In a contract of guarantee, a guarantor undertakes to perform the contractual obligations on behalf of or towards discharge of the liability of the principal debtor ("PD") towards a creditor, in the event that such PD has defaulted in performing its contractual obligation or discharging its liability. The guarantor has certain rights under the Indian Contract Act, 1872 ("Contract Act"), such as the right to be discharged of its liability under the guarantee in case of a corresponding discharge of the PD, and the right to subrogation against the PD once the guarantor has paid debts on the PD's behalf.
However, these rights of the guarantor do not find favour under the Insolvency and Bankruptcy Code, 2016 ("IBC"). This piece will discuss the position of a guarantor under the IBC in light of the cardinal principles of the law of guarantee and the several court rulings in India and also attempt to explain the ramifications of these decisions on the rights of a guarantor under the IBC.
II. Right of creditor to proceed against both the PD and the guarantor
Section 128 of the Contract Act provides that, unless otherwise provided by the terms of the contract of guarantee, the liability of the guarantor is co-extensive with the liability of the PD.1 Further, Section 137 of the Contract Act stipulates that mere forbearance on part of the creditor to sue the PD or to enforce any remedy against the PD, does not discharge the guarantor. Both the PD and the guarantor are liable at the same time to the creditors, and the creditor has the right to proceed against both the PD and the guarantor for repayment of the debt amount.2 The creditor need not exhaust its remedy against the PD before suing the guarantor.3
The right of a creditor to sue both the PD and the guarantor is also enshrined under the IBC. Section 14(3)(b) of the IBC provides that an order of moratorium against the corporate debtor will not apply to a guarantor in a contract of guarantee to the corporate debtor.4 The intent of this provision is to differentiate the assets of the corporate debtor from the assets of the guarantor, and to provide the creditors with an alternative to recover the debt in case the corporate debtor fails to repay, as would be the case when the corporate debtor is undergoing corporate insolvency resolution process ("CIRP").
Furthermore, Sections 60(2) and 60(3) of the IBC provide that if the CIRP of a corporate debtor is pending before the National Company Law Tribunal ("NCLT"), any application pertaining to the CIRP, liquidation or bankruptcy of a guarantor of such corporate debtor is liable to be filed before/transferred to the same NCLT.
The Supreme Court of India ("Supreme Court") has explained in State Bank of India v. V. Ramakrishnan and Others5 ("Ramakrishnan") that in a contract of guarantee, a creditor can proceed against the assets of either the corporate debtor, or the guarantor, or both, in no particular sequence, and therefore, any moratorium which bars legal proceedings against the corporate debtor would not restrict a creditor from proceeding against the guarantor.
Recently, the Delhi High Court in Kiran Gupta v. State Bank of India and Another6 has held that the liability of the corporate debtor and the guarantor remains co-extensive, and that the creditor is well-entitled to initiate proceedings against the guarantor under the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 during the continuation of CIRP against the corporate debtor.
In Dr. Vishnu Kumar Agarwal v. Piramal Enterprises Ltd,7 ("Piramal") the National Company Law Appellate Tribunal ("NCLAT") held that there was no restriction on a creditor against the filing of simultaneous applications under Section 7 of the IBC (Initiation of corporate insolvency resolution process by financial creditor) against both the corporate debtor and the guarantor. However, the NCLAT applied a caveat to this rule, by stating that once an application under Section 7 of the IBC filed by the creditor is admitted against either the corporate debtor or the guarantor, then another application by the creditor for the same set of claims against either the corporate debtor or the guarantor could not be admitted. In other words, if, for instance, an application filed under Section 7 of the IBC has been admitted as against the guarantor, then another application for the same debt cannot be admitted against the corporate debtor, and vice versa. This decision of the NCLAT is pending in appeal before the Supreme Court.
However, recently in State Bank of India v. Athena Energy Ventures Private Limited,8 ("Athena") the NCLAT has indicated that the judgment in Piramal is per incuriam, as the judgment failed to pay attention to Sections 60(2) and 60(3) of the IBC, which clearly envisage simultaneous CIRP proceedings against both the corporate debtor and the guarantor by the creditors. Further, the NCLAT in Athena, relying on Ramakrishnan, held that simultaneous remedy was central to a contract of guarantee, and thus a creditor can file claims in the CIRP of both the corporate debtor and the guarantor at the same time. It is to be noted that the decisions of Piramal and Athena were both passed by benches of equal strength of the NCLAT.
It is also pertinent to note that the Insolvency Law Committee in its 2020 report has suggested that in cases where both the PD and the guarantor are undergoing CIRP, the creditor should be allowed to file claims in the CIRP of both the PD as well as the guarantor.9
In the United Kingdom ("UK"), the principles governing a creditor's right to proceed against both the corporate debtor and the guarantor in case of the corporate debtor's insolvency is encapsulated in the UK Supreme Court decision of In the matter of Kaupthing Singer and Friedlander Limited (in administration).10 In this case, it was held that there was a rule of double proof against the creditor, wherein a creditor can file a proof of claim in the insolvency of both the corporate debtor and the guarantor, but the creditor cannot cumulatively recover an amount more than the original debt owed to it. It was also held that the guarantor cannot enforce his right to indemnity against the corporate debtor in the latter's insolvency until the guarantor has satisfied the creditor's debt in full.
III. Guarantors bound by the resolution plan passed with regard to the corporate debtor
Section 133 of the Contract Act provides that any variance made in the terms of the contract between the PD and the creditor, without the guarantor's consent would discharge the latter. A guarantor is also discharged of its obligations under a contract of guarantee if: (a) consequent to a contract between the PD and the creditor, the PD itself stands discharged;11 or (b) the PD and the creditor enter into a compromise or composition for extending time to the PD or for not suing the PD (without the guarantor's assent).12 Since the liabilities of the PD and guarantor are co-extensive, it only stands to make sense that any partial or complete discharge of the PD must necessarily result in the discharge of the guarantor to the same extent.13
However, the same is not true in case of the 'haircuts' that a corporate debtor receives in its debts in a resolution plan. Section 31(1) of the IBC provides that a resolution plan approved by the NCLT shall be binding inter-alia on the corporate debtor as well as its guarantors. The Calcutta High Court ("CHC") in Gouri Shankar Jain v. Punjab National Bank and Others14 has further clarified that the resolution plan of a corporate debtor, which reduces the liability of the corporate debtor, does not in any way alter the right of a creditor to claim the remaining amount from the guarantor. The CHC relied on the Supreme Court judgment of Maharashtra State Electricity Board v. Official Liquidator,15 wherein it was held that the discharge of the principal debtor by operation of law does not operate as the discharge of the sureties. The CHC thus held that the discharge of the liabilities of a corporate debtor under a resolution plan, being through operation of law, will not discharge the guarantor of its liability to the creditors.
In Ramakrishnan, the Supreme Court had also observed that if the resolution plan of the corporate debtor provides for payments to be made by the guarantor, the guarantor cannot escape such liability. It was further held that Section 133 of the Contract Act will not come to the rescue of the guarantor in this regard.
Similarly, it has been observed by the NCLT, Mumbai bench in IDBI Bank Ltd. v. EPC Constructions India Limited,16 ("EPC Constructions") that the very purpose of the contract of guarantee is the recovery of that amount from the guarantor which the corporate debtor is unable to repay, and thus, when a resolution plan only provides for part payment to a creditor, the statutory right of the creditor would be defeated if it cannot recover the remaining amount from the guarantor. However, EPC Constructions also observed that the guarantors would not be liable to pay the debts of the corporate debtor unless and until the resolution plan expressly provided that the guarantees would continue even after the approval of the resolution plan.
IV. Guarantor's right to subrogation
The guarantor, upon performing the obligations on behalf of the PD, steps into the shoes of the creditor and is invested with all the rights that the creditor possessed as against the PD.17 This right of subrogation is founded on the equitable principle that the guarantor should be indemnified.18 There is an implied promise, in every contract of guarantee, by the PD to indemnify the guarantor for any sum rightfully paid by the latter under the guarantee.19 However, under the IBC, the guarantor does not possess this right to proceed against the corporate debtor once the guarantor has paid the corporate debtor's debts to the creditors.
In Lalit Mishra and Others v. Sharon Bio Medicine Ltd. And Others,20 ("Lalit Mishra") the NCLAT held that any right available to the guarantor under the law of contract will not be applicable in the case of an approved resolution plan, as proceedings under the IBC are not recovery proceedings. The NCLAT also observed that it was not the intention of the legislature to benefit guarantors by excluding the exercise of legal remedies available in law by the creditors for the recovery of legitimate dues by enforcing the guarantees. The NCLAT in Lalit Mishra further held that the object of the IBC was the maximization of the assets of the corporate debtor.
It has also been observed in EPC Constructions that if the guarantor is allowed to recover the debt paid to the creditors post-CIRP from the corporate debtor, it would in turn mean that the resolution applicant, who has now stepped into the shoes of the corporate debtor, would end up paying the original amount of debt that was owed, nullifying the 'haircuts' it received in the resolution plan and thereby defeating the object of the IBC.
This stand has also found favour in Committee of Creditors of Essar Steel India Limited v. Satish Kumar Gupta and Others,21 wherein the Supreme Court, relying on Ramakrishnan, held that a resolution plan, which states that the claims of the guarantor on account of subrogation shall be extinguished, is valid.
V. Effect on the guarantor
It is evident from the aforementioned authorities, that under the scheme of the IBC, a guarantor is caught in a catch-22 situation. Neither does the discharge of the corporate debtor as a result of the resolution plan discharge the guarantor, nor does the guarantor have the right to recover the amounts paid to the creditors from the corporate debtor. This is in direct contravention with the guarantor's subrogation and indemnification rights under Sections 140 and 145 of the Contract Act.
The courts have adopted a contradictory approach towards the law of guarantee. On one hand, the courts have relied on the fundamental principle of the contract of guarantee to ensure that the creditors, notwithstanding the resolution plan, can claim the remaining amount of debt from the guarantors. On the other hand, the rights of subrogation and indemnity, which also emanate from the law of guarantee, are being denied to the creditor.
This approach can be justified by appreciating that the underlying object of law of guarantee is securing the interests of the creditor. The Supreme Court of Canada in Kuproski v. Royal Bank of Canada has observed that the possibility of loss through the bankruptcy of the principal debtor is precisely one of the contingencies against which the contract of guarantee is meant to provide.22 Such a construction would put the rights of the creditor in a contract of guarantee on a higher pedestal as compared to the rights of the guarantor.
Another possible way to justify this inconsistency is to refer to the non-obstante clause of the IBC, which provides that the provisions of the IBC shall have effect, notwithstanding anything inconsistent contained in any other law.23 Thus, even if the guarantor is being deprived of its statutory rights under the Contract Act, the provisions of the IBC will take precedence over the provisions of the Contract Act on account of the IBC being a special law.24
Despite the aforesaid, the authors opine that the detrimental effect of such an approach cannot be underestimated. The guarantor has a right under the law of equity to recover the amount of money paid on behalf of the PD. The authors believe that in the absence of this right, guarantors would be discouraged from providing guarantees for the debts of any PD, fearing that in the event of insolvency of the PD, the guarantor would stand to be at a loss with no recourse under the law against the PD. In the authors' opinion, such a situation may have a negative impact on the availability of credit.
However, it is also pertinent to note that in many instances, guarantees are given by parties related to the corporate debtors, such as a holding company, an associate company, promoters, etc. In Lalit Mishra, the impugned resolution plan was challenged on the basis that it mentioned that the personal guarantees given by the existing promoters of the corporate debtor would not result in any liability towards the resolution applicant. The NCLAT held that such a provision in the resolution plan was valid, as the IBC prohibits the promoters of the corporate debtor from benefitting from the CIRP. The NCLAT observed that the promoters are responsible for having contributed to the insolvency of the corporate debtor, and therefore cannot be allowed to reward themselves at the expense of creditors.
1. Om Parkash Laceria v. Punjab National Bank, 2017 SCC OnLine HP 1523.
2. Industrial Investment Bank of India Ltd. v. Biswanath Jhunjhunwala, (2009) 9 SCC 478.
3. Bank of Bihar Ltd. v. Damodar Prasad & Another, (1969) 1 SCR 620.
4. Insolvency and Bankruptcy Code, 2016, §14(3)(b).
5. AIR 2018 SC 3876.
6. W.P. (C) 7230/2020 and C.M. Appl. 24414/2020.
7.  149 CLA 30.
8. Company Appeal (AT) (Ins) No.633 of 2020.
9. REPORT OF THE INSOLVENCY LAW COMMITTEE, FEBRUARY 2020, Ministry of Corporate Affairs, Government of India.
10. (2011) UKSC 48.
11. The Indian Contract Act, 1872, §134.
12. The Indian Contract Act, 1872, §135.
13. Subramania Chettiar v. M.P. Narayanaswami Gounder, AIR 1951 Mad 48.
14. AIR 2020 Cal 90.
15. AIR 1982 SC 1497.
16. MA 2738/2019 & MA 354/2019 in CP No.1832/IBC/NCLT/MB/MAH/2017.
17. The Indian Contract Act, 1872, §140.
18. Duncan Fox & Co. v. North and South Wales Bank, (1980) 6 AC 1.
19. The Indian Contract Act, 1872, §145.
20.  148 CLA 154.
21. 2019 (16) SC ALE 319.
22. Kuproski v. Royal Bank of Canada,  SCR 532.
23. Insolvency and Bankruptcy Code, 2016, §238.
24. See Gujarat Urja Vikash Nigam Ltd v. Essar Power Ltd, AIR 2008 SC 1921: "It is well settled that the special law overrides the general law."
Originally published 7 January 2021
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