Liability of guarantors after landmark India verdict

By Soummo Biswas and Shivani Sinha, Shardul Amarchand Mangaldas & Co
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Guarantors, whether personal or corporate, have an intrinsic relationship with the corporate debtor in their capacities as directors, promoters, associates, subsidiaries or holding companies. The nebulous nexus between guarantors and corporate debtors has been tested under the aegis of the Insolvency and Bankruptcy Code, 2016 (IBC) on several occasions before various courts. In this regard, a significant piece of jurisprudence has evolved with the judgment of the Supreme Court in Lalit Kumar Jain v Union of India and Ors (2021).

Soummo Biswas, Partner, Shardul Amarchand Mangaldas & Co
Soummo Biswas
Partner
Shardul Amarchand Mangaldas & Co

Since the IBC came into force the guarantors have in many cases unsuccessfully tried to nullify the rights of the creditors. In the case of Lalit Kumar Jain, with the question of survival of the liability of the guarantors, the liability of the corporate debtor was discharged by way of approval of the resolution plan in the insolvency resolution process.

The petitioners, being personal guarantors of the corporate debtors, argued that since the guarantor’s liability is co-extensive with the corporate debtor, once a resolution plan is approved by the committee of creditors (CoC) of a corporate debtor, the guarantor, along with the corporate debtor, stands discharged of the liability towards the creditors. Therefore, the creditors cannot proceed against them separately.

The Supreme Court rejected these arguments, stating that the liability of guarantors subsists against the creditors, and an approved resolution plan can only lead to a “revision of amount or exposure for the entire amount”. The court also rejected the argument on discharge of surety upon variance in terms of the contract under section 133 of the Indian Contract Act, 1872, by relying on the case of State Bank of India v V Ramakrishnan, where the Supreme Court had clarified that section 31 of the IBC made it clear that an approved resolution plan was binding on a guarantor, specifically to avoid any attempt to escape liability under the provisions of the Contract Act.

guarantors
Shivani Sinha
Counsel
Shardul Amarchand Mangaldas & Co

The Supreme Court also relied on the case of Committee of Creditors of Essar Steel (I) v Satish Kumar Gupta, where it had refused to interfere with the proceedings initiated by the financial creditors to enforce personal guarantees.

Another important observation of the Supreme Court was that the release or discharge of a principal borrower from its debt to its creditor by an involuntary process did not absolve a guarantor of their liability that arises out of an independent contract. The court concluded that sanction of a resolution plan and finality imparted to it by section 31 of the IBC did not per se operate as a discharge of the guarantor’s liability, the nature and extent of which depended on the terms of the guarantee itself.

While the ruling in Lalit Kumar Jain sufficiently clarified that approval of resolution plan and the finality attained by it under section 31 of the IBC is not an automatic discharge of liability of the guarantors, but can only lead to a revision of amount or exposure, more clarity is required on the aspect of the liability of the guarantors if the implementation of the resolution plan leads to the assignment of the debt owed to the creditors to a resolution applicant or a third party, or conversion of debt owed to the creditors into equity or preference shares. As per commercial understanding, a haircut undertaken by the creditors, i.e. the revised liability of the guarantors, is equal to the total debt reduced by the amount received by the creditors under the resolution plan. The same is yet to be confirmed judicially in cases of assignment of debt, or conversion of debt into preference or equity shares.

In The State Bank of India v Subodh Kumar Agarwal and Ors before the National Company Law Appellate Tribunal (NCLAT), one of the financial creditors had raised the above-mentioned questions, i.e. whether a guarantee would subsist and could be enforced even in a situation where debt was converted into preference shares or was assigned to a third party under a resolution plan pursuant to the corporate insolvency resolution process. The NCLAT did not answer these questions, observing that it would amount to pre-judging an issue that had yet not arisen on the judicial side, as the appellant had come up with the questions even when the voting by the CoC on the resolution plan was yet to conclude.

With the Lalit Kumar Jain case, the jurisprudence has taken giant strides towards preserving the rights of creditors, which had been sought to be invalidated by the guarantors to avail ipso facto discharge of liability as a consequence of insolvency resolution of the corporate debtors. Still, clarity on the aspect of liability of guarantors upon assignment of the debt, or conversion of debt into equity or preference shares pursuant to the resolution plan would further strengthen the hands of the creditors in seamlessly pursuing enforcement and insolvency proceedings against the guarantors.

Soummo Biswas a partner and Shivani Sinha is a counsel at Shardul Amarchand Mangaldas & Co

Shardul Amarchand Mangaldas & CoShardul Amarchand Mangaldas & Co

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soummo.biswas@amsshardul.com

shivani.sinha@amsshardul.com