NCLAT allows creditor to invoke bank guarantee during moratorium

On 26 February 2021 the National Company Law Appellate Tribunal (NCLAT) allowed the invocation of a bank guarantee during a moratorium period imposed under Section 14 of the Insolvency and Bankruptcy Code (IBC) 2016. This article summarises the NCLAT’s decision in this case (Bharat Aluminium Co Ltd v JP Engineers Pvt Ltd).

Facts

Bharat Aluminium entered into an agreement with JP Engineers for the sale and purchase of aluminium products, the payments for which were guaranteed by Andhra Bank (which has since merged with the Union Bank of India). In the meantime, an application to initiate the corporate insolvency resolution process of JP Engineers was admitted, resulting in the imposition of a moratorium under Section 14 of the IBC.

When JP Engineers defaulted on its payments under the agreement, Bharat Aluminium invoked the bank guarantee. However, Andhra Bank resisted the invocation on the grounds that a bank guarantee could not be invoked because of the IBC moratorium. Therefore, Bharat Aluminium filed an application before the adjudicating authority of JP Engineers’ corporate insolvency resolution process (the National Company Law Tribunal (NCLT)) for the invocation of the bank guarantee. Andhra Bank filed an application before the NCLT to resist the invocation of the bank guarantee.

The NCLT admitted Andhra Bank’s application in view of the IBC moratorium, thereby directing Bharat Aluminium to demand no invocation or release of the bank guarantee. Bharat Aluminium filed an appeal before the NCLAT.

Decision

The key issue before the NCLAT was whether a financial bank guarantee can be invoked after the imposition of a moratorium under Section 14 of the IBC.

The NCLAT held that the NCLT had not considered a retrospective amendment made to Section 14 of the IBC prior to the passing of its order and had wrongly relied on orders passed before the amendment.

It observed that:

• the IBC prevents personal and other guarantors from escaping the independent and co-extensive liability to pay off the entire outstanding debt;
• Section 14 of the IBC does not apply to such guarantees; and
• as per the amendment to the IBC, Section 14(1) does not apply to sureties in guarantee contracts for the debts of a corporate debtor.Relying on the Supreme Court’s judgment in SBI v V Ramakrishnan, the NCLAT held that a bank guarantee can be invoked, even during a moratorium period under Section 14 of the IBC, in view of the amendment.

Comment

The NCLAT decision is a welcome clarification of the issue of whether financial bank guarantees, as they are issued by third parties outside the insolvency process under the IBC, can be invoked during a moratorium period imposed under Section 14 of the IBC. The NCLAT recognised that the amendment was passed on the recommendations contained in the March 2018 Report of the Insolvency Law Committee, which specifies that:

• the assets of a surety are separate from those of the corporate debtor; and
• proceedings against the corporate debtor may not be seriously affected by the actions of third parties such as sureties.

However, the NCLAT decision may cause some difficulty for banks which have extended bank guarantees. Where a moratorium period is imposed under the IBC, recouping the monies paid under bank guarantees from a corporate debtor may be challenging.

For further information on this topic please contact Ishan Handa, Shivanand Nayak or Janhavi Patankar at AZB & Partners by telephone (+91 22 4072 9999) or email (ishan.handa@azbpartners.com, shivanand.nayak@azbpartners.com or janhavi.patankar@azbpartners.com). The AZB & Partners website can be accessed at www.azbpartners.com.

Authors:

Ishan Handa, Partner
Shivanand Nayak, Senior Associate
Janhavi Patankar, Associate