Holding Company under Corporate Insolvency Resolution Process, as a Guarantor of its Subsidiary Company
Owais S. Khan
Final Year Student, Government Law College, Mumbai
Recently, the Hon’ble Supreme Court (SC) in the BRS Ventures Investments Ltd. vs. SREI Infrastructure Finance Ltd. & Anr. [1] (“BRS Ventures”). adjudicated on some of the very imperative prepositions of Law, viz-a-viz the role of Holding Company as Corporate Guarantor (Guarantor) for a loan undertaken by its Subsidiary Company, the Corporate Insolvency Resolution Process (CIRP) against the Guarantor as well the Corporate Debtor (CD) and the Separate Corporate Personality of the Holding and Subsidiary Company.
Facts of the Case
The case pertains to default in the repayment of loan by a Corporate Debtor (CD) and subsequent course of remedial Action by the Financial Creditor (FC). One, Gujarat Hydrocarbon & Power SEZ ltd., Respondent 2, approached SREI Infrastructure Finance Ltd (SREI)., Respondent 1 for a grant of loan of Rs. 100 Crores. The said loan was secured by a mortgage of leasehold land by the CD, and the pledge of its own shares and its holding Company, M/s. Assam Company India Ltd (ACIL). The said loan was also secured by a Corporate Guarantee executed by ACIL in favour of SREI. Pursuant thereto, Respondent 2, committed a default in repayment of Loan and subsequently, SREI, the FC invoked the Corporate Guarantee of ACIL, the Holding Company of the CD u/s. 7 of the Insolvency and Bankruptcy Code (IBC). Thus, CIRP was initiated against ACIL, and the claim amount of SREI as the FC was reckoned at Rs. 241.27 Crores, inclusive of the principal amount of Rs. 100 Crores. The Appellant, BRS Ventures Investments Ltd., emerged as the Successful Resolution Applicant in the CIRP, after its Resolution Plan was approved by the Committee of Creditors (CoC) and subsequently, confirmed by the Adjudicating Authority as well as the NCLAT. The Appellant paid SREI Rs. 38.87 Crores in full and final settlement of all its dues, against the Admitted claim of Rs. 241.27 Crores.
In a bid to realize the remaining unpaid debt, SREI filed an application u/s. 7 of the IBC, against the CD, Gujarat Hydrocarbon and Power SEZ ltd. which was accepted by the Adjudicating Authority and CIRP was initiated against the CD. Post admission of CD in CIRP, appeals were made by the Suspended Directors and BRS Ventures Investment Ltd., which were subsequently dismissed. M/s. Zaveri & Co. Pvt. Ltd. submitted a Resolution Plan for the CD which was then approved by the CoC. Aggrieved by the said admission, the appellant in the capacity of the Holding company of the CD has reached the contours of the SC.
Issues Involved
The following issues were framed for adjudication before the SC:
- Liability of a Guarantor/ Surety for a default committed by the CD, as a principal borrower OR the Liability of the CD, as a principal Borrower, where the Liability of the Guarantor is discharged due to insolvency.
- Nature of Proceedings against the Guarantor under IBC.
- Can the Assets of the CD, who is a subsidiary of the Guarantor, be included in the Resolution Plan, and subsequently CIRP of the Guarantor.
- Right of Subrogation in favour of the Guarantor under the Indian Contracts Act, 1872. (Contracts Act).
Arguments and Adjudication
Liability of the Surety/ Guarantor:
The Appellant, in the capacity of a Successful Resolution Applicant of the Guarantor argued that, with the payment of Rs.38.87 Crores in favour of SREI as full and final settlement of its total dues of Rs. 241.27 Crores, it has discharged its liability under the Contract of surety and thus by virtue of Section 140 of the Indian Contract Act, dealing with the Right of the Surety (Guarantor) on payment, the Appellant has now stepped into the shoes of SREI, the FC. Thus, the Appellant would have right over the dues as well as security provided by the Corporate Debtor, including the Leasehold land mortgaged and not the FC. It further stated that the payment of the entire debt is not a prerequisite for the subrogation in its favour as held by the SC in Economic Transport Organization, Delhi vs. Charan Spinning Mills Pvt. Ltd. & Anr [2]. Finally, it argued that by virtue of this payment made, the FC is estopped from enforcing the remaining debt from the CD as the debt has been satisfied as full and final settlement, which is also held by the SC in Lala Kapurchand Godha & Ors. vs. Mir Nawab Himayatalikhan Azamjah [3].
The Respondent, accentuating the principle that the liability of the Guarantor is co-extensive with that of the CD, argued that the partial recovery of debt from the Guarantor, does not absolve the CD from his financial obligation. As laid down in Maitreya Doshi vs. Anand Rathi Global Finance Ltd. & Anr [4] the FC prayed that it has every right to enforce the remaining debt against the CD, since the entire debt has not been realized from the Guarantor.
The SC advancing its judgement under the light of Contracts Act, outrightly declared that the Liability of the Guarantor is co-extensive with that of the Principal Debtor by virtue of Section 128. It stated that by virtue of Section 137, the Creditor (Respondent) is at liberty to sue either the Principal Borrower (CD) or the Surety (Guarantor), unless there is a contract to the contrary. Thus, the SC held that the Respondent has every right to first proceed against the Guarantor, and not the CD. Further, even though the respondent has received a part of the Amount Guaranteed by the Guarantor and agrees not to proceed against him for the balance amount, the remaining debt to be payable by the CD is not extinguished and the Respondent has every right to recover the same from the CD.
Taking into consideration, the mechanism of Surety Agreement under CIRP, the SC, quoted Lalit Kumar Jain vs. Union of India & Ors. [5], wherein it was held that “Approval of a resolution plan does not ipso facto discharge a personal guarantor (of a corporate debtor) of her or his liabilities under the contract of guarantee. As held by this Court, the release or discharge of a principal borrower from the debt owed by it to its creditor, by an involuntary process i.e. by operation of law, or due to liquidation or insolvency proceeding, does not absolve the surety/guarantor of his or her liability, which arises out of an independent contract.” By the said judgement, since the Guarantor is not discharged of his Liability, taking the facts of the present case on the same pedestal, the SC held that discharge of Surety, by virtue of his Insolvency, does not discharge the Principal Borrower. Thus, the Respondent has every right to proceed against the CD, notwithstanding the CIRP of the Guarantor.
Outlining Section 31 of IBC, dealing with Approval of the Resolution Plan and its binding nature, The SC held that the if the CIRP of the Corporate Guarantor ends with a Resolution Plan, it shall be binding on the Creditor and the liability of the Guarantor shall cease. However, this shall not affect the liability of the principal borrower to repay the remaining amount to be recovered.
On a concluding note, for the said preposition, the SC held that in case of a loan transaction, secured by a guarantee, two distinct obligations to repay are created, first against the Principal Borrower and second against the Guarantor. However, the right to recover in both the obligations remains the same, which is the amount of Loan payable by the Borrower.
Nature of Proceedings Against Guarantor under IBC:
Elaborating on the definition of “Financial Debt” u/s. 5(8) of IBC, the court held the liability of the Guarantor is in the nature of a Financial Debt. Section 60 of IBC provides that where a CIRP or liquidation proceeding against the CD is pending before the NCLT, an Application relating to the Insolvency Resolution or Liquidation or Bankruptcy of the Corporate Guarantor shall be filed before the NCLT, and the proceedings of the Corporate Guarantor shall stand transferred to the Adjudicating Authority dealing with the proceedings of the Corporate Debtor.
Thus, the Court held that the IBC permits simultaneous as well as separate proceedings against the CD and the Guarantor, to be initiated u/s.7 by a Financial Creditor.
Assets of the CD, as a subsidiary in the CIRP of Guarantor, the Holding Company:
The Respondent FC argued that the main point of contention of the appellant is the institution of Corporate Insolvency of the CD, for the assets which are part of the CIRP of ACIL, the Holding Company of CD, is also included in the CIRP of the CD. The respondent, also relied on the Information Memorandum (IM) in the CIRP of ACIL, which disclosed that the IM did not contain any of the assets of the CD. The IM, only provided for the assets in which the Holding Co. has invested. Relying on Section 36(4) and Section 18 of the IBC, it was argued that the assets of the Subsidiary (CD in the present case) cannot be included in the Liquidation Estate and the Resolution process of the Holding Company. To buttress the argument, the Respondent relied on the Judgement of Vodafone International Holdings BV vs. Union of India & Anr [6], highlighting that Holding Company and Subsidiary Company are distinct legal persons and the Holding Company does not own the assets of the Subsidiary Company. The Respondent also stated the fact that the IM has a specific clause providing that the right of subrogation shall not be available to the Guarantor (Earlier ACIL, now Appellant).
The court satisfied with the arguments of the Respondent held that it is the Duty of the Interim Resolution Professional under Section 18 of IBC to ensure that the Assets of the CD, shall not include the assets of its Indian or Foreign Subsidiary. Since, the Guarantor is subjected to CIRP, the assets of its Subsidiary (The Principal Borrower) cannot be included in the assets of the Guarantor facing insolvency. The SC opined that the raison for not including the assets of the Subsidiary is because, the Shareholders of the company have no interest in the Assets of the Company. Quoting the decision of Bacha F. Guzdar vs. Commissioner of Income Tax, Bombay [7], the SC held that shareholders have a right in the dividends of the Company, which forms a part of the Profit of the Company, in which the shareholders own a share. The Property (Assets) of the Company does not belong to its Shareholders, but to the Company itself owing to its Separate Juristic Personality.
Thus, the court held that the Holding and Subsidiary Companies are distinct legal entities. Though, the holding company can own majority of Shares in the Subsidiary Company, it does become the owner of the Assets of its Subsidiary. Elaborating on the assets of the Subsidiary Company, the SC quoting Vodafone Holdings, held that in the event a Subsidiary is wound up, the assets would belong to the Liquidator and not the Holding Company.
Hence, the Appellant as a Holding Company does not have any right over the Assets of the CD, and thus the same cannot be included in the CIRP of the Holding Company.
Subrogation in favour of Guarantor:
The Intervenors argued that the provisions of Section 140 of the Contracts Act, which provides that that the surety upon payment or performance of all that he is liable for is invested with the rights which the Creditor had against Principal debtor, where a guaranteed debt has become due, or a default has been committed by the Borrower, is not applicable in case of Part Payment of the Debt. Thus, the Appellant is not entitled to all the rights over its Subsidiary.
Elaborating Section 140 of Contracts Act, The SC held that the provisions apply only if the surety pays the entirety of amount payable under Guarantee to the Creditor. Highlighting the words ‘all that he is liable’, it stated that when a surety pays only a part of the amount payable to the creditor, the equitable right which the Surety gets will be confined to the Debts cleared by him and not the entire debt.
Thus, the Appellant, in the present case, does not acquire all the rights of the FC, since the Appellant as a Guarantor has paid only a part of the Debt, and not the Entire Debt.
Analysis and Evaluation:
The Judgement can be hailed as one of the Landmark decisions, in case of Corporate Guarantee provided by the Holding Company on a Loan taken by its Subsidiary Company. It upholds some previous judgements, as well as calls for the needs of some necessary measures that can be taken that can streamline the proceedings, when both the Corporate Debtor as well as the Corporate Guarantor is subject to CIRP.
Firstly, it upholds the judgement of Laxmi Pat Surana vs. Union Bank of India [8], which inter-alia states decides on the liability of Guarantor in CIRP. It held that the When the Guarantor is a Corporate Person, and a default is committed by the Principal Borrower, regardless of not being a Corporate Person, the status of the Guarantor metamorphoses into Corporate Debtor. Similarly, in S.B.I vs. V. Ramakrishnan [9], The SC held that the procedure with respect to the proceedings in relation to the Insolvency Resolution and Liquidation of a Corporate Guarantor would be similar to that of the Corporate Debtor. Both, the above judgement along with the BRS Ventures acts in furtherance of the purpose behind CIRP, which is to ensure and promote reorganization of the CD, and to delicately ensure the interest of all the stakeholders including the Creditors and the Employees.
Secondly, in relation to the nature of proceedings against the Guarantor, The SC has stressed on the need for grouping together the CIRP of the CD and the Guarantor in Embassy Property Developments (P) Ltd. vs. State of Karnataka [10], so that the proceedings do not proceed on different tracks, before different fora, leading to conflict of interests, situations or decisions. Also, in Schweitzer Systemtek India (P) Ltd. vs. Phoenix ARC (P) Ltd [11] the NCLAT held that for initiating proceedings against Guarantor u/s. 60 of IBC, a separate application shall be filed before the same bench which is hearing the proceedings against the CD. The BRS Ventures, is unique in the aspect that the FC, initiated the CIRP against the Guarantor in the first instance and not the CD directly, on the ground of Co-extensive liability, and the same has been upheld.
Thirdly, dealing with the assets of the CIRP, a very imperative but hardly discussed topic deserves attention, which is that of ‘Consolidated CIRP’. In Oase Asia Pacific Pte Ltd. vs. Axis Bank [12], The NCLAT allowed the Consolidated CIRP of a Holding Company with its two Subsidiary Companies to keep the Holding Company as a going concern. Further the NCLT in State Bank of India vs. Videocon Industries Ltd.[13], while upholding a consolidation laid down certain yardsticks that must be satisfied before arriving at any conclusion on ‘consolidation’, viz. Common Control, Directors, Assets, Liabilities; Inter-dependence; Inter lacing of Finances; Pooling of Resources; Co-existence for survival; Inter-looping of Debts; Singleness of economics of units; Cross- Shareholding, etc. Similarly, in Jitendra Arora vs. Tek Chand [14], The NCLAT held that for successful resolution of a CD, ‘piercing of the Corporate Veil’ of the two Companies – Holding and Subsidiary becomes absolutely necessary and imperative. However, the BRS Ventures was silent on the said concept, even though CIRP was initiated against both the Holding as well as the Subsidiary Company. This calls the need for a legislative amendment to explore the possibilities of a Consolidated CIRP when the Guarantor is the Holding Company of the CD, as this streamlines the entire CIRP process into a single channel, and at the same time, enable the creditors in recovery of their dues. However, the process suffers from two major drawback. Owing to the consolidation of Assets of both the Companies, the Big Shot Corporate Houses gets placed at a much better position, owing to their Deep Corporate Pockets, as compared to other Corporate Players, to come up with a Resolution Plan. Similarly, ambiguities could arise in the functioning of Committee of Creditors (CoC) when more than CD is involved within the same CIRP.
Conclusion:
Thus, the BRS Ventures is no doubt, a feather in the Cap in the ever-evolving landscape of IBC Jurisprudence. The judgement, explicitly recognizes the importance bestowed upon the recovery of debts, highlighting that FCs have every legitimate right to invoke the provisions of IBC against a Corporate Guarantor, and only a complete repayment of Debt devolves the right of the FC in favour of a Successful Resolution Applicant.
References:
[1] . (2024) ibclaw.in 170 SC.
[3] . (1963) 2 SCR 168
[7] . (1955) 1 SCR 876
[11] . [2017] ibclaw.in 24 NCLAT
[12] . (2021) ibclaw.in 138 NCLAT
[13] . (2019) SCC OnLine NCLT 745
