2014 (2) TMI 1440 - HC - Companies Law

Principal debtor's discharge under compromise scheme doesn't release guarantor's liability, secured creditors retain pursuit rights

Western India Shipyard Limited Versus State Bank of India, Mumbai

The Bombay HC held that a principal debtor's discharge under a scheme of compromise and arrangement does not affect the guarantor's liability. The court ... Sanction of scheme of compromise and arrangement - Whether the principal debtor's discharge under a scheme of compromise and arrangement affects the liability of the guarantor/surety? - HELD THAT:- It may be mentioned that since the guarantor/surety is not discharged the secured creditor could certainly proceed against the guarantor after part liability is discharged and satisfied. This would give the guarantor/surety the rights under Section 140 of the Act to be invested with all the rights of the creditor against the principal debtor. The guarantor would be required to make payment of the remainder of the liability. It is held in the case of Jagannath Ganeshram Agarwala Vs. Shivnarayan Bhagirath [1939 (11) TMI 12 - HIGH COURT OF BOMBAY] that the discharge of the principal debtor by operation of law would not discharge a surety. In the case of Punjab National Bank Ltd. Vs. Sri Bikram Cotton Mills Ltd. [1969 (9) TMI 68 - SUPREME COURT] the Supreme Court considered the contract of guarantee, indemnity and the liability of a guarantor under Section 128 of the Contract Act. This was also a case of composition under a contract of compromise and arrangement. It was held that binding obligation created in a composition under Section 391 of the Companies Act between the company and its creditors does not effect the liability of a surety / guarantor unless the contract of suretyship otherwise provides. In that case a Director / Managing Agent stood guarantee to a bank from whom the company took some loans and executed certain documents. Consequently after the discharge of the liability by the applicant company by payment of the one time settlement amount its release was in order. The No Dues Certificate was called for. The claim against the applicant company before the Releasing Officer may not survive and may be withdrawn. However the right of the respondent / secured creditor to proceed against the guarantor / surety was open and available in law subject of course, to the contract of guarantee. That right having been kept open is in accordance with the law. It would have been a legal not to keep it so. The review application is rejected. Issues Involved:1. Whether the principal debtor's discharge under a scheme of compromise and arrangement affects the liability of the guarantor/surety.2. The legal implications of a scheme of compromise and arrangement under Sections 391-394 of the Companies Act, 1956.3. The applicability of Sections 128, 133, 134, and 135 of the Indian Contract Act, 1872, concerning the discharge of a guarantor/surety.4. The effect of statutory operation of law on the liability of a guarantor/surety.Detailed Analysis:1. Discharge of Principal Debtor and Guarantor's Liability:The court examined whether the discharge of the principal debtor under a scheme of compromise and arrangement affects the liability of the guarantor/surety. It was determined that the principal debtor was discharged upon payment of the agreed amount under the scheme, which was accepted as full and final settlement by the creditor. However, the guarantor/surety was not discharged. The court emphasized that the guarantor's liability is co-extensive with that of the principal debtor under Section 128 of the Indian Contract Act, 1872, and the guarantor remains liable for any unpaid and undischarged debt unless discharged under specific statutory provisions.2. Scheme of Compromise and Arrangement:The court discussed the legal framework of a scheme of compromise and arrangement under Sections 391-394 of the Companies Act, 1956. The scheme involved a tripartite agreement between the principal debtor, secured creditors, and the guarantor/surety. The scheme allowed for the repayment of a reduced amount by the principal debtor, which was accepted by the secured creditors as full settlement. However, the court noted that the scheme did not discharge the guarantor's liability, as the guarantor had consented to the terms of the scheme, which constituted a novation of the contract.3. Applicability of Sections 128, 133, 134, and 135 of the Indian Contract Act:The judgment analyzed the applicability of Sections 133, 134, and 135 of the Indian Contract Act, 1872, concerning the discharge of a guarantor. Section 133 discharges a guarantor if the terms of the contract are varied without the guarantor's consent. Section 134 discharges a guarantor if the principal debtor is released by the creditor. Section 135 discharges a guarantor if the creditor compounds with, gives time to, or agrees not to sue the principal debtor without the guarantor's consent. In this case, the court found that the guarantor was not discharged because it had consented to the terms of the scheme, which varied the contract.4. Statutory Operation of Law:The court considered the effect of statutory operation of law on the liability of a guarantor. It was held that the statutory operation of a scheme of compromise or arrangement does not discharge a guarantor's liability unless specifically provided for in the contract of guarantee. The court cited precedents to support the position that a guarantor is not discharged by the statutory discharge of the principal debtor, as the guarantor's obligations under the contract of guarantee remain unaffected by such statutory operations.Conclusion:The court concluded that the review application to alter the previous order could not be granted. The principal debtor was rightfully discharged under the scheme, but the guarantor's liability remained intact. The secured creditor retained the right to proceed against the guarantor for any remaining liability, consistent with the terms of the contract of guarantee. The review application was thus rejected, affirming the legal principles governing the discharge of guarantors in the context of schemes of compromise and arrangement.