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Liability of guarantor under Indian Contract Act, 1872

ResolutionBazaar

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The High Court of Calcutta in Gouri Shankar Jain v. Punjab National Bank was faced with the similar question, i.e., whether liability of the personal guarantor is extinguished upon approval of the resolution plan. The Calcutta High Court observed that liability of the personal guarantor is not extinguished upon approval of the resolution plan. While coming to the said conclusion, the Court analyzed various provisions of the Contract Act dealing with discharge of the surety and observed the following:

1. According to section 128 of the Contract Act, liability of the guarantor is co-extensive with that of the principle debtor. The word “co-extensive” relates to the quantum of the principal debt. The lawyers for personal guarantors contended that liability of the principal debtor is extinguished upon approval of resolution plan, i.e., principal debt becomes zero and, consequently, in light of section 128 of the Contract Act, liability of the guarantor also stands extinguished. However, the Supreme Court in Maharashtra State Electricity Board, Bombay v. Official Liquidator, High Court, Ernakulam observed that it is a well settled principle of law that a discharge which is secured by a principal debtor by operation of law (i.e., by bankruptcy or insolvency or liquidation proceedings) does not absolve surety of his liability. Therefore, the Court observed that in case of discharge by operation of law, the liability of the surety is not extinguished.

2. According to second part of section 134 of the Contract Act, a surety is discharged by any act or omission of the creditor, the legal consequence of which is the discharge of the principal debtor. The question, which arises for consideration, is whether an application filed by financial creditor under section 7 of the IBC could amount to a “voluntary act” on part of the creditor. The Calcutta High Court observed that a financial creditor filing an application under section 7 of the IBC is exercising its statutory right and not contractual right. Therefore, the exercise of such statutory right, which is involuntary in nature, will not alter the contractual obligations of the parties. Consequently, the guarantor is not discharged upon discharge of debtor by way of an insolvency proceeding.

3. According to section 135 of the Contract Act, a surety is discharged if the creditor makes a composition with the principal debtor. The Court observed that it could not be said that the filing of an application under section 7 of the IBC amounts to a composition with the principal debtor. Further, the resolution plan may either provide for payment of the entire claim or only a portion of the claim as final settlement and in neither of the two situations can the creditor be said to have entered into voluntary compromise with the corporate debtor with regard to the quantum of debt.

4. According to section 139 of the Contract Act, a surety is discharged if the creditor does any act inconsistent with the rights of the surety and the eventual remedy of the surety against the principal debtor is thereby impaired. The Court observed that the filing of an application under section 7 of the IBC is a statutory right and does not affect the contractual obligations of the parties, who are bound by independent contracts between the creditor, principal debtor and guarantor. The question still remains whether a resolution plan that takes away the right of subrogation, thereby impairing the remedy of the surety, will be hit by section 139 of the Contract Act and consequently discharge the surety?
 
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