ABROGATION OF SUBROGATION RIGHTS OF THE

PERSONAL GUARANTORS

Project submission towards the completion of the end term examinations for the semester
(July – November 2021)

Submitted By Submitted To

Naman Jain – 1625 Ms. Heemanshi Sen

Disha Lohiya – 1665 Faculty of Law

VII Semester Law of Corporate Insolvency and Bankruptcy

 ACKNOWLEDGEMENT

We are whole heartedly thankful to the almighty who gave us enough skills and patience to
complete our project work We are also deeply indebted and thankful to our teacher, Ms.
Heemanshi Sen, for honing our skills and enabling us, through her guidance and advice, in
completing this project and blessing us with the knowledge during this period of learning.
Her keen interest, constant inspiration and encouragement gave us the strength to put our
best for completion of this project.
We also extend our thanks to the librarians of NLU, Jodhpur, especially the law department.
We express our immense debt and gratitude to the learned authors whose work we have
consulted.
We are also grateful to all our friends who have been there, with me, while we worked on this
project, supporting me, both, mentally and emotionally.
We, most importantly, are in debt to the support our parents show me, without whose
affection and hard work, the position we have reached today would seem like a distant
dream.

Page 2 of 20
 LIST OF CASES

1. Lalit Kumar Jain v. Union of India, 2021 SCC OnLine SC 396.

2. Committee of Creditors of Essar Steel v. Satish Kumar Gupta, 2019 SCC OnLine SC
1478.
3. E G. Bankruptcy: Jagannath v. Shivnarayan, AIR 1940 Bom. 387.
4. Amrit Lai Goverdhan Lalan v State Bank of Travancore, AIR 1968 SC 1432.
5. State Bank of India v Fravina Dyes Intermediate, AIR 1989 Bom. 95.
6. Morgan v. Seymour, 1 Chan. Rep. 120, 21 Eng. Rep. 525 (1637).
7. State Bank of India v. V. Ramakrishnan, (2018) 17 SCC 394.
8. Maharashtra State Electricity Board, Bombay v. Official Liquidator, High Court,
Ernakulam and Ors., AIR 1982 SC 1497.
9. Committee of Creditors of Essar Steel India Limited v. Satish Kumar Gupta, 2019 SCC
OnLine SC 1478.
10. Lalit Mishra & Ors. v. Sharon Bio Medicine Ltd. & Ors., 2018 SCC OnLine NCLAT 669.
11. State Bank of India v. Calyx Chemicals & Pharmaceuticals Limited, 2018 SCC OnLine
NCLT 28227.
12. IDBI Bank Ltd. v. EPC Constructions India Limited, 2018 SCC OnLine NCLT 24901.
13. Krishna Pillai Rajasekharan Nair v. Padmanabha Pillai, (2004) 12 SCC 754, p. 767.
14. Kundanmal Dabriwala v. Haryana Financial Corporation and Ors., [2012] 171 Comp
Cas 94 (P&H).
15. Swynson Ltd. v. Lowick Rose LLP, [2017] UKSC 32.
16. Eileen Joan Rosina Filby v. Mortgage Express (No 2) Limited, [2004] EWCA Civ 759.
17. Wasco Country v. New England Equitable Ins. Co. Et al., Supreme Court of Oregon,
1918. 88 Or. 465, 172 Pac. 126.
18. Swiss Ribbons Pvt. Ltd. vs Union Of India, 2019 SCC OnLine SC 73.
19. Solidaire India Ltd vs Fairgrowth Financial Services, (2001) 3 SCC 71.
20. Davinder Ahluwalia v. Sumit Aviation, IB No. (IB)-229 (ND)/2017.
21. Economic Transport Organisation v. M/S Charan Spinning Mills, (2010) 4 SCC 114.
22. Levit v. Ingersoll Rand Financial Corp., 874 F.2d 1186.

Page 3 of 20
 ABSTRACT

This project seeks to criticize the concept of clean slate theory of IBC with regard to the
abrogation of the surety’s/personal Guarantor’s right of subrogation as provided under
Section 140 of the Indian Contract Act, 1872.

While it is also pertinent to note that in many instances, guarantees are given by parties
related to the corporate debtors, such as a holding company, an associate company,
promoters, etc. In Lalit Mishra judgment, the impugned resolution plan was challenged on
the basis that it mentioned that the personal guarantees given by the existing promoters of
the corporate debtor would not result in any liability towards the resolution applicant.
The NCLAT held that such a provision in the resolution plan was valid, as the IBC
prohibits the promoters of the corporate debtor from benefitting from the CIRP. The
NCLAT observed that the promoters are responsible for having contributed to the
insolvency of the corporate debtor, and therefore cannot be allowed to reward themselves
at the expense of creditors.

However, the authors opine that the detrimental effect of such an approach cannot be
underestimated. The guarantor has a right under the law of equity to recover the amount
of money paid on behalf of the PD. The authors believe that in the absence of this right,
guarantors would be discouraged from providing guarantees for the debts of any PD,
fearing that in the event of insolvency of the PD, the guarantor would stand to be at a loss
with no recourse under the law against the PD. In the authors' opinion, such a situation
may have a negative impact on the availability of credit. The NCLT should seek to
distinguish between personal guarantors who are promoters of the corporate debtor (or
related to the promoters of the firm in any manner) under CIRP and independent personal
guarantors who have offered a guarantee form a commercial perspective. Creating such a
distinction would prevent promoters who may have contributed to the insolvency of the
corporate debtor from benefitting from the same while incentivizing independent
guarantors to continue providing guarantees.

Page 4 of 20
 TABLE OF CONTENTS

I. Introduction.........................................................................................................................6

II. The concept of personal Guarantors/ surety under The Indian Contract Act, 1872.......8

A. Right of Subrogation under Indian Contract Act, 1872..............................................8

III. Extinguishment of Right of Subrogation Under IBC and its implications...................10

A. Denial of Right of Subrogation under IBC................................................................10

B. Subrogation: An Equitable Right..............................................................................12

C. Impact of Denial of Subrogation...............................................................................13

IV. Critical Analysis: Position in India vis-à-vis Position in United States........................15

A. Legal Position in India..............................................................................................15

B. Legal Position in United States.................................................................................16

C. Comparative Analysis................................................................................................16

V. Conclusion.....................................................................................................................18

Page 5 of 20
 INTRODUCTION

The concept of CIRP is provided under the Insolvency and Bankruptcy Code, 2016. As per
this concept once the existence of a default is established the Tribunal will initiate a CIRP
after consulting the creditors of the company. In such a scenario, question arises as to how the
provisions of Insolvency or liquidation of a company under the Insolvency and Bankruptcy
Code, 2016 treat the guarantor. Recently on 21 May 2021, Supreme Court in Lalit Kumar
Jain v. Union of India1 (“Lalit Kumar”), upheld the Insolvency and Bankruptcy (Application
to Adjudicating Authority for Insolvency Resolution Process for Personal Guarantors to
Corporate Debtors) Rules, 2019 (2019 Rules) notified by the Indian Government on 15
November 2019 (effective from 1 December 2019).

The 2019 Rules inter alia notified Section 2(e) of the Insolvency and Bankruptcy Code, 2016
(Code) in relation to personal guarantors to corporate debtors, who were recognized as a
distinct category of individuals vide the Insolvency and Bankruptcy Code (Amendment) Act,
2018 (2018 Amendment Act), effective from 23 November 2017. The 2018 Amendment Act
inter alia created three distinct categories of persons: (i) personal guarantors to corporate
debtors; (ii) partnership firms and proprietorship firms; and (iii) individuals, with a view to
treat each category differently under the Code.

The above table shows the total number of Insolvency Applications filed against the Personal
Guarantors from December 2019 to March 2021. Within a short Span of 16 months, There
have been insolvency proceedings against the Personal Guarantors for an amount exceeding
Rs. Twelve Thousand Crores. Therefore, it is extremely necessary to discuss about the rights
of the personal guarantors under the Insolvency and Bankruptcy Code, 2016.
1
Lalit Kumar Jain v. Union of India, 2021 SCC OnLine SC 396.

Page 6 of 20
Lalit Kumar is seen as a welcome move by creditors, as now they may recover their dues
from both the corporate debtor and the personal guarantor thereof under one forum
simultaneously. Further, Lalit Kumar reiterates the position in Committee of Creditors of
Essar Steel v. Satish Kumar Gupta, 2 namely, upon completion of the CIRP of a corporate
debtor, the creditors who would otherwise be taking a haircut, are entitled to separately
proceed against the personal guarantor to the corporate debtor to recover the remainder of the
amounts, assuming the resolution plan does not extinguish the guarantors' liability. However,
this implication will disincentivize individual personal guarantors from extending a guarantee
to corporate debtors.

PERSONAL GUARANTORS UNDER THE INDIAN CONTRACT ACT, 1872

2
Committee of Creditors of Essar Steel v. Satish Kumar Gupta, 2019 SCC OnLine SC 1478.

Page 7 of 20
The concept of guarantee is introduced and explained under Section 126 of the Indian
Contracts Act, 1872. It puts an obligation on a surety to honor the promise of principal debtor
by paying the principal debtor’s present of future debt, provided to him by a creditor. 3 In
absence of the 4 components in the guarantee contract; (1) A Contract of guarantee, (2)
Suretyship, (3) Principal debtor and (4) Creditor4 the contract would be a simple contract.
The presence of 3 parties in the contract extends the privity of contract to tripartite privity of
contract.5 Further, section 1286 creates a co-extensive liability between the surety and the
debtor so in case a proceeding is initiated against the principal debtor guarantors conduct will
be governed by it. Only exception to this is laid down in “E G. Bankruptcy: Jagannath v.
Shivnarayan”7 wherein the court said that “discharge of principle debtor by discharge of law
does not discharge the surety.”8

This position has been further reaffirmed in the Lalit Kumar judgment also that a personal
guarantor would not be discharged if the resolution plan is accepted because discharge of
principle debtor by the operation of law does not discharge the surety. In other words, in case
the debtor is able to secure discharge of the liability by way of operation of law, then also the
guarantors obligation is not absolved or discharged for the balance amount of dues, not
recovered by the lender. Thus, if under IBC a resolution plan is approved, or the debtor goes
into winding up, because of which part of the debt is only settled, the guarantor, shall still be
liable, to the lender, for the balance amount of the debt, which remained outstanding and
unrecovered from the debtor.

A. RIGHT OF SUBROGATION UNDER INDIAN CONTRACT ACT, 1872.

A surety who pays off the debt of another party is subrogated to the creditor’s former claims
and remedies against the debtor to recover the sum paid. This would include the endorser on
a bill of exchange. In relation to the surety’s subrogation rights, the surety will also have the
benefit of any security interest in favor of the creditor for the original debt. Conceptually this
is an important point, as the subrogate will take the subrogor’s security rights by operation of
law, even if the subrogee had been unaware of them. Accordingly, in this area of the law at

3
LORD CHORLEY, LAW OF BANKING (2nd edn, Pitman 1947).
4
S.N GUPTA, LAW RELATING TO GUARANTEES WITH PRO-FORMAS OF BANK GUARANTEES AND INDEMNITY
BONDS (6th edn, Pitman 1947).
5
Id.
6
The Indian Contract Act, 1872 act No. 9 OF 1872, s. 126.
7
E G. Bankruptcy: Jagannath v. Shivnarayan, AIR 1940 Bom. 387.
8
Id.

Page 8 of 20
least, it is conceptually improbable that the right of subrogation is based upon any implied
term.
A guarantor who pays off the whole debt is entitled, not only to securities deposited by the
customer but also to those deposited by third parties. This is what right of subrogation is
under English Law. In India, the right of subrogation has been enunciated in Sections 140 and
141 of the Indian Contract Act, 1872. Section 140 of the Contract Act, 1872 states that:
“140. Rights of surety on payment or performance: where the guaranteed debt has
become due, or default of the principal- debtor to perform a guaranteed duty has
been taken place, the surety, upon payment or performance of all that is liable for, is
invested with all the rights which the creditor had against the principal- debtor.”

When the surety has paid all that he is liable for he is invested with all the rights which the
creditor had against the principal debtor. The surety steps into the shoes of the creditor. The
creditor had the right to sue the principal debtor. The surety may, therefore, sue the principal
debtor in the rights of the creditor.

The Supreme Court has laid down in Amrit Lai Goverdhan Lalan v State Bank of
Travancore9 that the surety will be entitled to every remedy which the creditor had against
the principal debtor; to enforce every security and all means of payment; to stand in the place
of the creditor; to have the securities transferred to him, though there was no stipulation for
that; and to avail himself of all those securities against the debtor. This right of surety stands
not merely upon contract, but also upon natural justice. The language of Section 140 which
employs the words "is invested with all the rights which the creditor had against the principal
debtor" makes it plain that even "without the necessity of transfer, the law vests those rights
in the surety"
It was decided by the Bombay High Court in State Bank of India v Fravina Dyes
Intermediate10 that the guarantor by invoking the doctrine of subrogation can apply for a
temporary injunction against the debtor even before making payment to the creditor if he
apprehends that the debtor threatens or is about to remove or dispose of his property with
intent to defraud the creditor. That is, the guarantor is entitled to a grant of Quia Timet
injunction against the principal debtor under certain circumstances.

9
Amrit Lai Goverdhan Lalan v State Bank of Travancore, AIR 1968 SC 1432.
10
State Bank of India v Fravina Dyes Intermediate, AIR 1989 Bom. 95.

Page 9 of 20
 EXTINGUISHMENT OF RIGHT OF SUBROGATION UNDER IBC AND ITS
IMPLICATIONS

Guarantees play a pivotal role in any commercial transaction because the parties prefer to be
secured if the other party fails to perform its obligation. For example, in a loan transaction
between A & B; C stands as a guarantor of B, ensuring the repayment of the loan if B
defaults. Guarantee is purely a contractual arrangement between/among the parties, and it can
be drafted according to the transaction and needs of the parties. However, there are certain
principles enshrined under the Indian Contract Act, 1872 (‘Contract Act’) that protect the
rights of both, the parties, and the guarantor.

Anything done, or promised to be done, in favour of the party is a sufficient consideration for
the guarantor.11 Further, the surety/guarantor is subrogated to all the rights of the creditor
against the principal debtor viz. the guarantor steps into the shoes of the creditor, and is
entitled to enforce all the securities that the creditor has against the borrower, on whose
behalf the payment is made.12

Recently, the issue of subrogation came to be discussed in the cases of Insolvency and
Bankruptcy Code, 2016, wherein the right of subrogation was denied to the guarantor. In the
very celebrated case of Essar Steel, followed by many, the Apex Court approved the
resolution plan which denied the rights of subrogation to the guarantors.

Subrogation is a right of equity and natural justice. Even though the Courts have been
justifying the denial of right of subrogation citing cogent reasons, it is unjust on the part of
the guarantor; besides, the principle borrower gets unjustly enriched in this set-up. Therefore
it is important to discuss the concept of ‘Equitable Subrogation’ with the help of foreign
jurisprudence, and analyses the impact of such denial of the right of subrogation of the
guarantor on the Indian credit market.

A. DENIAL OF RIGHT OF SUBROGATION UNDER IBC

It is established that the approval of the resolution plan and consequent extinguishment of the
liabilities of the Corporate Debtor does not absolve the guarantor of its liability under the

11
§127, The Indian Contract Act, 1872.
12
Amrit Lai Goverdhan Lalan v. State Bank of Travancore, AIR 1968 SC 1432; See, Morgan v. Seymour, 1
Chan. Rep. 120, 21 Eng. Rep. 525 (1637).

Page 10 of 20
Contract Act.13 The primary reason for this is that the discharge of Corporate Debtor’s
liability is through the operation of law as the same is stemming from the proceeding under
the Insolvency and Bankruptcy Code.14

Now, once it is established that the guarantor is still liable to pay the principle creditor even
though the Principle Borrower (Corporate Debtor) is absolved, the question of the right of
subrogation surfaces naturally. The right of subrogation is an equitable and natural right of
the guarantor against the Corporate Debtor on whose behalf he has paid the money. In the
Essar Steel15 case, the creditors of the corporate debtor sought to invoke the guarantees given
for the remainder amount, after receiving the haircut amount through the Resolution Plan.16 In
the said case, the Supreme Court relied upon SBI v. V. Ramakrishnan17 and held that the
guarantor’s liability remains intact even after the approval of the resolution plan. 18 Further,
the Court approved the resolution plan that rest the guarantors devoid of their right of
subrogation and did not hold anything substantial, backed by reasoning in this regard.

In the case of Lalit Mishra & Ors. v. Sharon Bio Medicine Ltd. & Ors. 19, the NCLAT
discussed the issue of subrogation when the promoters, who were also the personal
guarantors, sought to claim the right of subrogation under section 133 and 140 of the Contract
Act. The NCLAT held that the resolution under IBC is not a recovery suit, and it was not the
intention of the legislature to benefit the ‘Personal Guarantors’ by excluding the exercise of
legal remedies available in law by the creditors, to recover legitimate dues by enforcing the
personal guarantees, which are independent contracts.

Further, NCLT Mumbai in the case of State Bank of India v. Calyx Chemicals &
Pharmaceuticals Limited20 and IDBI Bank Ltd. v. EPC Constructions India Limited21 again
approved a resolution plan that had not given the right of subrogation to the guarantors of the
Corporate Debtor on whose behalf the payment was made.
13
State Bank of India v. V. Ramakrishnan, (2018) 17 SCC 394.
14
Maharashtra State Electricity Board, Bombay v. Official Liquidator, High Court, Ernakulam and Ors., AIR
1982 SC 1497.
15
Committee of Creditors of Essar Steel India Limited v. Satish Kumar Gupta, 2019 SCC OnLine SC 1478.
16
Pinak Parikh, Liability of Personal Guarantors vis a vis their Rights under the IBC: A Legal Conundrum,
INDIACORPLAW (Last accessed Sept. 01, 2021) https://indiacorplaw.in/2020/01/liability-personal-guarantors-
vis-vis-rights-ibc-legal-conundrum.html
17
State Bank of India v. V. Ramakrishnan, 2018 (9) SCALE 597, ¶ 22.
18
Id.
19
Lalit Mishra & Ors. v. Sharon Bio Medicine Ltd. & Ors., 2018 SCC OnLine NCLAT 669.
20
State Bank of India v. Calyx Chemicals & Pharmaceuticals Limited, 2018 SCC OnLine NCLT 28227.
21
IDBI Bank Ltd. v. EPC Constructions India Limited, 2018 SCC OnLine NCLT 24901.

Page 11 of 20
 B. SUBROGATION: AN EQUITABLE RIGHT
The surety paying off a debt shall stand in the place of the creditor and have all the rights
which he has, for the purpose of obtaining reimbursement. This rule here is undoubted, and it
is founded upon the plainest principles of natural reason and justice. 22 Subrogation rests upon
the doctrine of equity and is a settled common law principle.23

In the case of Kundanmal Dabriwala v. Haryana Financial Corporation and Ors.24 the High
Court of Punjab & Haryana discussed the liability of the surety where the liability of the
Principle Borrower stands extinguished through a sanctioned scheme of arrangement under
section 391 of the Companies Act, 1956. The Court absolved the surety of the liability on the
ground inter alia that the surety cannot be placed in the shoes of the creditor i.e. cannot have
the right of subrogation. This case becomes significant as it stresses the importance of
subrogation right, in absence of which, the liability of the surety stands pointless.

The foreign jurisprudence considers the right of subrogation as one of the ways to cure the
‘unjust enrichment’ under the law of restitution. 25 In the case of Swynson Ltd. v. Lowick Rose
LLP26 the UK Court discussed the equitable subrogation and unjust enrichment in the
following words,
“Equitable subrogation as a remedy for unjust enrichment
…It belongs to an established category of cases in which the claimant discharges the
defendant’s debt on the basis of some agreement or expectation of benefit which fails.
…
…The cases on the use of equitable subrogation to prevent or reverse unjust
enrichment are all cases of defective transactions. They were defective in the sense
that the claimant paid money on the basis of an expectation which failed.…
…What this suggests is that the real basis of the rule is the defeat of an expectation of
benefit which was the basis of the payer’s consent to the payment of the money for the
relevant purpose…”27

22
Amrit Lai Goverdhan Lalan v. State Bank of Travancore, 1968 AIR SC 1432
23
Krishna Pillai Rajasekharan Nair v. Padmanabha Pillai, (2004) 12 SCC 754, p. 767.
24
Kundanmal Dabriwala v. Haryana Financial Corporation and Ors., [2012] 171 Comp Cas 94 (P&H).
25
Rory Gregson, Is subrogation a remedy for unjust enrichment? LAW QUARTERLY REVIEW (L.Q.R. 481),
2020.
26
Swynson Ltd. v. Lowick Rose LLP, [2017] UKSC 32.
27
Id.

Page 12 of 20
The party is said to be enriched if his financial position is materially improved or the
financial burden is relieved.28 The enrichment will be at the expense of the claimant if, in
reality, it was the claimant’s money which effected the improvement. 29 When the surety pays
on behalf of the principle borrower, and he is not given the right to subrogation, then the
principle borrower is unjustly enriched, since it is the principle borrower who is liable to pay
in the first place and the surety has an equitable right to be subrogated. Though the concept of
‘Equitable Subrogation’ is associated with the law of Restitution and not per se the contract
law, the emphasis upon the equitable nature of the right of subrogation is something that can
be relevant in determining the positioning of the guarantor under the IBC.

C. IMPACT OF DENIAL OF SUBROGATION

The right of subrogation is the backbone of the concept of guarantee, which is an integral part
of any commercial transaction. Therefore, it is imperative to analyse the impact of such
denial of the right of subrogation under IBC.

NCLT Mumbai bench held that the right of subrogation cannot be granted as it will render the
process of resolution meaningless. The relevant portion is quoted below,
“Thereafter, they (Guarantor) would be entitled to exercise their right of subrogation against
the Corporate Debtor which is then under the control and management of the Resolution
Applicant. Hence, the Resolution Applicant will then pay the debt of the guarantor under its
right of subrogation. Hence, in effect, the Resolution Applicant would pay the full amount of
creditors, therefore, there was no idea left for filing the resolution plan and taking over the
debtor company by settling the dues of the creditors. This vicious circle is a never-ending
process and it was definitely not intended by the legislators while framing the I&B Code.”30

Further, in the case of Wasco County v. New England Equitable Ins. Co. et al.,31 the Supreme
Court of Oregon (US State), held that the right of subrogation is an equitable right and cannot
be enforced strictly, overlooking the parallel equitable and legal rights of other parties,
“Subrogation is not a matter of strict right nor does it necessarily rest on contract, but it is
purely equitable in its nature; and, since it is a creature of equity, it will not be enforced
where it will work injustice to the rights of those having equal equities.”
28
Eileen Joan Rosina Filby v. Mortgage Express (No 2) Limited, [2004] EWCA Civ 759, ¶ 62.
29
Id.
30
IDBI Bank Ltd. v. EPC Constructions India Limited, 2018 SCC OnLine NCLT 24901.
31
Wasco Country v. New England Equitable Ins. Co. Et al., Supreme Court of Oregon, 1918. 88 Or. 465, 172
Pac. 126.

Page 13 of 20
Now, when it is established that the right of subrogation after the approval of the resolution
plan will be counter-productive to the objective of the IBC, and it is not a strictly enforceable
right; the flip side effect of the same on the market needs to be seen. If the guarantors would
not be given the recovery rights, then they will not be willing to stand as guarantors to any
transaction, and it will heavily affect the credit market, which every transaction is
substantially based upon.

India stands as the 63rd country in the Ease of Doing Business Index of the World Bank. 32
Smooth availability of the credit severely affects the ranking in the said index as credit is the
fuel to any industry and transaction. India’s stand on the right of subrogation, though justified
from one side, can impair the credit market and consequently lower India’s ranking in the
said index.

CRITICAL ANALYSIS: POSITION IN INDIA VIS-À-VIS POSITION IN UNITED

STATES

A. LEGAL POSITION IN INDIA

32
Doing Business 2020, WORLD BANK GROUP, (Last accessed on Sept 01, 2021)
http://documents1.worldbank.org/curated/en/688761571934946384/pdf/Doing-Business-2020-Comparing-
Business-Regulation-in-190-Economies.pdf

Page 14 of 20
Since its inception, the IBC has been a debtor-centric legislation,33 with the primary object
saving companies from insolvency. However, it could be argued that the legislation has a
very myopic approach when it comes to personal guarantors. In the crusade to ‘to maximise
the value and assets of the corporate debtor’, it seems that the courts have forgotten that the
CIRP must also ‘balance the interests of all stakeholders’.

A guarantor’s right of subrogation is founded upon the theory of unjust enrichment,34 which
states that no one should profit at the expense of another. The corporate debtor is unjustly
enriched due to the denial of this right, which is justified by the fact that further encumbering
the assets of the debtor would defeat the objectives of the IBC.

This disparity between the guarantor’s contractual rights and their liabilities under IBC is
defended by the overriding effect of section 238 of the IBC, which states that the provisions
of the IBC shall prevail over anything inconsistent contained in any other law in force.
Further, in the event of an inconsistency between two special legislations, the latter enacted
legislation shall prevail.35 An approved resolution plan would prevail over the contractual
rights of a guarantor. This leads to the inescapable conclusion that the right of subrogation
must be sacrificed at the altar of the IBC.

Furthermore, allowing the personal guarantors to exercise their right will initiate a never-
ending vicious circle as can be seen from Davinder Ahluwalia v. Sumit Aviation,36 wherein
the personal guarantor was placed into the shoes of the creditor. The corporate debtor
defaulted again which compelled the guarantor to file a section 7 application to initiate CIRP
against the corporate debtor.

However, multiple irregularities present themselves when the legal position is considered
from a natural law perspective. A surety’s obligation is to discharge the debt of the principal
borrower in the event of a default. Once the surety has fulfilled their liability, they obtain a
corresponding right, i.e., to step into the shoes of the creditor and recover the debt. In the

33
Swiss Ribbons Pvt. Ltd. vs Union Of India, 2019 SCC OnLine SC 73.
34
Saransh Kothari, Theory of Unjust Enrichment, LEGAL SERVICES INDIA (Last Accessed 02 Sept. 2021)
http://www.legalservicesindia.com/article/1351/Theory-of-Unjust-Enrichment.html.
35
Solidaire India Ltd vs Fairgrowth Financial Services, (2001) 3 SCC 71.
36
Davinder Ahluwalia v. Sumit Aviation, IB No. (IB)-229 (ND)/2017.

Page 15 of 20
authors’ opinion, the argument that the surety cannot recover the amount from the debtor,
without doing anything egregious or defaulting on their payments, is wholly unsustainable.
Subrogation is an equitable right37 which cannot be strictly enforced by overlooking
analogous legal and equitable rights of other parties. However, that does not mean that it
should be treated as being entirely expendable. To incorporate the right into the IBC, far-
reaching changes would have to be made, as any solution that attempts to indemnify personal
guarantors would have the potential to restart the CIRP all over again, as it did in Davinder
Ahluwalia.

D. LEGAL POSITION IN UNITED STATES

Unlike the IBC, the United States Bankruptcy Code38 has devised a more pragmatic approach
towards the insider guarantor’s rights of reimbursement or subrogation. Under section 547(b)
of the Bankruptcy Code, an insider guarantor who has fulfilled their obligation and
indemnified the insolvent corporation is treated like a creditor of the corporate debtor, and
can exercise their right of subrogation and recovery their assets.

This approach to insider guarantee reduces the cost of financial agency, as the guarantors are
personally liable to the creditors, and they are incentivized to prevent the debtor from
spiralling into insolvency by making efficient management and investment decisions. Further,
even after the creditors move against the insider guarantors and the guarantor has to
indemnify the company, the presence of subrogation rights would mean that the guarantor’s
incentives remain aligned with the corporation, as any increase in the borrower’s assets
would also increase the amount the guarantor can recover from the corporate debtor.

E. COMPARATIVE ANALYSIS
In contrast, the scheme of the IBC provides no such incentives to personal guarantors.
Personal guarantors are made coextensively liable39 while simultaneously being deprived of
their subrogation rights. Once insolvency is imminent, they realise that they would be at the
mercy of the creditors and have no advantage in acting in the interests of the corporate
debtor. In such a situation, they are more likely to prioritize their own perverse incentives to
the detriment of the CIRP.

37
Economic Transport Organisation v. M/S Charan Spinning Mills, (2010) 4 SCC 114
38
United States Code, Title 11 – Bankruptcy, 1978.
39
State Bank of India vs V. Ramakrishnan, 2018 (9) SCALE 597.

Page 16 of 20
Alternatively, the US law also contemplates a waiver of the right of subrogation or
reimbursement through clauses in the contract of guarantee, also known as ‘Deprizio
waivers’40. Such clauses protect creditors from the reduction in the potential liability of the
guarantor to discharge the debt by nullifying the validity of pre-petition payments, which are
preferential transactions made by the debtor for the benefit of the guarantor. Such
transactions are protected by virtue of the fact that the guarantor retains his subrogation rights
and consequently, its status as a ‘creditor’ under section 547(b). However, if the subrogation
rights are waived, the guarantor can no longer be classified as a ‘creditor’.

Even in common law countries like the United Kingdom and Australia, the insolvency
resolution procedure does not contemplate a statutory extinguishment of the guarantor’s right
of subrogation. However, like the US, this right may be expressly or impliedly waived
through contract clauses,41 or the conduct and intention of the parties of the parties.

In doing so, these legal systems incorporate the personal guarantor’s right of subrogation into
the insolvency procedure without resorting to unjust enrichment of the corporate debtor or
violating the principles of equity or natural justice, while devising mechanisms to allow
creditors to protect themselves. This is something the IBC has not been able to do.

CONCLUSION

In all, the extinguishment of the personal guarantor’s right of subrogation is not an

unavoidable and unassailable fact, but a corollary of a flawed insolvency resolution structure
40
Levit v. Ingersoll Rand Financial Corp., 874 F.2d 1186.
41
Rita Lowe, Nick Amis, Guarantees: Right of Subrogation, MONDAQ, (December 2007),
mondaq.com/uk/insolvencybankruptcy/55562/guarantees-rights-of-subrogation

Page 17 of 20
that has become too myopic and debtor-centric. One of the primary objects of the IBC is to
provide greater ‘ease of doing business’ to all stakeholders, bring about a more transparent
corporate structure and foster better corporate governance. 42 India currently ranks 63rd on the
World Bank’s Ease of Doing Business 2020 report.
The fact that the IBC actively and unashamedly undermines a core aspect of
commercial transactions, i.e. contracts of guarantee, goes directly against that object.
Contracts entered into by personal guarantors are essential for the smooth injection of capital
into the market as they put the creditors at ease. Undermining such contracts shall have a
detrimental effect on the economy,43 as it would impair the willingness of both creditors and
guarantors to enter into such contracts. However, considering the direction that jurisprudence
under IBC is taking with regard to the rights and liabilities of personal guarantors, any
mechanism that encumbers the assets of the corporate debtor after the CIRP process,
especially for the benefit of the personal guarantors, may be anathema to the IBC scheme.
Therefore, a window should be made available to a Guarantor at any time during
CIRP to stake a claim on the basis of Subrogation. Such a Guarantor should have an absolute
right to participate and conduct in the meetings of COC. The definition of a Creditor as per
Section 3(10)[21] of the Code is required to be enlarged so as to also include a Guarantor. It
would have been appropriate to amend the definition of the word ‘Creditor’ simultaneous
with the addition of Sub-section 3(b) to Section 14 of the Code.
It is needless to state that the Personal Guarantors are liable towards the Creditors in
respect of the outstanding dues of the Corporate Debtor. It is however equally important to
recognize the rights of the Personal Guarantors and treat them at par with the rest of the
management of the Company. The purpose of the Code is revival and restoration of the
Company and Personal Guarantors being a part and parcel of the whole process, need due
consideration.

42
Ministry of Corporate Affairs, Year End Review -2019 of Ministry of Corporate Affairs: Several initiatives
taken for providing Ease of Doing Business to law abiding corporates – Creation of Institution of a robust
Insolvency & Bankruptcy framework, PRESS INFORMATION BUREAU (Last Accessed Sept 02, 2021) available at:
https://pib.gov.in/PressReleaseIframePage.aspx?PRID=1596523
43
Gopal Gaur, Right of Subrogation Under IBC: Impact on Market, THE CBCL BLOG (August 13, 2020)
available at: https://cbcl.nliu.ac.in/banking-law/right-of-subrogation-under-ibc-impact-on-market/.

Page 18 of 20
 BIBLIOGRAPHY

The bibliography is divided into following sections: Statutes; Books; Journals; Online
Databases; and Newspaper Reports.

A. STATUTES/ORDINANCES

1. The Indian Contract Act, 1872

2. Insolvency and Bankruptcy Code,2016
3. Insolvency and Bankruptcy Code (Amendment) Act, 2020
4. Insolvency and Bankruptcy Code( Amendment) Ordinance, 2019
5. Insolvency and Bankruptcy Code( Amendment) Ordinance, 2020

B. JOURNALS

1. Athota, Shreeja, ‘Reverting Back: A Critical Analysis of the Insolvency and Bankruptcy
Code’ (SSRN Scholarly Paper ID 3710944, 13 September 2020).
2. Atkins, Scott and Kai Luck, ‘Legal Update: Corporate and Business Rescue in a
COVID-19 World’ (2020) 32(2) Australian Restructuring Insolvency & Turnaround
Association Journal 16–21.
3. Bangha-Szabo, Attila and Anthony Morton, ‘Germany: Restructing Update’ (2020)
35(7) Journal of International Banking & Financial Law 511–512.
4. Coneyworth, Amanda, ‘Safe Harbour Advisory in Unchartered Waters Is It Still
Relevant?: An Insolvency Practitioner’s Perspective’ (2020) 20(7) Insolvency Law
Bulletin 132–134.
5. Bradley, Christopher G, ‘The New Small Business Bankruptcy Game: Strategies for
Creditors Under the Small Business Reorganization Act’ (2020) 28 American
Bankruptcy Institute Law Review 47.

C. DATABASES
1. Wiley Online Library.
2. Yale University Press.
3. University of Oxford News [www.ox.ac.uk/news].
4. HeinOnline [home.heinonline.org].
5. Jstor [www.jstor.org].
6. SSRN [www.ssrn.com].

Page 19 of 20
7. Culture Trip [https://theculturetrip.com]
8. Lexis nexis
9. SCC Online
10. Manupatra

D. BOOKS

1. LORD CHORLEY, LAW OF BANKING (2nd edn, Pitman 1947).

2. S.N GUPTA, LAW RELATING TO GUARANTEES WITH PRO-FORMAS OF BANK GUARANTEES
AND INDEMNITY BONDS (6th edn, Pitman 1947).
3. C.A KAMAL GARG, CONCISE COMMENTARY ON INSOLVENCY AND BANKRUPTCY CODE,

2016 (Wolters Kluwer India Pvt Ltd; 2019th edition, 1 January 2019)
4. IAN F FLETCHER, THE LAW OF INSOLVENCY 23-34 (Sweet & Maxwell Ltd, 3rd Ed. 2003)

E. REPORTS

1. Lok Sabha, Report of the Joint Committee on the Insolvency and Bankruptcy Code, 2015,
6 (2016).
2. Report of The Insolvency Law Committee (Mar, 2018)
https://www.ibbi.gov.in/uploads/resources/ILRReport2603_03042018.pdf

F. NEWSPAPER REPORTS

1. The Wire [www.thewire.in].

2. The Hindu [www.thehindu.com]
3. Mint [www.livemint.com]
4. Huffington Post [www.huffpost.com]
5. Scroll. In [https://scroll.in/]
6. The Economic Times [https://economictimes.indiatimes.com/]
7. N.Y Times [https://www.nytimes.com/international/]
8. FirstPost [https://www.firstpost.com/]

Page 20 of 20