In a recent judgment delivered by the Supreme Court of India ("Court") in Laxmi Pat Surana vs. Union Bank of India & Anr.1, the Court has held that the principal borrower need not be a 'corporate person' for insolvency process to be initiated against a company which stood as its guarantor, under the Insolvency and Bankruptcy Code, 2016 ("IBC").
Brief Facts of the Case
In the present case, the financial creditor being the bank, had extended credit facility to the principal borrower i.e. M/s Mahaveer Construction, a proprietary firm, through two loan agreements in the years 2007 and 2008 for a term loan of Rupees Nine Crore approx. and an additional amount of Rupees Two Crore approx. The corporate guarantor i.e. M/s. Surana Metals Limited had offered guarantee to the two loan accounts of the principal borrower. The stated loan accounts were declared a Non-Performing Asset ("NPA") in the year 2010. The bank then issued a recall notice in the year 2010 to the principal borrower, as well as, the corporate debtor, demanding repayment of the outstanding amount. During the pendency of the action initiated by the bank against the principal borrower before the Debt Recovery Tribunal, Kolkata, the bank wrote to the corporate guarantor/debtor on 3rd December, 2018 in the form of a purported notice of payment under the IBC. The corporate guarantor/debtor replied to the notice of demand vide a letter dated 8th December, 2018, inter alia, clarifying that it was not the principal borrower nor owed any financial debt to the bank and had not committed any default in repayment of the outstanding amount. The bank then proceeded to file an application under Section 7 of the IBC on 13th February, 2019 for initiating Corporate Insolvency Resolution Proceeding ("CIRP") against the corporate guarantor/debtor before the National Company Law Tribunal ("NCLT"), Kolkata. This application came to be resisted on diverse counts and in particular, on the preliminary ground that it was not maintainable because the principal borrower was not a 'corporate person'; and further, it was barred by limitation, as the date of default was 1st January, 2010, whereas, the application had been filed on 13th February, 2019 i.e., beyond the period of three years. The NCLT held that the action had been initiated against the corporate guarantor, being coextensively liable to repay the debt of the principal borrower and having failed to do so despite the recall notice, became the corporate debtor and thus liable to be proceeded with under Section 7 of the IBC.
Issue before the Supreme Court
- Whether an action under Section 7 of the IBC can be initiated by the financial creditor against a corporate person (being a corporate debtor) concerning guarantee offered by it in respect of a loan account of the principal borrower, who had committed default and is not a 'corporate person'?
- Whether an application under Section 7 of the IBC filed after three years from the date of declaration of the loan amount as a NPA, being the date of default, is not barred by limitation?
Analysis & Reasoning
The Court's observations on maintainability of action under Section 7 of the IBC:
- The Court observes that Section 7 is an enabling provision, which permits the financial creditor to initiate CIRP against a corporate debtor which can be the principal borrower, or a corporate person assuming the status of corporate debtor having offered guarantee, if and when the principal borrower/debtor (be it a corporate person or otherwise) commits default in payment of its debt.
- A right or cause of action would enure to the financial creditor to proceed against the principal borrower, as well as to proceed against the guarantor in equal measure in case they commit default in repayment of the amount of debt acting jointly and severally. The Court clarifies that it would still be a case of default committed by the guarantor itself, if and when the principal borrower fails to discharge its obligation in respect of the amount of debt. Thus, the obligation of the guarantor is coextensive and coterminous with that of the principal borrower to defray the debt, as predicated in Section 128 of the Contract Act, 1872. As a consequence of such default, the status of the guarantor metamorphoses into a debtor or a corporate debtor if it happens to be a corporate person, within the definition of 'corporate debtor' under the IBC.
- The principal borrower may or may not be a 'corporate person', if a corporate person extends guarantee for the loan transaction concerning a principal borrower not being a corporate person, it would still be covered within the meaning of expression 'corporate debtor' under the IBC.
- The Court states that there is no reason to limit the width of Section 7 of the IBC despite law permitting initiation of CIRP against the corporate debtor, if and when default is committed by the principal borrower. The liability and obligation of the guarantor to pay the outstanding dues would get triggered coextensively.
- Further, while discussing the remedy under Section 7, the Court states that such remedy is not for recovery of the amount, but is for reorganisation and insolvency resolution of the corporate debtor who is not in a position to pay its debt and commits default in that regard. It is open to the corporate debtor to pay off the debt, which had become due and payable and is not paid by the principal borrower, to avoid the rigours of Chapter II of the IBC in general and Section 7 in particular.
The Court's observations on maintainability of action under Section 7 of the IBC on the ground of being barred by limitation:
- The Court observes that the principal borrower as well as the corporate guarantor/debtor had acknowledged the debt time and again after 30th January, 2010 and lastly on 8th December, 2018, which was the basis of filing of the application under Section 7 of the IBC on 13th February, 2019.
- Ordinarily, upon declaration of the loan account/debt as an NPA that date can be reckoned as the date of default to enable the financial creditor to initiate action under Section 7 of the IBC. However, the Court highlights that Section 7 comes into play when the corporate debtor commits 'default'. Section 7 consciously uses the expression 'default' and not the date of notifying the loan account of the corporate person as an NPA. In cases where the corporate person had offered guarantee in respect of a loan transaction, the right of the financial creditor to initiate action against such entity would get triggered the moment the principal borrower commits default due to non-payment of debt.
- Thus, when the principal borrower and/or the corporate guarantor admit and acknowledge their liability after declaration of NPA, but before the expiration of three years therefrom including the fresh period of limitation due to successive acknowledgments, the Court states that it is not possible to extricate them from the renewed limitation accruing due to the effect of Section 18 (effect of acknowledgement in writing) of the Limitation Act, 1963. Section 18 would come into play every time when the principal borrower and/or the corporate guarantor, as the case may be, acknowledge their liability to pay the debt. Such acknowledgment, however, must be before the expiration of the prescribed period of limitation including the fresh period of limitation due to acknowledgment of the debt, from time to time, for institution of the proceedings under Section 7 of the IBC.
- Further, the liability of the corporate guarantor also gets triggered when the principal borrower acknowledges its liability in writing within the expiration of the prescribed period of limitation to pay such outstanding dues and fails to pay the acknowledged debt. The right to initiate action within three years from such acknowledgment of debt accrues to the financial creditor. This right, however, needs to be exercised within three years of when the right to sue/apply accrues in accordance with Article 137 of the Limitation Act. The financial creditor has not only the right to recover the outstanding dues by filing a suit, but also has a right to initiate resolution process against the corporate person (being a corporate debtor) whose liability is coextensive with that of the principal borrower and more so when it activates from the written acknowledgment of liability and failure of both parties to discharge that liability.
1 Civil Appeal No. 2734 OF 2020
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.