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Guarantor's Right To Subrogation Under The Insolvency And Bankruptcy Code, 2016

In a recent judgment dated June 27, 2022 in Orbit Towers Pvt. ltd against Sampurna Suppliers Pvt. Ltd.[1], the NCLT Kolkata decided that a Corporate Guarantor is entitled to initiate insolvency proceedings under Section 7 of the Insolvency and Bankruptcy Code 2016[2] (hereinafter "IBC") against the Principal Borrower using the Transitional Law even in the absence of an agreement between the Guarantor and the Principal Borrower.

The NCLT has determined that the creditor's rights to recover the money from the debtor would automatically transfer to the surety/guarantor. The guarantor who has fulfilled the principal debtor's obligations that are the subject of his suretyship has the right to put himself in the position of the creditor and to enjoy all the rights that the creditor had against the principal debtor. The purpose of this article is to analyse the current legal situation regarding the guarantor's right of subrogation in the context of IBCs.

Factual Matrix Of The Case:
Sampurna Suppliers Pvt. ltd (hereinafter the "Corporate Debtor") needed funds for its operations, so it turned to various banks and financial institutions for a loan. Consequently, Indian Bank agreed to provide a loan of Rs. The loan had to be secured by collateral and other guarantees. Against this background, the corporate debtor approached Orbit Towers Pvt. ltd (hereinafter the "Corporate Guarantor") to act as corporate guarantor for the loan in favor of Indian Bank.

In addition, the corporate debtor requested the corporate guarantor to place an appropriate mortgage on the corporate guarantor's property. The corporate guarantor agreed.

The corporate guarantor and the corporate debtor agreed that the corporate debtor should repay the loan along with accrued interest and obtain the release of the mortgaged property. However, the Corporate Debtor has failed to pay its instalments including but not limited to the accrued interest.

Following various requests from the Corporate Debtor, the Corporate Debtor made a partial payment of Rs.2,60,00,000/- to the corporate guarantor to settle his liability, thereafter a sum of Rs. 5,85,19,907/- remained due and payable to the corporate guarantors. The legal debtor has acknowledged his liability for this amount towards the legal guarantor by signing a balance confirmation from 04/01/2015 to 01/31/2015.

As the corporate debtor failed to pay the remaining instalments to the corporate guarantor, the corporate guarantor filed a Section 7[3] application alleging that it was a financial creditor under the IBC . The Corporate Debtor contested the sustainability of the proceedings, arguing that the Corporate Guarantor initiated the proceedings based on payments made by the Corporate Guarantor to Indian Bank on behalf of the Corporate Debtor, Indian Bank's principal borrower.

The Corporate Debtor's contention was that the claim of the purported financial creditor in its capacity as guarantor did not fall within the definition of a financial liability under the IBC and therefore the Corporate Guarantor did not qualify as a creditor under the IBC. The NCLT noted that the present case raised an interesting legal issue relating to a guarantor's rights to indemnification from the principal borrower's liability of the corporate debtor. Accordingly, the NCLT proceeded to analyze the provisions of the Indian Contract Act, 1872

Analysis Of The Relevant Provisions
Right of Subrogation under the Indian Contract Act, 1872
Articles 140[4] and 141[5] of the Indian Contract Act, 1872 provide for the right of subrogation. In accordance with these provisions, the bond is endowed with all the rights that the obligee has against the principal obligor after paying or fulfilling the guaranteed debt upon maturity of that debt, which corresponded to the principal obligor's breach of the guaranteed obligation. .

The entire doctrine of principal and suretyship with all its contributory consequences etc., which was developed from the established principles of a Court of Equity, is derived from the common law.

The guarantor is entitled to all means against the principal that the creditor has against the principal to enforce all guarantees and all means of payment, to put himself in the creditor's position, etc.

In Bank of Bihar v. Damodar Prasad[6], the Supreme Court has held that it is the bail's duty to pay the debt and upon such payment, the bail is entitled to collect the full amount from the principal debtor. The law of bail is not based on the treaty principles, but on the principle of natural law. Therefore, the guarantor is entitled to all resources that the creditor has towards the debtor to execute all guarantees and all means of payment, including through registered titles, without knowing that the guarantor has the right to transfer these titles to you.

However, the subrogation right has been given a different pedestal under the IBC regime discussed below.

Right of subrogation under the IBC
In the present case, the Indian Bank, i.e. the creditor, has not initiated any proceedings under the IBC against the debtor company. Rather, the corporate guarantor repaid the loan amount and released the liability of the corporate debtor. In view of this, the corporate guarantor claimed that all the rights of the then creditor, i.e. the Indian bank was granted to the corporate guarantor.

The NCLT found that since the Corporate Guarantor has repaid the amount of the Corporate Debtor's financial debt to the Bank of India, the Corporate Guarantor is treated as a "financial creditor" and can take action against the Corporate Debtor without an agreement between the two.

Principles of contract law do not require to have a written agreement in order for a guarantor to exercise its right of subrogation. Once the guarantor settles the principal's obligation to the creditor, all rights of the creditor to recover the money automatically pass to the guarantor.

The NCLT also found that after the corporate guarantor has performed the obligations of the principal, it is entitled to substitute itself for the creditor and enjoy any rights that the creditor would enjoy against the principal.

In view of the foregoing, Orbit Towers Pvt. ltd (the Company Guarantor) by paying the debt on behalf of Sampurna Suppliers Pvt. Ltd. (the main borrower) has replaced Indian Bank (the creditor). Consequently, all rights of Indian Bank are in favor of Orbit Towers Pvt. ltd assigned, who is entitled and entitled to oppose Sampurna Suppliers Pvt. Ltda. to proceed for reimbursement of these fees. Therefore, the petition was found acceptable under Section 7 of the IBC.

Similarly, in the case of Davindra Ahluwalia & Anr. v. M/s Sumit Aviation[7] ruled by the NCLT Delhi in 2017 that the NCLT granted the personal guarantor request under Section 7 of the IBC.

In this case, the personal guarantor had settled the corporate debtor's liability. However, failing to collect the installments from the joint and several debtor, the personal guarantor instituted proceedings against the joint and several debtor under Section 7 of the IBC, which were approved by the contracting authority. It is important to note that while the NCLT Delhi allowed the petition in this case, the court did not discuss the subrogation provisions.

There are currently different views on this topic. In our opinion, the view of the NCLT Kolkata in this case is progressive and adequately protects the rights of citizens. Since the liability of guarantors is equal, the recent judgments provide much-needed protection for guarantors who have fulfilled their obligations under the contract of guarantee.

  1. Orbit Towers Pvt. Ltd. Vs. Sampurna Suppliers Pvt. Ltd.,(2022) 610 NCLT
  2. The Insolvency and Bankruptcy Code, 2016 (Act 31 of 2016), s.7
  3. Ibid
  4. The Indian Contract Act, 1872 (Act 9 of 1872), s.141
  5. The Indian Contract Act, 1872 (Act 9 of 1872), s.142
  6. Bank of Bihar v. Damodar Prasad AIR 1969 SC 297
  7. Davindra Ahluwalia & Anr. v. M/s Sumit Aviation[7], IB No. (IB)-229 (ND)/2017

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