Author - Advocate Nitin Jain and Associate Nupur Mehrotra
Today, the concept of taking loans i.e. borrowing funds from banks or financial institutions has become very common. Borrower and guarantor are the important stakeholders in the entire process of borrowing money and repaying it. A borrower is an individual who obtains money from the opposite party commonly known as the lender with a legal contract to repay the borrowed sum with the stated interest. The money is borrowed for a specified period. The liability of the borrower is absolute and unconditional. The borrower is known as principal debtor. Whereas, a guarantor is a person who guarantees to pay a borrower’s debt in the event the borrower defaults on a loan obligation. A guarantor acts as co-signer because they pledge their own assets or services in case the original debtor cannot perform their obligations. The guarantor has a primary responsibility to repay the money borrowed.
Understanding the liability of Guarantor vs Borrower
The Indian Contract Act, 1872 (“Contract Act”) states that, “the liability of the surety (or guarantor) is co-extensive with that of the principal debtor unless the contract otherwise provides it.” The surety’s liability also depends on the terms of the contract and is not liable to pay more than the principal debtor has taken. If the parties specifically agree as to the extent of liability or the surety puts a limit on his ability at the time of entering into the contract, then the liability of the surety will not be co-extensive with that of the principal debtor. A surety’s liability to pay the debt is not removed by reason of the creditor’s omission to sue the principal debtor. As per Section 135, when the creditor enters into an arrangement with the principle debtor not to sue him or to provide extra time for payment of debt, the surety will be discharged from its liability unless the surety has assented to such arrangement.
The creditor is not bound to exhaust his remedy against the principal before suing the surety, and a suit may be maintained against the surety though the principal has not been sued. This has been discussed in the case of Bank of Bihar Limited v Damodar Prasad & Another wherein the Apex Court referred to a landmark judgment in the case of Lachhman Joharimal v Bapu Khandu and Tukaram Khandoji in which the Division Bench of the Bombay High Court held, “the court is of opinion that a creditor is not bound to exhaust his remedy against the principal debtor before suing the surety and that when a decree is obtained against a surety, it may be enforced in the same manner as a decree for any other debt.” The Apex Court in its judgment in the case of SBI v M/s Indexport Registered and Others has reiterated the settled principle of law that the guarantor can be sued before initiating proceedings against the surety.
The Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 also known as SARFAESI Act, was framed to allow the financial houses to assess the asset quality in different ways. In other words, the SARFAESI Act was made to identify and rectify the problem of Non-Performing Assets (“NPAs”) through multiple mechanisms. It allows banks and other financial institutions to auction residential or commercial properties to recover bad loans. In case of any default, the bank can give written notice to the defaulter to clear its debts within 60 days. If the borrower is unable to comply with the notice, the bank can take the property as security, sell off the property or appoint any person to handle the case. The definition of “borrower” is given under Section 2(f) of SARFAESI Act. According to Section 13(2) of the SARFAESI Act, a demand notice must be served to the borrower for repayment of loan. There is no explicit definition of guarantor under the Act. Guarantor is also taken within the fold of definition of “borrower” under Section 2(f) of SARFAESI Act. In cases where the guarantor has also created security interest and if the secured creditor intends to enforce the security interest created by a guarantor first, before enforcing the security interest created by the principal borrower, it can do so and the guarantor cannot direct or dictate the secured creditor as to which security interest is to be enforced first.
The Insolvency and Bankruptcy Code, 2016 (“IBC”) has brought a standard shift in the recovery process by introducing the concept of ‘creditor in control’ instead of ‘debtor in possession.' It is used for the recovery of bad debts by the banking sector or for recovery of monies due by goods / service providers. IBC relates to the insolvency resolution of corporate or partnership firms in a time-bound manner under the supervision of the National Company Law Tribunal (“NCLT”).
Section 7 of the Code empowers a financial creditor either by itself or jointly with other financial creditors to file insolvency plea against its corporate debtor before the NCLT. In a recent case of Dr. Vishnu Kumar Agrawal v M/s Piramal Enterprises Limited, the National Company Law Appellate Tribunal, New Delhi held that it is not necessary to initiate ‘Corporate Insolvency Resolution Process’ against the principal borrower before initiating ‘Corporate Insolvency Resolution Process’ against the corporate guarantors. Without initiating any ‘Corporate Insolvency Resolution Process’ against the principal borrower, it is always open to the Financial Creditor to initiate ‘Corporate Insolvency Resolution Process’ under Section 7 against the corporate guarantors, as the creditor is also the Financial Creditor qua corporate guarantor.
The position of a guarantor is similar under the three acts namely the Contract Act, SARFAESI Act and the IBC. Firstly, under the Contract Act, the liability of the surety/guarantor is co-extensive with that of the principle debtor/borrower unless there is an express contract between the creditor and the principle debtor limiting the liability of the surety. The creditor has the right to sue either the guarantor or the borrower or both in case of default. However, there are some circumstances under the Contract Act by virtue of which the surety can be discharged from liabilities. The provisions relating to the discharge of the surety are enshrined under Sections 133 to 139 of the Contract Act. Secondly, under the SARFAESI Act, instances where the secured creditor wants to enforce the security interest created by the guarantor first, he is permitted to do so under the Act. Thirdly, under the IBC similar situation of the guarantor has been discussed in a recent case of Dr. Vishnu Kumar Agrawal v. M/s Piramal Enterprises Ltd. Therefore, it is clear that the liability of the guarantor and the principal borrower is joint and several. Generally, guarantee deeds also have a clause to the effect that the guarantor is liable in the same manner as if the guarantor is the principal debtor. In instances, where proceedings under the SARFAESI Act and the IBC is simultaneously initiated there is no settled principle of law but in the 2017 case of Sanjeev Shriya v. State Bank of India the Allahabad High Court stayed the Debt Recovery Tribunal proceedings against the personal guarantors stating that two split proceedings cannot go on simultaneously before the DRT and the NCLT.