Supreme Court upholds NCLAT judgment ruling that insolvency proceedings may be invoked against corporate guarantor before proceeding against the principal debtor
On 11 February 2019, the Supreme Court dismissed the Civil Appeal bearing No. 1484 of 2019 filed by Rai Bahadur Shree Ram and Company Pvt. Ltd. (the shareholder and promoter of Ferro Alloys Corporation Limited) and affirmed the landmark judgment passed by the National Company Law Appellate Tribunal (NCLAT) in the matter of Ferro Alloys Corporation Limited v Rural Electrification Corporation Limited (Comp. App (AT) (Ins) No. 92 of 2017) and other connected appeals, in favour of Rural Electrification Corporation Limited (REC), the financial creditor.
In the said decision, the Supreme Court affirmed the NCLAT judgment which held that insolvency proceedings against the corporate guarantor may be undertaken without initiating prior proceedings against the principal debtor under the Insolvency and Bankruptcy Code 2016 (Code).
In the present case, REC served as a financial creditor and had sanctioned a loan amounting to INR 517.90 Crores to FACOR Power Limited, the principal debtor. Ferro Alloys Corporation Limited (Ferro Alloys) was the corporate guarantor of the said loan and had, therefore, undertaken to guarantee all amounts payable by FACOR Power Limited to REC. When FACOR Power Limited failed to repay the loan, REC invoked the corporate guarantee against Ferro Alloys on 27 October 2015. Thereafter, on the failure of Ferro Alloys to repay the loan, REC filed an Application under Section 7 of the Code before the National Company Law Tribunal, Kolkata (NCLT) to initiate corporate insolvency resolution proceedings against Ferro Alloys. NCLT passed an order in favour of REC admitting the application and appointed an interim resolution professional. Ferro Alloys filed an appeal before the NCLAT impugning the NCLT order. Thereafter, two other appeals were filed on behalf of a consortium of banks (Lenders Consortium) and Rai Bahadur Shree Ram and Company Pvt. Ltd, the shareholder and promoter of Ferro Alloys.
The appellants submitted that while the Code includes the concept of a ‘personal guarantor’, it does not recognize the concept of a corporate guarantor. Therefore, an insolvency proceeding cannot be initiated against a corporate guarantor. Without conceding that a ‘corporate guarantor’ is subsumed within the definition of a ‘corporate debtor’, the appellants further contended that an insolvency proceeding cannot be initiated against the corporate guarantor without proceeding and exhausting the relief provided against the principal debtor.
On the other hand, REC submitted that the corporate guarantee provided by Ferro Alloys was unconditional, joint and several and co-extensive with that of the principal debtor and could be invoked even without exhausting the remedies against the principal debtor. It was further argued that a corporate guarantor becomes a corporate debtor as soon as a guarantee agreement is invoked. REC also argued that on a joint reading of Section 3(8) of the Code (which defines a ‘Corporate Debtor’ as “a corporate person who owes a debt to any person”) and Section 5(8) of the Code (which defines ‘Financial Debt’ as inter-alia, including “the amount of any liability in respect of any of the guarantee”) confirmed that a corporate person who owes a debt in the form of a liability in respect of a guarantee would be included in the definition of a “corporate debtor” under Section 3(8) of the Code.
NCLAT held that:
The Supreme Court has upheld and reaffirmed a long line of precedents under Indian and foreign contract and insolvency laws, which hold that a creditor may proceed against the guarantor on failure of the principal debtor to repay the loan upon demand by the creditor without exhausting his remedies against the principal debtor. If the argument of the appellants had been accepted, it would not only amount to rewriting the contract, but also reading provisions into a statute which is impermissible.
It is pertinent to note that the Insolvency and Bankruptcy Code (Second Amendment) Act, 2018 amended the Code to bring in Section 5A which defined ‘corporate guarantor’ as a corporate person who is the surety in a contract of guarantee to a corporate debtor. Section 60 of the Code has also been amended to provide for the same Adjudicating Authority to deal with the insolvency resolution or liquidation processes of the corporate debtor and its corporate guarantor. In view of the same, the argument that the Code does not recognize the concept of a ‘corporate guarantor’ along with the argument that an insolvency proceeding cannot be first initiated against the corporate guarantor without proceeding and exhausting the relief provided against the principal debtor becomes redundant and was therefore rejected by the Supreme Court.
Khaitan & Co represented Rural Electrification Corporation in the appeals.
- Vanita Bhargava (Partner), Wamika Trehan (Senior Associate), Zacarias Joseph (Associate) and Shweta Kabra (Associate)
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