The Supreme Court (“SC”) has in its judgment dated March 26, 2021, in the matter of Laxmi Pat Surana v. Union Bank of India and Another [Civil Appeal No. 2734 of 2020], held that a principal borrower need not be a ‘corporate person’ where insolvency proceedings are initiated against a company which acted as the corporate guarantor of the principal borrower.

Facts

The Union Bank of India (“Respondent”) had extended credit facilities to M/s. Mahaveer Construction (“Principal Borrower”), a proprietary firm belonging to Mr. Laxmi Pat Surana (“Appellant”), through two loan agreements entered into in the years 2007 and 2008 for term loans of INR 9.6 crores and INR 2.45 crores respectively.

M/s. Surana Metals Limited (“Corporate Debtor”), of which the Appellant was a Promoter/Director, had issued guarantees with respect to the aforementioned loan facilities of the Principal Borrower. Subsequently, on January 30, 2010, the said loan accounts were declared as being non-performing assets (“NPA”). Consequent to this, the Respondent issued a recall notice to the Principal Borrower on February 19, 2010, as well as the Corporate Debtor demanding repayment of the outstanding loan amount of INR 12,35,11,548/-. The Respondent also filed an application under Section 19 of the Recovery of Debts Due to Banks and Financial Institutions Act, 1993 (“RDB”), against the Principal Borrower before the Debt Recovery Tribunal at Kolkata.

During the pendency of the above, the Principal Borrower repeatedly assured the Respondent of payment of the outstanding amount, but failed to do so, consequent to which, the Respondent issued a notice of payment dated December 3, 2018, to the Corporate Debtor under Section 4(1) of the Insolvency and Bankruptcy Code, 2016 (“Code”). In reply to the said notice dated December 3, 2018, the Corporate Debtor addressed a letter dated December 8, 2018, to the Respondent stating that it was neither the Principal Borrower nor did it owe any financial debt to the Respondent nor had it committed any default in repayment of the stated outstanding amount.

Pursuant to the above, the Respondent proceeded to file an application under Section 7 of the Code on February 13, 2019, towards initiating corporate insolvency resolution proceedings against the Corporate Debtor before the National Company Law Tribunal, Kolkata (“Adjudicating Authority”). The said application was resisted by the Corporate Debtor on several counts including on the preliminary ground that it was not maintainable as the Principal Borrower was not a “corporate person”. This ground was however rejected by the Adjudicating Authority by its judgment and order dated December 6, 2019, where under it held that the aforesaid application under Section 7 of the Code had been initiated against the Corporate Debtor as it was coextensively liable to repay the debt of the Principal Borrower and upon it having failed to do so despite the recall notice, the Corporate Debtor became liable to be proceeded against under Section 7 of the Code. The Appellant thereafter preferred an appeal before the National Company Law Appellate Tribunal, New Delhi (“Appellate Tribunal”) which, by the impugned judgment and order dated March 19, 2020, dismissed the appeal and affirmed the conclusion reached by the Adjudicating Authority under its judgment and order dated December 6, 2019. Aggrieved by the above, the Appellant approached the SC in the present appeal.

Issue

• Whether insolvency process is maintainable against a corporate guarantor even if the principal borrower is not a ‘corporate person’.

Arguments

Contentions raised by the Appellant:

The Appellant, inter alia, contended that Section 7 of the Code plainly ordains that an application can be filed by a financial creditor only against the corporate debtor. A corporate debtor can either be a corporate person who had borrowed money or a corporate person, who gives guarantee regarding repayment of money borrowed by another corporate person. In other words, the Code cannot apply in respect of “debts” of an entity who is not a “corporate person”. The Appellant further contended that this position is further reinforced by the fact that initiation of insolvency of firms and/or individuals in terms of Part III of the Code has still not been notified. Also, Section 2 of the Code came to be amended to clarify that partnership firms and proprietorship firms would fall within Part III of the Code on the basis of the differentiation made in the report of the Insolvency Law Committee in February, 2020. It was argued by the Appellant that any other view would inevitably result in indirectly enforcing the Code even against entities, such as partnership firms and proprietorship firms and/or individuals, who are governed by Part III of the Code, without notification thereof. It was further argued by the Appellant that a corporate guarantee extended in respect of a loan given to a “corporate person”, comes within the purview of Part II of the Code. This was reinforced by the insertion of the definition of “corporate guarantor” in the Code by the Insolvency and Bankruptcy Code (Second Amendment) Act, 2018, which came into effect from June 6, 2018 (“Amendment Act”). The Appellant contended that since an application under Section 7 of the Code could not be maintained against the Principal Borrower itself, who was not a “corporate person”, it should follow that in respect of such transaction, no action under Section 7 of the Code could be maintained against a company or corporate person, merely because it had extended guarantee thereto.

Contentions raised by the Respondent:

The Respondent on the other hand contended that the liability of the Principal Borrower and of the Corporate Debtor was coextensive and coterminous, as predicated in Section 128 of the Indian Contract Act, 1872. Section 7 of the Code enabled the financial creditor to initiate corporate insolvency resolution process against a principal borrower if it was a corporate person, including against the corporate person being a guarantor in respect of loans obtained by an entity not being a corporate person. Aside from placing reliance on Section 7 of the Code, the Respondent also relied on the definitions of “corporate debtor” in Section 3(8), “debt” in Section 3(11), “financial creditor” in Section 5(7), and “financial debt” in Section 5(8) of the Code. The Respondent argued that upon conjoint reading of these provisions, it was crystal clear that a “financial debt” includes the amount of any liability in respect of any guarantee or indemnity for any money borrowed against interest. Consequently, the money borrowed by the sole proprietorship of the Appellant against payment of interest for which the Corporate Debtor stood guarantor, was also a “financial debt” of the Corporate Debtor and for that reason, the Respondent could proceed under Section 7 of the Code. It was further argued that the definition of “corporate guarantor” introduced by way of the Amendment Act was to define a corporate guarantor in relation to a corporate debtor against whom any corporate insolvency resolution process was to be initiated. The objection regarding maintainability of the application against a corporate guarantor was therefore devoid of merit.

Observations of the Supreme Court

The SC observed that Section 7 of the Code propounded the manner in which corporate insolvency resolution process may be initiated by the “financial creditor” against a “corporate person being the corporate debtor”. The expression “default” is expounded in Section 3(12) of the Code to mean non-payment of debt which had become due and payable and was not paid by the debtor or the corporate debtor, as the case may be. Section 7 of the Code is an enabling provision, which permits the financial creditor to initiate corporate insolvency resolution process against a corporate debtor. The corporate debtor could be the principal borrower and it could also be 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) committed default in payment of its debt.

The SC further observed that, the term “financial creditor” had been defined in Section 5(7) of the Code, which read with the expression “creditor” in Section 3(10) of the Code would include a person to whom a financial debt was owed and thereby comprise a person to whom such debt has been legally assigned or transferred to. This means that the applicant should be a person to whom a financial debt is owed. The SC noted that the expression “financial debt” has been defined in Section 5(8) of the Code. Amongst other categories specified therein, it could be a debt along with interest, which was disbursed against the consideration for the time value of money and would include the amount of any liability in respect of any of the guarantee or indemnity for any of the items referred to in sub clauses (a) to (h) of the same clause. It has been provided in sub clause (i) of Section 5(8) of the Code to take within its ambit a liability in relation to a guarantee offered by the corporate person as a result of the default committed by the principal borrower. Further, the expression “debt” has been defined separately in Section 3(11) of the Code to mean a liability or obligation in respect of “a claim” which is due from any person including a financial debt and operational debt. The SC also observed that the expression “claim” would certainly cover the right of the financial creditor to proceed against the corporate person being a guarantor, due to the default committed by the principal borrower. It noted that the expression “claim” has been defined in Section 3(6) of the Code, to mean a right to payment, whether or not such right is reduced to judgment, fixed, disputed, undisputed, legal, equitable, secured or unsecured. It also means a right to remedy for breach of contract under any law for the time being in force, if such breach gives rise to a right to payment in respect of specified matters. Undoubtedly, a right or cause of action would enable to the lender (financial creditor) to proceed against the principal borrower, as well as the guarantor, in equal measure in case they commit default in repayment of the amount of debt acting jointly and severally. The SC noted that it would still be a case of default committed by the guarantor itself, if and when the principal borrower fails to discharge his obligation in respect of the amount of debt.

The SC also observed that the obligation of the guarantor was coextensive and coterminous with that of the principal borrower to defray the debt, as laid down in Section 128 of the Indian Contract Act, 1872. As a consequence of such default, the status of the guarantor metamorphosed into a debtor or a corporate debtor, if it happened to be a corporate person. If the guarantor was a corporate person (as defined in Section 3(7) of the Code), it would come within the purview of the expression “corporate debtor”, within the meaning of Section 3(8) of the Code. Further, the generic provision contained in Section 3(37) of the Code postulates that the words and expressions used and not defined in the Code, but defined in enactments referred to therein, shall have the meanings respectively assigned to them in those acts. Drawing support from this provision, it would follow that the lender would be a financial creditor within the meaning of the Code. The SC further observed that the principal borrower may or may not be a corporate person, but 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 the expression “corporate debtor” under Section 3(8) of the Code. Thus, it was not possible to countenance the argument of the Appellant that as the Principal Borrower was not a corporate person, the Respondent could not have invoked the remedy under Section 7 of the Code against the Corporate Debtor who had merely offered guarantee for such loan account. The action could still be proceeded against the guarantor being a corporate debtor consequent to the default committed by the Principal Borrower.

The SC observed that Section 5(5A) of the Code, which defines the expression “corporate guarantor” to mean a corporate person, who is the surety in a contract of guarantee to a corporate debtor, was inserted by way of the Amendment Act to empower the national company law tribunals to deal with the insolvency resolution or liquidation processes of the corporate debtor and its corporate guarantor in the same tribunal pertaining to the same transaction. That, however, does not mean that proceedings under Section 7 of the Code cannot be initiated against a corporate person in respect of guarantee to the loan amount secured by a person not being a corporate person in case of default in payment of such a debt. Accepting the aforementioned argument of the Appellant would therefore result in diluting or constricting the expression “corporate debtor” occurring in Section 7 of the Code.

The SC also observed that the expression “corporate debtor” is defined in Section 3(8) of the Code which applies to the Code as a whole. Whereas, the expression “corporate guarantor” in Section 5(5A) of the Code, applies only to Part II of the Code. Upon harmonious and purposive construction of the governing provisions, it is not possible to extricate the corporate person from the liability (of being a corporate debtor) arising on account of the guarantee given by it in respect of a loan given to a person other than a corporate person. The liability of the guarantor is therefore coextensive with that of the principal borrower.

Decision of the Supreme Court

Dismissing the appeal, the SC found no substance in the argument advanced that since the loan was offered to a proprietary firm (not a corporate person), action under Section 7 of the Code could not be initiated against the corporate person even though it had offered guarantee in respect of that transaction. Accordingly, the present appeal was disposed of.

VA View:

The SC has, in arriving at its judgment in the instant matter, aptly interpreted the applicable provisions/sections of the Code and the Indian Contract Act, 1872, to determine that obligations of guarantors are coextensive and coterminous with those of principal borrowers to repay a debt. Accordingly, default on repayment of money loaned would change the position of a guarantor to that of the principal debtor within the meaning of Section 3(8) of the Code, if it happens to be a corporate person.

As has been rightly upheld by the SC, if credence is given to the argument that where the principal borrower is not a corporate person, then the financial creditor cannot invoke its remedy under Section 7 of the Code against the guarantor, it would lead to limitation of the intended width and application of Section 7 of the Code, which permits the initiation of corporate insolvency resolution process against the corporate guarantor, if and when default is committed by the principal borrower.

For more information please write to Mr. Bomi Daruwala at [email protected]

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