Issue 2:

Against personal guarantor’s side:

In the case of Essar Steel Ltd., the Supreme Court, relying on Section 31 of the IBC, observed that the
goal of the resolution process is to provide the resolution applicant with a fresh start, also known as
the clean slate theory. Granting the personal guarantor the right to subrogation would be
antithetical to this principle of a fresh start, as once the resolution plan is approved, subrogation will
allow the guarantor to step into the shoes of the creditor and file his claims against the debtor as a
creditor himself. The clean slate theory prohibits such a possibility as once the debts are discharged,
the creditors cannot bring further claims against the debtor. It is also an unfathomable scenario to
step in as it will leave the debtor back with debts, vitiating the whole purpose of the CIRP. Insertion
of Section 32A in the IBC after the amendment in 2020 reemphasises the point of fencing the
liabilities of the corporate debtor to what has been already approved once in the resolution plan,
and thus cannot be liable for further claims. 

NCLT Mumbai bench held that the right of subrogation cannot be granted as it will render the
process of resolution meaningless. The relevant portion is quoted below[23],

“Thereafter, they (Guarantor) would be entitled to exercise their right of subrogation against
the Corporate Debtor which is then under the control and management of the Resolution
Applicant. Hence, the Resolution Applicant will then pay the debt of the guarantor under its
right of subrogation. Hence, in effect, the Resolution Applicant would pay the full amount of
creditors, therefore, there was no idea left for filing the resolution plan and taking over the
debtor company by settling the dues of the creditors. This vicious circle is a never-ending
process and it was definitely not intended by the legislators while framing the I&B Code.”

23- DBI Bank Ltd. v. EPC Constructions India Limited, MA 2738/2019 & MA 354/2019 in CP
No.1832/IBC/NCLT/MB/MAH/2017.

Furthermore, allowing the personal guarantors to exercise their right will initiate a never-ending
vicious circle as can be seen from Davinder Ahluwalia v. Sumit Aviation, wherein the personal
guarantor was placed into the shoes of the creditor. The corporate debtor defaulted again which
compelled the guarantor to file a section 7 application to initiate CIRP against the corporate debtor.

Where the judgment at hand is unclear about the rights of the guarantor on stepping into the shoes
of the creditor. Another judgment by the NCLAT in the case of Lalit Mishra and Ors vs. Sharon
biomedicine held that the guarantor cannot exercise its right of subrogation under the Contract Act
as proceedings under the IBC are not recovery proceedings. Further, the object of the proceedings
under the IBC is to revive the company and focus on maximization of the value of its assets and not
to ensure that credit is available to all stakeholders. Thus, no such recovery can be made by a
guarantor. Also in most cases, the promoters being the guarantors for the company, makes it
impossible for them to recover their money because of the restriction under 29A which provides for
ineligibility of the people who can file their claims.

NCLAT: Liability of the corporate debtor towards the

promoter-personal guarantor can be
waived by the resolution plan
Between the lines...
4Between the lines...January, 2019
1. The resolution plan did not envisage paying off the Appellants
who were the promoters of the Corporate Debtor.
2. The resolution plan was discriminatory towards the Appellants
who were also the personal guarantors of the
Corporate Debtor.
Issue
Whether NCLT, Mumbai should have approved the resolution plan
in light of the personal guarantors excluded from
being paid off?
Arguments
The Appellants submitted that the payment terms provided in the
resolution plan were in contravention to the
applicable provisions of law. They also submitted that the
successful resolution applicant had arbitrarily reduced or
written off substantial liabilities of the Appellants without any legal
basis. It was further pleaded that the lenders had
not been treated similarly and restructuring for its entire claims of
the Corporate Debtor was against the provisions of
the Insolvency and Bankruptcy Code, 2016 (“Code”). The
Appellants argued that the security interest which includes
the personal guarantees of the Appellants had been reduced to ‘nil’
under the resolution plan. Therefore, the
resolution plan was contrary to Section 133 and 140 of the Indian
Contract Act, 1872 ("Contract Act"). Section 133 of
the Contract Act provides that if any change is made in the terms of
the contract between the principal debtor and
the creditor without the surety's consent, it will discharge the surety
from transactions subsequent to the change.
Further, Section 140 of the Contract Act deals with the right of
subrogation to the surety, which provides that when
the surety has paid the guaranteed debt or performed a guaranteed
duty, it steps into the shoes of the creditor and all
rights of the creditor start to vest with the surety.
The submissions of the Respondent were not recorded in the
judgement.
Observations of the NCLAT
The NCLAT observed that one of the primary objects of the Code is
maximization of the value of the assets of the
Corporate Debtor and then to balance the interest of all the
creditors. Further the Code prohibits the promoters from
gaining, directly or indirectly, control of the Corporate Debtor, or
benefiting from the corporate insolvency resolution
process or its outcome. The Code seeks to protect creditors of the
Corporate Debtor by preventing promoters from
rewarding themselves at the expense of creditors and undermining
the insolvency processes. This is evident from the
fact that powers of the promoters as the members of the board of
directors of the Corporate Debtor are suspended
once the resolution process begins and the promoters and
shareholders have no right of representation,
participation or voting in the meeting of the committee of creditors.
The NCLAT also observed that the personal guarantors who had
filed the appeal in the present matter were the
promoters, who contributed to the insolvency of the Corporate
Debtor. Therefore, a resolution plan that does not
envisage a payment of dues to the Appellants in their capacity as
promoters /personal guarantors or discharges the
liability of the Corporate Debtor as well as successful resolution
applicant would not be discriminatory in nature.
Between the lines...
5Between the lines...January, 2019
The NCLAT also held that the liability of guarantors is co-extensive
with the borrower. Also, it was not the intention of
the Code to benefit the personal guarantors by excluding exercise
of legal remedies available in law to the creditors,
to recover legitimate dues by enforcing the personal guarantees,
which are independent contracts.
Decision of the NCLAT
The NCLAT held that resolution plan does not discriminate against
the promoters/shareholders/personal guarantors
and therefore dismissed the appeal filed by the Appellants.
VA View
The NCLAT held that the resolution plan can effectively deny a
personal guarantor the right of subrogation enshrined
in the Contract Act. It is trite to mention that promoters or related
parties are usually the ones who provide personal
guarantees to the corporate debtors. It has been observed in some
cases, that the promoters are the ones driving a
company to insolvency and in such cases, providing a less
favourable payment arrangement or, no payment at all
under a resolution plan for such promoters compared to other
creditors or even shareholders would be far from
discriminatory.
This is in line with the spirit of the judgement in case of J.R. Agro
Industries Private Limited v. Swadisht Oils Private
Limited (decided on July 24, 2018) where the National Company
Law Tribunal, Allahabad (“NCLT Allahabad”)
ordered a modification of a resolution plan that gave priority to the
related party financial creditors over the
operational creditors. The NCLT Allahabad applied the principle
enshrined in paragraph 55 of the UNCITRAL
Legislative Guide which specifies that when an organisation owes
debts to more than one creditor, the priority
scheme established under the applicable law may provide for
subordination of certain types of claim: for example,
the determination of the priority of related party claims.
Further, the doctrine of equitable subordination also provides that a
court can permit the subordination of a
controlling shareholder’s claims upon debt to those of other bona
fide creditors in bankruptcy, if the controlling
shareholder has behaved unfairly or wrongly towards the company
and its outside creditors. In line with the
aforementioned decision of the NCLT Allahabad and the doctrine of
equitable subordination, this judgement acts
equitably by differentiating the promoters from other creditors and
share

Under contract law, if the guarantor pays the debt — either partially or in full — owed by a
corporate debtor, then the guarantor will have the right to recover the amount from the borrower.
The apex court had, in the Essar Steel case, moved away from the settled principles under the
Contract Act and clarified that guarantors are not entitled to right of subrogation, if the resolution
plan states so. Thus a guarantor’s remedy against the borrower is eroded. Now, this may put the
personal guarantor — who is most often the promoter — in a fix.
In favour of personal guarantor

 Although the Court in the Lalit Kumar Jain judgement has rejected the argument of
discharge of surety under Section 135 of the Indian Contract Act owing to
composition between corporate debtor and creditor, it ignores the equitable principle
of subrogation. On the question of whether the settlement of debts in the resolution
plan between the corporate debtor and the creditor permits them to exterminate the
rights of the personal guarantor, a third party who is not a party to the contract, the
Court must not lose sight of the decision of the Supreme Court in Krishna Pillai
Rajasekharan Nair (D) by Lrs. v. Padmanabha Pillai (D) by Lrs. and Ors., where the
Supreme Court observed that:

“A subrogation rests upon the doctrine of equity and the principles of natural justice and not
on the privity of contract. One of these principles is that a person, paying money which
another is bound by law to pay, is entitled to be reimbursed by the other. This principle is
enacted in Section 69 of the Contract Act, 1872. Another principle is found in equity: ‘he who
seeks equity must do equity’.”

 The Courts wrongly believe that in the vast majority of cases, the personal guarantees
are given by the directors, who often promote the value of the company out of
personal interest rather than in the interest of the companies. Thus, any attempt to
avoid their liabilities must be negated. 

Nevertheless, disregarding the rights of the personal guarantor will demotivate them to stand
as guarantors in the future. This will eventually raise difficulties for companies to raise funds
as it would dissuade potential creditors from lending loans, and thus, companies will exhibit
slower monetary growth with lower capital injection. It is undeniably true that the growth of
companies has a spiralling effect on the economy of the nation and the role of personal
guarantors cannot be dismissed by placing the rights of the creditors on a higher pedestal.  

https://nualslawjournal.com/2021/06/29/subrogation-rights-of-personal-guarantor-a-
comparative-analysis/

In the case of Kundanmal Dabriwala v. Haryana Financial Corporation and Ors.[14] the
High Court of Punjab & Haryana discussed the liability of the surety where the liability of the
Principle Borrower stands extinguished through a sanctioned scheme of arrangement under
section 391 of the Companies Act, 1956. The Court absolved the surety of the liability on the
ground inter alia that the surety cannot be placed in the shoes of the creditor i.e. cannot have
the right of subrogation. This case becomes significant as it stresses the importance of
subrogation right, in absence of which, the liability of the surety stands pointless.
The surety paying off a debt shall stand in the place of the creditor and have all the rights
which he has, for the purpose of obtaining reimbursement. This rule here is undoubted, and it
is founded upon the plainest principles of natural reason and justice.[12] Subrogation rests
upon the doctrine of equity and is a settled common law principle.[13]

Amrit Lai Goverdhan Lalan v. State Bank of Travancore, 1968 AIR SC 1432, See
Cravethorne v. Swinburne,  (1807) 14 Ves 160; Hodgson v. Shaw, 3 Mylne 7 K. 183, 190
(1834); Hidden v. Bishop, 5 R. I. 29, 31 (1857) and Lumpkin v. Mills, 4 Ga. 343, 345, f49
(1848).
[13]
Krishna Pillai Rajasekharan Nair v. Padmanabha Pillai, (2004) 12 SCC 754, p. 767.

Where the creditor after initiation of CIRP against the principal debtor (i.e. the Corporate
Debtor) but before approval of resolution plan or passing of liquidation order under IBC,
recover the debt from the surety, the surety shall be entitled to stand in the place of the
creditor and file the claim as required under the IBC. The Hon’ble Supreme court has held
that the right of surety not merely stands upon contract but also upon natural justice[17].
However, the surety will not be able to sue the principal debtor (i.e. Corporate Debtor) due to
applicability of moratorium under Section 14[18] of IBC.

Read more at: https://taxguru.in/corporate-law/indemnity-surety-ibc.html#_ftn16

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Amritlal Goverdhan Lalan Vs. State Bank of Travancore, AIR 1968 SC 1432

This concept stems from the case of Morgan v. Seymore26 in which the court decided that the
guarantor acquires the right to stand in the creditor‘s shoes after disposing of the principal
debtor‘s obligations. The Indian judicial system upholds the right of subrogation of the
guarantor by granting him all the legal rights of the creditors. Amrit Lai Goverdhan Lalan v.
State Bank of Travancore27 is an example of this, wherein the judge ruled that the concept of
subrogation is relevant not just to the contract of guarantee, but also with the principle of
natural justice. In place of all that, the court also ruled out that Section 140 of the ICA
28states that the guarantor is given all of the creditor‘s protection against the debtor. In this
case, a transition is needed.

The major issue now is whether the guarantor is obligated to initiate CIRP action against the
debtor under the Insolvency and Bankruptcy Code, 2016.

The response had been confirmed in the case of Davinder Ahluwalia and Ors. v. Sumit
Aviation29, in which the defaulter company‘s personal guarantors paid Punjab National Bank
around 1.05 crores. The subrogation theory has positioned the guarantor in the position of the
creditor. The corporation has once again failed to pay the guarantors. The money paid to
absolve the debt incurred as a result of MS Sumit Aviation‘s payment of the debt. Under
Section 730 of the IB Code, the guarantors contacted NCLT. The Tribunal then approved the
Corporate Insolvency Resolution deliberations against the principal debtor, citing the debtor‘s
failure to pay a sum as a default.
In the recent judgment with respect to challenge of provisions related to Personal Guarantors
in the ‘Anil Ambani case’[7] in 2019, it was held that the provisions in the code, specifically
Section 14 and Section 31(1), have been structured in a way so as to indicate that the
guarantor’s rights to subrogation cannot be taken away if in case he/she settles the debts of
the Corporate Debtor before or during the CIRP, but before the passing of the Resolution
plan. Post passing of the Resolution Plan, as per Section 31(1) of the Code, it shall be binding
on all stakeholders including the guarantors.[8] Section 31(1) of the Code stipulates that once
a Resolution plan is approved by COC, it shall be binding on all stakeholders including the
Creditors. Approval of a Resolution Plan would tantamount to extinguishment of all
outstanding claims against the Corporate Debtor. As such, the liability of the Personal
Guarantor would also be extinguished. This is to ensure that the Personal guarantors do not
altogether escape the liability of doing their part by seeking refuge under the veil of CIRP.

State Bank of India Vs Anil Dhirajlal Ambani, 2019 SCC OnLine SC 240