Contract of guarantee
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This article is written by Sankeit Taneja, pursuing a Diploma in Advanced Contract Drafting, Negotiation and Dispute Resolution from Lawsikho.

Introduction

Contract of Guarantee is controlled by the under Chapter VIII of the Indian Contract Act, 1872. The fundamental purpose of a Contract of Guarantee is to protect the creditor’s interest which presumes a principal debtor and a liability for which the principal debtor is predominantly liable. Since the Insolvency & Bankruptcy Code has been enacted, there have been several issues with respect to credit in the credit market which was the prime objective of the Code when it was enacted.

Contract guarantee under Indian Contract Act, 1872

Section 126 of the Indian Contract Act, 1872 contains provision regarding contract guarantee. As per the said section, a contract of guarantee is a contract to execute the promise or discharge the liability of a third person in case of his default.

The person who gives the guarantee is called the Surety;

  • The person who creates the default with respect to which the said guarantee is arranged for, is called as the Principal Debtor,
  • And the person whom the guarantee is given is known as the Creditor.

In absenteeism of the four important elements of contract of guarantee i.e the Contract itself, Suretyship, Principal Debtor & the Creditor, the contract would be termed as a simple contract.

Status of contract of guarantee & the guarantor under Insolvency & Bankruptcy Code, 2016

In Alpha & Omega Diagnostics (India) Ltd. v. Asset Reconstruction Company of India Ltd. & Ors Company Appeal (AT) (Insol.) No. 116 of 2017, the Bombay High Court focused on the issue being if the creditor shall be entitled to sell the assets of the personal guarantor. While scrutinizing the word “it” mentioned under section 14 of Insolvency & Bankruptcy Code, 2016, the Court held that the moratorium is unavailable to the personal guarantors of the said corporate debtors. 

Section 14 (1)(c) of Insolvency & Bankruptcy Code, 2016 clearly states that during the period of moratorium, “any action to foreclosure, recover or enforce any security interest created by the corporate debtor in respect of its property.”

Section 126 of the Indian Contract Act 1872, the liability of the guarantor arises only when a default has been committed by the principal debtor while repaying the loan. Very similar relief has emerged under Insolvency & Bankruptcy Code, 2016 wherein the creditor is bound to prove that a default exists. Once it is proved then the Tribunal shall initiate Corporate Insolvency Resolution Process (CIRP) against the corporate debtor by appointing a Resolution Professional who shall then be responsible to look into the affairs of the company.

A contract of guarantee emphasizes on the breaking of a promise whereas the Code emphasizes on the existence of a default. Different to the proceedings carried out under the Code, a breach of contract guarantee can be bought before the Debt Recovery Tribunal.

As per section 60 of Insolvency & Bankruptcy Code, 2016, while Corporate Insolvency Resolution Process (CIRP) remains pending before the National Company Law Tribunal (NCLT), an insolvency process can be initiated against the personal guarantor as well in NCLT. In Sanjeev Shreya v. LML Industries Writ – C No. – 30285 of 2017, Allahabad High Court had arrived at a conclusion which stated that when Corporate Insolvency Resolution Process (CIRP) or liquidation proceedings has been commenced against the corporate debtor, a claim of insolvency or bankruptcy can also be commenced against the guarantor of the said corporate debtor.

The Creditor (either financial or operational) does not have to consume all the legal remedies available to him against the Debtor prior to the Corporate Insolvency Resolution Process (CIRP) being initiated. However, Creditor (either financial or operational) has the option to initiate Corporate Insolvency Resolution Process (CIRP) against the Guarantor than the Debtor

In State Bank of India v. V Ramakrishnan and Veesons Energy Limited, CP/510/IB/CB/2017, NCLAT had to deal with an issue that would affect the moratorium period under section 14 of the code applied to the Personal Guarantor. The NCLAT while relying on sextion14, 30 & 31 of the Code came to a conclusion that the period of moratorium would not only be applicable to the Principal debtor but also to the Personal Guarantor as well.

Insolvency Law Committee (ILC) conducted an in-depth analysis of the code and gave an amplification of section 14 of the code by stating that the assets of the Personal Guarantor shall not be within the scope of moratorium imposed under the code. Pursuant to the remarks of ILC, an amendment to the code was carried out in 2018 which stated that the moratorium shall not be applicable to the personal guarantor 

Governance of insolvency laws prior to the enactment of IBC

The Presidency Towns Insolvency Act, 1909 (for the presidency towns of Bombay, Madras, Calcutta) & the Provincial Insolvency Act, 1920 governed the jurisdiction over insolvency & bankruptcy of a person which included personal guarantors.

The above mentioned acts were replaced by the Insolvency & Bankruptcy Code, 2016 as the said acts lack provisions pertaining to appointment of resolution professionals to carry out insolvency procedure, lack of strict timeline, etc.

Procedure to initiate insolvency proceedings against personal guarantor under IBC Code, 2016

Before the Notification pertaining to section 60 of the Code, Debt Recovery Tribunal (DRT) had jurisdiction to entertain matters pertaining to Insolvency & Bankruptcy of Personal Guarantor. But it is not that after the said code came into force that DRT was withdrawn from its jurisdiction of Insolvency & Bankruptcy of Personal Guarantor. Both the courts of law i.e NCLT & DRT have jurisdiction over Insolvency & Bankruptcy of Personal Guarantor but the scenarios differ.

As per Section 60(2) & 60(3) of the Code, NCLT would have jurisdiction with respect to proceedings against Personal Guarantors who fall within the ambit of the two respective sections which include proceedings against corporate debtor which is pending or already filed during pendency of proceeding against personal guarantor. DRT would have jurisdiction with respect to individuals & firms including personal guarantors.

Before proceedings against the personal guarantor is commenced, the creditor is required to send a notice in compliance to section 95(4)(b) of Insolvency & Bankruptcy Code, 2016 by virtue of the said notice, the personal guarantor shall be entitled to pay the default amount of the principal debtor within 14 days from the date of delivery of notice. On the expiry of the said period mentioned in the demand notice, Insolvency Resolution Proceedings can be instigated against the personal guarantor under section 95 of the said code by filling Form C of Insolvency & Bankruptcy Rules. The said application shall be sent to the personal guarantor as well as the corporate debtor as the proceedings relate to each of them.

In Dr Vishnu Kumar Agarwal v. M/s Piramal Enterprise Ltd, Company Appeal No. 346 of 2018, the Hon’ble National Company Law Appellate Tribunal (NCLAT) accurately acknowledged that counter indemnity obligation with respect to a personal guarantor falls within the realm of “financial debt” defined under the Code. The appeal was filed by the Appellant against the order delivered by NCLT Delhi by allowing Insolvency Resolution Proceedings against two distinct corporate guarantors. The concern brought before NCLAT was to decide whether two distinct proceedings can commence the same default under section 7 of the code.

The verdict of NCLAT was that as there is no specific restriction against filling two applications under section 7 of the code against the Principal Borrower and the Guarantor(s), once the application has been filed under section 7 of the code by the creditor for a specific amount of claims & the said claim has been admitted against any one of the Corporate debtor, a second application by the Financial Creditor against the other Corporate Debtor cannot be filled.

The verdict in this particular appeal has been followed by NCLT around the country by asserting that duplicity by creditors of the exact similar amount and amount of default is not permissible.

It is important to know that simultaneous proceedings be declared admissible by tribunals not only to honour legislature’s intent but also protect shareholder’s interest.

It is pertinent for the Central Government to consider and work on the practical difficulties arising by the Tribunal when they handle matters on a day to day basis. The Central Government needs to work on reducing discrepancy between provisions which govern the said two distinct proceedings.

Conclusion

Though IBC code has bought immense relief in the process of insolvency and bankruptcy proceedings yet the relationship between contract of guarantee & the Insolvency & Bankruptcy Code, 2016 seems to be vague to some extent leading to a lack of balance while handling matters involving Guarantor of the Principal Debtor as apt interpretation of judiciary is required to fill in the gaps so left out because of uncertainty. IBC has brought a huge amount of changes with respect to the Insolvency Proceedings in our country. There’s a need for the Legislature to step ahead to protect the interests of creditors, lenders recovering debts by making provisions for commencing consolidated proceedings against the borrower and the surety.


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