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INITIATION OF INSOLVENCY PROCESS AGAINST ‘COMPANY’ STANDING AS ‘GUARANTOR’ FOR LOAN GIVEN TO ‘FIRM’

Paper Details Paper Code: SP-CLA-V2-01 Category: Special Paper Date of Submission for First Review: March 28, 2022 Date of Acceptance: July 6, 2022 Citation: C.S. Raghu Raman, “Initiation of Insolvency Process against Company standing as Guarantor’ for Loan given to Firm”, 2, AIJACLA, 1, 1-6 (2022).

Author Details: Prof. (Dr.) C. S. Raghu Raman, Visiting Professor, Law, A.P., Telangana, Karnataka, West Bengal, Delhi, Bihar States Judicial Academies, Email: csraghuraman1954 @gmail.com




Abstract Whether, M/s. Surana Metals Limited, a company incorporated under the Companies Act, 2012 can be brought under insolvency proceedings under the Insolvency and Bankruptcy Code, 2016, for failure to discharge the pecuniary liability to the Union Bank of India, as ‘guarantor’ for the loan provided by the bank to M/s. Mahaveer Construction, the Firm. Rejecting the argument of Laxmi Pat Surana, interestingly, both director of the company as well proprietor of the firm, The SC correctly held that ‘the company, on making default in discharge of the loan to the bank as guarantor can be brought under insolvency process, notwithstanding that the principal borrower happened to be the firm.’On reading and noting the objects of the IBC, with purpose interpretation of different provisions, the SC clearly came to the above opinion on the universally accepted solid foundation that ‘guarantor has coextensive liability with the principal borrower unless there was limitation of that liability’ as found in the law of contract of guarantee in Indian Law. The Author says a good decision has come from The Supreme Court without taking a too technical approach entity taking loan from the bank since the Bank interest shall be recognized. Keywords: Company; Guarantor; Insolvency Process; Loan; Firms


INTRODUCTION First question of law, the most interesting and relevant, out of two questions of law, raised on the strength of following brief facts before the Supreme Court (known as the SC) Bench of Hon’ble Justices A. M. Khanwilkar, B.R. Gavai and Krishna Murari [1] was as follows: (i) Whether an action can be initiated by the Bank, financial creditor, against a corporate person under the Code concerning guarantee offered by it in respect of a loan account of the principal borrower, committed default and is not a “corporate person” within the meaning of the Code? [2] A proprietary ‘firm’ called M/s. Mahaveer Construction, principal borrower, took loans from ‘Union Bank of India, Respondent No. 1 and ‘financial creditor.’ M/s. Surana Metals Limited, the company offered guarantee [3] referred to ‘guarantor or surety’ to the bank for the loan. Laxmi Pat Surana, Appellant, was both proprietor of the firm and promoter/director of the company. The financial creditor commenced insolvency proceedings against the guarantor i.e., the company under Sec. 7 of the Code. [4] Despite vehemently arguing that ‘insolvency proceedings cannot be initiated against the company when the loan was given to firm, not being corporate entity, since both borrower and guarantor shall be corporate entities, ’the Appellant lost his case in the two rounds when the ALT[5] affirmed the decision of the NCLT [6] given on the strength of universally accepted principle of ‘coextensive liability of the guarantor with the principal borrower,’[7] that ‘the action had rightly been initiated against the company, the guarantor, when principal borrower made default in discharging the loan.’ The SC declared that ‘if the principal borrower fails to discharge his obligation in respect of amount of debt, since the obligation of the guarantor becomes coextensive and coterminous with that of the principal borrower to defray the debt, in view of Sec. 128 of the Contract Act. Indubitably, the lender, as financial creditor, obtains right or cause of action to proceed against the principal borrower, as well as the guarantor in equal measure, jointly and severally, in case of default in repayment of the amount of debt. 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 meaning of Section 3(8) of the Code[8] by looking at the meaning of the expression ‘default’ in the Code.[9] Therefore, ‘in the context of the provisions of the Code, ‘if the guarantor is a corporate person as defined in Section 3 (7) of the Code[10] it would come within the purview of expression ‘corporate debtor’ within the meaning of Sec. 3(8) of the Code.’ In support of the above view, The SC referred to Sec. 3 (37) [11] of the Code to declare ‘the lender would be a financial creditor within the meaning of the Code. 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 expression “corporate debtor” in Section 3(8) of the Code.’ Rejecting the argument of the appellant that ‘as the principal borrower is not a corporate person, the financial creditor could not have invoked remedy under Sec. 7 of the Code against the corporate person who had merely offered guarantee for such loan account,’ Hon’ble Justices A. M. Khanwilkar, B.R. Gavai and Krishna Murari, said that ‘action can still proceed against the guarantor being a corporate debtor, consequent to the default committed by the principal borrower. There is no reason to limit the width of Sec. 7 of the Code despite law permitting initiation of Corporate Insolvency Resolution Plan against the corporate debtor, if default is committed by the principal borrower. For, the liability and obligation of the guarantor to pay the outstanding dues would get triggered coextensively.’ When principal borrower ‘in order to extricate from this legal position, relied on Section 5 (5A) of the Code,[12] that “corporate guarantor” to mean a corporate person, who is the surety in a contract of guarantee to a corporate debtor,’ the 3 Justices rightly declared thatdoes not mean that proceedings under Sect. 7 of the Code cannot be initiated against a corporate person in respect of guarantee to the loan amount secured by person not being a corporate person, in case of default in payment of such a debt.’ The Full Bench said that accepting the above argument of the appellant would result in diluting the expression “corporate debtor” which means ‘a corporate person, who owes a debt to any person, when the expression “debt” in Sec. 3 (11 ) [13]of the Code is ‘wide enough to include liability of a corporate person on account of guarantee given by it in relation to a loan account of any person including not being a corporate person in the event of default committed by the latter, the debt would still be a ‘financial debt’ [14]of the corporate person, arising from the guarantee given by it, within the meaning of Section 5(8) of the Code.’[15] Upon harmonious and purposive construction of the governing provisions in Sec. 3 (8) of the Code which applies to the Code as a whole, together with expression ‘corporate guarantor’ in Sec. 5 (5A), the SC held that ‘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 loan given to a person other than corporate person as the liability of the guarantor is coextensive with that of the principal borrower.’ Therefore, in law, the status of the guarantor, who is a corporate person, metamorphoses into corporate debtor, the moment principal borrower (regardless of not being a corporate person) commits default in payment of debt which had become due and payable. Thus, action under Sec. 7 of the Code could be legitimately invoked even against a (corporate) guarantor being a corporate debtor on understanding the definition of “corporate guarantor” in Section 5(5A) of the Code.’ Laxmi Pat Surana lost his appeal even in the highest Cout of Appeal when the question stands answered against him.

COMMENTS OF THE AUTHOR With great respect to judicial wisdom of the Hon’ble Justices, The Author says that ‘with or without metamorphosis, when a company provides guarantee to any entity like ‘firm,’ the company does not cease to be a corporate guarantor having coextensive liability recognized in almost all jurisdictions,[16] on default committed by principal debtor, to be brought under insolvency process’ as correctly said by the all the Justices without any dissent, ‘though the principal borrower was not a corporate entity, but the guarantor, being the corporate entity.’ On the other hand, as correctly observed by ‘if the guarantor was a firm or an individual, but not corporate person, the provisions of Part III of the Code [17] comes into operation.’ Of course, it can also be argued that the creditor-bank could have chosen ‘the remedy of filing of ordinary civil suit to recover the amount from the guarantor’ but ‘chose to take recourse under the Code when the loan account of the borrower was declared ‘non-performing asset.’ The Author says that when a company give guarantee with open eyes taking responsibility to clear the debts on failure of the principal borrower, the company shall face insolvency process under Part II [18] of the Code. The guarantor continuous to be a guarantor, but non else, and shall never cease to be so, except in the following circumstances. 1. After complete discharge of the debt to the creditor,[19] the guarantor can claim the right to indemnity against the principal borrower under Sec. 145 [20] of the C Act. 2. When the surety and principal borrower have joint and several liability for the debt,[21] the creditor may get the decree against the guarantor [22] or the principal borrower [23] or against principal borrower as well as guarantor.’ [24] 3. At the worth scenario, ‘when the guarantor becomes insolvent or bankrupt, then creditor can claim ‘dividend’ from the estate of the guarantor by proof of his debts to in insolvency proceedings of the guarantor.’ Can Laxmi Pat Surana be applied ‘when the principal borrower happens to be an individual’ is highly controversial and debatable question. Yet the Author firmly believes that cannot be done. Finally, it was good decision to kept in view by corporate entities before extending guarantee to others.


[1] Laxmi Pat Surana v. Union Bank of India on 26 March 2021 (FB) [2] ‘Whether application filed under Sec. 7 of the Code to initiate insolvency process against corporate debtor was barred under law of limitation’ was second question, not relevant for this essay [3] Sec. 126 of the Indian Contract Act, 1872 (known as the ‘The C Act’) declares that a ‘contract of guarantee’ is a contract to perform the promise, or discharge the liability, of a third person in case of his default. The person who gives the guarantee is called the ‘surety’; the person in respect of whose default the guarantee is given is called the ‘principal debtor’, and the person to whom the guarantee is given is called the ‘creditor.’ [4] Initiation of Corporate Insolvency Resolution Process by Financial Creditor [5] The National Company Law Appellant Tribunal [6] The National Company Law Tribunal [7] Sec. 128 of the C Act declares that ‘the liability of the surety is co-extensive with that of the principal debtor, unless it is otherwise provided by the contract’ [8]corporate debtor’ means ‘a corporate person who owes a debt to any person’ [9]default’ means ‘non-payment of debt when whole or any part or instalment of the amount of debt has become due and payable and is not 1[paid] by the debtor or the corporate debtor, as the case may be’ [10]corporate person’ means ‘a company as defined in clause (20) of section 2 of the Companies Act, 2013’ (18 of 2013), ‘a limited liability partnership, as defined in clause (n) of sub-section (1) of section 2 of the Limited Liability Partnership Act, 2008’ (6 of 2009), or ‘any other person incorporated with limited liability under any law for the time being in force but shall not include any financial service provider’ [11] words and expressions used but not defined in this Code but defined in the Indian Contract Act, 1872 (9 of 1872), the Indian Partnership Act, 1932 (9 of 1932), the Securities Contact (Regulation) Act, 1956 (42 of 1956), the Securities Exchange Board of India Act, 1992 (15 of 1992), the Recovery of Debts Due to Banks and Financial Institutions Act, 1993 (51 of 1993), the Limited Liability Partnership Act, 2008 (6 of 2009) and the Companies Act, 2013 (18 of 2013) [12] ‘corporate guarantor’ means ‘a corporate person who is the surety in a contract of guarantee to a corporate debtor’ [13] ‘debt’ means ‘a liability or obligation in respect of a claim which is due from any person and includes a financial debt and operational debt’ [14] Sec. 5 (8) (i) ‘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 this clause’ [15] Hon’ble 3 Justices also observed that ‘nothing stopped Legislature if it was intended ‘to exclude a corporate person offering guarantee in respect of a loan secured by a person not being a corporate person, from the expression “corporate debtor’ [16] In Pollock & Mulla on Indian Contract and Specific Relief Act, it is observed thus : "Co-extensive-Surety's liability is co-extensive with that of the principal debtor. A surety's liability to pay the debt is not removed by reason of the creditor's ommission to sue the principal debtor. The creditor is not bound to exhaust his remedy against the principal before suing the surety, and a suit may be maintained against the surety though the principal has not been sued’ (Tenth Edition, at page 728) [17] Part III of the Code, from Chapters I to VII is applicable to debtors who are individuals or partnership firms. See Section 2 of the Code. [18] From Chapters I to VII, both corporate insolvency and liquidation process [19] Refer to Author’s Article ‘SURETY’S RIGHT TO SUBROGATION—PRIOR TO PAYMENT OF AMOUNT TO THE CREDITOR CRITICAL COMMENTS ON CASE LAW’ (Lawz, New Delhi) [20] ‘Implied promise to indemnify surety,’ For critical analysis of decisions, refer to Author’s Article ‘RIGHT OF SUBROGATION OF SURETY--RIGHTFUL OR WRONGFUL PAYMENT’ (All India Reporter, Nagpur, February 2016) [21] Chitty ‘on Contracts’ stated: "Prima facie the surety may be proceeded against without demand against him, and without first proceeding against the principal debtor.’ (24th Edition Volume 2 at page 1031 paragraph 4831) In Halsbury's Laws of England it has been observed that "it is not necessary for the creditor, before proceeding against the surety, to request the principal debtor to pay, or to sue him, although solvent, unless this is expressly stipulated for’ (Forth Edition paragraph 159 at page 87), also reference given above to Pollock and Mulla [22] The creditor can sue surety alone without joining the principal borrower, Pradip D Kothari v. Ceat Fin. Services Ltd 2000 AIHC 4242 Madras HC, and N. Narasimhaia v. Karnataka State Fin. Cor. AIR 20004 Karn, 46, Vijaysingh Padole v Simcom Ltd. 4 Maha. LJ 772 and Kailash Chand Jain v. UP Fin. Cor. Air 2002 All 3029 [23] Similarly, the creditor’s suit filed against the principal borrower alone cannot be dismissed as he has not joined the guarantor, Ashok Mohansing Bajaj v. Elegan Pharmaceuticals Ltd. 2000 Maha. LJ 855 and Union Bank of India v. Noor Dairy farms 1997 3 Bombay CR 126 [24] State Bank of India v. Indexport Registered and Ors 1992 AIR 174, Yogeshwar Dayal, Rangnathan, S and Ramaswami, V confirmed ‘the composite decree passed by lower court’

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