CIRP can be initiated against corporate debtor without proceeding against principal borrower

K. Paramasivam v. The Karur Vysya Bank Limited and Others
Supreme Court of India [Civil Appeal No. 9286 of 2019]
Dated 6th September, 2022

HELD THAT

The Corporate Insolvency Resolution Process("CIRP") can be initiated against the corporate debtor without proceeding against the principal borrower.

THE BRIEF FACTS

1. Mr. K. Paramasivam ("Appellant") is the promoter, shareholder and suspended director of Maharaja Theme Parks andResorts Private Limited ("Corporate Debtor"), which had stood as guarantor for the credit facilities granted by KarurVysya Bank ("Financial Creditor/ Respondent") to three entities, namely,

(i) Sri Maharaja Refineries, a Partnership Firm;
(ii) Sri Maharaja Industries, a proprietary concern of K. Paramasivam; and
(iii) Sri Maharaja Enterprises, a proprietaryconcern of P. Sathiyamoorthy.

2. Upon failure on part of the principal borrowers to repay the loan, the Financial Creditor filed an application under Section7 (Initiation of corporate insolvency resolution process by financial creditor) of the Insolvency and Bankruptcy Code, 2016("IBC") for initiation of the CIRP of the Corporate Debtor, on account of the corporate guarantee(s) extended by the
Corporate Debtor to secure the loans availed by each of the above-named borrowers.

3. In view thereof, the NationalCompany Law Tribunal, Chennai ("NCLT/ Adjudicating Authority") admitted the Corporate Debtor under CIRP, by orderdated April 8, 2019.

4. Thereafter, the NCLT order dated April 8, 2019 was challenged before the National Company Law Appellate Tribunal, NewDelhi ("NCLAT"), which came to be dismissed, by order dated November 18, 2019. Aggrieved by the impugned order datedNovember 18, 2019 passed by the NCLAT, the Appellant preferred an appeal before the Supreme Court.

ISSUE

5. Whether an action under Section 7 (Initiation of corporate insolvency resolution process by financial creditor) of the IBC canbe initiated by a financial creditor, against a corporate person, in relation to a corporate guarantee, given in respect of aloan advanced to the principal borrower, who is not a corporate person?

ARGUMENTS

6. Contentions raised by the Appellant:

6.1 The Appellant submitted that the Corporate Debtor does not fall within the definition of ‘corporate guarantor’ in terms ofSection 5(5A) of the IBC, wherein ‘corporate guarantor’ is defined as a corporate person who is the surety in a contract ofguarantee to a corporate debtor. As such, the Appellant contended that it has not stood as guarantor in respect of a loan,which was granted to a corporate person. In order to substantiate the aforesaid contention, the Appellant referred to thedefinition of ‘corporate person’ provided under Section 3(7) of the IBC:

"(7) "corporate person" means a company as defined in Clause (20) of Section 2 of the Companies Act, 2013 (18 of 2013), alimited 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 shallnot include any financial service provider;"

6.2 The Appellant submitted that on a conjoint reading of Section 5(5A), Section 3(7) and Section 3(8) of the IBC, it is clearthat a corporate guarantor is the surety in a contract of guarantee to a corporate debtor. However, the principal borrowersherein, not being corporate debtor; as such, the Corporate Debtor is not a corporate guarantor as defined under Section5(5A) of the IBC.

Contentions raised by the Respondent

6.3 The Respondent submitted that the question of law as to whether an action under Section 7 of the IBC can be initiated by afinancial creditor, against a corporate person, in relation to a corporate guarantee, given by that corporate person, inrespect of a loan advanced to the principal borrower, who is not a corporate person; has already been settled by theSupreme Court in the recent judgment of Laxmi Pat Surana v. Union Bank of India and Another [Civil Appeal No. 2734of 2020] ("Laxmi Pat Surana"). Hence, the position of law is clear that CIRP can be initiated against a corporate entitywho has stood as guarantor to secure the dues of a non-corporate entity as a financial debt, which accrues to the corporateperson, in respect of guarantee given by it, once the borrower commits default.

OBSERVATIONS OF THE SUPREME COURT

SECTION 3(6) of IBC,2016 Claims means—

(a) a right to payment, whether or not such right is reduced to judgment, fixed, disputed, undisputed, legal, equitable, secured or unsecured;
(b) right to remedy for breach of contract under any law for the time being in force, if such breach gives rise to a right to payment, whether or not such right is reduced to judgment, fixed, matured, unmatured, disputed, undisputed, secured or unsecured;

SECTION 3(10) of IBC,2016 Creditor-means any person to whom a debt is owed and includes a financial creditor, an operational creditor, a secured creditor, an unsecured creditor and a decreeholder;

SECTION 3(11) of IBC,2016"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;

SECTION 5(7) of IBC,2016 Financial Creditor - means any person to whom a financial debt is owed and includes a person to whom such debt has been legally assigned or transferred to.

SECTION 5(8) of IBC,2016Financial Debt means a debt along with interest, if any, which is disbursed against the consideration for the time value of money and includes—

(a) money borrowed against the payment of interest;
(b) any amount raised by acceptance under any acceptance credit facility or its de-materialised equivalent;
(c) any amount raised pursuant to any note purchase facility or the issue of bonds, notes, debentures, loan stock or any similar instrument;
(d) the amount of any liability in respect of any lease or hire purchase contract which is deemed as a finance or capital lease under the Indian Accounting Standards or such other accounting standards as may be prescribed;
(e) receivables sold or discounted other than any receivables sold on nonrecourse basis;
(f) any amount raised under any other transaction, including any forward sale or purchase agreement, having the commercial effect of a borrowing;
(g) any derivative transaction entered into in connection with protection against or benefit from fluctuation in any rate or price and for calculating the value of any derivative transaction, only the market value of such transaction shall be taken into account;
(h) any counter-indemnity obligation in respect of a guarantee, indemnity, bond, documentary letter of credit or any other instrument issued by a bank or financial institution;
(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.

The Apex Court

i) Upon examination of the above-mentioned terms, observed that undoubtedly, a right or cause of action arises onpart of the lender (financial creditor) to proceed against the principal borrower, as well as the guarantor in equal measure,in case of any default in repayment of debt.

ii) Further, even if the principal borrower fails to discharge its obligation inrespect of the debt, it would still be deemed as if the default was committed by the guarantor itself.

iii) In this regard, SCreferred to Section 128 of the Indian Contract Act, 1872 which clearly provides that the obligation of the guarantor is coextensive and coterminous with that of the principal borrower.

iv) The SC further observed that as a 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 IBC.

v) the term "default" as defined under Section 3(12) of the IBC would mean non-payment of debt when whole or any part or instalment of the amount of debt has become due or payable and is not paid by the debtor or the corporate debtor, as the case may be.

vi) Hence, SC observed that this argument on part of the Appellant could not be accepted that since the principal borrower isnot a corporate person, the financial creditor could not have invoked remedy under Section 7 of the IBC against the corporate person who had merely stood as a guarantor to secure such loan account. The financial creditor can still proceed against the guarantor being a corporate debtor, consequent to the default committed by the principal borrower.

vii) SC further observed that if the contentions raised by the Appellant were to be accepted, it would lead to diluting or narrowing the purview of the term "corporate debtor" occurring in Section 7 of IBC, which means a corporate person, who owes a debt to any person. It was further observed that the term "debt" as defined under Section 3(11) of the IBC is broad enough to include liability of a corporate person on account of guarantee extended by it to secure a loan by any person including not being a corporate person in the event of default committed by the latter.

viii) It would still be a "financial debt" of the corporate person, arising from the guarantee extended by it, within the meaning of Section 5(8) of the IBC.

ix) SC arrived at the conclusion that upon harmonious and purposive construction of the relevant definitions and provisions of the IBC, it is not possible to extricate the corporate person from the liability (of being a corporate debtor) arising onaccount of the guarantee extended by it in respect of loan given to a person other than corporate person.

x) Hence, the liability of the guarantor is coextensive with that of the principal borrower.

xi) Further, in the Laxmi Pat Surana judgment, SC had made it clear that CIRP can be initiated against the corporate guarantorwithout proceeding against the principal borrower.

DECISION OF THE APEX COURT

The SC held that in view of the issues raised in the present appeal having been already settled in the Laxmi Pat Suranajudgment, it is clear that liability of the guarantor is co-extensive with that of the principal borrower. Hence, FinancialCreditor can proceed against the guarantor without first suing the principal borrower.

The SC held that there is no reason to interfere with the concurrent findings of the NCLT and NCLAT, and therefore dismissed the appeal

CONCLUSION

From above judgment the Apex Court has clear the position of Corporate Guarantor as the liability of Corporate Guarantor is in co-existence with the principal borrower. In this case private limited company (Corporate Debtor) has given Corporate Guarantee against loan taken by its director, promoter in its proprietor and partnerships concerns. In case of default in payment of amount borrowed by the principal borrower a CIRP can be start against Corporate Debtor (given corporate guarantee against loan).

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