LIABILITY OF GUARANTOR AND PRINCIPAL DEBTOR IS CO-EXTENSIVE AND NOT IN ALTERNATIVE

By Richa Saraf (legal@vinodkothari.com)

In the case of Sanjeev Shriya v. State Bank of India & Ors.[1], the Hon’ble Allahabad High Court has barred parallel proceedings in Debt Recovery Tribunal (DRT) and National Company Law Tribunal (NCLT). Below we discuss the implications and analyse the judgment:

FACTS OF THE CASE:

State Bank of India approached the DRT, Allahabad, under Section 19(3) of the Recovery of Debts Due to Banks and Financial Institutions Act, 1993 and Lohia Machines Limited (Corporate Debtor) filed an application under Section 10 of the IBC before the NCLT, Allahabad, seeking the initiation of corporate insolvency resolution process.

The NCLT, Allahabad, by way of its order dated May 30, 2017, allowed the initiation of the corporate insolvency resolution process and declared moratorium under Section 14 of the Insolvency and Bankruptcy Code (IBC) and an Insolvency Resolution Professional was also appointed in this regard. Pursuant to such order of NCLT, the Corporate Debtor and the guarantors preferred an application before the DRT to stay the proceedings against them in light of the moratorium imposed by NCLT. The DRT allowed stay of its proceedings against the Corporate Debtor but ordered that the proceedings against the guarantors shall continue as the moratorium is only applicable in relation to the Corporate Debtor. Aggrieved by the decision of the DRT, the guarantors had filed a writ petition before the Hon’ble Allahabad High Court.

RELEVANT PROVISIONS AND PRECEDENTS:

In Pollock & Mulla on Indian Contract and Specific Relief Act, Tenth Edition, at page 728, it is observed-

“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 omission 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.”

In Chitty on Contracts 24th Edition Volume 2 at page 1031 paragraph 4831, it is stated-

“Prima facie the surety may be proceeded against without demand against him, and without first proceeding against the principal debtor.”

In Halsbury’s Laws of England Forth Edition paragraph 159 at page 87, it has been observed-

“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.”

In Bank of Bihar Ltd. v. Damodar Prasad & Anr.[2], the Apex Court referred to a judgment in the case of Lachhman Joharimal v. Bapu Khandu and Tukaram Khandoji[3], in which the Division Bench of the Bombay High Court held-

“The court is of opinion that a creditor is not bound to exhaust his remedy against the principal debtor before suing the surety and that when a decree is obtained against a surety, it may be enforced in the same manner as a decree for any other debt.”

The Hon’ble Supreme Court of India has taken a similar view, in the case of Industrial Investment Bank of India Ltd. v. Biswanath Jhunjhunwala[4] had observed-

“The very object of the guarantee is defeated if the creditor is asked to postpone his remedies against the surety. In the present case the creditor is a banking company. A guarantee is a collateral security usually taken by a banker. The security will become useless if his rights against the surety can be so easily cut down.”

In State Bank of India v. M/s. Indexport Registered[5], the Apex Court held that the decree holder bank can execute the decree against the guarantor without proceeding against the principal borrower. Guarantor’s liability is co- extensive with that of the principal debtor.

In Jagannath Ganeshram Agarwala v. Shivnarayan Bhagirath and Ors.[6], a Division Bench of the Bombay High Court held that the liability of the surety is co-extensive, but is not in the alternative. Both the principal debtor and the surety are liable at the same time to the creditors.

In Mukesh Hans & Anr. V. Smt. Uma Bhasin & Ors.[7], the Delhi High Court had observed that it is well settled that a director of a company, though he owes a fiduciary duty to the company, owes no contractual duty qua third parties. There are, however, exceptions to this rule. One of it is where the director or the directors make themselves personally liable, i.e., by execution of personal guarantees, indemnities, etc. It has also been held that upon the failure of the principal debtor to pay the whole or a part of the sum due, the guarantee stands invoked. “The guarantee is an independent contract and in all fairness, has to be honoured to fulfil the contractual obligation between the surety and the creditor”. Furthermore, there is no requirement (unless expressly stated in the contract) that the creditor is required to exhaust all remedies against the principal debtor to enforce its rights under the personal guarantee

Part-III (Insolvency resolution and bankruptcy for individuals and partnerships firms) of IBC deals with the insolvency and bankruptcy of individuals and the adjudicating authority for the purposes of Part-III of IBC is DRT. However, Section 60(2) of IBC makes an exception for the personal guarantors who have guaranteed obligations on behalf of a corporate debtor which is under the corporate insolvency resolution process and for the purposes of Section 60(2) of IBC, the adjudicating authority under IBC is NCLT. Section 60(1) read with Section 60(2) of IBC only governs ‘insolvency’ of personal guarantors of the corporate debtor and not enforcement of personal guarantee per se. It is also pertinent to note that Section 60 is not yet in force. If any corporate debt is secured by means of personal guarantee, then the bankruptcy of the personal guarantor shall also be dealt with by same NCLT rather than DRT. Thus, there will be a common forum for a creditor to enforce debt from both borrower and guarantor.

However, NCLT, Mumbai, while determining the scope of Section 14 of the IBC in Schweitzer Systemtek India Private Limited v. Phoenix ARC Private Limited[8] has clearly laid down the position that the moratorium has no application on the properties beyond the ownership of the corporate debtor. The relevant extract of the judgment is reproduced below:

“The outcome of this discussion is that the Moratorium shall prohibit the action against the properties reflected in the Balance Sheet of the Corporate Debtor. The Moratorium has no application on the properties beyond the ownership of the Corporate Debtor.”

The NCLT, Mumbai arrived at the above conclusion based on the proposition as hereunder:

“The plain language of the Section is that on the commencement of the Insolvency process the ‘Moratorium’ shall be declared for prohibiting any action to recover or enforce any security interest created by the Corporate Debtor in respect of “its” property. Relevant section which needs in-depth examination is Section 14(1)(c) of IBC.”

The understanding as propounded in the Schweitzer Case is in line with the very object and intent of IBC, furthers the interest of the creditors and elucidates a more reasoned position of law. Since, the personal guarantee is an alternative remedy and Section 14 of IBC does not operate against the personal properties of the directors (personal guarantors). Guarantee stands invoked upon the failure of the principal debtor to pay the whole or a part of the sum due, and that there is no bar on the creditor to initiate proceedings against the guarantor by virtue of an independent contract of guarantee.

COMMENTS

In the instant case, the Hon’ble Allahabad High Court appreciated that IBC provides separate provisions for the personal guarantors under Section 60(2) but failed to appreciate the settled principle of law regarding co- extensive nature of liability and barred parallel proceedings in the NCLT and DRT.

Liquidation of the principal debtor does not by itself affect the creditor’s rights against the guarantors. The creditor may proceed against the guarantors for any sums due under the guarantee, obtain judgement against the guarantor for any sum outstanding at the date of the judgement, and then proceed to enforce its judgement until it is paid in full and may at the same time, prove in liquidation the full balance due to it under the principal debt. The creditor is entitled to prove in the liquidation of the principal debtor, irrespective of its ability to recover against the guarantor[9].

[1] Writ-C 30285 of 2017 dated 06.09.2017

[2] (1969) 1 SCR 620

[3] (1869) 6 Bombay High Court Reports 241

[4] https://indiankanoon.org/doc/1320013/

[5] 1992 SCC (3) 159

[6] AIR [1940] Bombay 247

[7] https://indiankanoon.org/doc/1215854/

[8] http://nclt.gov.in/Publication/Mumbai_Bench/2017/Others/524.pdf

[9] Edward Bailey & Hugo Groves, Corporate Insolvency – Law and Practice, LexisNexis, First Indian Reprint, p. 1096.