Supreme Court: Even if Principal Borrower is Not 'Corporate Person' Insolvency proceedings Can be Initiated Against Corporate Guarantor

Supreme Court: Even if Principal Borrower is Not 'Corporate Person' Insolvency proceedings Can be Initiated Against Corporate Guarantor

The Supreme Court (SC) on 26 March 2021, in the case titled Laxmi Pat Surana (Appellant) v. Union Bank of India & Anr. (Respondents) ruled that even if the loan was offered to a proprietary firm that was not a corporate person, action u/s 7 Insolvency & Bankruptcy Code, 2016 (IBC) can lie against the corporate guarantor.

The SC bench comprising of Justices AM Khanwilkar, BR Gavai, and Krishna Murari was hearing an appeal filed against a judgment of the National Company Law Appellate Tribunal (NCLAT). It clarified that the Corporate Insolvency Resolution Process (CIRP) u/s 7 of the IBC can be initiated by the financial creditor (Bank) against a corporate person concerning guarantee offered regarding a loan account of the principal borrower, who had committed a default, even if the principal borrower is not a 'corporate person'.

The factual background of the case is that the respondent sanctioned two loans to M/s. Mahaveer Construction (Principal Borrower) i.e. a proprietary firm of the appellant through two loan agreements made in years 2007 and 2008.

A guarantee was offered by M/s. Surana Metals Limited and the appellant were also a Promoter/Director of the said company. On 30 January 2010, the loan accounts were declared non-performing assets.

A notice was issued by the financial creditor to the principal borrower, and the corporate debtor, for demanding the dues. An application u/s 19 of the Recovery of Debts Due to Banks and Financial Institutions Act (Act) was filed by the financial creditor against the principal borrower before the Debt Recovery Tribunal (DRT).

While the proceedings were pending before the Tribunal the principal borrower gave assurances to the financial creditor to pay the outstanding amount, however, he failed. The financial creditor sent another notice to the corporate debtor on 3 December 2018 for seeking payment under Section 4(1) of the IBC.

A reply was received on behalf of the corporate debtor wherein it was mentioned that it was not the principal borrower nor owed any financial debt to the financial creditor and had not committed any default in repayment of the stated outstanding amount and hence would not be held liable.

Then the financial creditor applied u/ 7 of the IBC and initiated CIRP against the corporate debtor. The National Company Law Tribunal (NCLT) said that the corporate debtor is liable to be proceeded with under Section 7 of the IBC and the Appellate Tribunal upheld the decision of the NCLT. Hence, an appeal was filed before the Apex Court.

Issues before the SC

- Whether an action u/s 7 of the IBC be initiated by the financial creditor against the corporate person regarding guarantee offered in case of a loan amount of the principal borrower who has defaulted and is not a corporate person according to the meaning provided under the IBC?

- Whether an application u/s 7 of the IBC be filed after 3 years from the date of declaration of a loan account as NPA be barred by limitation?

The Top Court while dealing with the first issue clarified that in law, the status of the guarantor, who is a corporate person, metamorphoses into a corporate debtor, the moment principal borrower, regardless of not being a corporate person, commits default in payment of a debt which had become due and payable.

The Court added that in case of a default by the principal borrower, it is the liability of the company (corporate person) being the guarantor, and based on it the right of the financial creditor triggers to proceed against the corporate person being the corporate debtor.

The SC bench examined the definitions of terms including "financial creditor" "financial debt", "debt", "claim" and "default" as defined under the IBC. After examining the said definitions the Court held that a right or cause of action would accrue to the financial creditor to proceed against the principal borrower, and the guarantor in equal measure if default occurred in repayment of the amount of debt acting jointly and severally.

The SC draws support from Section 3(37) of the IBC and stated that it must follow that the lender would be a financial creditor within the meaning of the IBC. It further stated that even though the principal is not a corporate person, but if a corporate person extends a 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" in Section 3(8) of the IBC.

The Top Court emphasized that the obligation of the guarantor is coextensive as that of the principal borrower as provisioned u/s 128 of the Contract Act. In case of default, the status of the guarantor transforms into a debtor or a corporate debtor if it happens to be a corporate person, within the meaning of Section 3(8) of the IBC.

The Apex Court while dealing with the second issue rejected the argument of the appellant regarding the maintainability of the application filed by the financial creditor u/s 7 of the IBC on the ground of being barred by limitation. It clarified that a fresh period of limitation is required to be computed from the date of acknowledgment of the debt by the principal borrower from time to time.

The Court concluded, "The financial creditors has not only the right to recover the outstanding dues by filing a suit but also has a right to initiate a resolution process against the corporate person whose liability is coextensive with that of the principal borrower and more so when it activates from the written acknowledgment of liability and failure of both to discharge that liability."

While dismissing the appeal the Court said that "There is no reason to limit the width of Section 7 of the Code despite law permitting initiation of CIRP against the corporate debtor, if and when the default is committed by the principal borrower. For, the liability and obligation of the guarantor to pay the outstanding dues would get triggered coextensively."