Insolvency Process Maintainable Against Corporate Guarantor Even If Principal Borrower Is Not A 'Corporate Person' : Supreme Court

The Supreme Court has held that the principal borrower need not be a "corporate person" for insolvency process to be initiated against a company which stood as its guarantor.

"Corporate Insolvency Resolution Process under Section 7 of the Insolvency and Bankruptcy Code, 2016 can be initiated by a financial creditor against a corporate person in respect of guarantee to the loan amount secured by person not being a corporate person, in case of default in payment of such a debt", the Court held.

Upon default committed by the principal borrower, the liability of the company (corporate person), being the guarantor, instantly triggers the right of the financial creditor to proceed against the corporate person (being a corporate debtor), the bench comprising Justices AM Khanwilkar, BR Gavai and Krishna Murari observed.

In this case, the Union bank of India extended credit facility to M/s. Mahaveer Construction, a proprietary firm. A company named M/s. Surana Metals Limited(the corporate debtor in the case) offered guarantee to the two loan accounts of the Principal Borrower. The stated loan accounts were declared NPA on 30.1.2010. The Bank issued notice to Principal Borrower, as well as the guarantor. Eventually, the Financial Creditor filed an application under Section 7 of the Code on 13.2.2019 for initiating Corporate Insolvency Resolution Proceeding against the Corporate Debtor, before the National Company Law Tribunal, Kolkata. Surana Metals raised objection against maintainability of this application contending that as the principal borrower is not a corporate person, the financial creditor could not have invoked remedy under Section 7 of the Code against the corporate person who had merely offered guarantee for such loan account.

The NCLT held that the Corporate Debtor, being co-extensively liable to repay the debt of the Principal Borrower and having failed to do so despite the recall notice, became Corporate Debtor and thus liable to be proceeded with under Section 7 of the Code. As regards the second objection, the Adjudicating Authority found that the Principal Borrower, as also, the Corporate Debtor had admitted and acknowledged the debt time and again, lastly on 8.12.2018 and thus the application filed on 13.2.2019 was within limitation. National Company Law Appellate Tribunal upheld this order of NCLT.

Challenging the orders of NCLT/NCLAT, appeal was filed in the Supreme Court.

In appeal before the Apex Court, these two issues were raised:

(i) Whether an action under Section 7 of the Insolvency and Bankruptcy Code, 20161 can be initiated by the financial creditor (Bank) against a corporate person (being a corporate debtor) concerning guarantee offered by it in respect of a loan account of the principal borrower, who had committed default and is not a "corporate person" within the meaning of the Code?

(ii) Whether an application under Section 7 of the Code filed after three years from the date of declaration of the loan account as Non ­performing Asset , being the date of default, is not barred by limitation?

Answering the first issue against the company, the bench observed that the principal borrower may or may not be a corporate person, but if a corporate person extends guarantee for the loan transaction concerning a principal borrower not being a corporate person, it would still be covered within the meaning of expression "corporate debtor" in Section 3(8) of the Code.

Indubitably, a right or cause of action would enure to the lender (financial creditor) to proceed against the principal borrower, as well as the guarantor in equal measure in case they commit default in repayment of the amount of debt acting jointly and severally. It would still be a case of default committed by the guarantor itself, if and when the principal borrower fails to discharge his obligation in respect of amount of debt. For, the obligation of the guarantor is coextensive and coterminous with that of the principal borrower to defray the debt, as predicated in Section 128 of the Contract Act. 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 the Code. For, as aforesaid, expression "default" has also been defined in Section 3(12) of the Code to mean non­payment 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.

Thus understood, it is not possible to countenance the argument of the appellant that as the principal borrower is not a corporate person, the financial creditor could not have invoked remedy under Section 7 of the Code against the corporate person who had merely offered guarantee for such loan account. That action can still proceed against the guarantor being a corporate debtor, consequent to the default committed by the principal borrower. 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 default is committed by the principal borrower. For, the liability and obligation of the guarantor to pay the outstanding dues would get triggered coextensively.

Referring to Section 5(5A) of the Code, which defines the expression "corporate guarantor" to mean a corporate person, who is the surety in a contract of guarantee to a Corporate debtor, the bench observed that the same cannot be interpreted to extricate the corporate person from the liability (of being a corporate debtor) arising on account of the guarantee given by it in respect of loan given to a person other than corporate person.

"The liability of the guarantor is coextensive with that of the principal borrower. The remedy under Section 7 is not for recovery of the amount, but is for re-organisation and insolvency resolution of the corporate debtor who is not in a position to pay its debt and commits default in that regard. It is open to the corporate debtor to pay off the debt, which had become due and payable and is not paid by the principal borrower, to avoid the rigours of Chapter II of the Code in general and Section 7 in particular.

In law, the status of the guarantor, who is a corporate person, metamorphoses into corporate debtor, the moment principal borrower (regardless of not being a corporate person) commits default in payment of debt which had become due and payable. Thus, action under Section 7 of the Code could be 23 legitimately invoked even against a (corporate) guarantor being a corporate debtor. The definition of "corporate guarantor" in Section 5(5A) of the Code needs to be so understood."

While dismissing the appeal, the court also rejected the contention regarding the maintainability of the application filed by the financial creditor under Section 7 of the Code on the ground of being barred by limitation. The court said that a fresh period of limitation is required to be computed from the date of acknowledgment of debt by the principal borrower from time to time and in particular the (corporate) guarantor/corporate debtor vide last communication dated 08.12.2018.

Case:  Laxmi Pat Surana vs. Union Bank Of India [CA 2734 OF 2020]

Coram: Justices AM Khanwilkar, BR Gavai and Krishna Murari

Counsel: Adv Abhijit Sinha, Adv O.P. Gaggar

Citation: LL 2021 SC 186

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