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Action under Section 7 IBC will lie against guarantor which is a corporate person though principal borrower is not a corporate person: SC

We find no substance in the argument that since loan was offered to a proprietary firm (not a corporate person), action under S. 7 cannot lie against the corporate person though it had offered guarantee, the Court held.

Action to initiate Corporate Insolvency Resolution Process under Section 7 of the Insolvency and Bankruptcy Code, 2016 (IBC) can be initiated by the financial creditor (Bank) against a corporate person concerning guarantee offered by it in respect of a loan account of the principal borrower, who had committed default, even if the principal borrower is not a ‘corporate person’, the Supreme Court held (Laxmi Pat Surana v. Union Bank of India).

The Court rejected the argument that if 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.

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

“We find no substance in the argument advanced before us that since the loan was offered to a proprietary firm (not a corporate person), action under Section 7 of the Code cannot be initiated against the corporate person even though it had offered guarantee in respect of that transaction,” the Court ruled.

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 the corporate debtor, the Court clarified.

The judgment was delivered by a three-judge Bench of Justices AM Khanwilkar, BR Gavai and Krishna Murari in an appeal against a judgment of the National Company Law Appellate Tribunal

Background

The respondent bank had extended two loans to M/s. Mahaveer Construction (Principal Borrower), a proprietary firm of the appellant Laxmi Pat Surana, through two loan agreements in years 2007 and 2008.

M/s. Surana Metals Limited, of which the appellant is also a Promoter/Director, had offered guarantee to the two loan accounts of the Principal Borrower.

The loan accounts were declared NPA on January 30, 2010. The Financial Creditor then issued a recall notice on 19.2.2010 to the Principal Borrower, as well as, the Corporate Debtor, demanding repayment of outstanding amount.

The Financial Creditor then filed an application under Section 19 of the Recovery of Debts Due to Banks and Financial Institutions Act, 19936 against the Principal Borrower before the Debt Recovery Tribunal7 at Kolkata.

During the pendency of the same, the Principal Borrower had repeatedly assured to pay the outstanding amount, but as that commitment remained unfulfilled, the Financial Creditor eventually wrote to the Corporate Debtor on December 3, 2018 in the form of a purported notice of payment under Section 4(1) of the Code.

The Corporate Debtor replied to the said notice of demand vide letter dated December 8, 2018, inter alia, clarifying that it was not the Principal Borrower nor owed any financial debt to the financial creditor and had not committed any default in repayment of the stated outstanding amount.

The Financial Creditor then proceeded to file an application under Section 7 of the Code on Fabruary 13, 2019 for initiating Corporate Insolvency Resolution Proceeding against the Corporate Debtor,

before the National Company Law Tribunal, Kolkata

The NCLT said that the Corporate Debtor had become liable to be proceeded with under Section 7 of the Code and the same decision was affirmed by the NCLAT leading to the appeal before the Supreme Court.

Argument

The appellant’s argument was that Section 7 plainly ordains that an application can be filed by a financial creditor only against the corporate debtor.

A corporate debtor can either be a corporate person, who had borrowed money or a corporate person, who gives guarantee regarding repayment of money borrowed by another corporate person.

In other words, the Code cannot apply in respect of “debts” of an entity who is not a “corporate person”, it was contended.

To buttress this argument, it was pointed out by the appellant that its stance is reinforced by the fact that initiation of insolvency of firms and/or individuals in terms of Part III of the Code has still not been notified.

It was, therefore, urged that any other view would inevitably result in indirectly enforcing the Code even against entities, such as partnership firms and proprietorship firms and/or individuals, who are governed by Part III of the Code, without notifying the same.

Judgment

The Court examined the definition of various terms under the IBC including “financial creditor” “financial debt”, “debt”, “claim” and “default”.

From the same it held that 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,” the Court observed.

Further, the Court also proceeded to place reliance on Section 3(37) of the IBC which lays down that the words and expressions used and not defined in the Code, but defined in enactments referred to therein, shall have the meanings respectively assigned to them in those Acts.

The question before the Court was whether a corporate person who has given guarantee would be a corporate debtor within the meaning of Section 3(8) of the IBC if the principal borrower is no a corporate person.

Drawing support from Section 3(37), it must follow that the lender would be a financial creditor within the meaning of the Code, the Court said.

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

“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,” the judgment said.

The court also turned down the contention of the appellant based on limitation and dismissed the appeal.

Source
Via Bar & Bench
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