India – Guarantees Under Insolvency Law.

 

14 March, 2018

 

 

The National Company Law Appellate Tribunal (NCLAT), in a recent order in State Bank of India v. V. Ramakrishnan (“Veesons Order”) has ruled that upon the admission of an insolvency petition against a corporate debtor, the “moratorium” under Section 14 of the Insolvency and Bankruptcy Code, 2016 (“IBC”) applies to both the property of the “corporate debtor” and a “personal guarantor”.

 

The NCLAT in upholding the order of the Chennai Bench of the National Company Law Tribunal has followed the September 6, 2017 ruling of the High Court of Allahabad in Sanjeev Shirya v. State Bank of India (“LML Order”). The Veesons Order, in our view, follows a settled principle of law that third party rights should not be prejudiced until the liabilities of the primary obligor have crystalised and are not in dispute. The NCLAT has adopted a purposive interpretation of Section 14(1)(b) of the IBC and has read that the prohibition on disturbing the property of the “corporate debtor” or “any legal right or beneficial interest therein” to include the rights and assets of a corporate debtor and a guarantor.

 

The NCLAT has expanded the other legal rights or interests to mean rights or interests which arise from the assets of the corporate debtor. Applying this principle, it would appear that any third-party security interests created on behalf of the obligations of the corporate debtor would be subject to this moratorium.

 

Allowing, a lender to enforce its rights against a third party security provider (whether a guarantor or a provider of other types of property based security) can give rise to certain anomalies: (a) triggering the rights of subrogation and recovery of the third party, therefore, potentially placing the third party security provider on par with other unsecured creditors; or (b) taking the position that the third party security providers have no subrogation rights, which would be a violation of the Indian Contract Act, 1872 and not permissible in law.

 

From an insolvency resolution process as well, it would seem that the order in Veesons is well founded as it affords the creditors with access to a larger asset pool in formulating a resolution plan.

 

However, the Veesons Order has brought up ambiguity in the law on account of two contrary decisions given by the NCLAT in Phoenix ARC and Alpha Omega, where the NCLAT held that a moratorium does not apply to personal guarantors. Accordingly, the decision of the NCLAT in Veesons has once again brought into question the discipline of judicial authorities in ignoring judicial precedents in making judicial orders. Given the supervisory jurisdiction that the High Court of Delhi exercises under Article 227 of the Constitution of India it may have been most prudent for the NCLAT to have referred the matter to the Chief Justice of the High Court of Delhi and to determine whether a larger bench of the NCLAT should be constituted to determine the matters in Veesons.

 

The NCLAT seems to have adopted a purposive interpretation of the law while passing an order in the Veesons’ matter. However, in our view, it may not be advisable to solely base insolvency and recovery related strategies on this order as the same may be challenged before the Supreme Court of India or the High Court of Delhi under Article 227 of the Constitution of India.