The legal landscape governing insolvency resolution in India has undergone significant transformation since the advent of the Insolvency and Bankruptcy Code, 2016 (“IBC”). One of the contentious issues in this evolving framework is whether simultaneous insolvency proceedings can be initiated against both the corporate debtor and its corporate guarantor for the same debt. The recent Supreme Court judgment in BRS Ventures Investments Ltd. v. SREI Infrastructure Finance Ltd. (2024 INSC 548) offers clarity on the treatment of such proceedings and reinforces key principles governing the relationship between creditors, debtors, and guarantors.
Factual Background of the Case
SREI Infrastructure Finance Ltd. (“SREI”/“Financial Creditor”) had loaned INR 100 crore to Gujarat Hydrocarbon and Power SEZ Limited (“Corporate Debtor”), which was secured by a corporate guarantee furnished by Assam Company India Limited (“ACIL”/“Corporate Guarantor”), the holding company of the Corporate Debtor. Following the Corporate Debtor’s default on loan repayments, SREI invoked the corporate guarantee and initiated corporate insolvency resolution process (“CIRP”) against ACIL under Section 7 of the IBC.
ACIL’s CIRP culminated in the approval of a resolution plan, which included a partial settlement of SREI’s claims. The successful resolution applicant, BRS Ventures Investments Limited (“BRS Ventures”/“SRA”), contended that the resolution plan approval for ACIL, along with payment of INR 38.87 crore, constituted a full and final settlement of the debt. SREI, however, sought to recover the remaining dues by initiating separate CIRP against the Corporate Debtor, which the NCLT admitted. However, the SRA and a suspended Director preferred an appeal before NCLAT, which was dismissed vide a judgment dated May 11, 2021. Hence, the present appeal was filed by the SRA before the Hon’ble Supreme Court.
Key Legal Issues
The Supreme Court’s analysis focused on the following critical issues:
- Whether the payment made under the resolution plan of the Corporate Guarantor extinguishes the liability of the Corporate Debtor to repay the loan amount to the Financial Creditor?
- Whether simultaneous insolvency proceedings could be initiated by the Financial Creditor against both – the Corporate Debtor and the Corporate Guarantor for the same debt?
- Whether the Corporate Guarantor has the right of subrogation over the rights of the Financial Creditor against the Corporate Debtor?
- Whether the assets of the Corporate Debtor were part of CIRP in respect of the Corporate Guarantor?
Supreme Court’s Key Findings
1. Co-Extensive Liability of the Guarantor and the Principal Debtor
The Court reaffirmed a foundational principle in contract law: the liability of a guarantor under a contract of guarantee is co-extensive with that of the principal debtor, as per Section 128 of the Indian Contract Act, 1872. This means that a creditor can pursue remedies against both the corporate debtor and the corporate guarantor without being restricted to choosing one party. As such, the Financial Creditor/ SREI was justified in initiating proceedings against the corporate debtor, even after the conclusion of the CIRP for ACIL/ Corporate Guarantor.
The Hon’ble Supreme Court relied on its judgment in Lalit Kumar Jain v. Union of India (2021) 9 SCC 321, where it was held that the approval of a resolution plan for a corporate debtor under the IBC does not automatically discharge the personal guarantors from liability. The apex court in the Lalit Kumar case had dealt with the issue of the legal effect of approving a resolution plan in CIRP of the Corporate Debtor on the liability of surety. It was held therein, that the contract between the creditor and the surety is independent; therefore, the approval of the resolution plan of the principal borrower will not amount to the discharge of the surety.
In the present case, the SC held that the same principle shall apply when the resolution plan is approved in CIRP of the surety. It was held that if the resolution plan of the corporate guarantor itself is approved, it may discharge the corporate guarantor’s liability by operation of law. However, the same would not affect the principal borrower’s liability to repay the creditor after adjusting the amount recovered from the corporate guarantor, or the amount paid by the resolution applicant on behalf of such corporate guarantor as per the resolution plan.
The apex court relied on Section 31 of the IBC and held that the resolution plan of the Corporate Debtor, approved by the adjudicating authority, binds the corporate debtor, its employees, members, creditors, guarantor and other stakeholders. Therefore, where a company furnishes a corporate guarantee for securing a loan taken by another company and if the CIRP of the corporate guarantor ends in a resolution plan, it will bind the creditor (in this case, SREI) of the corporate guarantor.
2. Simultaneous Proceedings Permissible under IBC
One of the most significant aspects of this judgment is the Court’s interpretation of Section 60(2) of the IBC, which allows for simultaneous insolvency proceedings against a corporate debtor and its guarantor. The Court emphasised that Section 60(3) of the IBC contemplates that where the CIRP or liquidation proceeding of a corporate debtor is pending, insolvency or bankruptcy proceedings against the corporate guarantor may also be filed/ transferred before the same adjudicating authority handling the corporate debtor’s case.
Further, the apex court also referred to sub-section (8) of Section 5, which defines ‘financial debt’. Under clauses (a) and (i) of Section 5(8) of the IBC, the money borrowed against the payment of interest and the amount of any liability in respect of any guarantee for repayment of the loan covered by clause (a), respectively, are categorised separately. The apex court thus observed that such distinct categorisation goes on to establish that the liability of a guarantor constitutes a financial debt, just as the money borrowed against the payment of interest is also a financial debt.
These provisions support the idea that there is no legal impediment preventing a financial creditor from initiating CIRP against both entities simultaneously, and neither proceeding is contingent upon the outcome of the other.
3. Subrogation Rights and Partial Payment
SRA/ BRS Ventures also raised the issue of subrogation, arguing that it had stepped into the shoes of SREI by paying INR 38.87 crore under the resolution plan. According to Section 140 of the Indian Contract Act, 1872, a guarantor who pays off the debt of a debtor is entitled to subrogate the creditor’s rights and recover the debt from the debtor.
The Hon’ble Supreme Court referred to Section 140 of the Indian Contract Act, 1872, which states that a surety is liable for the entire amount owed by the principal debtor upon payment or performance of their obligations. Hence, if the principal debtor defaults and the surety’s liability is not capped at a specific amount, the surety is responsible for full repayment to the creditor.
The apex court herein, held that the right of subrogation will be only to the extent of the amount recovered by the creditor from the surety. In this case, since BRS Ventures had paid only a partial amount of the debt (INR 38.87 crore), its right to subrogation was limited to that amount. The apex court further held that, notwithstanding the subrogation to the extent of the amount paid on behalf of the corporate guarantor by the resolution applicant, the right of the Financial Creditor to recover the balance debt from the Corporate Debtor is in no way extinguished.
The apex court referred to Economic Transport Organization, Delhi v. Charan Spinning Mills Pvt. Ltd. & Anr. Civil Appeal No.4565 of 2021, which holds that “the doctrine of subrogation is a creature of equity” and thus Section 140 of the Contract Act is to be interpreted having regards to the equitable principles. This implies that the surety is allowed to step into the shoes of a creditor after payment. Hence, if the surety pays the full amount owed under the guarantee, Section 140 allows them to recover that total from the principal debtor. However, if the surety pays only a part of the amount, their right to recovery will be limited to the portion of the debt as cleared by such surety.
4. Distinct Legal Entities: Holding Companies and Subsidiaries
Another critical issue raised in the appeal was whether the assets of the Corporate Debtor (subsidiary) were included in ACIL (holding company)’s CIRP as part of the resolution plan. BRS Ventures argued that since ACIL owned a significant portion of the corporate debtor’s equity, the debtor’s assets were indirectly part of the resolution process.
The Supreme Court rejected this argument, reiterating that a holding company and its subsidiary are distinct legal entities. The assets of the subsidiary cannot automatically be included in the CIRP of the holding company. The apex court thus reaffirmed the observation of the NCLAT that the resolution plan takes care only of the investments of ACIL in the subsidiaries and not the assets of subsidiaries.
The apex court relied upon the following provisions and precedents in reaching this conclusion:
- Section 36(4)(d) of the IBC states that the assets of an Indian subsidiary of a corporate debtor are not included in the liquidation estate and cannot be used for recovery during liquidation of the corporate debtor.
- Section 18 outlines the duties of IRPs regarding the corporate debtor’s assets, clarifying by way of an explanation (b) to Section 18(1), that the term “assets” does not encompass assets of any Indian subsidiary of the corporate debtor.
- In Vodafone International Holdings BV v. Union of India & Anr., Civil Appeal No.4565 of 2021, the apex court had upheld the principle that owning shares does not confer ownership of the subsidiary’s assets upon the holding company as they both are distinct legal entities. It was held in this case that a subsidiary’s assets belong to the liquidator upon liquidation of such subsidiary, and does not belong to its holding company, despite such holding company owing all the shares of such subsidiary.
- It is well settled that a shareholder has no interest in the company’s assets (held by Supreme Court in Bacha F. Guzdar v. Commissioner of Income Tax, Bombay, (1955) 1 SCR 876).
Thus, as the assets of the Corporate Debtor were not included in ACIL’s resolution plan, they remained separate, and SREI was entitled to proceed against the Corporate Debtor for recovery of the remaining dues.
Critical Analysis
The Supreme Court’s decision provides much-needed clarity on the inter-se liabilities of the corporate debtors and corporate guarantors, and strongly reinforces creditor rights. This decision aligns with previous rulings, including Lalit Kumar Jain v. Union of India (2021).
The ruling underscores the fundamental tenet of Indian contract law that a creditor may proceed against both the principal debtor and the guarantor simultaneously, or either of them, as their liabilities are co-extensive. This principle is essential in maintaining the integrity of credit markets, as creditors are afforded the protection of multiple avenues for debt recovery, thereby providing them with considerable power and flexibility.
Further, the judgment seeks to prevent a potential loophole where debtors could seek to evade liability by relying on the insolvency proceedings against their guarantors. By affirming that the CIRP of a corporate guarantor does not extinguish the corporate debtor’s liabilities and vice versa, the Court seems to have further strengthened the position of financial creditors under the IBC.
However, the judgment also presents certain critical points for consideration:
Strain on resources of both the debtor and guarantor: This judgment could place a disproportionate burden on corporate debtors and guarantors, who may face simultaneous litigation and insolvency proceedings, leading to potential inefficiencies and higher costs.
Corporate guarantors being more cautious: The judgment also places additional pressure on corporate guarantors, who may find themselves exposed to continued liability even after a resolution plan is approved. This could lead to a more cautious approach to providing corporate guarantees, as companies may seek to limit their exposure to future insolvency proceedings.
Risk of strategic litigation: This dual approach could lead to situations where creditors leverage the threat of simultaneous proceedings as a pressure tactic. Debtors and guarantors, often interlinked in corporate structures, could be forced into settlements under duress rather than through a fair, orderly insolvency resolution process.
Leeway for creditors to use IBC as a recovery mechanism: The judgment may be construed to grant creditors the ability to pursue residual claims against a corporate debtor after a guarantor has settled part of the debt through a CIRP. This leeway, while legally justified under the co-extensive liability principle, runs the risk of transforming the IBC into a de facto recovery mechanism for creditors seeking to reclaim/ recover balance amounts – which is not in consonance with the settled jurisprudence that IBC is not a substitute for traditional recovery mechanisms like debt recovery tribunals or civil courts (as reiterated in landmark rulings like Mobilox Innovations v. Kirusa Software (2017) and Swiss Ribbons v. Union of India (2019)). The primary objective of the IBC is to resolve insolvency and rehabilitate distressed businesses by allowing creditors and debtors to reach a resolution, rather than merely recover unpaid dues. The potential for overreach by creditors could lead to a flood of insolvency applications being filed, not with the goal of resolving a company’s financial distress, but to simply enforce payment of the balance dues.
Clarity in resolution plan: The ruling also emphasises the importance of clarity in drafting resolution plans. Creditors and resolution applicants must ensure that resolution plans clearly delineate the treatment of liabilities between corporate debtors and guarantors, and provide for full settlement of debts to avoid future litigation.
Lack of Group Insolvency Framework: By affirming that the assets of a subsidiary cannot be included in the resolution plan of a holding company, the Court has drawn a clear line between the two entities. However, it also shows the limitations of the current regime in dealing with complex corporate structures. In this case, ACIL’s role as a guarantor and Gujarat Hydrocarbon’s role as the principal debtor created a fragmented insolvency process, where the resolution of one entity’s debt did not fully resolve the financial distress of the group. This raises practical questions about how group companies should be treated in insolvency proceedings. Should group companies be treated as a single economic entity, or should their liabilities and assets remain separate? The IBC currently does not provide a comprehensive framework for group insolvency (although positive steps are being taken by the courts to fill in the lacunae through judicial pronouncements). The current system, as illustrated by this case, creates legal and practical hurdles when multiple proceedings are required for entities within the same corporate group, even when their financial fates are tied together. Thus, this judgment reinforces the need for legislative intervention to address the complexities that arise in such cases.
Commercial and economic implications: From a commercial perspective, the judgment has mixed implications. On one hand, it enhances creditor confidence, which is crucial for ensuring liquidity in the lending market. Creditors, especially financial institutions, are now more secure in their ability to pursue remedies against both corporate debtors and guarantors simultaneously. This could encourage more lending. On the other hand, it could have unintended consequences for ease of doing business in India, especially in terms of corporate guarantees. Companies may become more hesitant to provide guarantees if they are exposed to significant, prolonged litigation risks. This reluctance could make it harder for businesses, especially small and medium enterprises (SMEs), to secure credit, as lenders may demand more stringent terms or higher guarantees upfront to compensate for the perceived risk.
Conclusion
The Supreme Court’s decision in BRS Ventures v. SREI Infrastructure sets an important precedent in the realm of insolvency law. It provides clear guidance on the treatment of simultaneous insolvency proceedings against corporate debtors and their guarantors, ensuring that creditors’ rights are safeguarded. By reinforcing the co-extensive nature of liabilities under a guarantee, the Court has bolstered creditor confidence and laid down a crucial principle that will impact future insolvency and guarantee-related cases.
However, this ruling also underscores the need for corporate guarantors to exercise caution and take into consideration the risks and liabilities associated with providing guarantee, as they can now be directly exposed to insolvency proceedings even if the principal debtor is undergoing resolution. The ruling is a step forward in ensuring creditor confidence, but whether it will foster long-term economic balance in debtor-guarantor relationship remains to be seen.
Nevertheless, under India’s evolving insolvency regime, this judgment adds to the growing body of case laws, clarifying the rights and liabilities of stakeholders in insolvency proceedings, promoting both financial discipline and swift debt resolution. This decision will have wide-ranging implications for India’s insolvency landscape, particularly in cases involving complex corporate structures with interlocking guarantees.
For further information, please contact:
Vikash Kumar Jha, Partner, Cyril Amarchand Mangaldas
vikashkumar.jha@cyrilshroff.com
