India: NCLT Allows Simultaneous Proceedings Against Principal Borrower And Guarantor By Financial Creditors

Last Updated: 1 March 2018
Article by Trilegal .

In a first of a kind judgment, NCLT, Delhi ruled that a financial creditor may proceed against the debtor and the guarantor simultaneously, and be a part of both their Committee of Creditors. The NCLT relied on the principles of contract law and the intent behind the Insolvency and Bankruptcy Code, 2016 to reach this conclusion.

Introduction

It is a well-settled position of law that the liability of a principal borrower and guarantor is co-extensive under section 128 of the Contract Act, 1872 (Contract Act). A creditor can proceed against the borrower as well as the guarantor to recover its money, without any requirement to first exhaust all remedies against the borrower. The Indian courts have also endorsed that a creditor may proceed against the debtor and the guarantor simultaneously, provided that the creditor does not unjustly enrich himself by doing so.

The issue of simultaneous liability recently arose before the NCLT, Delhi Bench under the Insolvency and Bankruptcy Code, 2016 (Insolvency Code). Extending the principle of simultaneous liability under the Contract Act to the Insolvency Code, the NCLT allowed ICICI Bank Limited (ICICI) to become a member of the Committee of Creditors (CoC) of both, the principal borrower and the guarantor.

Facts

ICICI had advanced a loan of INR 76 crores to Educomp Solutions Limited (ESL) by way of a credit facility agreement. A corporate guarantee for this loan was executed by one of ESL's group companies, Edusmart Services Private Limited (ESPL). ESL defaulted in payment of the loan and thereafter initiated a suo moto corporate insolvency resolution process (CIRP) under section 10 of the Insolvency Code. Subsequently, ICICI filed its claim with the Interim Resolution Professional (IRP) appointed for ESL and was admitted into the CoC constituted for ESL (the principal borrower).

ICICI also simultaneously invoked the guarantee provided by ESPL (the guarantor) for the ESL loan and filed its claim with the IRP appointed for ESPL (under a CIRP initiated by another lender against ESPL), seeking admission into the CoC as well as voting rights in proportion of its claim. ICICI submitted that it intended to jointly recover only the loan amount from both the entities. ESPL's IRP rejected this request on the ground that ICICI was already a member of ESL's CoC and if it was admitted into ESPL's CoC as well, that would lead to an anomalous situation and give an unjust advantage to ICICI.

ICICI challenged the decision of ESPL's IRP before NCLT, Delhi and contended that being a financial creditor under the Insolvency Code, and in view of the co-extensive and simultaneous liability of the principal borrower and guarantor under the Contract Act, ICICI was entitled to be a member of and attain voting rights in both CoCs simultaneously. Arguing against simultaneous liability, ESPL's IRP further contended that since ICICI's claim was already pending in the CoC constituted for ESL, its liability against ESPL was not ascertainable.

NCLT Ruling

The NCLT, by its order dated 23 January 2018, allowed ICICI's application enabling it to simultaneously pursue its claims against both the principal borrower and guarantor and obtain voting rights equivalent to its claim in both the CoCs.

The NCLT analysed the definition of 'financial debt' and 'financial creditor' under the Insolvency Code and concluded that ICICI is a financial creditor for both ESL and ESPL, and the existence of debt is not under dispute.

Regarding the question of simultaneous liability of the principal borrower and guarantor, the NCLT read section 128 of the Contract Act together with the terms of the corporate guarantee executed by ESPL, and concluded that insolvency proceedings of the principal borrower do not absolve the liability of the guarantor.

Conclusion

NCLT's attempt to put to rest the controversy on financial creditors being simultaneous members of CoCs of both the principal borrower and guarantor is a positive development for banks and financial institutions that are struggling to recover their dues from defaulting borrowers and guarantors.

However, a question of law that remains unclear is that if a financial creditor's claim is partly settled in the CoC of the principal borrower, will it amount to a release of the guarantor from its liability towards the remainder of the debt, or not. The Contract Act clearly provides that the release of a principal borrower by settlement of debt or material variation of the original contract would discharge the guarantor, unless there is a contractual term with the guarantor to the contrary. However, at the same time, it is an established principle that the discharge of a borrower by operation of law does not amount to discharge of the surety.

Therefore, in the context of the Insolvency Code, the question that remains to be settled is whether discharge of the principal borrower by a resolution plan will amount to discharge by operation of law or not and consequently, will the liability of the guarantor continue or not. Notwithstanding the grey area of law, the judgment discussed above is a step in the right direction to allow lenders to recover, from creditors, the maximum amount of the debt possible.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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