Financial creditor can initiate CIRP against both Principal Borrower and Corporate Guarantor
Table of Contents
The Insolvency and Bankruptcy Code, 2016 (IBC) provides a time-bound legal framework for the resolution of financially distressed companies known as the Corporate Insolvency Resolution Process (CIRP). A financial creditor can initiate CIRP against a corporate debtor who has defaulted on a financial debt under section 7 of the IBC. In cases involving a loan to a principal borrower of the carrot guarantor in the event of a default. This ability to proceed against either entity raises the question of whether the financial creditor can initiate simultaneous or concurrent insolvency proceedings against both the principal borrower and the corporate guarantor for the same debt.
Understanding the Roles: Principal Borrower and Corporate Guarantor
A principal borrower is the entity that avails a loan, while a corporate guarantor is a corporate person who provides a guarantee for the repayment of that loan under a contract of guarantee. Under section 128 of the Contract Act, 1872, the liability of a corporate guarantor is co-extensive with that of the principal borrower, meaning both are jointly and severally liable for the debt upon default. The IBC treats the obligation of a corporate guarantor as independent if the principal borrower is not a corporate entity or if proceedings against the borrower are pending. This independence ensures that the guarantor’s liability is not extinguished by the approval of a resolution plan for the principal borrower, as the contract between the creditor and guarantor remains enforceable under section 31 of the IBC. Read more Section 95 Application under IBC After Expiry of Three Years Is Barred by Limitation
Legal Provisions Allowing Action Against Both
Under Section 7 of the IBC, a financial creditor can initiate the CIRP against a corporate debtor who has defaulted on a financial debt. The liability of a guarantor is co-extensive with that of the principal borrower, and was established by section 128 of the Contract Act. Sections 126-128 of the Contract Act provide the foundation for the contract of guarantee, defining the roles of the creditor, principal debt, and surety (guarantor), and specifying the extent of the guarantor’s liability. This principle carries into the IBC framework, allowing creditors to initiate insolvency proceedings against a personal guarantor even if the CIRP is ongoing for the principal debtor. THe Supreme Court has repeatedly affirmed that the approval of a resolution plan for the corporate debtor does not automatically discharge the liability of the guarantor, reinforcing the creditor’s right to proceed against both entities.
Key Judicial Pronouncements
The National Company Law Appellate Tribunal (NCLAT) in State Bank of India v. Athena Energy Ventures Pvt. Ltd. held that simultaneous CIRP proceedings can be initiated against both the principal borrower and the corporate guarantor for the same debt and default. The tribunal emphasized that the liability of the guarantor is co-extensive with that of the principal borrower under section 128 of the Contract Act, and the IBC does not prohibit such simultaneous proceedings. The Supreme Court in Laxmi Pat Surana v. Union Bank of India affirmed that the liability of a corporate guarantor is coextensive with that of the principal borrower’s default. Consequently, a financial creditor can initiate CIRP against the corporate guarantor under section 7 of the IBC, without first initiating proceedings against the principal borrower. Hence insolvency proceedings can run simultaneously, but the two resolution processes cannot be approved for the same debt.
Simultaneous CIRP Proceedings: Permissibility and Limits
Insolvency proceedings can be initiated against both a borrower and their guarantor simultaneously, however, the approval of a resolution plan against one entity can significantly impact the other. Once a debt is resolved in one CIRP, for example, against the guarantor, the same claim cannot be pursued against the borrower as the debt is considered discharged. Further, the NCLAT has clarified that a creditor’s right to file a claim is unaffected by an ongoing CIRP against the other entity, meaning they can still pursue the borrower even if a resolution plan for the guarantor is being processed.
Implications for Financial Creditors
By allowing multiple proceedings against both borrowers and guarantors, the legal position enhances creditors’ recovery mechanisms and strategic options. Creditors can decide whom to proceed against first based on potential for recovery and efficiency. However, this framework creates risks, including the duplication of claims if creditors prove their debt in both proceedings simultaneously. An effective coordination is required between parallel insolvency cases to ensure that any amounts recovered from one entity are appropriately adjusted in the claims against the other preventing unjust enrichment.
Impact on Corporate Guarantors
Initiation of CIRP against a borrower has severe repercussions for guarantors, significantly impacting their business and reputation. Guarantors face survival financial exposure and reputational damage, as their financial stability and operational capacity are scrutinized by stakeholders, including customers, investors, and suppliers. Critically, guarantors cannot escape liability simply because CIRP has begun against the principal borrower. Under the Contract Act and the IBC, their liability is co-extensive and arises from an independent contract. This means that creditors can pursue the guarantor even if a resolution plan has been approved for the borrower, as the IBC’s involuntary discharge does not absolve the guarantor’s contractual obligations. Therefore, before offering a corporate guarantee, it is essential for guarantors to perform proper due diligence, carefully assessing the borrower’s financial health, creditworthiness, and potential risks to avoid unforeseen liabilities and safeguard their own business and reputation.
Conclusion
A financial creditor is entitled under the IBC to initiate a CIRP against both the principal borrower and a corporate guarantor for the same debt, as their liabilities are considered co-extensive and not mutually exclusive. This provision fortifies credit discipline by ensuring that guarantors cannot evade their obligations and promotes faster debt recovery, which in turn strengthens creditor confidence in the lending ecosystem. However, while parallel proceedings are permitted, creditors must ensure proper procedural complaint to prevent the “double-dipping” of claims, where the same debt is recovered from multiple sources, by adjusting claims appropriately once recovery has been made from one entity. Further, insolvency law requires that such proceedings be handled by the same adjudicating authority to facilitate this adjustment.
FAQs
- Can a financial creditor initiate CIRP against both the borrower and the guarantor simultaneously?
Yes, A financial creditor can initiate CIRP against both the borrower and the guarantor simultaneously, as demonstrated in several judicial rulings.
- Can two separate resolution plans be approved for the same debt?
No, two separate resolution plans cannot be approved for the same debt, as the process is designed to result in a single, binding resolution plan approved by the CoC and the NCLT.
- Does the initiation of CIRP against one entity bar proceedings against the other?
The initiation of CIRP against one entity does not bar proceedings against another entity if they are distinct corporate debtors, but a single financial creditor cannot file a second insolvency application for the same debt against a different entity once one application has been admitted.
- What happens if the guarantor’s CIRP is completed first?
The creditor can still pursue the principal debtor for any outstanding debt, and the guarantor’s liability is not automatically discharged, as the resolution plan for the guarantor does not extinguish the principal debtor’s obligations or release the guarantor from liability to the creditor.
- Are personal guarantors treated the same as corporate guarantors under the IBC?
No, personal guarantors are not treated the same as corporate guarantors under the IBC.
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