[Mayank and Kanishka are students at Hidayatullah National Law University Raipur.]
The Supreme Court of India’s recent ruling in the case of BRS Ventures v. SREI Infrastructure Finance Limited and Another has highlighted the intricate relationship between the Insolvency and Bankruptcy Code 2016 (IBC) and the Indian Contract Act 1872 (Act).
Before delving into the core issues relating to the interplay of contract and insolvency laws, it is pertinent to briefly state the facts of the case. The financial creditor (FC) granted a loan of INR 100 crores to the corporate debtor (CD), secured by a corporate guarantee, the guarantor being the holding company of the CD. The CD committed a default in the repayment, resulting in the FC invoking the corporate guarantee. Thereafter, an application under Section 7 of the IBC was filed against the guarantor by the FC before the adjudicating authority since the guarantee was not honored. The appellant submitted the resolution plan, which was accepted by the committee of creditors, and thus, is a successful resolution applicant of the holding company. The appellant paid a part of the debt in full and final settlement to the financial creditor. Thereafter, the financial creditor filed an application under Section 7 of the IBC against the CD, which was admitted by the adjudicating authority.
The debate pertains to the permissibility of simultaneous or subsequent corporate insolvency resolution proceedings (CIRP) against the principal debtor and the corporate guarantor under the IBC. The court stated that the insolvency resolution of the corporate guarantor will not preclude the financial creditor from initiating another insolvency proceeding against the principal debtor. It further clarified that part payment of the debt by the successful resolution applicant of the corporate guarantor will not lead to the discharge of the principal debtor from repaying the balance debt. Another aspect dealt with by the court relates to whether the assets of the CD would be included in the liquidation estate of the guarantor. The court has answered the question negatively, relying on the principle of separate legal existence of the two entities. Through the article, the authors analyze these aspects pertaining to insolvency proceedings in contract of guarantee cases by the creditor in light of the above case.
The Permissibility of Subsequent or Simultaneous CIRP: Liability under Contract Law and Insolvency Regime
The IBC allows for concurrent or subsequent CIRP against the CD and the guarantor. The rationale behind this is rooted in enhancing the FC’s ability to recover its dues. Section 60(2) of the IBC explicitly permits for the initiation of simultaneous CIRP proceedings under Section 7 of the IBC by the FC against the guarantor and the CD. This is consistent with the rule of guarantee, which calls for the co-extensive liability of the principal debtor and the surety as provided under Section 129 of the Act.
While deliberating on the liability under a contract of guarantee, the court relied on the judgement in Maharashtra SEB v. Official Liquidator, wherein the same court laid down crucial principles pertaining to the liability of the guarantors. The court enumerated that according to Section 128 of the Act, “the liability of the guarantor is co-extensive with that of the principal debtor, and the liquidation of the principal debtor does not absolve the guarantor of the liability under the guarantee.” The Bombay High Court in Jagannath Ganeshram Agarwal v. Shivnarayan Bhagirath held that “the liability of the surety is co-extensive but is not in the alternative, meaning thereby that both the debtor and the surety are liable to the creditors at the same time.”
In Lalit Kumar Jain v. Union of India, the court dealt with the question of liability of surety post-approval of the resolution plan of the corporate debtor. The court held that the surety is liable to pay the remaining amount of debt post-approval of the resolution plan of the CD due to the fact that the contract between the creditor and surety is independent. Drawing from the above, on a similar line of reasoning, the resolution of the corporate guarantor would not absolve the liability of the CD. Thus, in a case wherein a part of the debt has been recovered through the resolution of the guarantor, the creditor can file a CIRP application against the principal debtor for the remaining amount.
Further, relying on the judgement of the UK Supreme Court in re Kaupthing Singer and Friedlander Limited, the court delved into the principle of double proof (or double dip). The concept of double proof of the same debt against two separate estates prevents the recovery of the same debt against the same estate, thereby leading to the payment of double dividend out of one estate. Double proof in guarantee contracts in the context of insolvency proceedings prevent the creditor from recovering the same debt from the surety and the principal debtor at the same time by filing his claim against both the principal debtor and the surety, when both are undergoing CIRP or liquidation. However, it must be noted that double proof prevents the payment of a double dividend out of one estate and does not come into play at the stage of filing of claim during CIRP or liquidation. The above position has been reiterated by the National Company Law Appellate Tribunal in Dr. Vishnu Kumar Agarwal v. Piramal Enterprises Limited. Thus, the creditor is not barred from filing a claim for the same debt with the IRP or the Liquidator of both the principal debtor and the surety, but he cannot claim any amount more than the total amount of debt owed.
Section 134 of the Act talks about the discharge of the surety in case the principal debtor is discharged or released through a contract between the principal debtor and the creditor. Thus, where the creditor and principal debtor voluntarily enter into a contract, the legal effect of which leads to the discharge of the principal debtor, the surety also stands discharged. However, the surety is not discharged in cases where the resolution plan of the principal debtor is approved. This is because the principal debtor is discharged by virtue of the operation of law through an involuntary process., which is not encompassed by Section 134.
Moreover, the court rightly concluded that the right of subrogation under Section 140 of the Act is an equitable right that arises only when the surety pays the entire amount to the creditor under the guarantee. Thus, the surety can step into the shoes of the creditor only when he pays the entirety of the amount payable under the guarantee. In cases where the surety has partly discharged his liability, he can only claim that part that he has discharged from the principal debtor without prejudicing the liability of the principal debtor towards the creditor.
Holding Company and Subsidiary: Separate Entities, Distinct Assets
Another issue before the court, as argued by the appellants, was whether the assets of the subsidiary company (principal debtor) would form part of the CIRP of the holding company (surety). The court, relying on the principle of separate legal existence, stated that the subsidiary company is a distinct entity from the holding company, and the assets of the subsidiary cannot form part of the CIRP of the holding company. This is in tune with the logic that the holding company holds shares of the subsidiary and is interested in the profits made by the subsidiary for the purposes of declaring dividend. Hence, holding shares of the subsidiary does not make the holding company the owner of its assets. The court correctly relied on the view taken by the Supreme Court of India in Vodafone International Holdings BV, wherein it was held that in the event of the winding up of the subsidiary, the assets of the subsidiary do not belong to the holding company, but rather the liquidator takes over its assets.
Furthermore, the scheme of the IBC clearly excludes the assets of the subsidiary to be included in the CIRP/liquidation of the holding company. The explanation to Section 18 provides a negative definition of the term assets. It states that assets shall not include “(b) assets of any Indian or foreign subsidiary of the corporate debtor.” Moreover, Section 36(4) provides for a list of assets not included in the liquidation estate. Sub-section 4 categorically excludes “(d) assets of any Indian or foreign subsidiary of the corporate debtor.” Hence, there is not an iota of doubt that the assets of the subsidiary do not form part of the CIRP or the liquidation proceedings of the holding company, and the creditor can proceed against the subsidiary under Section 7 after the approval of the resolution plan of the holding company.
Conclusion
The ruling in this case has provided clarity on the intersection of guarantee contracts and insolvency and bankruptcy laws. The court has rightly upheld the permissibility of simultaneous CIRP against the CD and its guarantor. This approach is in tune with the objectives of the IBC, which allow creditors to fully pursue their claims for an effective insolvency resolution process. The guarantor in this case was also the holding company of the CD, thus, giving rise to another aspect as to whether the assets of the holding company would form part of the resolution plan or the liquidation estate of the CD. The court has categorically laid down that the holding company can lay a claim over the assets of the subsidiary, and the resolution plan of the holding company can only include the ownership of the shares in the subsidiary. Lastly, the court shed light on the principle of subrogation by stating that the principal of subrogation is an equitable right that becomes applicable only when the surety has made the payment of the entire debt to the creditor. In the case of a part payment, the surety can only claim the part payment from the principal debtor, which should not be to the prejudice of the creditor. Concludingly, the judgement has wide implications for contracts of guarantee in the context of insolvency proceedings of the principal debtor and the surety.
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