India: Invocation Of Corporate Guarantee During Moratorium - Analysis

To punish the defaulters, India had numerous Acts in place like the Indian Contract Act,1872, the Recovery of Debts Due to Banks and Financial Institution Act 1993, the Securitizations and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 and the Sick Industrial Companies (Special Provisions) Act, 1985 (SICA). The Government supplanted the existing insolvency laws with the Insolvency & Bankruptcy Code, 2016, which takes care of the existing defaulters in a time constrained manner. The provisions of the Code are applicable to companies, limited liability entities, firms and individuals (i.e. all entities other than financial service providers).

One of the most significant features of the Code is the grant of moratorium, during which creditors' actions is be stayed. The moratorium is not automatic and is granted by the Adjudicating Authority u/s 14 of the Code. The Invocation of Corporate Guarantee during Moratorium remains a big question before the Judicial and Quasi-Judicial Authorities.

Banks in India have conventionally placed tremendous confidence on promoters and personal guarantees provided by them and the majority of promoters also always on the brink of extending guarantees as long as banks keep sanctioning more and more loans, aggregating to several times over the net worth of the guarantor. The Hon'ble NCLT, in Axis Bank Limited v. Edu Smart Services Limited, upheld that the invocation of corporate guarantee during the moratorium period was bad in law and rejected the plea of Axis Bank Limited, the financial creditor who filed its claim with the resolution professional appointed for the principal debtor as well as the guarantor. Reference is drawn to the pronouncement made by NCLAT in the case of Indian Overseas Bank (IOB) against Amtek Auto's IRP Dinnkar T. Venkatsubramaniam, where it was held that once moratorium is declared, financial institutions have to act "on the instructions of IRP" with respect to the corporate debtor's account. The Adjudicating Authority observed that corporate guarantees could not be invoked as the same would violate the moratorium provided to a company undergoing insolvency resolution and cannot take any action without the approval of resolution professional once Section 14 of the Code comes into play. The Hon'ble NCLT, Chennai Bench in the case of V Ramakrishnan V. Veesons Energy Systems Private Ltd and others ruled that financial creditor could not proceed against the corporate guarantor as allowing invocation of the corporate guarantor would mean that the interest would be shifted to the guarantor which would violate Section 14 (1) of the IBC,2016.

Once a case of insolvency is admitted by the NCLT, the Insolvency and Bankruptcy Code, 2016 provides a firm 180 days to restructure itself. It also imposes a moratorium on anybody claiming dues from the firm during this period. The basic idea behind the Corporate Insolvency Resolution Process is to restructure the firm; not to throw it into liquidation process. The invocation of guarantee during moratorium against the 'Company under Insolvency Proceedings' at a stage where Resolution Plan has to be executed is violating the basic idea of Resolution process.

In a situation where a creditor decides to continue/ initiate proceedings against a guarantor of a Corporate Debtor during the pendency of the CIRP, the creditor may well be able to satisfy its outstanding debts through the assets of the guarantor. However, this will alter the financial position of the Corporate Debtor after the declaration of the moratorium. This may effectively derail the CIRP and any resolution plan that the Committee of Creditors (COC) may be formulating, thereby defeating the scope and purpose of the Code.

It is notable here that the entire preamble of the Insolvency & Bankruptcy Code, 2016, relating to the revival and resolution of Corporate persons in a time bound manner is aimed for maximisation of value of assets keeping in view the interest of stakeholders. Further, the entire Chapter II of the Code relating to the CIRP is for the resolution of the 'Company under Insolvency Proceedings'. Therefore, the first endeavour of the Adjudicating Authority under the Code is resolution and rehabilitation of the corporate debtor and for the said purpose the IRP/RP is duly appointed.

CONCLUSION

The invocation of guarantee during moratorium against the 'Company under Insolvency Proceedings' is not only contrary to provision of the IBC Code but is also directly against the interest of the company and its stakeholders. The IBC code is exhaustive and promotes simultaneous insolvency proceedings against the principal debtors and guarantors. The recent judgments by several NCLTs and the High Courts have created confusion in the financial sector regarding the working of corporate guarantees under the code and this may adversely affect the finance sector. Therefore the IBBI should come up with clarifications on this cardinal issue.

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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