The Supreme Court recently settled significant issues relating to the interplay between corporate guarantees, the Insolvency and Bankruptcy Code, 2016 (for short, 'the IBC'), and the Indian Contract Act, 1872 (for short, 'the Contract Act'). The Court clarified the legal position on the liability of corporate debtors and guarantors in insolvency proceedings.
The facts of the case which led to the dispute involved a loan of Rs. 100 crores which was granted by SREI Infrastructure Finance Ltd. (financial creditor) to Gujarat Hydrocarbon and Power SEZ Limited (corporate debtor). This loan was secured by a corporate guarantee from Assam Company India Limited (ACIL) which is the holding company of the corporate debtor. After several defaults, insolvency proceedings were initiated against ACIL. The appellant, BRS Ventures Investments Ltd., became the successful resolution applicant for ACIL and paid Rs. 38.87 crores to the financial creditor as per the approved resolution plan. Subsequently, the financial creditor initiated insolvency proceedings against the corporate debtor for the remaining loan amount.
The Supreme Court, after analyzing rival submissions by the parties, dismissed the appeal. The Apex Court placed reliance on the judgment of Lalit Kumar Jain v. Union of India & Ors (2021) 9 SCC 321 and held that the approval of a resolution plan for a corporate guarantor does not ipso facto discharge the liability of the principal borrower. After placing reliance on Laxmi Pat Surana v. Union of India & Anr. (2021) 8 SCC, the Court emphasized that the liability of the principal borrower and the guarantor is co-extensive, and the creditor can proceed against either or both simultaneously under the IBC. In other words, it was clarified that as per Section 128 of the Contract Act, seeking repayment from either party will not exhaust remedies against the other.
The Apex Court further clarified that the assets of a subsidiary company cannot be included in the resolution plan of the holding company and The financial creditor can always file separate applications under Section 7 of the IBC against the corporate debtor and the corporate guarantor. The applications can be filed simultaneously as well. This interpretation was based on Sections 18 and 36 of the IBC, which explicitly exclude the assets of Indian subsidiaries from the definition of 'assets' in insolvency proceedings.
Further, the court noted that under Section 140 of the Contract Act, when a guarantor pays a part payment for the entire outstanding amount payable to the creditor, the equitable right of subrogation is limited to the extent of the debt cleared. In this case, the appellant's right of subrogation was limited to the Rs. 38.87 crores paid on behalf of the corporate guarantor. The subrogation will be only to the extent of the amount recovered by the creditor from the surety. Even after the subrogation to the extent of the amount paid on behalf of the corporate guarantor by the resolution applicant, the right of the financial creditor to recover the balance debt payable by the corporate debtor is in no way extinguished.
The Apex Court reaffirmed that a holding company and its subsidiary are always distinct legal entities. The holding company would own shares of the subsidiary company. In the case of Vodafone International Holdings BV v. Union of India & Anr (2012) 6 SCC 613, this Court took the view that if a subsidiary company is wound up, its assets do not belong to the holding company but to the liquidator. That does not make the holding company the owner of the subsidiary's assets. On this basis, the court rejected the appellant's argument that the corporate debtor's assets were part of ACIL's insolvency proceedings.
The Supreme Court's ruling provides clarity on several critical aspects of insolvency law and corporate guarantees. It upholds the principle of co-extensive liability of the principal borrower and guarantor while maintaining the separation of corporate entities. The judgment also offers a nuanced interpretation of the right of subrogation, balancing equitable principles with the literal interpretation of the Contract Act.
This decision will have significant implications for future insolvency proceedings involving corporate guarantees and holding subsidiary relationships. It reinforces the rights of creditors to pursue claims against both principal borrowers and guarantors, even after the resolution of one entity's insolvency. The judgment also provides valuable guidance on the interpretation of key provisions of the IBC and the Contract Act in the context of corporate insolvencies.