2011 (12) TMI 421 - HC - Companies Law

Invalidity of Show-Cause Notice under State Financial Corporations Act + Guarantor Liability

Kundanmal Dabriwala Versus Haryana Financial Corporation

The court held that the show-cause notice under Section 32G of the State Financial Corporations Act was invalid and without jurisdiction. The liability of ... Writ petition - company invoked the provisions of the Sick Industrial Companies – court passed an order of winding up - Scheme was approved by Court and debts of creditors including that of corporation were settled - corporation also invoked guarantee given by managing director asking for payment of rest of amount Whether the revival scheme submitted by the petitioner under sections 391 and 394 of the Companies Act, 1956 and accepted by court amounts to compounding with the principal debtor leading to the discharge of the surety within the meaning of sections 134 and 135 of the Indian Contract Act, 1872 – Held that:- Once the principal debtor has settled its loan account with the Corporation, the petitioner, who is a guarantor, cannot be made liable to pay any amount over and above the amount paid by the principal debtor - liability of the guarantor is co-extensive with that of the principal debtor and not exceeding the liability of the principal debtor. Once the Corporation has settled its loan account with the principal debtor, the guarantor cannot be saddled with any additional liability – In favor of petitioner Issues Involved:1. Validity of the Show-Cause Notice under Section 32G of the SFC Act2. Extent of Liability of the Guarantor3. Impact of Settlement with Principal Debtor on Guarantor's Liability4. Legal Provisions under the Indian Contract Act and Companies Act5. Judicial Precedents on Guarantor's LiabilityDetailed Analysis:1. Validity of the Show-Cause Notice under Section 32G of the SFC Act:The petitioner challenged the show-cause notice dated October 7, 2008, demanding Rs. 83,58,671 under Section 32G of the State Financial Corporations Act, 1951. The petitioner argued that since the principal debtor had settled its loan account with the Corporation, the petitioner, as a guarantor, should not be liable for any amount beyond what the principal debtor paid.2. Extent of Liability of the Guarantor:The petitioner contended that the liability of the guarantor is co-extensive with that of the principal debtor, as per Section 128 of the Indian Contract Act, 1872. The petitioner argued that once the principal debtor's liability is settled, the guarantor should not bear additional liability.3. Impact of Settlement with Principal Debtor on Guarantor's Liability:The petitioner argued that the revival scheme under Sections 391 and 394 of the Companies Act, 1956, accepted by the court, amounts to compounding with the principal debtor, leading to the discharge of the surety under Sections 134 and 135 of the Indian Contract Act, 1872. The petitioner cited several judicial precedents, including Syndicate Bank v. Pamidi Somaiah and Union Bank of India v. Chairperson, Debts Recovery Appellate Tribunal, to support the argument that the guarantor's liability is extinguished once the principal debtor's liability is settled.4. Legal Provisions under the Indian Contract Act and Companies Act:- Section 126 defines the contract of guarantee, surety, principal debtor, and creditor.- Section 128 states that the surety's liability is co-extensive with that of the principal debtor.- Section 134 discharges the surety if the principal debtor is released by any contract or by any act or omission of the creditor.- Section 135 discharges the surety when the creditor compounds with, gives time to, or agrees not to sue the principal debtor.5. Judicial Precedents on Guarantor's Liability:- Bank of Bihar Ltd. v. Dr. Damodar Prasad: The Supreme Court held that the surety has no right to dictate terms to the creditor and cannot restrain an action against him by the creditor.- Industrial Investment Bank of India Ltd. v. Biswanath Jhunjhunwala: The liability of the guarantor and principal debtor is co-extensive and not in the alternative.- Maharashtra State Electricity Board v. Official Liquidator: The Supreme Court held that the rights of the creditor are not affected by the operation of laws such as bankruptcy laws.- A. L. S. P. PL. Subramania Chettiar v. Moniam P. Narayanaswami Gounder: The Full Bench of the Madras High Court held that if the debt of the principal debtor is extinguished, the surety's liability is also extinguished.Conclusion:1. Binding Nature of the Revival Scheme: The scheme of arrangement sanctioned by the company court under Section 391 of the Companies Act, 1956, is binding on all creditors, including non-consenting creditors. This scheme extinguishes the remaining claim of the creditor.2. Discharge of Surety: Upon the extinction of the creditor's claim, the surety stands discharged because he cannot recover the amount paid from the debtor.3. Principle of Co-extensive Liability: The liability of the surety is co-extensive, not alternative. Thus, if the principal debtor's liability is extinguished, the surety's liability is also extinguished.4. Invalidity of the Show-Cause Notice: The show-cause notice under Section 32G of the State Financial Corporations Act is deemed illegal, unwarranted, and without jurisdiction.The writ petition was allowed, and the impugned notice was quashed with no order as to costs.