Introduction
The case of Suresh Kumar & Anr. v. Central Bank of India[i] highlights a critical interpretation of the rights and liabilities of personal guarantors under the Indian Contract Act, 1872 (‘ICA’) and the Insolvency and Bankruptcy Code, 2016 (‘IBC’). The dispute arose when personal guarantors, who had not discharged their liabilities under guarantees given for loans extended to the corporate debtor (‘CD’), sought recognition as financial creditors in the corporate insolvency resolution process (‘CIRP’). The National Company Law Appellate Tribunal (‘NCLAT’) clarified the conditions under which a guarantor can claim creditor rights, emphasizing that such rights arise only upon actual payment or performance of the guaranteed debt. This interpretation preserves the integrity of the IBC framework and safeguards the rights of secured creditors.
Brief Facts
The Central Bank of India, Respondent, extended financial facilities to M/s Ram Hari Auto Private Ltd., the CD, in 2012. Mr. Suresh Kumar and Mr. Rajesh Kumar, the Appellants, had provided personal guarantees for these loans.
In 2020, the CIRP was initiated against the CD following an application filed by an Operational Creditor. The Interim Resolution Professional (IRP) was appointed to further constitute a Committee of Creditors (‘CoC’) that initially included only unsecured financial creditors. Subsequently, the Respondent joined the CoC as a secured creditor and was allocated a voting share of 51.37%. During the second CoC meeting, the Respondent sought clarification regarding the claims admitted by the IRP for unsecured creditors through email correspondence.
Later, the Resolution Professional (‘RP’) reconstituted the CoC by adding the Appellants as unsecured financial creditors. The inclusion of their claims was based on a Recovery Certificate issued by the Debt Recovery Tribunal (‘DRT’), Chandigarh. As a result, the Respondent’s voting share was reduced from 51.37% to 26.86%, while each Appellant was allocated 23.85%.
The Respondent challenged this reconstitution of the CoC before the National Company Law Tribunal (‘NCLT’), filing an application seeking verification of claims and the reconstitution of the CoC, documentary evidence supporting the admission of claims of unsecured financial creditors, the release of assets unrelated to the CD, and the replacement of the IRP/RP for alleged fraudulent actions.
The NCLT upheld the Respondent’s objections, finding the Appellants ineligible to be CoC members as they had not made any payments to discharge their guarantee obligations. The NCLT directed the reconstitution of the CoC, prompting the Appellants to file the present appeal.
In the appeal, the Appellants argued that the NCLT had misinterpreted s. 140 of the ICA, which permits a guarantor to assume the creditor’s rights after fulfilling the guaranteed debt. They contended that the disposal of their mortgaged property by the Respondent constituted partial fulfilment of their obligations and that their claims should have been admitted as contingent or other creditors. They further alleged a violation of natural justice, as they were not given an opportunity to be heard.
The Respondent countered by arguing that the Appellants, as personal guarantors, had not repaid any debt despite a DRT decree and thus could not be recognized as financial creditors. The Respondent asserted that the Appellants’ inclusion in the CoC was improper, reducing the Respondent’s voting share from 51.37% to 26.86%, which reflected irregularities in the RP’s conduct.
Held
The NCLAT rejected the appeal filed by the personal guarantors and held that under s. 140 of the ICA, a guarantor can step into the creditor’s shoes only upon payment or performance of the guaranteed debt. It was held that a guarantor who has not discharged its liability cannot claim a right to payment against the principal debtor. It was further observed that as per s. 5(8)(i) of the IBC, a guarantee qualifies as financial debt only when liability arises with respect to the guarantee. The mere existence of a guarantee was held to be insufficient unless the guarantor had fulfilled its obligation under it.
The Tribunal observed that accepting non-paying guarantors as financial creditors would disrupt the statutory scheme of the IBC by disproportionately reducing the secured creditor’s voting share and granting undue rights to the guarantors. It was held that for a claim to be recognized under the IBC, there must be an existing right to payment, which arises for a guarantor only after they discharge their liability to the creditor. Since the Appellants, as personal guarantors, had not made any payment towards the guaranteed debt, they could not be considered financial creditors or allocated voting shares in the CIRP.
The NCLAT upheld NCLT’s decision, finding no error in excluding the Appellants from the CoC. However, it clarified that if the Appellants make any payment towards the debt before the closure of the CIRP, they may present such material to the RP for consideration as a contingent claim by the CoC. Thus, the appeal was dismissed, and the reconstitution of the CoC was affirmed.
Our Analysis
This decision is pivotal as it reinforces the principle of liability in the statutory framework of the IBC, which aims to streamline the CIRP while ensuring equitable treatment of stakeholders. By holding that guarantors can only be considered financial creditors upon discharging their liability, the judgment protects the voting rights of secured creditors from being disproportionately diluted by non-paying guarantors. It emphasizes that a mere guarantee does not qualify as financial debt under S. 5(8)(i) of the IBC unless a liability has arisen, thereby upholding the principle that a claim must involve a demonstrable liability arising from a guarantee.
The ruling also prevents misuse of the CoC framework by clarifying that guarantors who have not fulfilled their obligations cannot disrupt the resolution process or influence decisions. Furthermore, the Tribunal’s allowance for contingent claims, subject to payment by the guarantor during the CIRP, strikes a balance by ensuring that genuine contributions are considered while maintaining the sanctity of the insolvency process. This judgment provides crucial guidance on the treatment of guarantors’ claims, strengthening creditor confidence and the overall efficacy of the IBC framework.
End Note
[i] [2024] 169 taxmann.com 263 (NCLAT- New Delhi) [27-11-2024].
Authored by Shivam Mishra, Advocate at Metalegal Advocates. The views expressed are personal and do not constitute legal opinions.