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Insolvency: Foreign Creditors, Foreign Debtors and Indian Guarantors

May 6, 2019

[Sachin Santuka is a third-year student at National Law University, Odisha.]

 

It is commonplace for financing agreements to be structured in such a way that the parent company of a subsidiary stands as a guarantor to a loan obtained by the latter. Such parent company guarantees (PCGs) are extended to enhance the creditworthiness of subsidiary companies. They add an extra level of comfort in respect of the obligations that the subsidiary company has undertaken to perform. We often see Indian companies extending such guarantees to their overseas subsidiaries obtaining credit from foreign banks. Such guarantees must also necessarily comply with the provisions of the Foreign Exchange Management Act, 1999 and the regulations notified thereunder.

 

However, complications arise when there is a default by the subsidiary. The question that arises is whether a foreign creditor can proceed under the Insolvency and Bankruptcy Code, 2016 (Code) against an Indian corporate guarantor in respect of a guarantee issued on behalf of its foreign subsidiary.

 

The Position of Law

 

The issue may further be divided into two parts, namely:– (a) whether, under the Code, a corporate insolvency resolution process (CIRP) may be initiated against a corporate guarantor; and (b) whether the Code makes any distinction between Indian and foreign creditors.

 

(a) Whether, under the Code, a CIRP may be initiated against a corporate guarantor?

 

Section 7 of the Code provides for the initiation of CIRP against a corporate debtor by a ‘financial creditor’. A ‘financial creditor’ means any person to whom a ‘financial debt’ is owed. Consequently, ‘financial debt’ defined under section 5(8) includes ‘any liability in respect of any guarantee or indemnity’. Therefore, it is obvious that a section 7 application may be made even in respect of a corporate guarantor.

 

The position has been confirmed by the National Company Law Appellate Tribunal in Vishnu Kumar Aggarwal v Piramal Enterprises wherein the Tribunal observed that a creditor may file a section 7 application against a corporate guarantor and do so even without proceeding against the principal creditor.

 

(b) Whether the Code makes any distinction between Indian and foreign creditors?

 

The Code does not make any distinction between a foreign and Indian creditor. The terms ‘operational creditor’ and ‘financial creditor’ have been defined as ‘persons’ to whom financial or operational debt is owed. Consequently, the definition of ‘persons’ includes ‘persons resident outside India’.

 

The Supreme Court of India in Macquarie Bank v Shilpi Cable Technologies held that a foreign operational creditor cannot be excluded from the purview of the Code merely because it is unable by virtue of its foreign residency to follow a procedural aspect in relation to filing of application. Remarking that article 14 of the Constitution applies to foreigners as well, the Court allowed the creditor’s application.

 

Having answered the said questions, it becomes obvious that the Code permits foreign creditors to initiate CIRP against financial creditors which include corporate guarantors. Further, in one such instance, the National Company Law Tribunal, Chennai in Stanbic Bank Ghana v. Rajkumar Impex Private Limited allowed initiation of CIRP by a Ghana-based bank against an Indian company in respect of a guarantee extended by it in favour of its subsidiary based in Ghana.

 

Analysis

 

It appears that the law regarding the issue is well settled. However, there remains one possible argument against the above reasoning. Section 3(8) of the Code defines a ‘corporate debtor’ to be a corporate person who owes a debt to a person. Consequently, section 3(7) describes the term ‘corporate person’ inter alia to be a company as defined under section 2(20) of the Companies Act, 2013. Turning now to section 2(20) of the Companies Act, 2013, it may be noted that the same includes only companies incorporated thereunder or under any previous company law.

 

Therefore, it becomes evident that a foreign entity has not been envisaged as a ‘corporate-debtor’ under the Code. Now the question which arises for consideration is whether a guarantor to a loan obtained by a foreign entity can be held liable under the Code. Holding the guarantor liable under the Code when the principal debtor i.e. the foreign entity itself is not liable under the Code would be a marked deviation from the principle of co-extensive liability of principal debtor and surety.[1]

 

The said inconsistency had also existed in the pre-IBC winding up jurisprudence. The Delhi High Court in N & S & N Consultants v. SRM Exploration allowed a petition for winding up filed by the petitioner-company based in the Czech Republic in respect of an Indian company which had extended guarantee in favour of another company based in the Czech Republic dealing with the petitioner.

 

Even under the winding-up regime, a company defined under section 2(20) of the Companies Act, 2013 did not include foreign entities. Therefore, the admission of petition continued to be against the principle of co-extensive liability as the principal debtor itself was not liable for winding up.

 

Conclusion

 

The inconsistency pointed out has existed for a long duration and has been ignored by judges, and for good reason. The above argument appears to be based on an overly-literal construction and in ignorance of the legislative intent. It could never have been the intention of the Parliament to allow corporate sureties to escape their liability under a guarantee agreement merely because the principal loan transaction was between foreign entities. The same would defeat the object of the statute which in absolute terms does not distinguish between foreign and Indian creditors, as is evident from the fact that the definition of the term ‘persons’ includes ‘persons resident outside India’.

 

[1] Indian Contract Act 1872, s 128; State Bank of India v Indexport Limited, AIR 1992 SC 1740.

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