The Supreme Court of India in the recent case of Laxmi Pat Surana v. Union Bank of India has observed that proceedings under the Insolvency and Bankruptcy Code 2016 (IBC) can be initiated against a corporate guarantor who has given a guarantee on behalf of a sole proprietorship. This update briefly summaries this said judgment.

Background: In the present case, the financial creditor being Union Bank of India (Bank) extended a loan facility to the principal borrower, Mahaveer Construction (Principal Borrower), a proprietary firm. Surana Metals Limited stood as the guarantor (Corporate Guarantor) for the loan availed by the Principal Borrower. The loan was eventually declared as a non-performing asset in 2010 and the Bank issued recall notices against the Principal Borrower and the Corporate Guarantor. The Bank initiated proceedings before the Debt Recovery Tribunal, Kolkata against the Principal Borrower and during the pendency of the proceedings, the Bank also addressed a demand notice to the Corporate Guarantor under the IBC.

NCLT : The Bank initiated proceedings against the Corporate Guarantor for a default of a sole proprietorship firm, in its capacity as the corporate guarantor of the loan. NCLT admitted the application and held that the action had been initiated against the corporate guarantor, who was co-extensively liable to repay the debt of the Principal Borrower. As the Corporate Guarantor failed to do so despite the recall notice, the Corporate Guarantor in this scenario, became the corporate debtor liable to be proceeded against under the provisions of the IBC. An appeal was preferred from this decision before the National Company Law Appellate Tribunal (NCLAT).

NCLAT Before the NCLAT, the main contention raised on behalf of the Corporate Guarantor was that since no insolvency proceedings at present can be initiated against a sole proprietorship firm under IBC, as such, no insolvency proceedings can also be initiated against the Corporate Guarantor.

NCLAT upheld the observation of the NCLT that the definition of ‘Corporate Guarantor’ under IBC is merely explanatory and such definition could not be the basis of applicability or non-applicability of the provisions of IBC to those liable under the provisions thereof. NCLAT observed that a ‘Financial Debt' includes a debt owed to a creditor by a principal borrower and a guarantor. Thus, proceedings under Section 7 of the IBC may be initiated against a guarantor in the same manner as it would for a principal borrower, as their liability is coterminous and coextensive.

Supreme Court: The order of the NCLAT was then challenged in appeal before the Supreme Court. The Supreme Court held that a guarantor cannot escape from the lawful liability of the principal debtor under the contours of the IBC, in case of default in repayment by the principal debtor, despite being a sole proprietorship firm. Accordingly, the Supreme Court upheld the order and reasoning mentioned by the NCLT.

MHCO COMMENTS:

Supreme Court and NCLAT in this landmark decision have expanded the scope of the definition of ‘Corporate Guarantor' and have brought under its ambit firms acting as guarantors to loans of sole proprietorship firms. Thus, even though insolvency proceedings cannot be initiated against a firm in its capacity of a principal borrower in default, such action can be initiated against firms acting as guarantors. This provides an efficacious remedy to creditors who had to suffer at the hands of vagrant borrowers and guarantors trying to circumvent their liability.

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Author: Bhushan Shah - Partner

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This update was released on 17 May 2021.

The views expressed in this update are personal and should not be construed as any legal advice. Please contact us directly on +91 22 40565252 or legalupdates@mhcolaw.com for any assistance.

Legal Update Team
MANSUKHLAL HIRALAL & COMPANY
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