[Opinion] Application under Section 7 of the Insolvency and Bankruptcy Code 2016

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  • Last Updated on 5 August, 2022

Application u/s 7 of IBC

[2022] 141 taxmann.com 92 (Article)

I. Introduction

The Hon’ble Supreme Court of India in the case of Laxmi Pat Surana v. Union Bank of India and Another (“Laxmi Pat Surana”), has upheld the validity of an Application under Section 7 of the Insolvency and Bankruptcy Code 2016 (“IBC”), against a corporate person who stood as a guarantor for the debt of a sole proprietorship firm. This article seeks to analyse the decision of the Hon’ble Supreme Court of India in the case of Laxmi Pat Surana (Supra) in the backdrop of the objective and the scheme of the IBC.

Prior to the enactment of the IBC, the Personal and Corporate Insolvency regime in India was scattered in different enactments. Personal Insolvency was regulated by the Presidency Towns Insolvency Act, 1909 (“PTI Act, 1909”) (applicable to Mumbai, Kolkata, and Chennai) and the Provincial Insolvency Act, 1920 (“PI Act, 1920”) (applicable to the rest of the country), and corporate insolvency was mainly governed by the provisions of the Companies Act, 2013, Limited Liability Partnership Act, 2008 and the Sick Industrial Companies (Special Provisions) Act, 1985.

With the advent of IBC, the Legislature has enacted the repeal (not notified) of the PTI Act, 1909 and the PI Act, 1920, and provisions for personal insolvency are included in Part III of the IBC. Part III of the IBC is applicable to individuals and partnership firms. However, the provisions of Part III have not yet been notified even after more than 5 years of implementation of IBC. By a Press Release, the Ministry of Finance, Government of India clarified that as Part III of the IBC has not been notified till date, the stakeholders must pursue their insolvency cases under existing enactments before appropriate fora and not claim that their matters be dealt with provisions of the IBC which are in force.

II. Recent Amendment

The Insolvency and Bankruptcy (Second Amendment) Act, 2018 inserted the definition of ‘corporate guarantor’ by insertion of sub-section 5A after Section 5(5) in Part II of the IBC. The definition was inserted with the objective of enabling the NCLT to deal with proceedings initiated against a Corporate Debtor and “its” (emphasis supplied) Corporate Guarantor. Section 60 of the IBC was also suitably amended with the same objective.

Though the definition of Corporate Debtor is found in Part II of the IBC which deals with debts payable by Corporate Persons, the Courts have interpreted the definition of Corporate Debtor to include guarantors of sole proprietorship firms, individuals and partnership firms to fall within its ambit. The problem posed by such a wide interpretation is that the intention of the Parliament while demarcating the insolvency resolution scheme in two separate parts of the IBC was to treat the debts payable by Corporate Persons as one class and individuals and partnership firms as another class. There are wide differences in the insolvency resolution processes provided under Part II dealing with Companies and Part III dealing with individuals and partnership firms. The Parliament introduced amendments to Section 60 and then introduced Section 5(5A) with a view to consolidate the proceedings which may be initiated at different fora against a Corporate Debtor and its guarantor being either an individual or a company in one proceeding before one NCLT.

Section 60(3) of the IBC provides that,

“An insolvency resolution process or [liquidation or bankruptcy proceeding of a corporate guarantor or personal guarantor, as the case may be, of the corporate debtor] pending in any court or tribunal shall stand transferred to the Adjudicating Authority dealing with insolvency resolution process or liquidation proceeding of such corporate debtor.” (Emphasis supplied)

In the case of Ferro Alloys Corpn. Ltd. v. Rural Electrification Corpn. Ltd., the Financial Creditor filed an application under section 7 of IBC against the guarantor (being a company). The principal borrower was also a corporate person. The NCLAT held that such an application was maintainable as a Corporate Insolvency Resolution Process (“CIRP”)can be initiated against a corporate guarantor before initiating a CIRP against the Principal Borrower. The Hon’ble Supreme Court upheld the order of the National Company Law Appellate Tribunal. Pertinently this was a case where the Principal Borrower was also a corporate person.

In another case, Dr. Vishnu Kumar Agarwal v. Piramal Enterprises Ltd. proceedings under Part II of the IBC were initiated against two companies as they were guarantors of a debt owed by All-India Society for Advance Education & Research, which is a society registered under the Societies Registration Act, 1860. The NCLAT had an opportunity to deal with two questions, the first one being relevant to the context hereof, whether the CIRP can be initiated against a ‘Corporate Guarantor’, if the ‘Principal Borrower’ is not a ‘Corporate Debtor’ or ‘Corporate Person’? However, the NCLAT relying upon a judgement of the Hon’ble Supreme Court of India based on Section 128 of the Indian Contract Act, 1872 held that CIRP could be initiated against the guarantor before initiating any action against the Principal borrower. Therefore, the NCLAT failed to answer the aforementioned question which was posed for adjudication having far reaching ramifications.

The NCLAT in the case of K. Paramsivam v. Karur Vyasa Bank and another upheld an order passed by the NCLT allowing an application under Section 7 of the IBC against a Company which had guaranteed a debt borrowed by Partnership firm and Sole proprietorship firm.

III. Case

In the case of Laxmi Pat Surana (supra) the Hon’ble Supreme Court of India held that an application under Section 7 of IBC can be filed against a company being a corporate guarantor for a debt owed by a Sole Proprietorship firm under Part II of IBC. Therefore, opening floodgates for many such cases where albeit the principal borrower may be an individual, sole proprietorship firm or partnership firm their debt could be a subject matter of proceedings under Part II of IBC.

The factual matrix is as follows. M/s Mahaveer Construction (being a Sole Proprietorship firm) had borrowed money against the payment of interest from the Bank and M/s Surana Metals Ltd. (being a company registered under the Companies Act, 2013) stood as a guarantor in respect of the loan facilities availed by M/s Mahaveer Construction. The Bank initiated an action against the principal borrower before the Debt Recovery Tribunal, Kolkata. During the pendency of the action against the principal borrower, the bank filed an application under Section 7 of the IBC against M/s Surana Metals Ltd for the debt borrowed by M/s Mahaveer Construction. The Supreme Court while handing down the judgement analysed various definitions under the IBC including that of “financial debt” under Section 5(8) under Part II of the IBC and arrived at the conclusion that an application under Section 7 of the IBC would be maintainable against the guarantor. The Court relied upon Section 128 of the Contract Act, 1872 to hold that as the liability of surety is coextensive with the principal borrower, the creditor can maintain the application against the guarantor and concluded that on default of repayment of the loan amount the status of the guarantor metamorphoses into a debtor or a corporate debtor if it happens to be a corporate person, within the meaning of Section 3(8) of the Code. Further, the Hon’ble Court analysed Section 7 and held that an application can be filed against a corporate person assuming the status of corporate debtor by offering guarantee.

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