Corporate Law Daily
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Today’s newsletter analytically summarizes the top Corporate Law stories reported at taxmann.com.
I. Introduction
The Hon'ble Supreme Court of India in the case of?Laxmi Pat Surana?v.?Union Bank of India and Another ?("Laxmi Pat Surana"), has upheld the validity of an Application under Section?7?of the Insolvency and Bankruptcy Code 2016 ("IBC"), against a corporate person who stood as a guarantor for the debt of a sole proprietorship firm. This article seeks to analyse the decision of the Hon'ble Supreme Court of India in the case of?Laxmi Pat Surana?(Supra) in the backdrop of the objective and the scheme of the IBC.
Prior to the enactment of the IBC, the Personal and Corporate Insolvency regime in India was scattered in different enactments. Personal Insolvency was regulated by the Presidency Towns Insolvency Act, 1909 ("PTI Act, 1909") (applicable to Mumbai, Kolkata, and Chennai) and the Provincial Insolvency Act, 1920 ("PI Act, 1920") (applicable to the rest of the country), and corporate insolvency was mainly governed by the provisions of the Companies Act, 2013, Limited Liability Partnership Act, 2008 and the Sick Industrial Companies (Special Provisions) Act, 1985.
With the advent of IBC, the Legislature has enacted the repeal (not notified) of the PTI Act, 1909 and the PI Act, 1920, and provisions for personal insolvency are included in Part III of the IBC. Part III of the IBC is applicable to individuals and partnership firms. However, the provisions of Part III have not yet been notified even after more than 5 years of implementation of IBC. By a Press Release, the Ministry of Finance, Government of India clarified that as Part III of the IBC has not been notified to date, the stakeholders must pursue their insolvency cases under existing enactments before appropriate fora?and not claim that their matters be dealt with provisions of the IBC which are in force.
II. Recent Amendments
The Insolvency and Bankruptcy (Second Amendment) Act, 2018?inserted the definition of 'corporate guarantor' by insertion of sub-section 5A?after Section?5(5)?in Part II of the IBC. The definition was inserted with the objective of enabling the NCLT to deal with proceedings initiated against a Corporate Debtor and "its" (emphasis supplied) Corporate Guarantor.?Section?60?of the IBC was also suitably amended with the same objective.
Though the definition of Corporate Debtor is found in Part II of the IBC which deals with debts payable by Corporate Persons, the Courts have interpreted the definition of Corporate Debtor to include guarantors of sole proprietorship firms, individuals and partnership firms to fall within its ambit. The problem posed by such a wide interpretation is that the intention of the Parliament while demarcating the insolvency resolution scheme into two separate parts of the IBC was to treat the debts payable by Corporate Persons as one class and individuals and partnership firms as another class. There are wide differences in the insolvency resolution processes provided under Part II dealing with Companies and Part III dealing with individuals and partnership firms. The Parliament introduced amendments to Section 60 and then introduced Section 5(5A) with a view to consolidating the proceedings which may be initiated at different fora against a Corporate Debtor and its guarantor being either an individual or a company in one proceeding before one NCLT.
Section 60(3) of the IBC provides that,
"An insolvency resolution process or [liquidation or bankruptcy proceeding of a?corporate guarantor or personal guarantor, as the case may be, of the corporate debtor] pending in any court or tribunal shall stand transferred to the Adjudicating Authority dealing with insolvency resolution process or liquidation proceeding of such corporate debtor." (Emphasis supplied)
In the case of?Ferro Alloys Corpn. Ltd.?v.?Rural Electrification Corpn. Ltd. , the Financial Creditor filed an application under section 7 of IBC against the guarantor (being a company). The principal borrower was also a corporate person. The NCLAT held that such an application was maintainable as a Corporate Insolvency Resolution Process ("CIRP")can be initiated against a corporate guarantor before initiating a CIRP against the Principal Borrower. The Hon'ble Supreme Court upheld the order of the National Company Law Appellate Tribunal.?Pertinently this was a case where the Principal Borrower was also a corporate person.
In another case,?Dr Vishnu Kumar Agarwal?v.?Piramal Enterprises Ltd. ?proceedings under Part II of the IBC was initiated against two companies as they were guarantors of a debt owed by the All-India Society for Advance Education & Research, which is a society registered under the Societies Registration Act, 1860. The NCLAT had an opportunity to deal with two questions, the first one being relevant to the context hereof, whether the CIRP can be initiated against a 'Corporate Guarantor', if the 'Principal Borrower' is not a 'Corporate Debtor' or 'Corporate Person'??However, the NCLAT relying upon a judgement of the Hon'ble Supreme Court of India based on Section?128?of the Indian Contract Act, 1872?held that CIRP could be initiated against the guarantor before initiating any action against the Principal borrower.?Therefore, the NCLAT failed to answer the aforementioned question which was posed for adjudication having far-reaching ramifications.
The NCLAT in the case of?K. Paramsivam?v.?Karur Vyasa Bank and another?upheld an order passed by the NCLT allowing an application under Section 7 of the IBC against a Company which had guaranteed a debt borrowed by a Partnership firm and Sole proprietorship firm.
III. Case
In the case of?Laxmi Pat Surana?(supra) the Hon'ble Supreme Court of India held that an application under Section 7 of IBC can be filed against a company being a corporate guarantor for a debt owed by a Sole Proprietorship firm under Part II of IBC. Therefore, opening floodgates for many such cases where albeit the principal borrower may be an individual, sole proprietorship firm or partnership firm their debt could be a subject matter of proceedings under Part II of IBC.
The factual matrix is as follows. M/s Mahaveer Construction (being a Sole Proprietorship firm) had borrowed money against the payment of interest from the Bank and M/s Surana Metals Ltd. (being a company registered under the Companies Act, 2013) stood as a guarantor in respect of the loan facilities availed by M/s Mahaveer Construction. The Bank initiated an action against the principal borrower before the Debt Recovery Tribunal, Kolkata. During the pendency of the action against the principal borrower, the bank filed an application under Section 7 of the IBC against M/s Surana Metals Ltd for the debt borrowed by M/s Mahaveer Construction.?The Supreme Court while handing down the judgement analysed various definitions under the IBC including that of "financial debt" under Section 5(8) under Part II of the IBC and arrived at the conclusion that an application under Section 7 of the IBC would be maintainable against the guarantor. The Court relied upon Section 128 of the Contract Act, 1872 to hold that as the liability of the surety is coextensive with the principal borrower, the creditor can maintain the application against the guarantor and concluded that on default of repayment of the loan amount 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.?Further, the Hon'ble Court analysed Section 7 and held that an application can be filed against a corporate person assuming the status of corporate debtor by offering a guarantee.
IV. Analysis
Contracts of the guarantee are governed by Chapter VII of the Indian Contract Act, 1872. The liability of the surety is "joint and several" and "co-extensive with that of the principal borrower". The Hon'ble Supreme Court of India has emphasised that joint and several liabilities are the key features of the contract of guarantee.?The liability of the surety and principal borrower is co-extensive and not an alternative.?The surety would be subrogated to the position of the creditor once he pays off the debt for the principal borrower.?In India, the principle of subrogation is embodied in Section?140?of the Indian Contract Act, 1872.
It is submitted with the greatest respect that by applying this principle to the facts of the case before the Apex Court in?Laxmi Pat Surana, the guarantor M/s Surana Metals Ltd would have to recover the debt from M/s Mahavir Constriction (being a sole proprietorship) after paying off the debt owed to the bank. However, as Part III has not been notified, M/s Surana Metals Ltd would be unable to pursue the remedy under the IBC against M/s Mahavir Construction and would have to take steps under the already existing mechanism. In view thereof, the remedy under Part III is unavailable for the debt owed by the sole proprietorship firm. The end result would be to put the guarantors at the peril of undergoing a CIRP or liquidation whilst letting the principal borrower go scot-free under IBC.
It is noteworthy that the Courts have decided cases in teet of the right of subrogation of the guarantors under the IBC. In the case of?Lalit Mishra?v.?Sharon Bio Medicine Ltd.,?the National Company Law Appellate Tribunal rejected the contention of the promoters (personal guarantors) that the Resolution Plan violated the principles under Section?133?and 140 of the Indian Contract Act, 1882 and therefore denied the personal guarantor the right of subrogation which is deeply embedded in the law of contracts in India. In the case of?Committee of Creditors of Essar Steel India Ltd?v.?Satish Kumar Gupta ,?the Hon'ble Supreme Court of India?inter alia?upheld the provision under the resolution plan providing for extinguishment of the right of subrogation on the backdrop of the clean slate theory.
Applying the aforesaid principles, the NCLT has recently allowed an Application under Section?95?of the IBC by a Financial Creditor against a Personal Guarantor after the approval of the resolution plan as the debt was not fully recovered.?The liability of a Personal Guarantor to pay off on behalf of the principal borrower does not end even with the resolution plan being approved. As opposed to the principal borrower who is let off in spite of creditors facing various haircuts, the guarantor is in a precarious situation because the clean slate theory does not apply to the guarantors and therefore they are not discharged from the debts.
This leads to an absurd situation wherein a guarantor has to undergo CIRP merely because it is a company and has stood as a guarantor to a debt of a corporate person or an individual or a partnership firm or a sole proprietorship while there is no equally efficacious remedy against the principal borrower being the individual or a partnership firm or a sole proprietorship because Part III of the IBC is not notified.
V. The Box
The division of debts borrowed by Corporate Persons under Part II and debts borrowed by individuals and partnership firms under Part III shed light on the intention of the legislature as IBC was originally enacted— to segregate claims against Companies/LLPs and claims against individuals/partnership firms into Part II and Part III of the IBC. However, time and again there have been several amendments made to the IBC which seem to create a daze over the strict bifurcation between the two classes of claims. Section 60 of the IBC was amended in 2018 with a view to allowing the NCLT to exercise jurisdiction over the personal guarantors and corporate guarantors of corporate debtors and consolidate the proceedings which may be initiated at different forums against a Corporate Debtor.
Parliament wanted to deal with personal guarantors [under Section 2(e)], differently from partnership firms and proprietorship firms [under section 2(f),] and individuals other than persons referred to in Section?2(e)?[under Section 2(g)].
The recent case laws have once again created a need for either an amendment or at least a revisit of the legal position under IBC relating to guarantors. The possibility of collateral proceedings being initiated against an individual, sole proprietorship firm or a partnership firm along with initiation of CIRP against the guarantor being a corporate person to any of them could result in?inter alia?inconsistencies and contradictions.
It is trite law that what cannot be done directly cannot be done indirectly.?Therefore, if action against individuals and partnership firms cannot be initiated under Part II of the IBC then initiation of action against the guarantor of debts owed by such individuals and partnership firms under Part II merely because they are companies must also be impermissible. A Press Release issued by the MCA also echoes the same sentiment.
In the case of?Alpha and Omega Diagnostics (India) Ltd.?v.?Asset Reconstruction Co. of India Ltd. ,?the NCLAT upheld the judgment of the NCLT wherein the NCLT interpreted the term "its" appearing in Section?14?of IBC to denote that moratorium shall be declared for prohibiting any action to recover or enforce any security interest created by the Corporate Debtor in respect of "its" property i.e. the Corporate Debtor's property only and not any other property. The NCLT applied the doctrine of Noscitur A Sociis to arrive at the said conclusion.
The definition of Corporate Guarantor specifically lays down that it
"means acorporate person who is the surety in a contract of guarantee?to a corporate debtor"?(emphasis supplied).
By reading the plain language of the definition it follows that the intention of the Legislature in introducing the term corporate guarantors vide the 2018 Amendment was to make the Part II of the IBC applicable to Corporate Guarantors to Corporate Debtors.
In the case of?Laxmi Pat Surana, the Supreme Court remarked that
"if the legislature intended to exclude a corporate person offering guarantee in respect of a loan secured by a person not being a corporate person, from the expression "corporate debtor" occurring in Section 7, it would have so provided in the Code (at least when Section 5(5A) came to be inserted defining expression "corporate guarantor")."?
As noted above, the Supreme Court in?Laxmi Pat Surana?relied upon the definition of 'Corporate Debtor' and 'Financial Debt' to conclude that an application against a company which has offered a guarantee would be maintainable under Part II of the IBC. In the author's humble opinion, the Legislature has expressed its intent by amending Section 60 and inserting Section 5(5A) in Part II of the IBC which is applicable to debts borrowed by Corporate Debtor. The Court has adopted a piecemeal approach of looking at a few definitions in Part I and Part II whilst completely ignoring not only the provisions of Part III as though they don't exist in the statute book but also the intent behind introducing a separate scheme for individuals and partnership firms. A harmonious construction of the scheme of IBC would aid in elucidating the true intent of the Legislature.
VI. Conclusion
The Courts have allowed a backdoor entry to the dealing with debts of individuals and partnership firms into the provisions of Part II of the IBC. Debts of partnership firms and sole proprietorship firms are separately provided for in Part III of the IBC. Merely because Part III has not been enforced even after five years of the IBC coming into force cannot justify complete ignorance of the classification and fit them all under Part II. This would render this an instance of indirect judicial legislation. This one size fits all approach adopted by the Courts has opened pandora's box. As a result, cases for debts payable by Partnership firms and individuals may come before the already overburdened NCLT.
This would also create room for forum shopping when Part III is brought into force. If a creditor finds Part II more effective or NCLT more effective, it will prefer recovery against the guarantor and if the creditor finds Part III better or DRT more effective it will prefer recovery behind the firm or the individual.
As amendments were introduced to consolidate proceedings against personal guarantors and corporate debtors, amendments may become necessary when the DRT is in seisin of proceedings under Part III (when enforced) and applications are continued to be filed under Part II against the guarantor.
When the legislature amended the IBC to allow NCLT to have jurisdiction for corporate guarantors, its intention was to reduce or eliminate the possibility of a multiplicity of proceedings resulting in conflicting decisions. However, the decision in the case of?Laxmi Pat Surana?has revived the debate on the possibility of a multiplicity of proceedings and conflicting decisions and hence reintroduced the perplexity.
As a result of the opening of Pandora's box, Corporates will have to be wary next time they intend to give a guarantee for a debt owed by a promoter or promoter's proprietorship firm because the default could drag the guarantor company to the CIRP.
In the instant case, the corporate insolvency resolution process (CIRP) was initiated against the corporate debtor and the appellant filed its claim before Resolution Professional (RP) and submitted proof of claim. The RP rejected a claim of the appellant on the ground that proof of claim was submitted eight days after the expiry of 270 days of the CIRP period. ?
The appellant filed an application before the Adjudicating Authority (NCLT) seeking direction to RP for verification of its claim and giving it a rightful place in CoC. Meanwhile, an application was filed by a prospective resolution applicant before the NCLT. ?
The NCLT, without considering the application of the appellant, passed impugned order directing CoC existing as on date to consider the resolution plan filed by the resolution applicant while allowing exclusion of 245 days from the CIRP period. ?
Thereafter, an appeal was made to the National Company Law Appellate Tribunal (NCLAT) against the order passed by the National Company Law Tribunal (NCLT). ?
The appellant contended that the impugned order passed by the NCLT excluded its rightful position in the CoC as its claim was not considered by the RP and the application filed by the appellant to condone the delay in submission of the document in support of its claim was not decided in time by the NCLT. ?
It was noted that certain yardsticks of natural justice were considered by the NCLT in relation to the application of prospective resolution applicant regarding consideration of its proposed resolution plan and exclusion of time period from the CIRP period, however, no such opportunity was given to the appellant who had been pursuing matter diligently. ?
The NCLAT held that since the exclusion of 245 days had been granted in the CIRP period, the benefit of condonation of delay should have also been available to the appellant. Therefore, a delay of 8 days in filing proof of claim by the appellant was to be condoned and RP was to be directed to consider the proof of claim of the appellant.
That’s it from us for today! Stay Tuned for more updates from?Taxmann.com
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