1/31/2019 0 Comments
Significant NCLAT Judgment under IBC
In a recent judgment pronounced on 8th January, 2019 in the case of Ferro Alloys Corpn. Ltd. v. Rural Electrification Corpn Ltd.  101 taxmann.com 283 (NCLT - New Delhi) (in short "Ferro Alloys" judgment), a 3 Judge bench of the National Company Law Appellate Tribunal (NCLAT) upheld the decision dated 6th July, 2017 passed by the NCLT, Kolkata which allowed the "financial creditor" under Section 7 of the Insolvency & Bankruptcy Code 2016 ("IBC") to proceed directly against the "corporate guarantor" to recover outstanding debt dues payable by the "corporate debtor", without proceeding against the defaulting "corporate debtor". The Appellant before the NCLAT argued that the IBC does not use the concept or phrase "Corporate Guarantor" and that without exhausting remedies against the borrower company/corporate debtor, the provisions of IBC cannot be invoked against the "Corporate Guarantor" who guarantees the loan repayment by the corporate debtor. These arguments were rejected by the NCLAT. The NCLAT judgment is indeed very significant and augurs well for the Banks and Financial Institutions who are burdened with huge loan defaults (running into lakhs of crores of rupees) from the borrower "debtor company", despite such "Financial Creditor" being protected by "corporate guarantees" to cover up recovery of such loans.
Brief Facts of the case
Brief facts leading to the filing of the aforementioned appeal are that the Respondent – Rural Electrification Corporation Limited (Financial Creditor) sanctioned loan aggregating Rs. 517.90 crores to FACOR Power Limited ("Principal Borrower" described herein in short as "FACOR") and disbursed an amount aggregating to Rs. 510.97 crores on various dates. For securing the above mentioned loan facility extended by the 'financial creditor' to 'FACOR ('Corporate Debtor') a 'Corporate Guarantee Agreement' was signed and executed by "Ferro Alloys Corporation Limited" (in short "Ferro Alloys"/'Corporate Guarantor") and guarantee documents in favour of the 'financial creditor' were executed on 24th August, 2009, as revised on 29th October, 2010, 21st June, 2013 and again on 22nd January, 2015. 'Ferro Alloys' (i.e. 'corporate guarantor' of the 'corporate debtor'), as also borrower pledged 15,10,74,299 physical shares and 4,69,85,631 Dmat shares of 'FACOR Power Limited' totalling to 19,80,59,930 shares through various deeds in favour of the 'Financial Creditor'.
The case of the 'financial creditor' was that M/s. FACOR Power Limited (Principal Borrower) defaulted in making repayment of dues and the account of M/s. FACOR Power Limited was classified as Non-Performing Asset (NPA). In view of the defaults committed in the repayment of loan, as per the terms and conditions of the 'Loan Agreement' and other financing documents, the 'Financial Creditor' recalled the facilities on 1st October, 2015 and demanded the entire amount of loan, interest and all other amounts due in respect thereof. Despite receipt of the same, no payment was made to the 'financial creditor'. The Corporate Debtor M/s. FACOR Power Limited as the principal borrower had admitted its liability to the extent of Rs. 604,99,91,539/- as on 31st March, 2016 in the audited balance-sheet for the financial year 2015-16. Also, the 'corporate guarantor' – Ferro Alloys Corporation Limited in its audited balance-sheet for the financial year 2015-16 had acknowledged the debt to the tune of Rs. 517.90 crores. The copy of the audited balance-sheet of the 'Ferro Alloys Corporation Limited' was also enclosed along with the application under Section 7 of the I&B Code (Form-1).
Invoking Guarantee on Failure of the Defaulting Corporate Debtor
On default in payment of the debt amount payable by the 'Principal Borrower', the 'Financial Creditor' invoked the corporate guarantee of the 'Ferro Allows Corporation Limited' and called upon the 'Ferro Alloys Corporation Limited' ('corporate guarantor') to pay forthwith the amount due and payable by the 'M/s. FACOR Power Limited' (principal borrower') amounting to Rs. 564,63,50,544/- as on 30th September, 2015 along with future interest within a period of 21 days. M/s. Ferro Alloys Corporation ('corporate guarantor') issued a reply dated 26th November, 2015 but failed and neglected to pay the above sum.
The 'Financial Creditor' pleaded before the Adjudicating Authority and in the Appellate Authority (NCLAT) under the IBC that the 'corporate guarantee' furnished by 'Ferro Alloys Corporation Limited' is an unconditional, continuing and irrevocable guarantee. As per the terms of the guarantee, the obligation of guarantor is separate, independent and is that of primary obligor and not merely as surety, on a full indemnity basis to indemnify the 'financial creditor'. The 'corporate guarantee' provided by the 'Ferro Alloys Corporation Limited' is joint and several and co-extensive with that of the principal debtor and can be invoked even without exhausting the remedies against the principal debtor. The Adjudicating Authority taking into consideration the fact that there is a 'debt' and 'default' and the application under Section 7 of the IBC being complete, admitted the application by the impugned order dated 6th July, 2017.
Harmonious and purposeful construction of IBC provisions by NCLAT
The NCLAT heard the appeal against the decision of the Adjudicating Authority (NCLT, Kolkata Bench) and on a harmonious and purposeful reading and reasoning, noted that as per the definition of "Corporate Person" under Section 3(7) of the IBC, insolvency resolution process under section 7 of the IBC can be initiated against the "Guarantor", who is a "Corporate Person" and who, by operation of law, ipso-facto, becomes a "Corporate Debtor" by satisfying the ingredients of the terms as defined under Section 3(8) of IBC, which means a "Corporate Person" who owes a debt to any person. The term "debt" under Section 3(11) of the IBC stipulates that "debt" means a liability or obligation in respect of a claim, which is due from any person and includes a financial and operational debt. It was argued that the term "Corporate Debtor" under Section 3(8) may also be any person. Further, as per section 3(23) of the IBC, "person" includes a company. Thus, a "Corporate Debtor" must be a "Corporate Person" who owes a "debt" to "any person". The "debt" as used in Section 3(8) has to be a "debt" as defined under Section 3(11) of IBC. It must be the "liability" or "obligation" in respect of a "claim"(section 3(6)) which is due from any person – which means even a corporate entity and shall include "financial debt" and "operational debt" as defined under Sections 5(8) and 5(21) of the IBC.
NCLAT noted that under section 3(6) of the IBC, the term "claim" means--
(a) a right to payment, whether or not such right is reduced to judgment, fixed, disputed, undisputed, legal, equitable, secured or unsecured;
(b) right to remedy for breach of contract under any law for the time being in force, if such breach gives rise to a right to payment, whether or not such right is reduced to judgment, fixed, matured, un-matured, disputed, undisputed, secured or unsecured;
Also, as per section 3(8) of the IBC, a "financial debt" means a "debt along with interest, if any, which is disbursed against the consideration for the time value of money and includes--
(a) money borrowed against the payment of interest;
…(h) any counter-indemnity obligation in respect of a guarantee, indemnity, bond, documentary letter of credit or any other instrument issued by a bank or financial institution; and
(i) the amount of any liability in respect of any of the guarantee or indemnity for any of the items referred to in sub-clauses (a) to (h) of this clause."
It was also contended that as per Section 3(12) of the IBC, "default" means non-payment of debt when whole or any part of instalment of the amount of debt has become due and payable and is not repaid by the debtor or the corporate debtor, as the case may be. Thus, a "guarantee" becomes a "debt" or as soon as the "guarantee" is invoked against it wherein after a guarantor (corporate guarantor) becomes a "Corporate Debtor" in terms of the IBC Code.
SC decisions relied on in support of the claim by Financial Creditor
In the NCLAT, reference was invited to the decision of the Hon'ble Supreme Court of India in re: 'Bank of Bihar Ltd. v. Dr. Damodar Prasad AIR 1969 SC 297', wherein it was held that:
"3. The demand for payment of the liability of the principal debtor was the only condition for the enforcement of the bond. That condition was fulfilled. Neither the principal debtor nor the surety discharged the admitted liability of the principal debtor in spite of demands. Under Section 128 of the Indian Contract Act, save as provided in the contract, the liability of the surety is coextensive with that of the principal debtor. The surety became thus liable to pay the entire amount. His liability was immediate. It was not deferred until the creditor exhausted his remedies against the principal debtor." (emphasis supplied)
In the NCLAT, it was further argued that in re: Ram Bahadur Thakur v. Sabu Jain Ltd.  51 Comp Cas 301 (Delhi), the Hon'ble High Court of Delhi relying on the decision of Hon'ble Supreme Court in Kesoram Industries Cotton Mills Ltd. v. CWT  59 ITR 767, held that under the 'deed of guarantee' the liability of the company to pay debt arose when the borrower defaulted in making payments and the creditor sent a demand/notice invoking the guarantee.
Reasoning for upholding the decision of the Adjudicating Authority
The NCLAT further noted that in the present case of "Ferro Alloys", as per clause 1.2 of the 'Deed of Guarantee' dated 22nd January, 2015, there is a clear cut stipulation that "on the failure of principal borrower to pay and/or discharge the obligations, the guarantor shall, forthwith upon demand, pay to Rural Electrification Corporation Limited (Financial Creditor) without demur or protest", the amount stated in the demand made by Rural Electrification Corporation Limited to the guarantor thereby invoking the guarantee.
Admittedly, the guarantee was invoked by 'Rural Electrification Corporation Limited' against 'Ferro Alloys Corporation Ltd.' and demand was raised on 27th October, 2015 calling upon 'Ferro Alloys Corporation Ltd.' to pay the amount due within 21 days. Since then, Ferro Alloys Corporation Ltd. (Corporate Guarantor) became a 'corporate debtor' of 'Rural Electrification Corporation Limited' (Financial Creditor). In its Annual Report for the year ending 2016-17, 'Ferro Alloys Corporation Ltd.' has shown a sum of Rs. 517.90 crores payable to the 'financial creditor'. Therefore, it became clear that 'Ferro Alloys Corporation Ltd.' admitted the 'debt' and in absence of payment, there was no doubt to hold that there is a 'default'. The NCLAT also noted that the provision of the IBC do not bar a 'financial creditor' from initiating 'corporate insolvency resolution process' against the 'guarantor', who comes within the meaning of 'corporate debtor'. The aforesaid matter can be noticed from the statutory inter-se rights, obligations and liabilities of:
(i) A surety qua the creditor (the relationship as defined under the Indian Contract Act); or
(ii) Guarantor qua financial creditor.
It was argued before the NCLAT that the IBC does not exclusively delineate and/or prescribe any inter-se rights, obligation and liabilities of a guarantor qua 'financial creditor'. Thus, in absence of any express provision providing for inter-se rights, obligation and liabilities of guarantor qua 'financial creditor' under the IBC, the same will have to be noticed from the provisions of the Indian Contract Act, which exclusively and elaborately deals with the same.
In the NCLAT, reference was also made to the decision of the Hon'ble Supreme Court of India in re: Bank of Bihar (supra) where in, the Hon'ble Supreme Court referred to a judgment of Hon'ble Bombay High Court in Lachhman Joharimal v. Bapu Khandu and Tukaram Khandoji  6 Bom HCR 241, in which the Division Bench of the Hon'ble Bombay High Court held as under:
"The court is of opinion that a creditor is not bound to exhaust his remedy against the principal debtor before suing the surety and that when a decree is obtained against a surety, it may be enforced in the same manner as a decree for any other debt."
The Hon'ble Supreme Court while approving the said judgment, observed that, "The very object of the guarantee is defeated if the creditor is asked to postpone his remedies against the surety. In the present case the creditor is a banking company. A guarantee is a collateral security usually taken by a banker. The security will become useless if his rights against the surety can be so easily cut down."
In the NCLAT, a reference was also made to the decision of the Hon'ble Supreme Court of India in re: State Bank of India v. Indexport Registered  3 SCC 159, wherein the Hon'ble Supreme Court held that the decree holder bank can execute the decree first against the guarantor without proceeding against the 'Principal Borrower'. Guarantor's liability is co-extensive with that of the principal debtor under the 'Contract Act, 1872' (Section 128).
Therefore, in the aforementioned Ferro Alloys appeal, the NCLAT held that it is not necessary to initiate "Corporate Insolvency Resolution Process" against the "Principal Borrower", before initiating "Corporate Insolvency Resolution Process" against the "Corporate Guarantor". Further, without initiating any "Corporate Insolvency Resolution Process" against the "Principal Borrower", it is always open to the "Financial Creditor" to initiate "Corporate Insolvency Resolution Process" under section 7 of the IBC against the "Corporate Guarantors" as the creditor is also the "Financial Creditor" qua the "Corporate Guarantor". The NCLAT also noted that the Financial Creditor did not initiate two proceedings simultaneously against the "Corporate Debtor" as well as against the "Corporate Guarantor" and such a contention was not raised in the appeal. For the reasons aforesaid, the appeal filed by "Ferro Alloys" failed and accordingly dismissed.
The aforesaid NCLAT judgment will pave the way for the "Financial Creditors" to initiate "Corporate Insolvency Resolution Process" against the "Corporate Guarantors" without initiating CIRP against the "Principal Corporate Debtor" and will prompt faster recovery of outstanding dues and will also discipline the corporate debtors who had been enjoying protection hitherto fore and could afford to delay repayment of outstanding loans. This is a significant and welcome change from the earlier regime and will prevent corporate guarantor from escaping liability.