CAN BANK GUARANTEE BE ENCASHED DURING MORATORIUM UNDER IBC?
Author: Neha Gupta, IV Year law student pursuing BBA LL.B. (Hons) from Prestige Institute of Management and Research, Gwalior.
The contract of guarantee is three independent contracts between the Principal Debtor and Creditor, Principal Debtor and Surety, Surety and Creditor. The creditor under the contract of guarantee has a remedy in relation to his debt against both the principal debtor and surety and hence the liability of the surety is coextensive with that of the principal debtor and the creditor may go against either principal debtor or surety. A guarantee given by any bank/financial institution makes such a bank a ‘SURETY’ and mandates the liability of such institution to clear the debt when the principal debtor defaults. As soon as the principal debtor defaults, the liability of the surety to pay the creditor arises.
Moratorium under the Insolvency and Bankruptcy Code, 2016 is declared immediately once the NCLT accepts the application to initiate the Corporate Insolvency Resolution Process and as result, all institutions or continuation of pendency of suits against the corporate debtor, transfer of assets of the corporate debtor, any action to foreclose, recover or enforce any security interest created by the corporate debtor, etc. is prohibited so as to safeguard the interest of all stakeholders of the corporate debtor.
Whether a guarantee by any bank in favor of the corporate debtor is allowed to be encashed during the moratorium period?
For instance, if a company named ‘XYZ’ ltd. had an understanding with taxation related to export with Customs Department and ‘ABC’ bank had given a guarantee to the Customs Department on behalf of ‘XYZ’ Ltd. Now, if and when ‘XYZ’ limited defaults in fulfilling the conditions of understanding with Customs department and coincidentally moratorium has also been declared against it, can Customs Department force ‘ABC’ bank to perform such understanding on behalf of ‘XYZ’ ltd. or not?
Section 3(31) and Section 14 of Insolvency and Bankruptcy Code,2016
Section 126-147 of the Indian Contract Act,1872
There were several ambiguities related to the aforementioned issue, and hence after the 2018 amendment in Section 14 of the Insolvency Bankruptcy Code, 2016; several Hon’ble Courts in India in various judgments pronounced that Bank Guarantee shall be encashed even if a moratorium has been declared against the corporate debtor. The relevant Para of the judgments are mentioned below:
The Hon’ble Supreme Court in the case of SBI vs. Ramakrishnan while deciding whether the period of moratorium under section 14 of Insolvency and Bankruptcy Code, 2016 is applicable to Personal Guarantor relied upon Insolvency Law Committee Report of the year 2018 wherein the committee in its report dated 26.03.2018 made recommendations that Section 14 does not intend to bar actions against assets of guarantors to the debts of the corporate debtor and recommended that an explanation to clarify this must be inserted in Section 14 of the Code. The Insolvency Law Committee is also of the opinion that contractual principles of a guarantee require to be respected even during a moratorium. After these recommendations, Clause 3 was added in Section 14 wherein it is clearly provided that the provisions of Section 14 would not apply to the surety in a Contract of Guarantee.
The Hon’ble Apex Court after taking into consideration the Insolvency Committee report of the year 2018 observed that clause 3 of Section 14 of the Insolvency and Bankruptcy Code is only clarificatory in nature and should be observed retrospectively and cited that “Para29. The Report of the said Committee makes it clear that the object of the amendment was to clarify and set at rest what the Committee thought was an overbroad interpretation of Section 14. That such clarificatory amendment is retrospective in nature.”
In GAIL (India) Ltd. V. Rajeev Manadiar and Ors., Hon’ble NCLAT, New Delhi while observing that ‘Performance Bank Guarantee’ can be invoked during moratorium quoted that:
“Para 6. From sub-section (31) of Section 3, it is clear that the “security interest‟ do not include the “Performance Bank Guarantee‟, therefore, we hold that the “security interest” mentioned in clause (c) of Section 14(1) do not include the “Performance Bank Guarantee…”
The Hon’ble NCLAT in this case has made clear that ‘Security Interest’ does not include the ‘Performance Bank Guarantee’ meaning that moratorium, when declared against a corporate debtor, will not include any ‘Performance Bank Guarantee; issued by the corporate debtor in favor of any other party.
The Hon’ble NCLAT, New Delhi in the matter of Bharat Aluminum Co. Ltd vs. M/s J.P. Engineers Pvt Ltd. and Ors. while deciding on the issue if bank guarantee is revocable during moratorium held that bank guarantee is irrevocable even during the moratorium period under section 14 of the IBC against the Corporate Debtor and cited that: “Para 37. ….The bank guarantee is irrevocable and unconditional and payable on demand without demur. The assets of the surety are separate from those of the corporate debtor, and proceedings against the corporate debtor may not be seriously impacted by the actions against assets of a third party like surety. Bank guarantee can be invoked even during moratorium period issued under section 14 of the IBC in view of the amended provision under section 14 (3)(b) of the IBC”.
In M/s Levcon Valves (P) Ltd. Vs. Energo Engineering Projects Ltd.,while discussing Section 14 of Insolvency and Bankruptcy Code, 2016 and deciding upon the question that whether the moratorium could be extended to the guarantees furnished by banks; the Hon’ble NCLT, New Delhi held that moratorium would not apply to guarantee and bank guarantee can be invoked even after moratorium has been declared by the adjudicating authority and cited that: “Para 9. A close examination of the aforesaid provision would make it patent that moratorium would not apply to a surety in a contract of guarantee to a Corporate Debtor. It is therefore evident that Section 14(1) of the Code, 2016 would not come in the way of the non-applicant i.e. respondent no. 1 to encash the bank guarantee. Moreover, it is an independent agreement…”
Accordingly, it is now clear without an iota of doubt that bank guarantee due to its nature of being an independent contract between the corporate debtor and the bank can be encashed even during moratorium. Hence, it is mandatory for the bank to discharge its liability if and when the corporate debtor defaults.
Moratorium is declared once the Corporate Insolvency Resolution Process starts and it prohibits the institution/continuation of suits, transferring or disposal of assets etc. against the corporate debtor. Bank guarantee is entirely a different concept and hence is not prohibited during and even after the moratorium period ends. After deliberation the same has been introduced in the IBC, 2016 by the way of amendment in 2018 wherein clause 3 was added in Section 14 which clearly expresses that the provisions of moratorium i.e. Section 14 will not apply to a surety in a contract of guarantee. A plain reading of Section 14 (3) of the Insolvency and Bankruptcy Code, 2016 clarifies that moratorium will not be applicable to the surety in bank guarantee.