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Introduction
The commercial disputes in India are increasing in number and that is the reason why the law is creating a niche system for their disposal. One example of it is the enactment of Insolvency and Bankruptcy Code, 2016. It have become one of the milestones in the commercial highway as the Companies who were not serious about their well-being or of their cerditors are taken to task by the NCLT and NCLAT after IBC’S encactment.
But as it is a recent enactment most of the people are unaware as to how the NCLT and NCLAT functions. Even there is widespread ignorance of the fact that the NCLT and NCLAT are constituted under IBC but it’s not true as they are a creature of Section 408 & 410 of Companies Act, 2013 respectively.
Further it is pertinent to know that the function of NCLT and NCLAT is not restricted only to the invocation of insolvency proceedings against companies by filing of Insolvency Petition. NCLT also deals with other aspects of Company matters. One of which is Section 46 & 56 of the Companies Act whereby rather that filing a Insolvency & Bankruptcy Petition (called CP(IB))a party can approach the NCLT in a Company Petition(called CP). The difference between these two is that in the latter you are not approaching the NCLT to declare a company insolvent but rather the relief one seeks is a direction to the Company to do a particular act. Some examples of it are that when a Company is not holding its Annual General Meeting, one can approach NCLT to direct it to do so. Another instance of it is when there is a dispute regarding custody of Shares, NCLT is the competent authority to decide the issue.
Through this case we will try to understand the dynamics of NCLT and NCLAT together with the meaning of commonly used corporate jargons like Guarantor, Security difference between the terms Corporate and Personal Guarantee, what to do when the Principal Borrower refuses to pay the loan and the Bank or NBFC approaches Guarantor for loan recovery, what is a pledge and how it is different from hypothecation.
So, let’s see what is this case all about.
Brief Facts
It was the Petitioner’s argument that the Petitioner together with the Respondent No. 2, who was his brother, entered into an agreement whereby the Petitioner was given 87010 shares of M/s Spell Organics Ltd., which is Respondent No. 1(hereinafter referred to as the Company) in this petition. Petitioner stated that these share certificates were earlier in his possession
As per the Petitioner’s version his brother stole the Share Certificates from his house in 2015 due to which he filed a complaint with the police station. As the originals of the share certificates were lost the Petitioner, he asked the Company to issue duplicate share Certificates to him in lieu of the original ones. When the company declined to do so the Petitioner filed a complaint with the Registrar of Companies, but to no avail.
But the Respondent (who was also representing the Company) had a different case altogether. It was argued by him that the Petitioner is a Director in the M/s Apsom Turner Private Limited. Petitioner’s wife is also a majority shareholder with 88.19 percent equity in M/s Apsom. As M/s Apsom needed financial help, the Petitioner approached M/s Celica Developers Private Limited for a loan. As M/s Celica required some guarantee for grant of the loan to M/s Apsom, the Petitioner approached the M/s Spell and his brother for issuance of a Corporate Guarantee as well his brother’s Personal Guarantee. As the amount was a substantial one the Company asked the Petitioner to furnish some security in lieu of the Guarantee. In order to furnish the security the Petitioner pledged all his shares with the Company. The company then provided the corporate guarantee and Respondent No. 2, the brother provided the personal guarantee to M/s Celico.
Now let’s see what these terms mean.
What is a Guarantee and Who is a Guarantor?
When A takes a loan or debt from B, there is always a risk that the A may default in its payment. So what are the options with B in case that contingency occurs, because loans cannot be advanced only on word of mouth.
That’s where the concept of Guarantee comes in, which is defined in Section 126 of Indian Contract Act, 1872. Guarantee is given by a third party (let’s say C) to the Creditor of loan or debt on behalf of A, to assure him that in case the loan or debt is not paid by A to B, then C will repay the whole debt including principal and interest. Though sounds strange, it is a very common practice. Often when a Bank, Non Banking Financial Company (NBFC for short), or any other Creditor grants loan to someone, they insist on having a Guarantor, who can protect the Bank or NBFC against non-payment by the Principal Borrower (namely the party which borrows the loan). Generally a Promissory Note is executed by the Guarantor to personally bind him.
So, if a Principal Borrower fails to repay the debt to the Bank or NBFC, they have full power to recover the debt or loan from the Guarantor. Even the law is that the Bank or NBFC has the power to directly proceed against the Guarantor for recovery, without first resorting to Principal Borrower for loan recovery.
But how the Guarantor protects himself in such a case?
As the Bank or NBFC may collude in order to defund the Guarantor. There are two ways.
One is what we just saw before i.e. demanding some security from the Principal Borrower for becoming Guarantor. Imagine if the Petitioner have not deposited the Share Certificates with the Respondents, what Respondents would have done in case of Petitioner’s default (which indeed happened in this case as we will see later). But now they have the Share Certificates and they can sell them in order to recover the money they paid to the M/s Celico.
The second remedy is to first pay the money to the Creditor i.e. Bank or NBFC, and thereafter file a case against the Principal Borrower to recover that money (and do not forget to ask for the interest as cases in India take a considerable time for their disposal). That is precisely the reason that the Banks & NBFC’s ask for guarantee as rather than running to different courts they can simply invoke the guarantee. And the law is very clear in this aspect that when a guarantee is invoked there should be no interference by the Courts.
Now let’s see why despite having a Corporate Guarantee M/s Celico asked for a Personal Guarantee from Petitioner’s brother.
Difference between Corporate and Personal Guarantee
A company is a distinct entity which has its own independent existence. That’s why a company after incorporation under Companies Act, 2013 is treated as an independent person which means that when a recovery is to be made it should be made from the company and not its Directors or promoters. (See My Article)
Though that doesn’t mean that one should be hopeless. One can always approach the NCLT to recover the money from a Company and if it fails to do so, it can be liquidated i.e. sold after dividing into parts to pay the money to its Creditor.
Personal Guarantee is different, as it is not dependent on the security. So let’s say the A gives a loan of Rs. 100/- to B on the Corporate Guarantee of M/s C (a company) and personal guarantee of D (C’s promoter). Now as B does not repay the loan, A goes against M/s C, invoking Corporate Guarantee which M/s C denies to oblige. Therefore A approaches the NCLT to declare the M/s C insolvent. The Insolvency Petition gets admitted and having no resolution in sight M/s C is put up for liquidation. On liquidation and after selling the assets (including its machinery, office, inventory, goodwill etc.) of M/s C, only Rs. 70 is fetched. Now the remedy of A against M/s C is over as after liquidation the company is no more i.e. it have suffered a Corporate Death.
So, now A goes against D invoking the Personal Guarantee which is much more dangerous. Now every property of D can be put up for sale in order to get Rs. 30 and consequet interest. Till the last dime of Rs. 30/- is not paid the property of D including his car, balance in bank account, debentures, shares etc. is liable to be sild by A. Personal Guarantee is so ruthless that even the share of a Hindu Coparcener in the Hindu Undivided Family is put up for sale. This process of sale goes on till either Rs. 30 together with the interest is not recovered or D is declared an insolvent under Presidential Towns Insolvency Act, 1909 or Provincial Insolvency Act, 1920. ( Continued….)
Parveen Semwal
Advocate, High Court of Delhi and Supreme Court of India