Liability of the personal guarantor of the debtor company vis-à-vis the insolvency and bankruptcy code

In accordance with article 128 of theIndian Contracts Act, 1872, the liability of a guarantor coincides with that of the principal debtor. Furthermore, it is well established law that upon the conclusion of insolvency proceedings against a principal debtor, this amounts to the extinction of all claims against the principal debtor, except to the extent permitted in the insolvency resolution process itself via the approval of the resolution plan by the National Company Law Tribunal (“NCLT”). This is clear from Section 31 of the Insolvency and Bankruptcy Code 2016 (“IBC”) which makes the resolution plan approved by the contracting authority, i.e. NCLT, binding on the debtor company, its creditors and its guarantors.

Consequently, the question arises as to whether the liability of the personal guarantor of the corporate debtor is extinguished when the secured financial creditor receives payment of part of its claim on the basis of full and final settlement in terms of resolution approved by NCLT. The answer to this question was finally decided by the Supreme Court in Lalit Kumar Jain v. Union of India & Ors. However, this issue is best understood by analyzing the case law in this regard.
In Maharashtra State Electricity Board v. Official Liquidator, High Court, Ernakulam & Anr.2, a divisional bench of the Supreme Court held that, although under section 134 of the Contracts Act, a surety is released by any contract between the creditor and the principal debtor by which the debtor principal is released or by any act or omission of the creditor, the legal consequence of which is the release of the principal debtor, however, a release which the principal debtor may obtain by operation of law in the event of bankruptcy or liquidation in the case of a company does not exonerate the surety from liability although the liability of the surety is equivalent to that of the principal debtor under section 128 of the Contracts Act.
In Shri Kundanmal Dabriwala vs Haryana Financial Corporation & Anr, a divisional bench of the High Court of Punjab and Haryana while relying on Section 135 of the Indian Contracts Act, which states that a contract between the creditor and the principal debtor whereby the creditor settles with the principal debtor, releases the surety; has concluded that the plan of arrangement sanctioned by the Court in exercise of its jurisdiction under Section 391 of the Companies Act 1956 is binding on all creditors, including unwilling creditors. Such a scheme extinguishes the creditor’s remaining claim and, therefore, the surety is discharged. It was decided that:

“…after a fair reading of the provisions of the law on contracts, I am inclined to consider that the liability of the surety being coextensive with that of the principal obligor, if the liability of the latter is reduced in an amended decree, or otherwise extinguished in whole or in part by law, the liability of the surety is also reduced or extinguished pro tanto.”

However, subsequently, a single judge of the Calcutta High Court in Gouri Shankar Jain v. Punjab National Bank4, disagreed with the ratio of the High Court of Punjab and Haryana in the Kundanmal case. In the Gouri Shankar case, the Court held that a secured financial creditor who receives payment of part of its claim based on full and final settlement in terms of the resolution plan approved by NCLT does not extinguish liability of the surety of the debtor company. The sanctioned Resolution Plan cannot be interpreted as a modification of the terms of the contract between the principal debtor and the creditor, without the consent of the guarantor, releasing the guarantor as to the transaction after the variations or not at all in accordance with the article 133 of the law on contracts. It was decided that:

“Theoretically, since the liability of the surety is coextensive with that of the principal obligor, the obligee can act alone against the surety and recover the obligor’s liability from the surety. In such a situation, the subsequent reduction of the obligor’s liability to the surety, under bankruptcy or insolvency proceedings or otherwise, shall not obligate the creditor to repay the amount collected from the surety on behalf of the debtor to the surety.Prior to bankruptcy and insolvency, the creditor has the right to recover the after bankruptcy and insolvency proceedings of the debtor, the pre-bankruptcy and insolvency right of the creditor does not undergo any metamorphosis on the principle that, such proceedings emanate from a legal right and are involuntary in nature.”

The issue was finally settled by the Supreme Court in the Lalit Kumar case, in which the Supreme Court ruled that the approval of a resolution plan did not ipso facto relieve the personal guarantor of a debtor company of its obligations under the warranty contract. The release or release of a principal borrower from the debt he owes to his creditor, by an involuntary process, that is to say by operation of law, or following a procedure of liquidation or insolvency , does not relieve the guarantor of its liability, which arises from an independent contract.

The ratio in Lalit Kumar’s case is in line with the Supreme Court’s earlier decision in State Bank of India v. guarantors of a debtor company. In the Ramakrishnan case, it was further held that Article 14 refers only to debts owed by debtor companies, which are limited liability companies, and it is clear that in the vast majority of cases, guarantees personal data are given by the administrators who manage the companies. The purpose of the IBC is not to allow these guarantors to escape an independent and coextensive obligation to repay the whole of the outstanding debt, therefore Article 14 does not apply to them.

The Supreme Court report in the case of Lalit Kumar is a welcome decision as it finally settles the law on the above-mentioned issue. It ensures that personal guarantors do not escape their obligation to repay the debt to the creditor, when the creditor receives payment of part of their claim based on full and final settlement in terms of the approved resolution plan. by NCLT. In addition, pursuit of a creditor’s claim on a guarantor would not lead to a double recovery of debt since the creditor could only recover the balance remaining due and not recovered from the main borrower, following the payment made by the debtor company under the resolution plan approved by the NCLT.

The author is a barrister practicing in the courts of Bengaluru, the views are personal.