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Status of Personal Guarantor After Discharging debt of Corporate Debtor under IBC?

Personal Gurantors to corporate debtors are in the limelight now-a-days thanks to Insolvency and Bankruptcy Code, 2016 (Code). The personal guarantors are a worried lot as the lenders, particularly the financial creditors under the Code, are invoking guarantees calling upon them to pay the debts of debtors for which they stood surety regardless of pending corporate insolvency resolution process of the corporate debtor against which the surety stood. The law on liability of the surety is perspicuous in India after the Apex Court had held that “the creditor is not bound to exhaust his remedy against the principal Debtor before suing the surety, and a suit may be maintained against the surety though the principal has not been sued.” (State Bank of India v. Indesport Registered, AIR 1992 SC 1740). Also, there is no quarrel in the position that liability of the surety is co-extensive with that of the Principal Debtor unless the contract provides otherwise (S. 128 of the Indian Contract Act, 1872).

Let us analyse the position of the surety once the creditor or lender recovers the amount of the debt from the surety. A Surety, upon payment of debts due by a debtor to the creditor, steps into the shoes of the creditor. A question, however, arises is whether the surety becomes a financial creditor under section 5(7) of the Code upon payment debts of the corporate debtor? Section 5(7) of the Code defines the financial creditor as “any person to whom a financial debt is owed and includes a person to whom such debt has been legally assigned or transferred to”. The definition of financial creditor goes into the definition of financial debt, which has been defined in S.5(8) of the Code. It has a meaning and an inclusive part. The meaning part defines it as “a debt alongwith interest, if any, which is disbursed against the consideration for the time value of money”. The inclusive part contains nine instances which are construed as a financial debt.

Typically, a personal guarantor is entitled to recover the amount from the principal debtor any amount paid on his behalf. This position prevails under the general law of contracts and the surety gets the benefit of every security to which the creditor was entitled to (S. 141 of the Indian Contract Act). To this extent, the position is undisputed. The surety is also invested with all the rights which the creditor had against the principal debtor when the guaranteed debt has been paid by the surety (S. 140 of the Indian Contract Act). Whether the rights collected by the surety against the principal debtor also include the right to be called as a financial creditor under the IBC?

The definition of financial debt, as noted earlier, has two parts and one point of view suggests that to be considered as a financial creditor, the debt now owed to the personal guarantor should satisfy the ingredients of financial debt. The question hinges on satisfaction of element of ‘time value of money’ in the debt. On closer examination of the effect of section 140 and 141 of the Indian Contract Act, one may notice that the surety gets all rights that the creditor had against the principal debtor besides getting benefit of every security. The benefit of security assumes significance in the context of recovery but acquisition of “all rights of the creditor” has wider connotation. It would definitely include the right to be termed as financial creditor and exercise all rights that would have accrued to original creditor.  Subrogation of all the rights of creditor against Principal debtor includes access to securities and right to legal remedies which a creditor was entitled to. Subrogation is “an equitable doctrine holding that when a third party pays a creditor or obligee the third party succeeds to the creditor’s rights against the debtor or obligor”[“Subrogation.” Merriam-Webster, n.d. Web. 8 Apr. 2018] and legal right is “the aggregate of the capacities, powers, liberties, and privileges by which a claim is secured” [“Legal Right.” Merriam-Webster, n.d. Web. 8 Apr. 2018]. The amalgam of reasonings and meanings stated above leads to the conclusion that surety gets the right to be called as a financial creditor under the Code and gets all powers of financial creditor vested therein.

The result of the above discussion is that a claim can be filed by the surety as a financial creditor in corporate insolvency resolution process or liquidation process under the Code. Surety, therefore, steps into the shoes in every literal sense and the shoes does not pinch in the absence of any express provision debarring the surety to be considered as a financial creditor. Whether the surety will be a part of the committee of creditors is a different matter which hinges upon the related party concept as defined in the Code?

Conclusion : The proposition of surety attaining the status of a financial creditor upon discharge of debts on behalf of the principal debtor sounds logical and reasonable from legal perspective as well as equitable considerations.

© Ashish Makhija:

Disclaimer: The views expressed here are views based on my personal interpretation for academic purposes alone and should not be deemed as legal or professional advise on the subject. If relied upon, the author does not take any responsibility for any liability or non-compliance.