IBC: Guarantor's Liability Not Always The Same As Borrower's, Says Insolvency Tribunal

The liability of a corporate guarantor may not always be co-extensive or the same as that of the principal borrower, the Mumbai Insolvency Tribunal has said. The date of default for the corporate guarantor could be different from that of the borrower if the guarantee agreement specifies so, the court has held.

As the date of default in respect of the guarantor fell during the period during which the Insolvency Code was suspended, no proceedings can be initiated against the guarantor, according to the tribunal.

In the instant case, Direct Media Distribution Pvt. was a guarantor for the debentures issued by Essel Infra Projects Ltd.

Jay Properties Pvt., one of the debenture holders, acquired 425 unlisted debentures of Essel Infra with a face value of Rs 1 crore each, through a private placement. This was later transferred to Franklin Templeton Asset Management (India) Pvt.

The debentures became redeemable on May 22, 2020, which Essel Infra failed to redeem. However, a demand notice to the guarantor was only made on June 12, 2020.

The trustee for Franklin Templeton—IDBI Trusteeship Ltd.—argued that the demand notice served on May 9 amounted to an invocation of a guarantee.

However, according to Direct Media, the guarantee agreement clearly provided that the liability of the corporate guarantor cannot arise unless specifically invoked by the debenture holder. As the invocation in this case fell when Insolvency Code was suspended, bankruptcy proceedings cannot be initiated against the guarantor, it had argued.

The operation of the Insolvency and Bankruptcy Code was suspended for a year from March 25, 2020 to March 24, 2021. No proceedings under the code could be initiated for a default during such a period.

The court accepted Direct Media's argument that the date of default for the guarantor was two days after the date of invocation of the guarantee. Its liability can only arise after the invocation of the guarantee, as the agreement specifically says so. Moreover, there is nothing called "continuous default" as the date of default cannot be shifted, the court held.

The judgement follows the established precedent in respect of a guarantor’s liability under contract law, says Abhishek Sharma, partner at Dentons Link Legal.

Ameya Gokhale, partner at Shardul Amarchand Mangaldas and Co., also agreed with this assessment.

According to him, while the liability of the guarantor is co-extensive with that of the borrower, the method and time when such liability arises is subject to the contract i.e. the guarantee agreement.

In the present case, the contract mandates the invocation of the guarantee for the liability to arise. Therefore, the liability of the guarantor did not arise before June 14, 2020, which is two days after the invocation of the guarantee, he said.