2 January 2019

IBC | CORPORATE GUARANTEE | CLAIM INVOKED AFTER MORATORIUM IS ALLOWED BY NCLAT

An interesting issue under the Insolvency and Bankruptcy Code, 2016 (IBC) that resulted in contrary decisions by the National Company Law Tribunal (NCLT) and the National Company Law Appellate Tribunal (NCLAT) was whether a corporate guarantee issued by the corporate debtor that was invoked by the lender after commencement of the corporate insolvency resolution process and declaration of moratorium would entitle the lender to make a claim against the corporate debtor after admission of the insolvency petition. In Axis Bank v. Edu Smart Services Private Limited the NCLT answered the issue in the negative while the NCLAT on appeal allowed admission of the claim.

FACTS OF THE CASE:

• DBS Bank Limited filed an application as financial creditor of Edu Smart Services Private Limited (Corporate Debtor) to commence the corporate insolvency resolution process under the IBC against the Corporate Debtor. The application was admitted on 27 June 2017 and a moratorium declared by the NCLT.
  
  
• The interim resolution professional (IRP) appointed for the Corporate Debtor issued a public announcement seeking details of all claims against the Corporate Debtor on 30 June 2017. Axis Bank submitted its claim in Form ‘C’ to the IRP along with supporting documents on 11 July 2017. The claim of Axis Bank arose from a corporate guarantee issued by the Corporate Debtor for loans taken by Educom Solutions Limited (Borrower). IRP rejected the claim on the ground that since the corporate guarantee had not been invoked the claim could not be verified and was contingent. Thereafter, on 21 July 2017, Axis Bank invoked the corporate guarantee of the Corporate Debtor and notified the IRP. The IRP still refused to accept the claim of Axis Bank.
  
  
• Axis Bank approached the NCLT against the decision of the IRP. The NCLT rejected the application of Axis Bank on the following grounds:
  
  
  • The `corporate guarantee` had not been invoked prior to the initiation of the corporate insolvency resolution process and hence the liability under the guarantee had not crystallized as on the date on which the application seeking initiation of the insolvency process had been admitted. As a result, the claim of Axis Bank could not be verified on the insolvency commencement date;
  • Under the IBC only those claims should be considered which are due and payable as on the insolvency commencement date. The corporate guarantee, which was invoked after the insolvency commencement date, would not meet this requirement;
  • A right to claim any debt only arises when the creditor’s debt is due and payable. In case of a guarantee the debt becomes due only when a creditor invokes the guarantee, which in the present case occurred after the insolvency commencement date;
  • After the order of admission a moratorium is in effect which will bar any action to foreclose, recover or enforce any security interest created by the corporate debtor, thereby barring the invocation of the guarantee as well.
• This decision of the NCLT was challenged by Axis Bank before the NCLAT.

DECISION OF NCLAT

• After scrutinising the terms of the corporate guarantee, the NCLAT concluded that Axis Bank could be considered a lender of the Corporate Debtor since:
  
  
  • on a default by the borrower, the lenders could demand payment under the guarantee and the guarantor was required to make payment without demur or protest;
  • the lenders could act as if the guarantor was the principal debtor;
  • the guarantee was a continuing obligation till the borrower had repaid the loans.
• After considering the definitions of claim, debt and financial debt under the IBC, the NCLAT concluded that to initiate the corporate insolvency resolution process the financial creditor must show a default in relation to the financial debt. Such a requirement is not necessary for a claim, which is filed after commencement of the corporate insolvency resolution process, since it is defined as a right to payment whether disputed, undisputed, secured or unsecured or a right to payment arising from a breach of contract irrespective of whether the same is matured, unmatured, disputed or undisputed. Therefore, even an unmatured claim must be considered and verified by the IRP after commencement of the corporate insolvency resolution process. Thus, the appeal of Axis Bank was allowed.
  

MHCO Comment: While there appears to be merit in the stands taken by both the NCLT and the NCLAT, the view taken by the NCLAT appears to be more purposive and less technical. An interesting argument that was raised before the NCLAT was that Axis Bank had also filed a claim against the Borrower who was also part of a corporate insolvency resolution process and thus Axis Bank stood to gain from proceedings in relation to the Borrower and the Corporate Debtor. This argument was not dealt with by the NCLAT. It remains to be seen whether the Supreme Court would get involved in this matter to lay to rest the position of law in relation to guarantees that have not been invoked prior to commencement of the corporate insolvency resolution process.

The views expressed in this update are personal and should not be construed as any legal advice. Please contact us directly on +91 22 40565252 or legalupdates@mhcolaw.comfor any assistance.