to their liquidation without being found guilty. In such a way, it might be inferred that when the aim is only to increase revenues of creditors, the main goal of the IBC, which is to create value for all stakeholders, gets neglected.
In order to do this, the framework of insolvency law must work out a mechanism able to foster creditor confidence and protect entities providing guarantees against frivolous and unwarranted insolvency claims. At the same time, the enforcement of guarantees must not be undermined by legislation since they still play a crucial role in business financing.
CONCLUSION
It is obvious that the treatment of corporate guarantors under the IBC is an intersection point of contract law, commercial realities, and legal bankruptcy regulations. Although the possibility of pursuing the guarantors at the same time is an effective instrument for creditors to recover amounts that they are owed, such a scenario raises serious concerns about the fair treatment of independent stakeholder interests of the guarantor. The research of the legal development in this area proves that consistent legal interpretation is required in order to deal with such issues.
While in the course of the evolution of the insolvency regulations in India, the question remains whether the legal framework succeeds in balancing the need for immediate debt recovery with the long-term survival of the guarantors.
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WRITTEN BY: SWETHA DUTTA
