India: Case Note: Moratorium Prohibits Invocation Of Corporate Guarantee Against Corporate Debtor

The Hon'ble Adjudicating Authority (National Company Law Tribunal, Principal Bench, New Delhi) in the case of Axis Bank Limited and Another v. Edu Smart Services Private Limited (decided on 27.10.2017) held that invocation of corporate guarantee against the corporate debtor would result in enforcing of 'security interest' and it would amount to violation of the moratorium imposed under Section 14(1)(c) of the Insolvency and Bankruptcy Code, 2016.

Background Facts

Edu Smart Services Private Limited (hereinafter "Corporate Debtor") is the guarantor, by way of an irrevocable and unconditional corporate guarantee dated 03.06.2015, for Educom Solutions Ltd., which had entered into a Master Restructuring Agreement with Axis Bank Ltd. (hereinafter "Applicant") for restructuring and reconstitution of existing loans and working capital facilities granted by consortium of lenders.

Meanwhile, DBS Bank Limited filed an application for insolvency of the Corporate Debtor under Section 7 of the Insolvency and Bankruptcy Code, 2016 (hereinafter "the Code"). In the said proceedings, the corporate insolvency resolution process (hereinafter "CIRP") commenced on 27.06.2017 and moratorium was imposed under Section 14 of the Code. Thereafter, the Applicant made a claim based on the corporate guarantee, against the Corporate Debtor before the Insolvency Resolution Professional (hereinafter "IRP") on 11.07.2017 without invoking or making any demand on the Corporate Debtor- corporate guarantor. A communication was sent by the IRP to the Applicant on 20.07.2017 intimating that the claim cannot be verified as the corporate guarantee has not been invoked. The Applicant subsequently invoked the corporate guarantee against the Corporate Debtor on 21.07.2017, which was brought to notice of the IRP who responded by stating that the liability under the corporate guarantee was contingent as on the date of commencement of CIRP on 27.06.2017 and therefore the claim of the Applicant was not verifiable. The Applicant filed an application under Section 60(5) of the Code challenging the decision of the IRP dated 20.07.2017 whereby the claim of the Applicant was rejected.

Submissions by the Insolvency Resolution Professional

• A preliminary objection was raised by IRP stating that the Applicant has already claimed the amount of debt in the CIRP of the principal borrower- Educomp Solutions Ltd. and the said fact was deliberately suppressed by the Applicant. Further, it was contended that if such claim is accepted under two different CIRPs, then the same would amount to unjust enrichment to such creditor and would lead to anomalous situation.
• It was submitted that only a mature claim can be accepted by IRP at the time of the commencement of the insolvency process and that as per Section 3(11) of the Code, liability or obligation has to be due from any person in respect of a claim for it be accepted. Further, reliance was also placed on Regulation 13 of the Insolvency and Bankruptcy Board of India (Insolvency Resolution Process for Corporate Persons) Regulations 2016 (hereinafter "IBBI Regulations") to contend that the IRP has to verify only those claims which are existing as on the insolvency commencement date. Hence, it was argued that as the corporate guarantee was invoked after the commencement of CIRP, the same cannot be termed as a mature claim.
• It was also contended that the invocation of corporate guarantee against the Corporate Debtor was in violation of moratorium imposed under Section 14 of the Code as the liability under the corporate guarantee was contingent on the date of commencement of CIRP on 27.06.2017, resultantly making the claim non verifiable. Further, the Applicant did not submit fresh claim form subsequent to the invocation of the corporate guarantee, and hence the claim could not be accepted and verified.
• Moreover, it was submitted that the total claim of the secured creditors is about Rs. 112 crores, whereas the corporate guarantee furnished by the Corporate Debtor is of Rs. 2048 crores. Further, the liquidation valuation of the assets of the Corporate Debtor is about Rs. 25 crores only and therefore, it was submitted that the claim made by the Applicant on the basis of the corporate guarantee is a mala fide attempt to create hurdle in the CIRP of the Corporate Debtor.

Submissions by the Applicant

• It was argued that the liability of the principal debtor and the corporate guarantor is co-extensive as provided under Section 128 of the Indian Contract Act, 1872; and therefore there is no bar in filing claims against the Corporate Debtor- corporate guarantor. Further, it was submitted that it was not necessary to make disclosure relating to claim made against the principal borrower i.e. Educomp Solutions Ltd.
• Additionally, it was stated that the definition of "financial creditor" as provided under Section 5(7) of the Code includes "any person to whom financial debt is owed and also includes the person to whom the said debt has been legally assigned or transferred." Hence, it was submitted that the Applicant being a financial creditor has rightfully forwarded its claims before the IRP.

Issue

Whether the Applicant is entitled to make a claim by invoking the corporate guarantee after the date of commencement of the corporate insolvency resolution process of the Corporate Debtor- corporate guarantor?

Decision

In the present case, the CIRP commenced on 27.06.2017 and the corporate guarantee was invoked on 21.07.2017, which is much after the insolvency commencement date. In such situation, the IRP would not be in a position to verify the claim as it will not be reflected in the Books of Accounts which are supposed to be updated as on 27.06.2017. In absence of any record to verify the claim, it will be impossible for the IRP to accept any such claim which has become a debt after 27.06.2017.

The term 'debt' has been defined under Section 3(11) of the Code as "a liability or obligation in respect of a claim which is due from any person and includes a financial debt and operational debt". On the basis of this definition, the debt in this case has not become due from the Corporate Debtor on the insolvency commencement date and it became due only when the corporate guarantee was invoked by the Applicant which was later in time. Thus, it was held that in order to qualify as 'debt' firstly provisions of the corporate guarantee must be satisfied by raising a demand which is expressed by invoking the corporate guarantee and the date of its invocation has to be earlier than the insolvency commencement date

It was also observed that a careful consideration of Regulations 12 and 13 of IBBI Regulations show that the IRP has to verify every claim as on the insolvency commencement date and maintain a list of creditors containing names of all such creditors along with the amount claimed. Therefore the Applicant in the present case would not qualify for the consideration of its claim as it has become due and payable after the commencement date of CIRP.

Finally, the Hon'ble Adjudicating Authority held that a perusal of Section 14 of the Code makes it absolutely clear that the moratorium prohibits any action to foreclose, recover or enforce any security interest created by a corporate debtor in respect of its property; and that invocation of corporate guarantee against the Corporate Debtor would result in enforcing of security interest and it would amount to violation of moratorium under Section 14(1)(c) of the Code.

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