How the NCLAT interpreted the suspension of insolvency proceedings for defaults arising during the COVID-19 pandemic in relation to a corporate guarantee invoked after March 25, 2020.
Introduction
The Insolvency and Bankruptcy Code (IBC), 2016, is a comprehensive legislation that provides a time-bound and creditor-driven mechanism for resolving the insolvency and bankruptcy of corporate entities, partnership firms and individuals in India. The IBC aims to maximise the value of assets, promote entrepreneurship, ensure availability of credit and balance the interests of all stakeholders,the government introduced Section 10A of IBC .
However, due to the unprecedented situation caused by the COVID-19 pandemic, many businesses faced financial distress and were unable to repay their debts. To protect such businesses from being dragged into insolvency proceedings by their creditors, the government introduced Section 10A of IBC by an ordinance in June 2020. Section 10A suspends the initiation of corporate insolvency resolution process (CIRP) for any default arising on or after March 25, 2020, for a period of six months or more, as notified by the government. The proviso to Section 10A states that no application for CIRP shall ever be filed for the default occurring during the suspension period.
One of the issues that arose in relation to Section 10A was whether it applies to a corporate guarantee invoked after March 25, 2020, for a default committed by the principal borrower before March 25, 2020. This issue was recently decided by the National Company Law Appellate Tribunal (NCLAT) in the case of Vikram Kumar vs Aranca Mumbai Pvt. Ltd… This article analyses the facts, arguments and judgment of this case and discusses its implications for the interpretation and application of Section 10A of IBC.
Facts of the case
The appellant, Vikram Kumar, was the proprietor of Aranca Research India Pvt. Ltd., a company engaged in providing research and analytics services. The respondent, Aranca Mumbai Pvt. Ltd., was another company engaged in similar business activities. The appellant’s company had taken a loan of Rs. 2.5 crore from the respondent’s company in March 2019. The appellant had given a corporate guarantee to secure the repayment of the loan. The loan agreement stipulated that in case of default by the principal borrower, the respondent could invoke the corporate guarantee and demand repayment from the guarantor.
The appellant’s company defaulted in repaying the loan and the respondent invoked the corporate guarantee on April 1, 2020. The respondent sent a demand notice to the appellant asking him to repay Rs. 2.63 crore within seven days. The appellant failed to repay and the respondent filed an application for CIRP against him under Section 7 of IBC before the National Company Law Tribunal (NCLT), Mumbai Bench on September 29, 2020.
The NCLT rejected the application on December 18, 2020, on the ground that it was barred by Section 10A of IBC as the default arose during the suspension period from March 25, 2020 to March 24,2021.
The appellant challenged the order of the NCLT before the NCLAT on January 4, 2021.
Arguments before the NCLAT
The appellant submitted that Section 10A does not apply to his case as he is a personal guarantor and not a corporate debtor. He also submitted that his default was not a fresh default but a continuation of the default by his company, which occurred before March 25, 2020. He argued that Section 10A only bars applications for CIRP for defaults arising on or after March 25, 2020 and not for defaults arising before that date.
The respondent submitted that Section 10A applies to all applications for CIRP under Section 7,9 or 10 of IBC irrespective of whether they are filed against corporate debtors or personal guarantors. He also submitted that the invocation of the corporate guarantee was a fresh default by the appellant as it occurred after March 25, 2020 and hence it falls within the ambit of Section 10A. He argued that Section 10A prohibits any application for CIRP for defaults occurring during the suspension period from March 25,2020 to March24,2021.
Judgment of the NCLAT
The NCLAT dismissed the appeal and upheld the order of the NCLT on March 15, 2021. The NCLAT held that:
- The question that arises for consideration is whether the default committed by the principal borrower prior to 25th March, 2020 would be a fresh default when the Corporate Guarantee is invoked after 25th March, 2020 and whether such invocation of Corporate Guarantee would be covered under Section 10A of the Code. (Para 8)
- The default committed by the principal borrower is a continuing default till it is paid or settled. The invocation of Corporate Guarantee is not a fresh default but a continuation of the default committed by the principal borrower. Therefore, the date of default has to be reckoned from the date of default committed by the principal borrower and not from the date of invocation of Corporate Guarantee. (Para 9)
- The proviso to Section 10A clearly states that no application shall ever be filed for initiation of CIRP of a corporate debtor for the said default occurring during the said period. The said period means the period beginning from 25th March, 2020 and ending on 24th March, 2021. Therefore, any default occurring during this period is completely excluded for the purpose of initiation of CIRP under Section 7, 9 or 10 of the Code. (Para 10)
- The contention of the learned counsel for the appellant that Section 10A applies only to corporate debtors and not to personal guarantors is also devoid of merit. The language of Section 10A does not make any distinction between corporate debtors and personal guarantors. It applies to all applications for initiation of CIRP under Section 7, 9 or 10 of the Code. Therefore, it covers both corporate debtors and personal guarantors. (Para 11)
The NCLAT’s judgment in this case has clarified that Section 10A of IBC applies to both corporate debtors and personal guarantors and that it bars any application for CIRP for defaults arising during the suspension period from March 25, 2020 to March 24, 2021. The NCLAT has also held that the invocation of a corporate guarantee after March 25, 2020 does not create a fresh default but is a continuation of the default by the principal borrower. This implies that if the principal borrower had defaulted before March 25,2020, then the guarantor cannot be subjected to CIRP even if the guarantee is invoked after March 25,2020.
This judgment is in line with the objective of Section 10A, which is to protect the businesses from insolvency proceedings due to the impact of the COVID-19 pandemic. However, it may also have some adverse consequences for the creditors who have relied on corporate guarantees to secure their loans. It may also create uncertainty and confusion regarding the status and enforceability of corporate guarantees given before March 25, 2020.
Therefore, it is advisable for both creditors and guarantors to review their loan agreements and corporate guarantees in light of Section 10A and seek legal advice before initiating or defending any insolvency proceedings.
