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Liability Of Personal Guarantor Of Corporate Debtor Vis A Vis The Insolvency And Bankruptcy Code

Kritanjali Sarda
25 Jan 2022 6:13 AM GMT
Liability Of Personal Guarantor Of Corporate Debtor Vis A Vis The Insolvency And Bankruptcy Code
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As per Section 128 ofthe Indian Contract Act, 1872, the liability of a guarantor is co-extensive with that of the principal debtor. Further, it is settled law that upon conclusion of insolvency proceedings against a principal debtor, the same amounts to extinction of all claims against the principal debtor, except to the extent admitted in the insolvency resolution process itself via the...

As per Section 128 ofthe Indian Contract Act, 1872, the liability of a guarantor is co-extensive with that of the principal debtor. Further, it is settled law that upon conclusion of insolvency proceedings against a principal debtor, the same amounts to extinction of all claims against the principal debtor, except to the extent admitted in the insolvency resolution process itself via the approval of resolution plan by the National Company Law Tribunal ("NCLT"). This is clear from Section 31 of the Insolvency and Bankruptcy Code, 2016 ("IBC") which makes the resolution plan approved by the Adjudicating Authority, that is, NCLT binding on the corporate debtor, its creditors and guarantors.

Therefore, the question arises as to whether the liability of personal guarantor of corporate debtor is extinguished on the secured financial creditor receiving payment of a part of its claim on full and final settlement basis in terms of resolution plan approved by NCLT. The answer to this question was finally settled by the Supreme Court in the case of Lalit Kumar Jain v. Union of India & Ors. However, this issue is better understood by analyzing the case laws in this regard.
In Maharashtra State Electricity Board v. Official Liquidator, High Court, Ernakulam & Anr.2, a Division Bench of the Supreme Court held that though under Section 134 of Contract Act, a surety is discharged by any contract between the creditor and the principal debtor by which the principal debtor is released or by any act or omission of the creditor, the legal consequence of which is the discharge of the principal debtor, however, a discharge which the principal debtor may secure by operation of law in bankruptcy or liquidation proceeding in the case of a company does not absolve the surety of his liability although liability of surety is co extensive with that of principal debtor under Section 128 of Contract Act.
In Shri Kundanmal Dabriwala v. Haryana Financial Corporation & Anr, a Division Bench of the Punjab & Haryana High Court while relying on Section 135 of the Indian Contract Act, which states that a contract between the creditor and the principal debtor by which the creditor compounds with the principal debtor, discharges the surety; concluded that the scheme of arrangement sanctioned by the Court in exercise of its jurisdiction under Section 391 of the Companies Act, 1956 is binding on all creditors including non-consenting creditors. Such scheme extinguishes the remaining claim of the creditor and consequently the surety stands discharged. It was held that:
"…on a fair reading of the provisions of the Contract Act, I am inclined to hold that as the liability of the surety is co-extensive with that of the principal debtor, if the latter's liability is scaled down in an amended decree, or otherwise extinguished in whole or in part by statute, the liability of the surety also is pro tanto reduced or extinguished."
However, subsequently, a Single Judge Bench of the Calcutta High Court in Gouri Shankar Jain v. Punjab National Bank4, disagreed with the ratio of the Punjab & Haryana High Court in the Kundanmal case. The Court in Gouri Shankar's case held that the secured financial creditor receiving payment of a part of its claim on full and final settlement basis in terms of resolution plan approved by NCLT does not extinguish liability of surety of corporate debtor. The sanctioned Resolution Plan cannot be construed to be a variation of the terms of the contract between the principal debtor and the creditor, without the consent of the surety, discharging the surety as to transaction subsequent to the variants or at all as per section 133 of the Contract Act. It was held that:
"Theoretically, as the liability of the surety is coextensive as that of the principal debtor, the creditor can proceed solely against the surety and recover the liability of the debtor from the surety. In such a situation, the subsequent reduction of liability of the debtor to the surety, by virtue of a bankruptcy or insolvency proceeding or otherwise, will not require the creditor to refund the amount recovered from the surety on account of the debtor to the surety. Pre bankruptcy and insolvency, the creditor has the right to recover the entire claim against the debtor from the surety. Post the bankruptcy and insolvency proceeding of the debtor, the pre bankruptcy and insolvency right of the creditor does not undergo any metamorphosis on the principle that, such proceedings emanate out of a statutory right and are involuntary in nature."
The issue was finally settled by the Supreme Court in Lalit Kumar's case wherein the Supreme Court held that approval of a resolution plan does not ipso facto discharge a personal guarantor of a corporate debtor of his or her liabilities under the contract of guarantee. The release or discharge of a principal borrower from the debt owed by it to its creditor, by an involuntary process, that is by operation of law, or due to liquidation or insolvency proceeding, does not absolve the surety/guarantor of his or her liability, which arises out of an independent contract.
The ratio in Lalit Kumar's case is in consonance with the earlier decision of the Supreme Court in State Bank of India v. V. Ramakrishnan wherein it was held that the moratorium referred to in Section 14 of the IBC can have no manner of application to personal guarantors of a corporate debtor. In Ramakrishnan's case, it was further held that Section 14 refers only to debts due by corporate debtors, who are limited liability companies, and it is clear that in the vast majority of cases, personal guarantees are given by Directors who are in management of the companies. The object of the IBC is not to allow such guarantors to escape from an independent and coextensive liability to pay off the entire outstanding debt, which is why Section 14 is not applied to them.
The ratio of the Supreme Court in Lalit Kumar's case is a welcome decision as it conclusively settles the law on the aforesaid issue. It ensures that personal guarantors do not escape their liability to pay off the debt to the creditor, on creditor receiving payment of a part of its claim on full and final settlement basis in terms of resolution plan approved by NCLT. Further, the continuation of a creditor's claim against a guarantor would not lead to double recovery of a claim as the creditor would be able to recover only the balance debt which remains outstanding and unrecovered from the principal borrower, pursuant to payment made by the corporate debtor in terms of the resolution plan approved by the NCLT.
The author is an Advocate practicing in the Courts of Bengaluru, veiws are personal.
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