Encashment of bank guarantee and relevance of moratorium Bharat Aluminium Co. Ltd. v. J.P. Engineers (P) Ltd.: A Case Comment

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4 years ago

Introduction

Insolvency and Bankruptcy Code, 2016[1] (hereinafter “IBC”) has introduced a much more stable structure with strict time frames into the resolution process, providing the system with much-needed clarity and reliability. It has totally removed the governing powers of the companies under the resolution process and transferred them to a resolution professional to ensure a smooth transition and revival. Unlike the previous regime’s never-ending moratorium, the IBC established a far more practical structure with a set deadline. As per Section 14 of the IBC, while the moratorium is in effect, creditors of a company in the corporate insolvency resolution process (CIRP) are prohibited from taking any action to recover a security interest generated by the corporate debtor. However, the scope of this section has remained under debate for the longest time and has finally been settled by the Supreme Court as well as the National Company Law Appellate Tribunal (NCLAT). This comes after the 2018 Amendment to the IBC. In this paper, the issue whether a bank guarantee can be invoked during moratorium period in light of Bharat Aluminium Co. Ltd. v. J.P. Engineers (P) Ltd.[2] has been analysed.

Facts

M/s Worldwide Metals Pvt. Ltd., the operational creditors, had filed a company petition under Section 9[3] of the IBC to initiate the corporate insolvency resolution process against M/s J.P. Engineers Pvt. Ltd., the corporate debtor and Respondent 1. The National Company Law Tribunal (NCLT) admitted the application and appointed an interim resolution professional (IRP). Bharat Aluminium, the appellants, and the corporate debtor had entered into an agreement for purchase and sale of aluminium products. Subsequently, the corporate debtor issued a bank guarantee worth Rs one crore and sixty lakhs which was executed by Respondent 2 i.e., Andhra Bank. At the end of the contractual period, the debtor failed to make the payments as a result of which, the appellant wrote a letter to Respondent 2 for invoking the bank guarantee. To this letter, Respondent 2 replied that the bank guarantee could be encashed only upon the approval of the IRP. Thereafter, the appellant applied to the IRP, but the IRP refused to allow encashment of the bank guarantee on the grounds of enforcing moratorium against Respondent 1. Thereafter, the appellant had filed an application before NCLT seeking encashment of the bank guarantee on the grounds that it is not covered by moratorium as specified under Section 14 of the IBC. The Tribunal dismissed this application and directed the appellant to not ask for encashment of bank guarantee, as the same is covered under moratorium declared under Section 14 of the IBC. Thus, the appellant filed this appeal.

Issue

The NCLAT was posed with the issue whether a bank guarantee can be invoked against the surety once the moratorium has been imposed against the corporate debtor under Section 14 of the IBC.

Background of law

Section 14 of the IBC provides the effect and scope of the moratorium.[4] Until 2018, the law was unclear on whether the bank guarantees can be invoked during moratorium period. However, after an amendment passed in June 2018, a clause was introduced in the IBC which provided that in a contract of guarantee to a corporate debtor, the surety is not shielded under moratorium.[5] However, for a personal debtor, the Supreme Court, relying upon the report of the Insolvency Law Committee, held that moratorium will not apply to such debtor.[6] The report noted that the assets of the debtors and that of the surety are separate and thus, the ongoing proceedings of CIRP against the corporate debtor will not have any impact as a result of any actions taken against the assets of the surety.[7] Further, invoking guarantee will not have any significant impact on the corporate debtor’s debt because the creditor’s right against the debtor simply transfers to the surety, for the amount paid by surety.[8] The Committee recommended that the scope of moratorium should be limited only to the assets of the corporate debtor and actions against the guarantors cannot be barred.[9]

Analysis of the judgment

In the present case, the NCLAT held that “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”.[10] The appellant drew an analogy between performance bank guarantees and financial bank guarantees by referring to Section 14 and proviso to Section 3(31)[11], which excludes performance bank guarantees from “security interest”, to emphasise their contention that bank guarantees can be invoked during moratorium.[12] They also relied on the amendment discussed above and various case laws to submit that bank guarantees can be invoked during moratorium.[13] On the contrary, the respondent relied on cases to establish that once the moratorium period has begun, no amount can be debited from the account of the corporate debtor.[14] They distinguished between financial and performance bank guarantees.[15] Further, they submitted that since IBC is a specific law, it will prevail over a general law like the Contract Act, 1872.[16]

The Tribunal perused the submissions of the parties and held that the guarantee in question is a financial bank guarantee and not a performance bank guarantee.[17] The Reserve Bank of India (RBI) has also distinguished between the two types of guarantees in one of its circular.[18] The NCLT in its judgment dated 31-7-2020 had relied on Nitin Hasmukhlal Parikh v. Madhya Gujarat Vij Co. Ltd.[19], where the Tribunal held that the moratorium applies for all bank guarantees, except for performance bank guarantees, as they form a part of “security interest” defined under Section 3(31) of the IBC. This case was decided on 9-2-2018. The amendment to Section 14 was introduced on 6-6-2018.[20] The court gave the judgment on 31-7-2020, which was after the amendment was introduced. As mentioned above, the amendment provided that the effect of moratorium will not apply to “a surety in a contract of guarantee to a corporate debtor”.[21] Thus, the NCLT erred in its decision by relying on Nitin case[22] and overlooking the amendment which had a retrospective effect. The Tribunal then relied on Ramakrishnan[23], where the Supreme Court held that Section 14(3) is clarificatory in nature and has retrospective effect.[24] The Tribunal also backed its finding by relying on principles of Contract Act, which provides that the “liability of surety is coextensive with that of a principal debtor and the creditor may go against either of them”.[25] Thus, the NCLAT rightly held that the corporate creditor can invoke bank guarantee during moratorium with no difficulties, as the bank guarantee is irrevocable and unconditional.[26] It was held in U.P. State Sugar Corpn. v. Sumac International Ltd. that a bank is bound to honour irrevocable bank guarantees irrespective of any issue raised by the customers.[27] It further distinguished the assets of the corporate debtor with those of the surety and overruled the decision of the lower court i.e., NCLT.

Conclusion

Prior to the amendment, the law on the point on invocation of bank guarantee during moratorium was not clear. There were several conflicting decisions being passed by the tribunals across the country. The amendment put an end to the series of conflicting judgments. In addition to this, the judgment of the Supreme Court in Ramakrishnan[28], which explained the application and scope of the amended provision, acted as a cherry on top of the cake and gave more clarity on this issue. The NCLT, though, erred in its decision by not taking the amendment into consideration and relying on a case which was decided before the amendment was introduced. The NCLAT corrected the error made by the NCLT and by relying on the reports of the Insolvency Law Committee, the object of IBC and Section 14 of the IBC, rightly held that financial bank guarantee can be invoked during moratorium period under Section 14 of the Code. The judgment of the NCLAT is also in consonance with the judgments of the Supreme Court on the same issues.

The decision of the Court acts as a clarification on the issue whether the guarantees issued by third parties/banks can be invoked during the moratorium period. This decision, though, is definitely in favour of the creditors, banks may find it difficult to recover their money from a corporate debtor on whom moratorium is imposed under Section 14 of the IBC.

± 4th year student, BA LLB (Hons.), West Bengal National University of Juridical Sciences (WBNUJS)
Kolkata

[1] <http://www.scconline.com/DocumentLink/86F742km>.

[2] 2021 SCC OnLine NCLAT 57

[3] <http://www.scconline.com/DocumentLink/09ftZIDF>.

[4] The Insolvency and Bankruptcy Code, 2016, S. 14

[5] The Insolvency and Bankruptcy Code (Second Amendment) Act, 2018, S. 10

[6] SBI v. V. Ramakrishnan, (2018) 17 SCC 394

[7] Shri Injeti Srinivas, Report of the Insolvency Law Committee, 35 (26-3-2018), <http://www.scconline.com/DocumentLink/sYKPTj8e>.

[8] Ibid.

[9] Ibid.

[10] Bharat Aluminium Co. Ltd. v. J.P. Engineers (P) Ltd., 2021 SCC OnLine NCLAT 57, para 37

[11] <http://www.scconline.com/DocumentLink/rOllWgj8>.