Interpretation of Moratorium in Insolvency and Bankruptcy Code, 2016: A Dilemma

Jyotsna Chaturvedi | April 2018

The Insolvency and Bankruptcy Code (Code) still remains the crucial legislation wherein the
industry as well as the law fraternity is still anticipating clarifications on the numerous issues. The moot question of the secured creditors which is repeatedly being posed is whether after the introduction of the Code the security of personal or corporate guarantee is still available as a preferred security for the secured creditors against the Company, against which the Corporate Insolvency Resolution Process (CIRP) has been initiated under the Code.

The aforesaid matter was earlier dealt by the Mumbai bench of NCLT in the case of Schweitzer Systemic India Private Limited v Phoenix ARC. The bench while examining the aspect of Moratorium under section 14 of Code held that the ‘Moratorium’ has no application on the properties beyond the ownership of Corporate Debtor. The opinion and conclusion of the bench was based upon the language used in section 14 (1) (c) of the code which refers “its assets” denoting the property owned by “Corporate Debtor”. The Hon’ble Tribunal in the aforesaid case asserted that as the language mentioned in section 14 (1) (c) is clear there is no possibility even to supply ‘casus omissus’. The Tribunal was also of the opinion that the doctrine of ‘Noscitur a Sociis’, which means that the associated words take their meaning from one another so

that common sense meaning coupled together in their cognate sense be interpreted, may be somewhat applicable. The word “its” denotes the property owned by Corporate Debtor. The same view of the Tribunal was upheld by the Hon’ble National Company Law Appellate Tribunal (NCLAT) vide its order dated 31.07.2017 in of Alpha & Omega Diagnostics v Asset Reconstruction of Company India Limited

However, the latest ruling of the National Company Law Appellate Tribunal (Appellate Tribunal) in the case of State Bank of India (SBI) v Ramakrishnan and another has evoked another controversy touching upon Code that is serving as a major setback to creditors.

In the aforesaid case Mr. V. Ramakrishnan, the Managing Director and promoter of Veesons Energy Systems Limited (Company) gave personal guarantee against the loan secured by the Company from SBI. CIRP was initiated under the Code against the Company and accordingly a moratorium was declared. In accordance with the provisions of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI Act), SBI invoked the personal guarantee against the personal guarantor and took symbolic possession of the secured assets after issuing notice. The personal guarantor filed an application before the Chennai bench of National Company Law Tribunal, Chennai for staying the proceedings under the SARFAESI Act initiated against him in his capacity of a personal guarantor.

The Chennai Bench of NCLT ruled in favor of the Guarantor and held that the guarantor will substitute the lenders and as a result fresh security interest will be created on the corporate debtor’s property. The Tribunal reasoned that
creation of such an interest will affect the liability of the borrower and therefore cannot be permitted. The Tribunal placed reliance on sections 14 and 31 of the Code.

The Tribunal also placed its reliance on section 140 of the Indian Contract Act, 1872. Under section 140, where a guarantor has paid the whole or part of the liability which he guaranteed, the guarantor enters into the shoes of his
creditor and gets all the rights which he had against the principal debtor. For the aforesaid, the Tribunal allowed the application filed by the personal guarantor and consequently restrained SBI from proceeding against him till the moratorium period is over.

SBI, being aggrieved by the decision of the Tribunal approached the Appellate Tribunal. The Appellate Tribunal concurred with the decision of the Tribunal and ruled that a creditor cannot invoke personal guarantee while the borrower is undergoing CIRP. In other words, the moratorium on sale of assets applies not only to those of corporate
debtor but also to the personal guarantors’ assets.

It is important to note that the Appellate Tribunal made the following observation in its decision in the case
of Alpha & Omega Diagnostics v Asset Reconstruction of Company India Ltd:

“However, we are not inclined to accept such submissions as Appellant-Corporate Applicant has sought for “its” own

Insolvency resolution process that will include only the assets of the Corporate Debtor and not any assets, movable or immovable of a third party, like any director or other. In so far as ‘guarantor’ is concerned, we are not expressing any opinion, as they come within the meaning of ‘Corporate Debtor individually’, as distinct from principal debtor who has taken a loan.”

The Appellate Tribunal has not referred the findings of Schweitzer Systemic India Private Limited v Phoenix ARC in the case of State Bank of India (SBI) v Ramakrishnan. The Appellate Tribunal in the present case of State Bank of India (SBI) v Ramakrishnan and another concludes by holding:

“In view of the aforesaid provisions, we hold that the ‘Moratorium’ will not only be applicable to the property of the ‘Corporate Debtor’ but also on the ‘Personal Guarantor’.” In accordance with the aforesaid judgment,
no recovery proceedings can be initiated or continued against the personal guarantors of a Company which is into CIRP however it is important to note that the judgment suggests that rights cannot be exercised
against the guarantors only when they affect the liability of the corporate debtor.

The present interpretation as adopted by the Hon’ble Appellate Tribunal may lead to further difficulties for the Creditors to recover their dues. This would also lead to personal guarantors (who generally are either promoters or their close relatives) taking undue advantage of the protection provided to them. This may also lead to bankers imposing more strict rules while providing a loan.

The arguments may be placed that subrogation of a guarantor to the position of the creditor does not lead to creation of any fresh encumbrance on the assets of the borrower as it is more of a replacement of the encumbrance from the side of lender to the guarantor.

However it is pertinent to note that In the recent report , as has been circulated by the Insolvency Law Committee, the committee has made numerous recommendations to the Government on issues arising from the implementation of the Code. The Committee noted in its report that a literal interpretation of Section 14 is prudent, and a broader interpretation may not be necessary in the above context. The assets of the surety are separate from those of the corporate debtor, and proceedings against the corporate debtor may not be seriously impacted by the actions against assets of third parties like sureties. Additionally, enforcement of guarantee may not have a significant impact on the debt of the corporate debtor as the right of the creditor against the principal debtor is merely shifted to the surety, to the extent of payment by the surety. Thus, contractual principles of guarantee require being respected even
during a moratorium and an alternate interpretation may not have been the intention of the Code, as is clear from a plain reading of section 14. Further, since many guarantees for loans of corporates are given by its promoters in the form of personal guarantees, if there is a stay on actions against their assets during a CIRP, such promoters (who are also corporate applicants) may file frivolous applications to merely take advantage of the stay and guard their assets. In the judgments analysed in this relation, many have been filed by the corporate applicant under section 10 of the Code and this may corroborate the above apprehension of abuse of the moratorium provision. The Committee concluded and recommended that section 14 does not intend to bar actions against assets of guarantors to the debts of the corporate debtor and recommended that an explanation to clarify this may be inserted in section 14 of the Code. The scope of the moratorium may be restricted to the assets of the corporate debtor only.

Thus it is required to be seen now how the recommendations of the Committee is been taken by the Government and what changes are introduced in the code.