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ALL YOU NEED TO KNOW ABOUT THE INVOCATION OF THE BANK GUARANTEE UNDER THE IBC MORATORIUM


[1] INTRODUCTION

The enactment of the Insolvency and Bankruptcy Code, 2016 (hereinafter referred to as “IBC”/ “Code”) has completely changed the procedure of recovery of debt by creditors and the revival of the Corporate Debtors. Under the Code, a financial creditor, an operational creditor, and the corporate applicant itself can initiate the Corporate Insolvency Resolution Process (hereinafter referred to as “CIRP”) against the Corporate Debtor under Sections 7, 9, and 10 respectively if the Corporate Debtor defaults the repayment.


The Code also provides a step-by-step procedure that needs to be followed by the parties, insolvency professionals, and the Hon’ble Adjudicating Authority after the admission of aforesaid applications by the Hon’ble Adjudicating Authority. One of such requirements is to declare a moratorium against the Corporate Debtor. Declaring a moratorium also includes the prohibition of any action related to the security interest created by the Corporate Debtor for its property. Moreover, the proviso to the definition of “security interest” excludes a “performance guarantee” from the definition of “security interest”.


A collective reading of the provision of moratorium and definition of “security interest” creates an ambiguity regarding the invocation of bank guarantee during the existence of moratorium.

The Banks generally promise repayment or performance of obligations to the creditors or lenders in case their debtors fail to repay or perform their contractual obligations. Such a bank guarantee can be invoked as per terms of the contract of guarantee by the creditor to get back the outstanding debt amount. However, whether or not a bank guarantee can be invoked during the period of moratorium has been a debatable issue. A conflict in views regarding this can be seen in various judgments of the Hon’ble Apex Court and Tribunals. Sensing the ambiguity, an amendment to the provision of the moratorium was brought. Subsequently, the said issue was settled by the Hon’ble National Company Law Appellate Tribunal, New Delhi in February 2021 in the case of Bharat Aluminium Co. Ltd. v. M/S J.P. Engineers Pvt. Ltd. & Anr.


[2] WHAT IS A BANK GUARANTEE?

A bank guarantee is a contract wherein the bank, as a financial institution, promises to repay or compensate an amount to a creditor or lender on behalf of a debtor or borrower. In simpler words, if a debtor fails to repay an amount or fulfill the obligations, the bank will step into its shoes and fulfill the demands of the creditor.

There are two types of bank guarantees- a) Performance bank guarantee and b) Financial or non-performance bank guarantee. In a performance bank guarantee (hereinafter referred to as “PBG”), the bank promises to perform or fulfill the contractual obligations by paying a compensatory amount to the creditor if the debtor fails to fulfill its obligations. Whereas, in financial or non-performance bank guarantee (hereinafter referred to as “NPBG”), the bank promises to repay a debt amount to the creditor if the debtor defaults its payment either in part or full.


[3] WHAT IS A MORATORIUM UNDER THE IBC?

IBC has not defined the term “moratorium” anywhere. However, from the definitions given under the Oxford, Cambridge, and Merriam Webster dictionaries, the moratorium can be said as the permission or allowance by the legal authority to delay or postpone the obligations of the Corporate Debtor for a specified time.


In the context of IBC, it means a time period after initiation of CIRP wherein all the proceedings or actions initiated against the Corporate Debtor or its property will be suspended till completion or termination of CIRP. The moratorium against the Corporate Debtor also includes suspension or prohibition of foreclosure, recovery, or enforcement of any security interest in respect of the property of the Corporate Debtor for the time being.

Section 13 of the Code empowers the Hon’ble Adjudicating Authority to declare a moratorium under Section 14 after initiation of CIRP as a result of applications filed under Sections 7, 9, or 10 of the Code. Section 14 of the Code enlists all the proceedings which will be prohibited after the declaration of a moratorium.


[4] BANK GUARANTEE VIS-A-VIS MORATORIUM UNDER THE IBC

Section 14(1)(c) of the Code empowers the Adjudicating Authority to declare a moratorium forbidding or prohibiting foreclosure, recovery, or enforcement of any security interest created by the Corporate Debtor in respect of its property.

Moreover, Section 3(31) of the Code defines the expression “security interest”. As per the definition, “security interest” also includes a transaction or an arrangement that secures payment or performance of an obligation. However, its proviso excludes the guarantee of performance or performance guarantee from the purview of the definition. Thus, this inclusion of the performance of obligations and exclusion of the performance-based guarantees from the definition of “security interest” had created a lot of ambiguity and the same is evident in various case laws discussed further.


Apart from that, the amendment in Section 14(3)(b) of the Code made it clear that declaration or provisions of moratorium shall not apply to a surety under a contract of guarantee. While the amendment cleared the uncertainty regarding the invocation of third-party guarantees during the existence of moratorium, the ambiguity regarding the parties in dispute continued to exist for a long time till recently.


[5] INVOCATION OF BANK GUARANTEE DURING MORATORIUM

Whether or not a bank guarantee can be invoked during the moratorium period can be best understood through the judicial and quasi-judicial pronouncements. In the past, various tribunals and courts have expressed their diverse views regarding the invocation of PBG and NPBG after the declaration of a moratorium.


The IBC mandates that once the insolvency resolution process gets initiated, all the transactions, affairs, and conducts of the Corporate Debtor must be regulated by the Resolution Professional (hereinafter referred to as “RP”). In the case of Corporation Bank v. Amtek Auto Ltd., the Hon’ble NCLT held that after the declaration of the moratorium, the financial institutions have to act on the directions of the RP and the corporate guarantees cannot be invoked if the same has not been approved by the RP.

The very first case of invocation of bank guarantee during the moratorium came before the Hon’ble Gujarat High Court in 2017 in the case of ABG Shipyard Limited v. Government of India & Ors., wherein the Hon’ble Court held back the invocation of bank guarantee as the moratorium under Section 14 was already declared by the Hon’ble NCLT, Ahmedabad.

Similarly, a special bench of Hon’ble NCLT, New Delhi did not allow the invocation of bank guarantee as the Corporate Debtor was already under the moratorium period. However, the Hon’ble Tribunal did not determine the nature of the bank guarantee as to whether it was PBG or NPBG, which further led to ambiguity.


The departure from the aforesaid judgments can be seen in the case of Gudearth Homes Infracon v. Veebro Technoplast (IB-159 (PB)/2017). In this case, the Hon’ble Tribunal allowed the invocation of bank guarantee even when a moratorium was declared against the Corporate Debtor by the Hon’ble NCLT. However, in this case, as well, the nature and type of bank guarantee were not clarified by the Hon’ble Tribunal.


[5.1] INVOCATION OF PERFORMANCE BANK GUARANTEE (PBG) DURING MORATORIUM

Section 31(3) of the Code excludes “performance guarantee” from the definition of “security interest”. By excluding it from the scope of “security interest”, the Legislature has certainly expressed its intention. However, in 2018 in the case of ICIC Bank Ltd. v. Vista Steel Pvt. Ltd., a divergent view was adopted by the Hon’ble NCLAT wherein it stayed the invocation of PBG on the ground that it is in violation of the moratorium declared under Section 14 of the IBC.

Thereafter, the Hon’ble NCLAT and NCLT corrected the jurisprudence laid down in the above case and upheld the legislative intent. The Hon’ble NCLT Delhi, in the cases of Levcon Valves v. Energo Engineering Projects Limited, Indian Overseas Bank v. Arvind Kumar, and Mr. Nitin Hasmukhlal Parikh v. Madhya Gujarat Vij Company Limited & Ors. observed that the declaration of the moratorium will not have any effect on the performance bank guarantee as it falls under the exception carved out by Section 31(3) of the Code.

A similar issue regarding the invocation of PBG was again raised before the Hon’ble NCLAT. The Hon’ble Tribunal in the case of GAIL (India) Ltd. v. Rajeev Manaadiar & Ors. opined that the Corporate Debtor is entitled to approach the guarantor bank to invoke the performance guarantee either in full or in part, as per the terms of the contract of guarantee, on the ground that moratorium will not prohibit the PBG as per Section 14(1) read with Section 31(3) of the IBC.


[5.2] INVOCATION OF NON-PERFORMANCE BANK GUARANTEE (NPBG) DURING MORATORIUM

While the provisions of the IBC, to some extent, deal with the performance guarantee, they are silent regarding the non-performance guarantee. However, since the Legislature has exempted only the performance-based guarantees from the scope of security interest, it is clear that there is a significant difference between both the guarantees and operation of the moratorium will have different impacts on them.


An attempt to distinguish the PBG and NPBG was made by the Hon’ble NCLT, Ahmedabad in the case of Mr. Nitin Hasmukhlal Parikh v. Madhya Gujarat Vij Company Limited & Ors. The Hon’ble Tribunal observed that there is a clear distinction between both the guarantees. During the existence of a moratorium, the Corporate Debtor is not entitled to invoke bank guarantees other than those which fall within the ambit of performance guarantee. Though the Hon’ble Tribunal, in this case, reiterated the correct position of law, it did not take into consideration the amended provision of Section 14(3).


The issue of invocation of NPBG was raised for the first time before the Hon’ble NCLAT in the case of Berger Paints India Ltd. v. Precisions Engineers & Febricators Pvt. Ltd.. The Hon’ble Tribunal denied the invocation of NPBG on the ground that the operation of the moratorium will have no effect only on the invocation of PBG and not NPBG. In this case, the RP had declined the request of the Corporate Debtor regarding the invocation of the guarantee. Therefore, the Hon’ble Tribunal delivered the judgment in the favour of the RP and said that he was correct regarding the position of law.


[6] CURRENT SCENARIO

It is evident from the aforesaid pronouncements that there were inconsistencies and diversity amongst the Adjudicating Authorities regarding the enforcement of bank guarantees. However, the amendment act of 2018 cleared the ambiguity by exempting a surety under a contract of guarantee from the application of moratorium.

As per Section 14(3)(b), the moratorium will not apply to a surety under a contract of guarantee. The said provision was inserted in the Code on the recommendation of the Insolvency Law Committee in March 2018.


According to the report, the assets of the Corporate Debtor must be viewed as separate from those of the surety. Therefore, the proceedings such as CIRP against the Corporate Debtor will not be affected by the action against the surety. Similarly, enforcement or invocation of guarantee will not have a substantial effect on the CIRP proceedings of the debtor. Hence, the committee said that contractual obligations under the contract of guarantee should be respected even during the operation of a moratorium.


Subsequently, the Hon’ble Supreme Court in the case of SBI Vs. V. Ramakrishnan & Ors. relied upon and upheld the report of the Insolvency Law Committee.

In February 2021, the Hon’ble NCLAT in the case of Bharat Aluminium Co. Ltd. v. M/S J.P. Engineers Pvt. Ltd. & Anr. finally settled the conflict regarding the invocation of bank guarantee and upheld considering the amended provisions of Section 14(3) that, invoking a bank guarantee will not in any way affect the CIRP proceedings against the Corporate Debtor and thus it can be also invoked during the moratorium period.


[7] CONCLUSION

There have been various instances of misinterpretation or ambiguous interpretation of the legislative intent regarding the statutory provisions. The aspect of invocation of bank guarantee during the moratorium period is one of them. The Insolvency and Bankruptcy Code was enacted in 2016. It took more than two years and a subsequent amendment in the Code to draw a correct interpretation of Sections 14(1)(c) and 31(3) of the Code in respect of invocation of bank guarantee. The Hon’ble Tribunals and Courts had constantly made efforts to interpret and apply the provisions correctly related to the effect of a moratorium on bank guarantees, however, ambiguity regarding the distinction between Performance Bank Guarantee and Non-Performance Bank Guarantee was evident. The confusion was resolved by the amendment act of 2018 and subsequent pronouncements reiterating the report of the Insolvency Law Committee.


REFERENCES


(i) https://ibclaw.in/invocation-of-bank-guarantees-during-moratorium-tale-of-conflicting-decisions-by-anjali-patel/

(ii) https://www.livelaw.in/columns/financial-bank-guarantees-and-moratorium-under-ibc2016-161494

(iii) https://www.mondaq.com/india/insolvencybankruptcy/791130/invocation-of-bank-guarantees-during-moratorium-a-situation-of-conflicting-decisions?

(iv)https://www.mondaq.com/india/insolvencybankruptcy/790884/ibc-moratorium-is-vis-invocation-of-bank-guarantee


By Madhu Ayachit


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