State Bank of India & Ors. Vs. Mr. Prashant S. Ruia & Anr. - In the absence of any subsisting underlying debt due from ESIL, the Secured Financial Creditors cannot in law trigger the personal guarantees that have been given by the defendants.

  DRT Ahmedabad-1 (11.03.2022) in State Bank of India & Ors. Vs. Mr. Prashant S. Ruia & Anr.  [Interlocutory Application No.106 of 2022 in Original Application No. 650 of 2018 ] held that;

• It is required to be noted that in the present case, the principal debtor is discharged on account of assignment of the entire debt owed by it to the Applicant Banks. 

• The legal effect of such assignment is that the debt as a whole is discharged upon receipt of the amounts under the approved Resolution Plan, whereafter, the debt is totally extinguished leaving nothing for recovery from the guarantors. 

• It is therefore, clear that the sanction of a resolution plan and finality imparted to it by Section 31 does not per se operate as a discharge of the guarantor’s liability. As to the nature and extent of the liability, much would depend on the terms of the guarantee itself.

• In other words, in the absence of any subsisting underlying debt due from ESIL, the Secured Financial Creditors cannot in law trigger the personal guarantees that have been given by the defendants.

• That the present Original Application does not survive as the cause of action for recovery of alleged debt of the Financial Creditors has come to an end on assignment of the entire debt of the Corporate Debtor by the Financial Creditors in favour of AMIPL.

Excerpts of the order;

# 11. It is a settled law that the liability of a guarantor is co-extensive with that of the Principal Borrower as per Section 128 of the Contract Act. The Defendants in the present case admittedly stood as sureties for the financial assistance granted by the Applicants to Essar Steel and therefore they were jointly and severally liable to pay the dues of the Applicants along with the Principal Borrower. Therefore, the Applicants were entitled to file Original Application against the Principal Borrower and/or guarantors for recovery of their debt before this Tribunal u/s 19 of the RDB Act. Under the contract of guarantee executed with the Applicants, the Defendants were liable to pay the dues of the Applicants. It is a different matter that the Applicants later on entered into the Deed of Assignment for its debt with the Resolution Applicant— ArcelorMittal. But the contract of guarantee between the Applicants and Defendants was in existence at the time of filing the present OA and it is still subsisting . Therefore, the Applicants were entitled to recover their debt, if any, from the Defendants. In view of the provisions of Section 2(g) read with Section 19 of the RDB Act, it cannot be said that there was lack of inherent jurisdiction of this Tribunal at the time of filing the OA by the Applicants against the Defendants.

 

# 31. The ratio of law laid down by the Hon’ble Apex Court in Lalit Kumar Jain Vs. Union of India & Ors. is to the effect that the guarantors are not ipso facto absolved from their liability on approval of resolution plan. It is required to be noted that in the present case, the principal debtor is discharged on account of assignment of the entire debt owed by it to the Applicant Banks. The legal effect of such assignment is that the debt as a whole is discharged upon receipt of the amounts under the approved Resolution Plan, whereafter, the debt is totally extinguished leaving nothing for recovery from the guarantors. Moreover, the Applicant Banks have no dues recoverable from the principal borrower after assignment of debt. As stated hereinabove, if the Applicants have nothing to recover on the books of accounts from the principal borrower, the guarantors stand absolved from their liabilities under the guarantees and they stand discharged in spite of the fact that the personal guarantees have been retained and specifically excluded by the Applicant Banks in the approved Resolution Plan. Therefore, the aforesaid judgement would not be helpful to the Applicant Banks in the present case.

 

# 32. Upon a comprehensive reading of the decision of Hon’ble Supreme Court in Lalit Kumar Jain’s Case (Supra), the irresistible conclusion that emerges is that the Hon’ble Supreme Court has only dealt with the validity of the notification in relation to the personal solvency under the IBC and has restricted its analysis as regards the constitutionality of the Notification. While upholding the validity of the said Notification, the Court has not dwelt into individual facts and circumstances of any particular case. The instructive observations of the Hon’ble Supreme Court in Lalit Kumar Jain’s Case (Supra) are reproduced below;- 

• # 108. It is therefore, clear that the sanction of a resolution plan and finality imparted to it by Section 31 does not per se operate as a discharge of the guarantor’s liability. As to the nature and extent of the liability, much would depend on the terms of the guarantee itself. However, this court has indicated, time and again, that an involuntary act of the principal debtor leading to loss of security, would not absolve a guarantor of its liability.

 

From the judgment of Hon’ble Supreme Court of India, it is clear that both the nature as well as the extent to a guarantor’s liability in any particular case would depend upon the terms of the guarantee itself, which is an independent contract.

 

# 36. A conjoint reading of the clauses of the Deed of Guarantee and the approved Resolution Plan reveals that the Secured Financial Creditors have assigned their entire debt from the Borrower (i.e.ESIL) to the resolution applicant (i.e.Arcelor) under the Resolution Plan and have also accepted the amounts paid to them by Arcelor in discharge of the total debt owed by the ESIL to such Financial Creditors. This factual matrix invariably leads to the singular conclusion that the debt owed by the ESIL to the said Financial Creditors stands fully and finally satisfied.

 

# 39.  . . . . . . In the present case it is not disputed that the personal guarantees executed by the Defendants in favour of the Bank are retained by the assignor (Secured Creditors). However, it is also an admitted fact that the Secured Financial Creditors have under the Resolution Plan accepted the amounts paid to them by Arcelor in discharge of the total debt owed by the ESIL to such Financial Creditors. I am therefore of the view that there is no existing debt which can be claimed against the personal guarantees given by the defendants, for there is no subsisting underlying “debt” due from the Borrower (ESIL) which legally acts as a precondition for the Secured Financial Creditors to invoke the Guarantees. In other words, in the absence of any subsisting underlying debt due from ESIL, the Secured Financial Creditors cannot in law trigger the personal guarantees that have been given by the defendants.

 

# 40. In view of the aforesaid discussion, I am of the opinion that the present Original Application does not survive as the cause of action for recovery of alleged debt of the Financial Creditors has come to an end on assignment of the entire debt of the Corporate Debtor by the Financial Creditors in favour of AMIPL. In this context , it is worthwhile to refer to following observations of the Hon’ble Supreme Court in the case of “Shipping Corporation of India (Supra) ;-

• “Thus it is clear that by the subsequent event if the original proceeding has become infructuous, ex debito justitiae, it will be the duty of the court to take such action as is necessary in the interest of justice which includes disposing of infructuous litigation. For the said purpose it will be open to the parties concerned to make an application under Section 151 of CPC to bring to the notice of the court the facts and circumstances which have made the pending litigation infructuous. Of course, when such an application is made, the court will inquire into alleged facts and circumstances to find out whether the pending litigation has in fact become infructuous or not.”

 

# 41. In the facts and circumstances of the present case, I am inclined to exercise powers u/s 19(25) of the RDB Act (which are analogous to the powers of the Court u/s 151 of the CPC) to dismiss the present Original Application as having become infructuous. Hence, I pass the following order:

1. The present Interlocutory Application filed by the Defendants is allowed.

2. Since no debt is found due and recoverable by the Applicant Banks from the Defendants, the present Original Application is hereby dismissed with no order as to cost.

 

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Lalit Kumar Jain Vs, Union of India & Ors. - Approval of a resolution plan relating to a CD does not operate so as to discharge the liabilities of personal guarantors (to corporate debtors).

 Supreme Court (21.05.2021) in Lalit Kumar Jain Vs, Union of India & Ors. [Transferred Case  (CIVIL) NO. 245/2020] held that;

• It is held that the impugned notification was issued within the power granted by Parliament, and in valid exercise of it. The exercise of power in issuing the impugned notification under Section 1(3) is therefore, not ultra vires; the notification is valid.

• The object of the Code is not to allow such guarantors to escape from an independent and coextensive liability to pay off the entire outstanding debt, which is why Section 14 is not applied to them.

• it is held that approval of a resolution plan does not ipso facto discharge a personal guarantor (of a corporate debtor) of her or his liabilities under the contract of guarantee. As held by this court, the release or discharge of a principal borrower from the debt owed by it to its creditor, by an involuntary process, i.e. by operation of law, or due to liquidation or insolvency proceeding, does not absolve the surety/guarantor of his or her liability, which arises out of an independent contract.

• It is also held that approval of a resolution plan relating to a corporate debtor does not operate so as to discharge the liabilities of personal guarantors (to corporate debtors).

• it is difficult to accept Shri Rohatgi's argument that that part of the resolution plan which states that the claims of the guarantor on account of subrogation shall be extinguished, cannot be applied to the guarantees furnished by the erstwhile Directors of the corporate debtor.

 

Excerpts of the order;

I The Petitions and Common Grievances

# 2. The common question which arises in all these cases concerns the vires and validity of a notification dated 15.11.2019 issued by the Central Government (hereafter called “the impugned notification”). Other reliefs too have been claimed concerning the validity of the Insolvency and Bankruptcy (Application to Adjudicating Authority for Insolvency Resolution Process for Personal Guarantors to Corporate Debtors) Rules, 2019 issued on 15.11.2019. Likewise, the validity of regulations challenged by the Insolvency and Bankruptcy Board of India on 20.11.2019 are also the subject matter of challenge. However, during the course of

submissions, learned counsel for the parties stated that the challenge would be confined to the impugned notification.

 

# 100. It is clear from the above analysis that Parliamentary intent was to treat personal guarantors differently from other categories of individuals. The intimate connection between such individuals and corporate entities to whom they stood guarantee, as well as the possibility of two separate processes being carried on in different forums, with its attendant uncertain outcomes, led to carving out personal guarantors as a separate species of individuals, for whom the Adjudicating authority was common with the corporate debtor to whom they had stood guarantee. The fact that the process of insolvency in Part III is to be applied to individuals, whereas the process in relation to corporate debtors, set out in Part II is to be applied to such corporate persons, does not lead to incongruity. On the other hand, there appear to be sound reasons why the forum for adjudicating insolvency processes – the provisions of which are disparate- is to be common, i.e through the NCLT. As was emphasized during the hearing, the NCLT would be able to consider the whole picture, as it were, about the nature of the assets available, either during the corporate debtor’s insolvency process, or even later; this would facilitate the CoC in framing realistic plans, keeping in mind the prospect of realizing some part of the creditors’ dues from personal guarantors.

 

# 101. In view of the above discussion, it is held that the impugned notification is not an instance of legislative exercise, or amounting to impermissible and selective application of provisions of the Code. There is no compulsion in the Code that it should, at the same time, be made applicable to all individuals, (including personal guarantors) or not at all. There is sufficient indication in the Code- by Section 2(e), Section 5(22), Section 60 and Section 179 indicating that personal guarantors, though forming part of the larger grouping of individuals, were to be, in view of their intrinsic connection with corporate debtors, dealt with differently, through the same adjudicatory process and by the same forum (though not insolvency provisions) as such corporate debtors. The notifications under Section 1(3), (issued before the impugned notification was issued) disclose that the Code was brought into force in stages, regard being had to the categories of persons to whom its provisions were to be applied. The impugned notification, similarly inter alia makes the provisions of the Code applicable in respect of personal guarantors to corporate debtors, as another such category of persons to whom the Code has been extended. It is held that the impugned notification was issued within the power granted by Parliament, and in valid exercise of it. The exercise of power in issuing the impugned notification under Section 1(3) is therefore, not ultra vires; the notification is valid.

 

# 105. In Vijay Kumar Jain v. Standard Chartered Bank, this court, while dealing with the right of erstwhile directors participating in meetings of Committee of Creditors observed that:

• “we find that Section 31(1) of the Code would make it clear that such members of the erstwhile Board of Directors, who are often guarantors, are vitally interested in a resolution plan as such resolution plan then binds them. Such plan may scale down the debt of the principal debtor, resulting in scaling down the debt of the guarantor as well, or it may not. The resolution plan may also scale down certain debts and not others, leaving guarantors of the latter kind of debts exposed for the entire amount of the debt. The regulations also make it clear that these persons are vitally interested in resolution plans as they affect them”

 

# 106. The rationale for allowing directors to participate in meetings of the CoC is that the directors’ liability as personal guarantors persists against the creditors and an approved resolution plan can only lead to a revision of amount or exposure for the entire amount. Any recourse under Section 133 of the Contract Act to discharge the liability of the surety on account of variance in terms of the contract, without her or his consent, stands negated by this court, in V. Ramakrishnan where it was observed that the language of Section 31 makes it clear that the approved plan is binding on the guarantor, to avoid any attempt to escape liability under the provisions of the Contract Act. It was observed that:

• “25. Section 31(1), in fact, makes it clear that the guarantor cannot escape payment as the resolution plan, which has been approved, may well include provisions as to payments to be made by such guarantor.…” And further that:

• “26.1 Section 14 refers only to debts due by corporate debtors, who are limited liability companies, and it is clear that in the vast majority of cases, personal guarantees are given by Directors who are in management of the companies. The object of the Code is not to allow such guarantors to escape from an independent and coextensive liability to pay off the entire outstanding debt, which is why Section 14 is not applied to them. However, insofar as firms and individuals are concerned, guarantees are given in respect of individual debts by persons who have unlimited liability to pay them. And such guarantors may be complete strangers to the debtor - often it could be a personal friend. It is for this reason that the moratorium mentioned in Section 101 would cover such persons, as such moratorium is in relation to the debt and not the debtor.”

 

# 107. In Committee of Creditors of Essar Steel (I) Ltd. v. Satish Kumar Gupta (the “Essar Steel case”) this court refused to interfere with proceedings initiated to enforce personal guarantees by financial creditors; it was observed as follows:

• “106. Following this judgement in V. Ramakrishnan case [SBI v. V. Ramakrishnan, (2018) 17 SCC 394], it is difficult to accept Shri Rohatgi's argument that that part of the resolution plan which states that the claims of the guarantor on account of subrogation shall be extinguished, cannot be applied to the guarantees furnished by the erstwhile Directors of the corporate debtor. So far as the present case is concerned, we hasten to add that we are saying nothing which may affect the pending litigation on account of invocation of these guarantees. However, NCLAT judgement being contrary to Section 31(1) of the Code and this Court's judgement in V. Ramakrishnan case [SBI v. V. Ramakrishnan, (2018) 17 SCC 394], is set aside.”

 

# 108. It is therefore, clear that the sanction of a resolution plan and finality imparted to it by Section 31 does not per se operate as a discharge of the guarantor’s liability. As to the nature and extent of the liability, much would depend on the terms of the guarantee itself. However, this court has indicated, time and again, that an involuntary act of the principal debtor leading to loss of security, would not absolve a guarantor of its liability. In Maharashtra State Electricity Board (supra) the liability of the guarantor (in a case where liability of the principal debtor was discharged under the insolvency law or the company law), was considered. It was held that in view of the unequivocal guarantee, such liability of the guarantor continues and the creditor can realize the same from the guarantor in view of the language of Section 128 of the Contract Act as there is no discharge under Section 134 of that Act. This court observed as follows:

• “7. Under the bank guarantee in question the Bank has undertaken to pay the Electricity Board any sum up to Rs 50,000 and in order to realise it all that the Electricity Board has to do is to make a demand. Within forty-eight hours of such demand the Bank has to pay the amount to the Electricity Board which is not under any obligation to prove any default on the part of the Company in liquidation before the amount demanded is paid. The Bank cannot raise the plea that it is liable only to the extent of any loss that may have been sustained by the Electricity Board owing to any default on the part of the supplier of goods i.e. the Company in liquidation. The liability is absolute and unconditional. The fact that the Company in liquidation i.e. the principal debtor has gone into liquidation also would not have any effect on the liability of the Bank i.e. the guarantor. Under Section 128 of the Indian Contract Act, the liability of the surety is coextensive with that of the principal debtor unless it is otherwise provided by the contract. A surety is no doubt discharged under Section 134 of the Indian Contract Act by any contract between the creditor and the principal debtor by which the principal debtor is released or by any act or omission of the creditor, the legal consequence of which is the discharge of the principal debtor. But a discharge which the principal debtor may secure by operation of law in bankruptcy (or in liquidation proceedings in the case of a company) does not absolve the surety of his liability (see Jagannath Ganeshram Agarwala v. Shivnarayan Bhagirath [AIR 1940 Bom 247; see also In re Fitzgeorge Ex parte Robson [(1905) 1 KB 462] ).”

 

# 109. This legal position was noticed and approved later in Industrial Finance Corpn. of India Ltd. v. Cannanore Spg. & Wvg. Mills Ltd. An earlier decision of three judges, Punjab National Bank v. State of U.P. pertains to the issues regarding a guarantor and the principal debtor. The court observed as follows: 

• “The appellant had, after Respondent 4's management was taken over by U.P. State Textile Corporation Ltd. (Respondent 3) under the Industries (Development and Regulation) Act, advanced some money to the said Respondent 4. In respect of the advance so made, Respondents 1, 2 and 3 executed deeds of guarantee undertaking to pay the amount due to the bank as guarantors in the event of the principal borrower being unable to pay the same. Subsequently, Respondent 3 which had taken over the management of Respondent 4 became sick and proceedings were initiated under  the Sick Textile Undertakings (Nationalisation) Act, 1974 (for short ‘the Act’). The appellant filed suit for recovery against the guarantors and the principal debtor of the amount claimed by it. The following preliminary issue was, on the pleadings of the parties, framed:  ‘Whether the claim of the plaintiff is not maintainable in view of the provisions of Act 57 of 1974 as alleged in para 25 of the written statement of Defendant 2?’ The trial court as well as the High Court, both came to the conclusion that in view of the provisions of Section 29 of the Act, the suit of the appellant was not maintainable. We have gone through the provisions of the said Act and in our opinion the decision of the courts below is not correct. Section 5 of the said Act provides for the owner to be liable for certain prior liabilities and Section 29 states that the said Act will have an overriding effect over all other enactments. This Act only deals with the liabilities of a company which is nationalized and there is no provision therein which in any way affects the liability of a guarantor who is bound by the deed of guarantee executed by it. The High Court has referred to a decision of this Court in Maharashtra SEB v. Official Liquidator, High Court, Ernakulam [(1982) 3 SCC 358 : AIR 1982 SC 1497] where the liability of the guarantor in a case where liability of the principal debtor was discharged under the insolvency law or the company law, was considered. It was held in this case that in view of the unequivocal guarantee such liability of the guarantor continues and the creditor can realize the same from the guarantor in view of the language of Section 128 of the Contract Act as there is no discharge under Section 134 of that Act. In our opinion, the principle of the aforesaid decision of this Court is equally applicable in the present case. The right of the appellant to recover money from Respondents 1, 2 and 3 who stood guarantors arises out of the terms of the deed of guarantee which are not in any way superseded or brought to a naught merely because the appellant may not be able to recover money from the  principal borrower. It may here be added that even as a result of the Nationalisation Act the liability of the principal borrower does not come to an end. It is only the mode of recovery which is referred to in the said Act.”

 

# 111. In view of the above discussion, it is held that approval of a resolution plan does not ipso facto discharge a personal guarantor (of a corporate debtor) of her or his liabilities under the contract of guarantee. As held by this court, the release or discharge of a principal borrower from the debt owed by it to its creditor, by an involuntary process, i.e. by operation of law, or due to liquidation or insolvency proceeding, does not absolve the surety/guarantor of his or her liability, which arises out of an independent contract. 

 

# 112. For the foregoing reasons, it is held that the impugned notification is legal and valid. It is also held that approval of a resolution plan relating to a corporate debtor does not operate so as to discharge the liabilities of personal guarantors (to corporate debtors). The writ petitions, transferred cases and transfer petitions are accordingly dismissed in the above terms, without order on costs.

 

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