Entity versus Enterprise: Dealing with Insolvency of Corporate Groups

By Vinod Kothari & Sikha Bansal

Present-day businesses sweep across multiple entities, such that the “enterprise” consisting of multiple entities, often in multiple jurisdictions, is referred to as a “group”. While accounting standards and securities market regulators have moved on to the concept of “business groups”, the ghost of the 19th century ruling in Salomon v. Salomon & Co continues to hover over corporate laws and, consequentially, over insolvency laws too.

Insolvency laws have not been accommodative of “group concerns” – the insolvent entity is treated as a separate and focused subject matter altogether, and the group entities remain insulated, irrespective of the extent of intermingled structures and shared resources. The relevance of the enterprise approach may be seen from two perspectives – the objective of insolvency or liquidation proceedings, and the complex, inter-connected nature of legal entities in corporate groups of the present day. Given the primary objective of insolvency laws to rescue an entity, a mostly entity-focused approach may fail to do justice to the needs of an ailing enterprise, where resources, operations and assets may be scattered across entities. In liquidation too, where the intent is to liquidate assets, if the assets are entangled across entities and jurisdictions, no meaningful liquidation may be achieved. In any case, due to the entangled nature of the entities, whereby picking up one of the group entities and seeing the same in isolation may not be meaningful at all, the group approach becomes unarguable.

As Sir Goode[1] laments,
Business, entity or group enterprise?

The subject of insolvency proceedings has always been, and continues to be, the particular corporate entity that has become         insolvent, and this focus is accentuated by the reluctance of English law to pierce the corporate veil. What insolvency law here and overseas has so far singularly failed to accommodate is the management of enterprise groups where one or more, or possibly all, members of the group have become insolvent. Whereas the preparation and filing of group accounts has long been required, when it comes to insolvency the distinct legal personality of each individual company within the group is respected, with separate proceedings for each company, yet the insolvency of one member of a group may threaten the viability of previously solvent members and where the group activity is integrated a coordination of the management of the group as a whole may be highly desirable. This is particularly the case as regards multinational group of companies, where the complexity is exacerbated by the variety of corporate structures and the possibility of concurrent proceedings in different jurisdictions governed by different laws, . . .

[emphasis supplied]

While India is pondering over developing a framework under the Insolvency and Bankruptcy Code for group-based insolvency, a lot of work has already been done across the globe – UNCITRAL had constituted a working group, Working Group V, to deal with insolvency law, and through its various sessions, the Working Group has been advancing its work on insolvency of enterprise groups. The UNCITRAL Legislative Guide to Insolvency Law has dedicated a complete part, viz., Part 3, dealing with insolvency of enterprise groups. The EU Insolvency Regulation also applies in cases where there are insolvency proceedings in two or more EU member states.
When it comes to approaches, a group-focused approach may involve looking in multiple directions – as in “looking up”, “looking down” and “looking laterally”. As it suggests, looking up would mean looking at the holding or controlling entities, looking down would mean looking at the subsidiary level, and looking laterally would require looking at fellow subsidiaries, or entities equally controlled by holding entities. The UNCITRAL work discusses several approaches – extension of liability and contribution orders, equitable subordination, avoidance applications, procedural consolidation, and substantive consolidation – last two being major and extensive ones.

Procedural consolidation is where the proceedings of insolvency of different entities are coordinated, even if before different judicial or adjudicating authorities. On the other hand, substantive consolidation disregards the separation of entities and pools the assets and liabilities of various entities into a common hotchpot. This extreme remedy is rarely used, even though UNCITRAL has been aggressively working on developing the principles for the same. Basically, substantive consolidation is ordered by courts where pooling of assets and liabilities is to the larger benefit of different creditors, and generally not prejudicial to any. Mostly, this is done under circumstances similar to those inviting “lifting or piercing the corporate veil”; even substantive consolidation is different from veil lifting or piercing. US courts have well developed jurisprudence around substantive consolidation, though the remedy has been considered to be one which should be “sparingly used”, particularly after the ruling in Owens Corning. Recourse to the remedy will depend upon several factors, majorly, interests of creditors of the entire group.

India does not seem to have any trail of winding up case law on substantive consolidation, though “lifting of corporate veil” has been a well-known recourse in several judicial precedents. While, under the Insolvency and Bankruptcy Code, a subsidiary’s assets cannot form a part of an insolvent holding company, it is felt that the very idea of substantive consolidation is based on a substantive, equitable power of the adjudicating bodies. The remedy is applied in cases where the separation of legal entities is either artificial, or it is observed that dealing with the insolvency of one of the several entities, without disturbing the others, will be self-frustrating approach. Therefore, it is futile to search for legal provisions to permit approaches such as substantive consolidation. It is felt that insolvency laws have equity at their core: therefore, irrespective of the provisions explicitly providing for exclusion of the assets of a subsidiary from those of the holding entity, the National Company Law Tribunal has the equitable power to order substantive consolidation, wherever deemed appropriate and in the ends of justice.

In the Paper titled Entity versus Enterprise: Dealing with Insolvency of Corporate Groups, posted on SSRN  the authors have delved deeper into the discussions and have made an effort to identify  ways for making group insolvency work from global and Indian perspective.

The powers of a Court, specifically Bankruptcy Court w.r.t. “substantive consolidation”, lifting of corporate veil etc., in case of SPVs, has been discussed in the article titled “Consolidation” available at: http://vinodkothari.com/consolidation/

[1] Goode on Principles of Corporate Insolvency Law, Fifth Edition, by Kristin Van Zwieten, pg. 29-30.

Post-Admission Withdrawal of Insolvency Proceedings- Balancing Between Creditors’ Supremacy and Adjudicators’ Discretion

-By Richa Saraf

(richa@vinodkothari.com); (resolve@vinodkothari.com)

Initiation of insolvency proceedings, whether by creditors or by the debtor himself, may be compared with the Brahmastra: as the latter cannot be retracted without killing the target, the former, once admitted, cannot be withdrawn. However, after all, any insolvency resolution process is a case of a mutual contract between the creditors and the debtor – with requisite majority of creditors, it gets the seal of approval of the Adjudicating Authority and becomes a “statutory contract”. Resolution is, therefore, a consensus in substance. Isn’t it possible for the creditors to reach to a consensus with the debtor outside of the insolvency resolution process, and thus, recall the proceedings? In banking parlance, can there be a one-time-settlement (OTS) after admission of insolvency proceedings?

Section 12A was inserted specifically providing for withdrawal after admission. It is well known that the section was inserted after the Supreme Court ruling in Lokhandwala Kataria Construction Private Limited v. Nisus Finance And Investment Managers LLP, where the Apex Court had to use its plenary powers under Article 142 of the Constitution of India to permit withdrawal after admission of resolution process. The SC subsequently eased out the process of withdrawal by its ruling in Brilliant Alloys Private Limited v. Mr. S. Rajagopal & Ors.

Post this ruling, there has been a spate of withdrawals under Section 12A. Data from IBBI shows that out of the 142 cases closed, 63 have been withdrawn under Section 12A[1].

This article intends to get into the limits, if any, of creditors’ discretion in withdrawal under Section 12A. The article reviews the law in this regard based on precedents under the winding up regime under the Companies Act, 1956, and international experience. Finally, the article tries to identify the boundaries of creditors’ wishes and the discretion of the Adjudicating Authority.

Law of Section 12A

As per Section 12A of the Insolvency and Bankruptcy Code, 2016, the Adjudicating Authority may allow the withdrawal of application admitted under Sections 7, 9 or 10, with the approval of ninety per cent. voting share of the committee of creditors. Considering that the proceedings are primarily carried on behalf of and for the benefit of stakeholders of the corporate debtor, the section stipulates two layers of consent. While it is understood that this is the sole requisite is consent of the majority of creditors, the ultimate authority to permit withdraw or not to permit vests with the Adjudicating Authority.

The Hon’ble Supreme Court in the case of Brilliant Alloys Private Limited v. Mr. S. Rajagopal & Ors. held that Section 12A contains no time stipulation and allowed the settlement, even after issue of invitation for expression of interest, thereby annulling the CIRP proceedings.

Further, the National Company Law Appellate Tribunal in V. Navaneetha Krishnan v. Central Bank of India, Coimbatore held:

“In view of Section 12A even during the liquidation period if any person, not barred under Section 29A, satisfy the demand of COC then such person may move before the Adjudicating Authority by giving offer which may be considered by the COC, and if by 90% voting share of the COC, accept the offer and decide for withdrawal of the application under Section 7 of IBC, the order of liquidation passed by the Adjudicating Authority will not come in the way of Adjudicating Authority to pass appropriate order.”

In Satyanarayan Malu v. SBM Paper Mills Ltd., NCLT Mumbai permitted withdrawal of CIRP at the stage when resolution plan was pending approval of the NCLT, after acceptance by CoC. The Bench took into account the offer of one-time settlement (OTS) made by the corporate debtor to the financial creditor, which was more economical than the resolution plan.

Previous Law:

Similar provisions were contained in Section 35 of the Provincial Insolvency Act, 1920, which provides for power to annul adjudication of insolvency. Under the Companies Act, the general rule was that “wishes of the majority creditors prevail”. If the majority show confidence in the continuance of the business of the company, the court will not interfere. The law on this point is stated in Palmer’s Company Law 21st Edition, page 742, as follows:

 “The right to winding up order is, however, qualified by another rule, viz., that the court will regard the wishes of the majority in value of the creditors, and if, for some good reason, they object to a winding up order, the court in its discretion may refuse the order.”

The wishes of the creditors will, however, be tested by the court on the grounds as to whether there are matters which should be inquired into and investigated if a winding up order is made. The court is invested with a wide jurisdiction, and if the facts disclose an unsatisfactory state of affairs so as to make out a strong case for investigation, the court will not hesitate to make a winding up order, inspite of the wishes of the creditors[2]. [See Madhusudan Gordhandas & co. v. Madhu Woollen Industries P. Ltd.]

Considering the facts and circumstances of the case, and in exercise of its inherent powers under Rule 9 of the Companies (Court) Rules, 1959, the courts have on several occasions allowed revival of a company even after winding up order was passed. In the case of NGEF Ltd., since attempts to revive the company by clearing the debts had failed, as per the suggestions of Board for Industrial & Financial Reconstruction, the Karnataka High Court had on 3rd August, 2004 ordered the winding up of the company. However, on 22nd June, 2017, the court recalled its 13-year-old order[3]. In the said case, while the minority shareholder claimed that there was no provision in law for recalling a wind-up order and there was no scheme placed by the state for revival; the court very clearly held that though there is no specific provision in the Companies Act for recalling of a wind-up order, the law does not restrict the court from it either, if the circumstances requiring such recall are established by any of the applicants, be it the Official Liquidator, or a creditor, or a contributory or a shareholder. The court also went on to state that revival of a company does not necessarily mean revival and restoring of the usual manufacturing or business activity. It is a broader term including therein, the best utilisation of the assets. It is only the live and operating companies or business, which contribute to the economic welfare of the country and not the process of winding up of companies, which achieves this objective of larger public good.

In Sudarsan Chits (I) Ltd v. O. Sukumaran Pillai, the Apex Court observed that it is well settled that a winding up order once made can be revoked or recalled.

Global Law:

Section 706(a) of US Bankruptcy Code bestows upon the debtor one-time absolute right of conversion of a liquidation case to a reorganization or individual repayment plan case. If the case has already once been converted as such, then the debtor cannot exercise the right. The policy of the provision is that the debtor should always be given the opportunity to repay his debts, and a waiver of the right to convert a case is unenforceable. Section 706(b) permits the court, on request of a party in interest and after notice and a hearing, to convert the case to one under reorganisation at any time. The decision whether to convert is left on the sound discretion of the court, based on what will most inure to the benefit of all parties in interest. For instance, in Re Wallace, 191 B.R. 925, 927 (Bankr. M.D.Fla. 1995), the bankruptcy court has taken due cognizance to the fact that conversion of a bankruptcy case to one under reorganisation would be a futile, where there exits circumstance that will cause reconversion to bankruptcy.

Section 261 of the UK Insolvency Act, 1986 also stipulates that a debtor can make a proposal for voluntary arrangement, and if creditors approve the voluntary arrangement, the bankruptcy order may be annulled by the court. As to all matters relating to the winding up of a company, the court will give effect to the wishes of the majority[4] (Section 195). Section 282 further provides for court’s power to annul bankruptcy order. The considerations for annulling the order is provided under Section 282(1) of the Act. The relevant extract is reproduced below for reference:

“The court may annul a bankruptcy order if it at any time appears to the court-

   that, on any grounds existing at the time the order was made, the order ought not to have been made..”

on plain reading of the provision, it may be stated that the court retains a discretion whether to annul the adjudication or not, for Section 282(1) merely mentions that the court “may” annul the bankruptcy order under the circumstances described[5]. Thus, a bankrupt may still be denied an annulment if his conduct has been in some way improper [Refer In Taylor, Re (1901) 1 QB 744 (DC)].

Discretion of the Adjudicating Authority:

Section 12A stipulates that the Adjudicating Authority may allow the withdrawal on an application made with the approval of ninety per cent. voting share of the committee of creditors. While the pre-condition is approval of CoC members holding 90% share, the final discretion to allow or disallow vests with the Adjudicating Authority. The report of the Bankruptcy Law Reforms Committee also discussed that “Once a bankruptcy petition is filed, it cannot be withdrawn without the leave of the Adjudicating Authority[6].

In case where no resolution plan has been received or the resolution plan is not approved before the expiry of the insolvency resolution process period or the maximum period permitted for completion of the corporate insolvency resolution process, the Adjudicating Authority shall pass an order for liquidation of the corporate debtor, in terms of Section 33 of the Code. As against the mandatory provisions of Section 33, Section 12A is not an automatic remedy. If the debtor files an OTS scheme, the creditors may consider the same. However, the ultimate authority to approve withdrawal of CIRP vests with the Adjudicating Authority, and the power should be exercised, considering commercial as well as social interest.

The Adjudicating Authority has adequate powers to deal with illegal activity or abusive conduct. The considerations for permitting withdrawal may be nature of OTS, in terms of fundamental requirements. The provisions of the Code should not be misused by any stakeholder to strip asset value or otherwise work to the detriment of the business or other stakeholders. The intent of IBC was to provide a reasonable opportunity for rehabilitation of a business before a decision is taken to liquidate and the Adjudicating Authority may allow withdrawal if the pre-conditions are met, however, Section 12A should not provide the debtor with an opportunity to abuse the process of law. The Adjudicating Authority should, therefore, have relevant information about the debtor for effective consideration of withdrawal. If required, the Tribunal may obtain independent comment and analysis of that information by experts.

Section 12A and Section 29A:

Can Section 12A be used as the surrogate to enable what is not possible under Section 29A? It may be noted that Section 29A is ineligibility to submit resolution plan by promoters. Section 12A is not a resolution plan- Section 12A hits at the very roots of the initiation of the process itself. However, if in guise of withdrawal of CIRP, the creditors are actually agreeing to a resolution plan, then the Adjudicating Authority may exercise discretion. The idea of withdrawal under Section 12A is akin to a declaration by overwhelming majority of creditors that the circumstance which led to initiation of insolvency do not exist anymore. If the facts are that the entity is intrinsically insolvent, the idea of Section 12A cannot be perpetuation of insolvent business. Section 12A should not be allowed to become a re-run of the process under BIFR or earlier regime where an insolvent business could continue to run without any hard time lines. The IBC regime does not want deadwood to continue to lock economic resources, and unsuccessful/unscrupulous promoters to continue to manage businesses. Hence, if the circumstances that led to initiation of insolvency continue to prevail, the Adjudicating Authority will be justified in using its discretion to refuse to allow withdrawal.

[1] https://ibbi.gov.in/uploads/publication/QUARTERLY_NEWSLETTER_FOR_OCT_DEC_2019.pdf

[2] Re Clandown Colliery Co. 91915) 1 Ch 369.

[3] http://judgmenthck.kar.nic.in/judgmentsdsp/bitstream/123456789/173277/1/CA184-15-22-06-2017.pdf

[4] P. & J. Macrae Ltd. (1961) 1 WLR 229: (1961) 31 Com Cases 424: (1961) 1 All ER 302 CA

[5] Askew Peter Dominic Ltd. (1997) BPIR 163; Coney, Re (1998) BPIR 333

[6] https://ibbi.gov.in/BLRCReportVol1_04112015.pdf

RBI’s 12th February circular: The Last Word Becomes the Lost World

RBI’s 12th February circular:

The Last Word Becomes the Lost World

Abhirup Ghosh (abhirup@vinodkothari.com)

The 12th February 2018 circular of the Reserve Bank of India (RBI)[1] (Circular), arguably one of the sternest of measures requiring banks to stop ever-greening bad loans, and resolve them once for all, with a hard timeline of 6 months, or mandatorily push the matter into insolvency resolution, was aimed at being the last word, overriding several of the previous measures such as CDR, JLF, SSSS-A, etc. However, with the Supreme Court striking it down, in the case of Dharani Sugars and Chemicals Limited vs Union of India and Ors.[2], the mandate of the RBI in directing banks with how to deal with stressed loans has fallen apart. While the SCI has used very technical grounds to quash the 12th Feb circular, the major question for the RBI is whether it should continue to micro-manage banks’ handling of bad loans, and the major question for the banks is when will they grow up into big boys and stop expecting RBI to tell them how to clean up the mess on their balance sheet.

The judgment has received mixed reactions from various parts of the economy. This write-up will take you through how it started, and how it ended and what the way forward is.

How it started?

The inception of the entire trail dates back to 5th May, 2017 when the Banking Regulation (Amendment) Ordinance, 2017 was notified. The Ordinance was passed with the intention to empower the Central Government (CG) to authorise the RBI to issue directions to banking companies to initiate insolvency resolution process (IRP) under the provisions of Insolvency and Bankruptcy Code, 2017 (IBC). Two new sections were introduced in the Banking Regulation Act, 1949, namely, sections 35AA and 35AB. While section 35AA empowered the CG to authorise RBI to direct banks to initiate IRP proceedings, section 35AB empowered the RBI to issue directions to the banking companies for resolution of stressed assets.

Soon after the Ordinance was notified, the Ministry of Finance empowered the RBI to issue directions under section 35AA on 5th May, 2017[3].

The Ordinance was replaced by the Banking Regulation (Amendment) Act, 2017 on 25th August, 2017[4]. However, before the Ordinance could turn into an Act, the RBI issued a press release[5] conveying the following:

  1. That it has constituted an Internal Advisory Committee that will help identifying accounts for which IRP must be launched;
  2. That it is laying down criterion for referring accounts for resolution under IBC among top 500 exposures in the banking system which are either wholly or partially NPA; and that 12 accounts satisfy the conditions;
  3. That for the accounts which do not satisfy the criterion laid down by IAC, the banks must prepare a resolution plan within six months and where a valid resolution plan is not agreed upon IRP must be launched after the expiry of six months;
  4. That the RBI will issue directions, based on the recommendations of the IAC, to banks to initiate insolvency proceedings under IBC;
  5. That the RBI will subsequently issue framework for dealing with other NPAs.

Subsequently, the RBI came out with a framework for dealing with other NPAs on 12th February, 2018. The framework was notified by RBI, purportedly, deriving powers from four sections – sections 35A, 35AA and 35AB of the BR Act and section 45L of the RBI Act.

The central theme of this framework revolved around identification of stress in large ticket sized accounts, implementing a resolution plan within 180 days from the date of default and in case of failure to implement, IRP action must be initiated against the borrower under IBC, within 15 days from the date of expiry of the timeline. Large accounts for this purpose means accounts where the aggregate exposure of the lenders exceed ₹ 2,000 crores.

The salient features of the framework are as follows:

  • Identification of early signs of stress in accounts with outstanding of Rs. 5 crores or above, through SMA account classifications and filing of relevant information with the Central Repository of Information on Large Credits (CRILC).
  • Resolution plans must be worked upon for all cases of default and must be implemented within a period of 180 days from the date of default or from the reference date, that is 1st March, 2019, in case the default was subsisting as on the date of reference date. This timeline is however applicable for accounts with outstanding debt of Rs. 2000 crores. However, the reference date was accounts with outstanding of debt of less than the specified amount but more than Rs. 100 crores, for the purpose of debt resolution, has not been notified yet.
  • Independent credit rating to be obtained before implementing the RP.
  • In case of failure to implement the RP within the specified timeline, the account must be dragged into IRP under the IBC within a period of 15 days from the expiry of the time period. The reference under IBC can be made by the banks either singly or jointly.
  • In case of timely implementation of RP, if the account faces any default during the specified period, then the same must be referred for IRP under IBC by the lenders singly or jointly, within 15 days from the date of default. Specified period, in this regard means period within which at least 20 percent of the outstanding principal debt as per the RP and interest capitalisation sanctioned as part of the restructuring, if any, is supposed to be repaid.
  • Sale and leaseback transactions of any asset of the borrower will be treated as a case of restructuring for the purpose of the framework and be subject to asset classification norms applicable to restructured accounts.
  • The framework repealed all the other frameworks for dealing with stressed assets, issued earlier by the RBI, namely, Framework for Revitalising Distressed Assets, Corporate Debt Restructuring Scheme, Flexible Structuring of Existing Long Term Project Loans, Strategic Debt Restructuring Scheme (SDR), Change in Ownership outside SDR, Scheme for Sustainable Structuring of Stressed Assets (S4A), and Joint Lenders’ Forum (JLF) as an institutional mechanism for resolution of stressed accounts.

How it ended?

The framework raised several eyebrows as some felt that the RBI had categorised all defaulted accounts into one single bucket, irrespective of the kind of stress they are facing. Other felt that the framework becoming applicable even on a single day default is an unreasonable measure. However, the most important issue of contention that dragged the matter to the court was questioning the authority of RBI to issue the framework on the first place.

The ruling passed by the SCI is result of this contention and the SCI has ruled it against the RBI. The SCI declared that the issuance of the framework ultra vires the powers granted to the RBI under various statutes and that the framework shall be of no effect in law.

While building up this ruling the SCI considered the following:

  • Sections 35A, 35AA and 35AB of the BR Act – The SCI stated that the stressed assets can be resolved through the provisions of IBC or otherwise. When the measure intended is IBC, section 35AA is the only resort. However, if the RBI wishes to resolved stressed accounts other than through IBC, then it can use general powers under section 35A and 35AB. While section 35A grants wide powers to RBI to give directions when it comes to the matters specified therein, section 35AA calls for an additional requirement of “authorisation” from CG to give directions to banks to proceed under IBC.

Therefore, for exercising powers under the 35AA, the RBI requires specific authorisation from the Central Government, however, for enforcing powers granted under sections 35A and 35AB, no specific authorisation is required. Had there been no section 35AA, RBI would have needed no authorisation to give such directions, as such power could be derived from the existing section 35A, which is wide and expansive enough.

To quote SCI –

“30. The corollary of this is that prior to the enactment of Section 35AA, it may have been possible to say that when it comes to the RBI issuing directions to a banking company to initiate insolvency resolution process under the Insolvency Code, it could have issued such directions under Sections 21 and 35A. But after Section 35AA, it may do so only within the four corners of Section 35AA.

  1. The matter can be looked at from a slightly different angle. If a statute confers power to do a particular act and has laid down the method in which that power has to be exercised, it necessarily prohibits the doing of the act in any manner other than that which has been prescribed. . .”

The court pointed out that if the RBI had the power under sections 35A or 35AB of the BR Act to direct the banks to initiate proceedings under the IBC, it would obviate the necessity of the Central Government authorisation under section 35AA to do so. It noted the following:

“40. Stressed assets can be resolved either through the Insolvency Code or otherwise. When resolution through the Code is to be effected, the specific power granted by Section 35AA can alone be availed by the RBI. When resolution de hors the Code is to be effected, the general powers under Sections 35A and 35AB are to be used. Any other interpretation would make Section 35AA otiose. In fact, Shri Dwivedi’s argument that the RBI can issue directions to a banking company in respect of initiating insolvency resolution process under the Insolvency Code under Sections 21, 35A, and 35AB of the Banking Regulation Act, would obviate the necessity of a Central Government authorisation to do so. Absent the Central Government authorisation under Section 35AA, it is clear that the RBI would have no such power.”

Therefore, it becomes important to understand if the RBI acted well within its powers under section 35AA while issuing the circular. Section 35AA states the following:

‘35AA. The Central Government may, by order, authorise the Reserve Bank to issue directions to any banking company or banking companies to initiate insolvency resolution process in respect of a default, under the provisions of the Insolvency and Bankruptcy Code, 2016.

Explanation.—For the purposes of this section, “default” has the same meaning assigned to it in clause (12) of section 3 of the Insolvency and Bankruptcy Code, 2016.

As noted above, section 35AA allows the RBI to issue directions to banks to initiate IRP in respect of “a default”. The meaning of term default has been drawn from the IBC, as per which a default is non-payment of a debt when it has become due and payable by the corporate debtor. All this indicates that the default in the present context refers to a specific default and not defaults in general.

Further, the SCI also took note of the press note of the Ordinance of 5th May, 2017 which indicated that the intention of deal with resolution of “specific” stressed assets which will empower the RBI to intervene in “specific” cases of resolution of NPAs. The same was also the understanding of the Central Government when it issued the notification on 5th May, 2017 to authorise the RBI to issue directions to the banks to act against “a default” under IBC. Therefore, this made it conclusive that directions issued in relation to debtors in general, is ultra vires the powers under section 35AA.

  • Section 45L of the RBI Act – The RBI stated in the framework that it drew one of its powers from section 45L of the RBI Act. The section grants power to direct non-banking financial institutions. However, section 45(3) of the RBI Act states the following:


(3) In issuing directions to any financial institution under clause (b) of sub-section (1), the Bank shall have due regard to the conditions in which, and the objects for which, the institution has been established, its statutory responsibilities, if any, and the effect the business of such financial institution is likely to have on trends in the money and capital markets.


It was emphasised that in order to issue any direction under this section, the RBI must have due regard to the conditions in which, and the objects for which, the institutions have been established, their statutory responsibilities, and the effect the business of such financial institutions is likely to have on trends in the money and capital markets. However, the framework did not discuss anything as such. Further, since, the very intention of bringing in NBIs under this framework was to deal with cases which had joint lending arrangements between banks and NBIs, the SCI found it difficult to separate banks and NBIs and make the circular applicable on NBIs even though ultra vires for the banks.

Therefore, the entire circular was declared ultra vires as a whole.

What is the way forward?

The ruling has created an awkward situation, as the banks have already acted upon the directions issued by the RBI. They have either implemented an RP or dragged the borrower to NCLT to proceed under IBC. Now that the circular is gone, following are the probable outcomes:

  1. For cases where RPs have been implemented – the lenders may decide to go ahead as per the RP and treat the same as restructured account.
  2. For cases where the corporate debtor has been taken to the NCLT – now that the very basis for taking the account to NCLT is gone, the lenders will have to take a call whether they want to pursue the proceedings under the Code without making references to RBI Circular.

Another apparent question that arises here is what will happen to the various frameworks which were withdrawn vide the 12th February circular. As stated by the SCI, the Circular will have no effect in law, therefore, the “withdrawal” clause too has been nullified. Therefore, the old restructuring frameworks can be said to be existing as on date.

Nevertheless, the Circular played the role of a game-changer by inducing a certain degree of credit discipline or at least the fear of being dragged into IBC. Now, as the Circular goes away, RBI may have to think of new restructuring frameworks – if that is through IBC, it would surely need CG’s authorisation.

[1] https://rbi.org.in/Scripts/NotificationUser.aspx?Id=11218&Mode=0

[2] https://www.sci.gov.in/supremecourt/2018/42591/42591_2018_Judgement_02-Apr-2019.pdf

[3] http://egazette.nic.in/WriteReadData/2017/175797.pdf


[5] https://rbi.org.in/scripts/BS_PressReleaseDisplay.aspx?prid=40743

Simultaneous Claim by a Beneficiary of Guarantee

By Richa Saraf (resolution@vinodkothari.com)


In a recent case of Dr. Vishnu Kumar Agarwal v. M/s. Piramal Enterprises Ltd.[1] Company Appeal (AT) (Insolvency) No. 346 of 2018, the NCLAT has held that an application for initiation of corporate insolvency resolution process for same very claim/debt is not permissible. Now, consider a situation where Company A (guarantor) has guaranteed the loans given to Company B (principal debtor). When Company B defaulted in payment, the creditor issued a notice to Company A invoking the corporate guarantee, however, even Company A failed to make the payment. If Company A and Company B both are undergoing insolvency proceedings (whether corporate insolvency resolution process or liquidation), can the creditor who has already filed its claim for the entire debt due with the IRP/ Liquidator of Company A, also file its claim with the IRP/ Liquidator of the Company B for the entire debt due?

Section 5(8) of the Insolvency and Bankruptcy Code, provides for the definition of financial debt. The relevant extract is reproduced below:

“Financial debt” means a debt along with interest, if any, which is disbursed against the consideration for the time value of money and includes–

  • money borrowed against the payment of interest; **

** (i) the amount of any liability in respect of any of the guarantee or indemnity for any of the items referred to in sub-clause (a) to (h) of this clause.”

Accordingly, it is clear that the liability w.r.t. guarantee given by a corporate guarantor is a financial debt, however, the moot question that arises for consideration is that whether having filed a claim with the principal debtor, the creditor can file its claim for the entire amount with the corporate guarantor; below the author tries to answer the same.


Section 128 of the Indian Contract Act, 1872 stipulates- “The liability of the surety is co-extensive with that of the principal debtor, unless it is otherwise provided by the contract.”

It is thus, well settled that the creditor can directly approach the guarantor, without having exhausted its remedies against the principal debtor, but to analyse whether in insolvency cases, the creditor can file dual claims- one against the guarantor and the other against the principal debtor, it is pertinent to cite the following cases:

In Bank of Bihar v. Damodar Prasad and Anr.[2] 1969 AIR 297, 1969 SCR (1) 620, the Hon’ble Supreme Court held:

“3. The demand for payment of the liability of the principal debtor was the only condition for the enforcement of the bond. That condition was fulfilled. Neither the principal debtor nor the surety discharged the admitted liability of the principal debtor in spite of demands. Under Section 128 of the Indian Contract Act, save as provided in the contract, the liability of the surety is coextensive with that of the principal debtor. The surety became thus liable to pay the entire amount. His liability was immediate. It was not deferred until the creditor exhausted his remedies against the principal debtor.

  1. Before payment the surety has no right to dictate terms to the creditor and ask him to pursue his remedies against the principal in the first instance. As Lord Eldon observed in Wright v. Simpson “But the surety is a guarantee; and it is his business to see whether the principal pays, and not that of the creditor”. In the absence of some special equity the surety has no right to restrain an action against him by the creditor on the ground that the principal is solvent or that the creditor may have relief against the principal in some other proceedings.
  2. Likewise where the creditor has obtained a decree against the surety and the principal, the surety has no right to restrain execution against him until the creditor has exhausted his remedies against the principal. In Lachhman Joharimal v. Bapu Khandu and Surety Tukaram Khandoji the Judge of the Court of Small Causes, Ahmednagar, solicited the opinion of the Bombay High Court on the subject of the liability of sureties. The creditors having obtained decrees in two suits in the Court of Small Causes against the principals and sureties presented applications for the imprisonment of the sureties before levying execution against the principals. The Judge stated that the practice of his court had been to restrain a judgment-creditor from recovering from a surety until he had exhausted his remedy against the principal but in his view the surety should be liable to imprisonment while the principal was at large. Couch, C.J., and Melvill, J. agreed with this opinion and observed-

This 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.

Again, in State Bank of India v. Indexport Registered and Ors.[3] 1992 AIR 1740, 1992 SCR (2)1031, it was held that:

“13. In the present case before us the decree does not postpone the execution. The decree is simultaneous and it is jointly and severally against all the defendants including the guarantor. It is the right of the decree-holder to proceed with it in a way he likes. Section 128 of the Indian Contract Act itself provides that “the liability of the surety is co-extensive with that of the principal debtor, unless it is otherwise provided by the contract”.

In the case of Dr. Vishnu Kumar Agarwal v. M/s. Piramal Enterprises Ltd.[4], the NCLAT has also relied on the aforementioned judgments.

Other relevant judgments:

In Jagannath Ganeshram Agarwala v. Shivnarayan Bhagirath and Ors.[5], 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.[6], the Delhi High Court had observed “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”.

UK Insolvency Act, 1986

The rule against double proof was discussed in detail in the case of Kaupthing Singer and Friedlander Limited (in administration)[7] [2011] UKSC 48, wherein the Supreme Court observed as follows:

“11. The function of the rule is not to prevent a double proof of the same debt against two separate estates (that is what insolvency practitioners call “double dip”). The rule prevents a double proof of what is in substance the same debt being made against the same estate, leading to the payment of a double dividend out of one estate. It is for that reason sometimes called the rule against double dividend. In the simplest case of suretyship (where the surety has neither given nor been provided with security, and has an unlimited liability) there is a triangle of rights and liabilities between the principal debtor (PD), the surety (S) and the creditor (C). PD has the primary obligation to C and a secondary obligation to indemnify S if and so far as S discharges PD’s liability, but if PD is insolvent S may not enforce that right in competition with C. S has an obligation to C to answer for PD’s liability, and the secondary right of obtaining an indemnity from PD. C can (after due notice) proceed against either or both of PD and S. If both PD and S are in insolvent liquidation, C can prove against each for 100p in the pound but may not recover more than 100p in the pound in all.”

Replying on the aforementioned ruling, Fletcher in his famous treatise The Law of Insolvency[8] has mentioned-

“Where the creditor to whom the liability is owed has already roved in the insolvency of the principal debtor, the surety’s own liability is thereafter reduced to the amount for which the creditor’s proof has been admitted, less the value of any dividends that has been paid to him.”


The issue under consideration is whether a creditor can simultaneously claim its entire amount of due from the principal borrower as well as from the corporate guarantor, and considering the afore-mentioned, it is clear that the liability of the guarantor and the principal borrower is joint and several. Generally, guarantee deeds also have a clause to the effect that the guarantor is liable in the same manner as if the guarantor is the principal debtor. Under such circumstances, if there is default by the principal debtor, it cannot be that the claim of the creditor against the guarantor can be for any amount lesser than the amount due from the principal debtor. Accordingly, the creditor can claim its dues from the principal borrower and/or the corporate guarantor.

[1] https://nclat.nic.in/Useradmin/upload/2233762365c34633dbd7b3.pdf

[2] https://indiankanoon.org/doc/743049/

[3] https://indiankanoon.org/doc/1553951/

[4] https://nclat.nic.in/Useradmin/upload/2233762365c34633dbd7b3.pdf

[5] AIR [1940] Bombay 247

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

[7] https://www.supremecourt.uk/cases/docs/uksc-2010-0018-judgment.pdf

[8] Para 23-003, page 728 of The Law of Insolvency, Fifth Edition 2017,


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