Corporate insolvency can be initiated against a guarantor who is a corporate debtor when the principal borrower, regardless of him not being a corporate person, has committed default in payment.

In the matter of Laxmi Pat Surana Vs. Union Bank of India & Anr. in Civil Appeal No. 2734 of 2020, decided by the Hon’ble Supreme Court on 26.03.2021

Facts of the case-
Respondent No.1 bank (Financial creditor) extended credit facility to a proprietary firm (principal borrower) of the Appellant through two loan agreements in 2007 and 2008. M/s Surana Metals Ltd. (Corporate Debtor), of which the Appellant is also a promotor/director, had offered guarantee to the two loan accounts of the principal borrower. The stated loan accounts were declared NPA in 2010 and recall notice was issued to both principal borrower and corporate debtor followed by an application u/s 19 of RDDBFI, 1993 against the principal borrower before DRT, Kolkata.
During pendency of the said action, the Bank filed an application u/s 7 of IBC for initiating CIRP against the corporate debtor after sending a notice of payment to the corporate debtor u/s 4(1). This application was resisted particularly on the ground that it was not maintainable because the principal borrower was not a ‘corporate person’. This contention was negatived by Adjudicating Authority, and the said order was further upheld by NCLAT, Delhi.
The Appellant before the Hon’ble Apex Court by way of the present appeal contended that since an application u/s 7 cannot be maintained against a principal borrower who is not a “corporate person”, therefore it must follow that no action u/s 7 of the Code can be maintained against a company or corporate person, merely because it has extended guarantee thereto.

Issue raised before the Court-

Whether an action u/s 7 of IBC can be initiated by a bank against a corporate person being a corporate debtor concerning guarantee offered by it in respect of a loan account of the principal borrower, who has committed default and is not a “corporate person”?

Observations of the Court-

The Apex Court observed that sec 7 is an enabling provision, which permits the financial creditor to initiate CIRP against a corporate debtor. The corporate debtor can be the principal borrower or it can be a corporate person assuming the status of corporate debtor having offered guarantee, if and when the principal borrower, regardless of it being a corporate person or otherwise, commits default in payment of its debt.
A right or cause of action would arise in favour of the financial creditor in case of default, to proceed against the principal borrower as well as the guarantor, acting jointly and severally. The obligation of the guarantor is coextensive and coterminous with that of the principal borrower to discharge the debt, as predicated in section 128 of the Contract Act, 1872. As a consequence of such default, the status of the guarantor transforms into a corporate debtor if it happens to be a corporate person, within the meaning of sec 3(8) of the Code.
The Apex Court while disposing of the appeal held that “In law, the status of the guarantor, who is a corporate person, metamorphoses into corporate debtor, the moment principal borrower (regardless of not being a corporate person) commits default in payment of debt which had become due and payable. Thus, action u/s 7 of the code could be legitimately invoked even against a (corporate) guarantor being a corporate debtor.”