IBC: Law of guarantees and corporate insolvency process

The National Company Law Appellate Tribunal (NCLAT), in its recent ruling in the case of Vishnu Kumar Agarwal v Piramal Enterprises Ltd, while examining the validity of an application made under section 7 of the Insolvency and Bankruptcy Code, 2016 (code), against corporate guarantors, held that: (1) there is no bar on filing two simultaneous applications under section 7 against the principal borrower as well as the corporate guarantors and against both guarantors; and (2) it is not necessary to initiate a corporate insolvency resolution process (CIRP) against the principal borrower before initiating a CIRP against the corporate guarantors.

The NCLAT was hearing the appeal preferred by one of the shareholders against the order of the National Company Law Tribunal, New Delhi, initiating CIRP against the corporate guarantors.

The CIRP proceedings were initiated as the principal debtor, being a society, was not amenable to the insolvency proceedings under the code.

Moreover, two separate insolvency applications were filed by the creditor and admitted simultaneously against the two corporate guarantors for the same claim amount and default.

The NCLAT held that the liability of the corporate guarantors is coextensive with the principal debtor, and consequently there is no requirement under the code to exhaust the remedies against the principal debtor before initiating proceedings against the corporate guarantors, as laid down by the Supreme Court in the case of Bank of Bihar v Damodar Prasad and Anr (1969) and State Bank of India v Indexport Registered and Ors(1992).

Further, it held that once, for the same set of claims, an application under section 7 filed by the financial creditor is admitted against one of the corporate debtors (principal borrower or corporate guarantors, the financial creditor cannot subsequently initiate a CIRP against the other corporate debtor (the corporate guarantors or the principal borrower) for the same set of claims and default.

This case also follows the Supreme Court’s judgment in the case of State Bank of India v V Ramakrishnan (applicability of moratorium to the corporate guarantors), denying the corporate guarantors the option of insulating themselves from the recovery proceedings as against the default by the principal borrowers or debtors.

By upholding the principles of law of guarantee to insolvency applications made under the code, the above ruling once again provides an insight into the principles of interpretation of the provisions of the code in consonance with the provisions of the Indian Contract Act, 1872 (act).

However, the tribunal did not deal with situations where the creditor may choose to claim only a part of the debt from one of the corporate guarantors. This question is still open to interpretation. In this regard, it may be pertinent to consider sections 146 and 147 of the act, which provides for the limit of liability of the guarantors in accordance with the contract of guarantee. Hence, the validity of applications filed simultaneously in such situations remain a contentious issue.

The above ruling is in contrast with an earlier order of the NCLAT in the case of Export Import Bank of India v CHL Limited. In this case, the tribunal held that where the reconciliation of the claim amount is pending with the principal borrower, the creditor cannot proceed to issue proceedings against corporate guarantors.

Only when the principal borrower fails to pay the reconciled amount, would the creditor be entitled to invoke the corporate guarantee against the corporate guarantors. The connected question, however, is if there are reconciliation issues pending in relation to the claim amount, would the same qualify as a dispute under the code?

The ruling in the CHL Limited case can be distinguished from the Vishnu Agarwal case judgment in as much as the amount claimed was not settled with the principal borrower, and the reconciliation of the interest was pending.

However, leaving aside the distinction in the factual matrix it will be interesting to see how these two conflicting judgments will be applied in the future. At the time of publication, the Vishnu Agarwal judgment has been appealed in the Supreme Court and is pending admission. Hence, it would be relevant to see the Supreme Court’s view on this.