Section 31 of the Insolvency and Bankruptcy Code, 2016 (Code) provides that a resolution plan, once approved by the Adjudicating Authority, is binding on all stakeholders including the creditors and surety/guarantors of the Corporate Debtor (CD), and extinguishes all accrued liabilities of the CD except as provided under the approved plan. While the liability of a guarantor is co-extensive with the liability of the principal debtor as per Section 128 of the Indian Contract Act, 1872 (Contract Act), the Code specically provides for the initiation of insolvency proceedings against both personal and corporate guarantors of the CD along with the Corporate Insolvency Resolution Process (CIRP) of the CD. This note discusses whether the liability of a guarantor of a debt of the CD stands extinguished/discharged or reduced upon approval of the resolution plan under the Code.
Some of the pertinent provisions of the Contract Act that have a bearing on the debate on the liability of a guarantor are as follows:
- Section 128: The creditor has remedies available to recover the amount payable by the principal debtor by proceeding against both or any of them.
- Section 137: Unless there is a contract to the contrary, the surety will not be discharged merely because the creditor forbears/omits to enforce any remedy against the principal debtor. Thus, the creditor can initiate recovery proceedings against the surety in respect of the debt without seeking to recover the debt against the principal debtor.
- Section 133: Upon a variance made in the terms of the contract between the principal debtor and the creditor without the surety's consent, a surety can be discharged to the extent of the transactions subsequent to such variance.
- Section 134: Surety's liability extinguishes upon the discharge of the principal debtor either by way of a contract between the creditor and the principal debtor, or by any act or omission by the creditor having the legal consequence of discharging the principal debtor.
- Section 135: If the creditor agrees to give time or not sue the principal debtor without the assent of the surety, the surety stands discharged.
- Section 140 (places the surety in the creditor's position): Where the principal debt has become due, the surety, upon fulfilling its liability, acquires all the rights that the creditor had against the principal debtor. This is called the right of subrogation and is limited to the extent of the payment made by the guarantor.1
At first glance, the aforementioned provisions suggest that a guarantor's liability towards the principal debtor (CD) would be discharged upon the approval of the resolution plan, after which the CD is absolved of all liabilities except those crystallised in the plan. However, judicial discourse on this matter presents a different perspective:
- November 13, 2019
Gouri Shankar Jain v. Punjab National Bank2
The Petitioner, a surety to the CD, was served with a notice under the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002, (SARFAESI Act) in respect of the principal debt, after approval of the resolution against the CD. The Calcutta High Court held that the Code does not allow personal guarantors to escape their liability as the exercise of the statutory right to initiate insolvency is independent of the contractual obligations inter se the creditor, the principal debtor and the surety, which cannot be said to have rescinded, novated, frustrated, modified, altered or affected in any manner upon the initiation of CIRP. This is why the moratorium under Section 14 of the Code does not apply to guarantors. The resolution plan, which may provide for partial or complete repayment of the debt, is not a voluntary agreement under Section 134 of the Contract Act that discharges the liability of the CD. Even in case of partial repayment under the approved plan, the creditor's right to fully enforce the guaranteed amount does not get reduced.
- May 21, 2021
Lalit Kumar Jain v. Union of India3
The Supreme Court was adjudicating the validity of the Central Government's notification bringing into force Part III of the Code (relating to personal insolvency) only in respect of guarantors of the CD. The Court held that the approval of a resolution plan and the finality accorded to it under Section 31 of the Code does not per se operate as a discharge of the guarantor's liability, as the discharge of a principal borrower by an involuntary process, i.e. approval of a resolution plan, does not discharge the guarantor of its liability, which arises out of an independent contract. Accordingly, a personal guarantor would continue to be liable for the balance amount even after approval of a resolution plan of the principal debtor (CD).
- August 21, 2023
SVA Family Welfare Trust v. Ujaas Energy Ltd4
The National Company Law Appellate Tribunal (NCLAT) was adjudicating the validity of a resolution plan extinguishing the liability of the CD's guarantors, i.e. extinguishment of the creditor's right to proceed against the personal guarantor of the CD. The plan provided for release of the guarantees on payment of INR 24 crore. The NCLAT clarified that the Supreme Court's decision in Lalit Kumar cannot be read to mean that personal guarantee can never be discharged under a resolution plan. Noting that the Committee of Creditors (CoC) had deliberated on the clause providing for relinquishment of the creditor's security interest (personal guarantee), the NCLAT upheld the power of the CoC, in exercise of its commercial wisdom, to address the security interests (including personal guarantees) of creditors, including dissenting financial creditors in a resolution plan.
- December 7, 2023
Roshan Lal Mittal v. Rishabh Jain5
In a challenge to a resolution plan by which the resolution applicant, taking over the CD's ongoing projects, had committed to undertaking the liability towards only a limited share of the bank guarantee (if invoked), the NCLAT dismissed the challenge and held that the approval of the resolution plan does not ipso facto absolve guarantors from their guarantee.
An analysis of the above judgments underlines the fact that Courts have consistently upheld the creditor's right to pursue guarantors independently, even when the CD's obligations are reduced or extinguished, leading to the conclusion that guarantors – both corporate and personal – cannot assume automatic discharge from liability upon the approval of a resolution plan. However, as recent rulings suggest, guarantees can be discharged if expressly provided for in the resolution plan and approved by the CoC.
While the recent developments are consistent with the Court's long-standing views on upholding the commercial wisdom of the CoC, they highlight the importance of carefully negotiating and structuring guarantees to avoid unforeseen liabilities for all stakeholders. Proactive financial risk management, including structuring guarantees with precise terms and exploring legal safeguards, is essential for guarantors to protect their financial position and avoid unintended exposure even after the CD's resolution.
Footnotes
1 BRS Investments Ltd v. SREI Equipment Finance Ltd, 2024 SCC Online SC 1767
2 AIR 2020 Cal 90
3 (2021) 9 SCC 321
4 2023 SCC Online NCLAT 518
5 2023 SCC Online NCLAT 2398
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