INTRODUCTION:
In a recent judgment passed on 27th June 2022 in the case of Orbit Towers Pvt. Ltd. v. Sampurna Suppliers Pvt. Ltd., (hereinafter the “Case”), the NCLT Kolkata (hereinafter the “NCLT”) held that a Corporate Guarantor can initiate insolvency proceedings under Section 7 of the Insolvency & Bankruptcy Code, 2016 (hereinafter the “IBC”) against Principal Borrower using the Right of Subrogation even in the absence of any agreement between the Guarantor and the Principal Borrower. The NCLT has observed that the rights of the Creditor to recover the money from the Debtor would automatically be transferred in favor of the Surety/Guarantor. The Guarantor, who has performed the obligations of the Principal Debtor which are the subject of his guarantee, is entitled to stand in the shoes of the Creditor and to enjoy all the rights that the Creditor had as against the Principal Debtor. The present article seeks to analyze the current position of law regarding the right of subrogation available to the guarantor under the IBC.
FACTUAL BACKGROUND OF THE CASE:
Sampurna Suppliers Pvt. Ltd. (hereinafter the “Corporate Debtor”) required funds for its business and therefore, approached several banks and financial institutions for a loan. Pursuant thereto, Indian Bank agreed to grant a loan of Rs. 10,00,00,000/-(Rupees Ten Crores Only). The loan had to be secured by way of guarantees and other securities. In view thereof, the Corporate Debtor approached Orbit Towers Pvt. Ltd. (hereinafter the “Corporate Guarantor”) to act as a Corporate Guarantor for the loan in favor of Indian Bank. Further, the Corporate Debtor also requested the Corporate Guarantor to create an equitable mortgage of the property owned by the Corporate Guarantor. The Corporate Guarantor agreed to this.
The Corporate Guarantor and Corporate Debtor arrived at an understanding and arrangement wherein the Corporate Debtor was to repay the said loan along with the accrued interest and obtain the release of the mortgaged property. However, the Corporate Debtor failed to make payment of its dues including but not limited to the interest accrued.
Pursuant to several requests made by the Corporate Guarantor, the Corporate Debtor made part-payment of a sum of Rs. 2,60,00,000/- (Rupees Two Crore Sixty Lakhs only) to the Corporate Guarantor towards discharge of its liability, after which, a sum of Rs. 5,85,19,907/- (Rupees Five Crores Eighty-Five Lakhs Nineteen Thousand Nine Hundred and Seven only) remained due and payable to the Corporate Guarantor. The Corporate Debtor acknowledged its liability for the said sum to the Corporate Guarantor by signing a statement of balance confirmation on and from the year 01.04.2015 to 31.03.2016.
Since the Corporate Debtor defaulted in payment of the remaining dues to the Corporate Guarantor, the Corporate Guarantor filed a Section 7 application claiming to be a Financial Creditor under the IBC. The Corporate Debtor opposed the maintainability of the proceedings on the ground that the Corporate Guarantor had initiated the proceedings based on payments made by it to Indian Bank on behalf of the Corporate Debtor, the Principal Borrower of Indian Bank. It was the Corporate Debtor’s submission that the claim made by the alleged Financial Creditor in its capacity as guarantor did not fall within the definition of a financial debt under the IBC and therefore the Corporate Guarantor did not qualify as a Financial Creditor under the IBC. The NCLT noted that the instant case involved an interesting question of law pertaining to the rights of a guarantor upon having discharged the liability of the Principal Borrower, i.e., the Corporate Debtor. Accordingly, the NCLT proceeded to analyze the provisions of the Indian Contract Act, 1872 (hereinafter the “Contract Act”).
LEGAL ANALYSIS:
Right of Subrogation under the Contract Act
Sections 140 and 141 of the Contract Act provide for the right of subrogation. According to the said provisions, the Surety is invested with all the rights which the Creditor has against the Principal Debtor after it has paid the guaranteed debt upon the said debt becoming due or performed whatever it was liable for upon the Principal Debtor defaulting on the duty guaranteed.
The whole doctrine of principal and surety with all its consequences of contribution etc. developed from established principles of a court of equity is derived from common law. The Surety is entitled to every remedy against the Principal Debtor that the Creditor has against the Principal Debtor, to enforce every security and all means of payment, to step into the shoes of the Creditor, etc.
In Bank of Bihar v. Damodar Prasad, the Supreme Court has observed that it is the duty of the surety to pay the debt, and on such payment, the surety is entitled to recover the entire amount from the principal debtor. The right of Surety is not founded on the principles of contract but is rather based upon the principle of natural justice. The Surety is therefore entitled to every remedy that the Creditor has against the Debtor, to enforce every security and all means of payment, even by means of securities entered without the knowledge of Surety having a right to have those securities transferred to him. However, the right of subrogation has been given a different pedestal under the IBC regime which is discussed herein below.
Right of Subrogation under the IBC
In the present case, the Indian Bank, i.e., the Creditor did not initiate any proceedings under the IBC against the Corporate Debtor. Rather, the Corporate Guarantor repaid the loan amount and discharged the liability of the Corporate Debtor. In view thereof, the Corporate Guarantor contended that all the rights of the then Creditor, i.e., the Indian Bank were bestowed upon the Corporate Guarantor. The NCLT observed that since the Corporate Guarantor had repaid the amount of financial debt owed by the Corporate Debtor to the Indian Bank, the Corporate Guarantor will be treated as a “Financial Creditor” and shall be eligible to proceed against the Corporate Debtor without there being any agreement between the two.
As per the principles of the Contract Act, for a Guarantor to exercise its right of subrogation, it is not necessary to have an agreement in writing. Once the Guarantor discharges the liability of the Principal Borrower towards the Creditor, all the rights of the Creditor to recover the money get automatically transferred to the Guarantor. The NCLT further noted that the Corporate Guarantor, having performed the obligations of the Principal Debtor, is entitled to stand in the shoes of the Creditor and to enjoy all the rights that the Creditor would otherwise enjoy against the Principal Debtor.
In view thereof, Orbit Towers Pvt. Ltd. (the Corporate Guarantor) had, by repaying the debt on behalf of Sampurna Suppliers Pvt. Ltd. (the Principal Borrower) stepped into the shoes of Indian Bank (the Creditor). Accordingly, all the rights of Indian Bank stood subrogated in the favor of Orbit Towers Pvt. Ltd. who, is eligible and entitled to proceed against Sampurna Suppliers Pvt. Ltd. for recovery of the said dues. Thus, the petition under Section 7 of the IBC was held to be maintainable.
Similarly, in the case of Davindra Ahluwalia & Anr. v. M/s Sumit Aviation decided in 2017 by the NCLT Delhi, the NCLT admitted the petition of the Personal Guarantor under Section 7 of the IBC. In this case, the Personal Guarantor had discharged the liability of the Corporate Debtor. However, having failed to recover the dues from the Corporate Debtor, the Personal Guarantor initiated proceedings under Section 7 of the IBC against the Corporate Debtor which came to be allowed by the adjudicating authority. It is pertinent to note that whilst the NCLT Delhi admitted the petition in this case, the Bench did not discuss the provisions pertaining to the right of subrogation.
CONCLUSION
Presently, there are divergent views on the subject. In our opinion, the view of NCLT Kolkata in the Case is progressive and adequately safeguards the rights of the guarantors. Given that the liability of guarantors is co-extensive, the recent judgments will provide a much need layer of protection to Guarantors who have discharged their obligations under the contract of guarantee.
DISCLAIMER
This alert has been written for general information of our clients and should not be treated as a substitute for legal advice. We recommend that you seek proper legal advice prior to taking any action pursuant to this alert. We disclaim all liability for any errors or omissions. For further clarifications, you may write to Pooja Tidke (pooja.tidke@parinamlaw.com), Krushi N. Barfiwala (krushi.barfiwala@parinamlaw.com), Rima Desai (rima.desai@parinamlaw.com), and Divyanshu Gupta (divyanshu.gupta@parinamlaw.com)
