There’s A Bigger Win For Creditors In Supreme Court’s Essar Steel Ruling

There's a bigger win for creditors in the Supreme Court's Essar Steel ruling than what meets the eye. The apex court has not only upheld the primacy of financial creditors but also allowed them to go after guarantors for debt that hasn't been settled under the resolution plan. Combine that with the personal guarantors' insolvency regime effective from Dec. 1, and creditors can hope for a much higher and faster recovery of their dues.

Supreme Court Fixes The Upset Caused By NCLAT

In its July order, the National Company Law Appellate Tribunal had held that promoter Prashant Ruia's right of subrogation has become ineffective since Essar Steel's debt has been cleared under the resolution plan. This right stems from the Contract Act that allows the guarantor—in this case Ruia—to step into the shoes of the lenders to recover from the corporate borrower—Essar Steel—the amount it has paid to clear the debt. The guarantee deed becomes ineffective once the financial creditors are paid under the resolution plan.

This conclusion had implications not just for Ruia but creditors as well. This meant that lenders couldn't invoke the guarantees, given by Ruia, to recover the remaining amount of debt.

The Supreme Court has disagreed with this NCLAT conclusion. It has held that once the creditors' committee approves a resolution plan, it is binding on all stakeholders.

The approved resolution plan for Essar Steel says:

• The rights of creditors on account of corporate or personal guarantees would survive.
• And, claims of the guarantor on account of subrogation will get extinguished.

The apex court upheld the provision of the resolution plan that allowed extinguishing promoters' subrogation rights but didn't dwell on the invocation of guarantees issue on grounds that it doesn't want to say anything that might impact pending litigation on this issue. Lenders have invoked the personal guarantees given by Ruia, the erstwhile promoter of Essar Steel, before the Debt Recovery Tribunal.

“I don't think the Supreme Court has gone to the substance of whether Essar Steel's creditors can legitimately go after the guarantor under the terms of the guarantee or indemnity,” Nilang Desai, partner at AZB & Partners, told BloombergQuint. But the principle the apex court has laid down is that simply because the creditors have accepted 60 cents under the resolution plan doesn't mean that they can't go after the personal guarantor for the remaining 40 cents, he added.

Desai explained that most guarantee deeds say that whatever a creditor might do in respect of the debt to the principal borrower—compromise it, give relief, etc.—the guarantor would owe the creditor the full amount. A lot of guarantee documents will also have an indemnity claim which allows the creditor to go after the guarantor for any loss, he added.

The Kicker For Creditors

The insolvency regime for personal guarantors has come into effect starting Dec. 1. Insolvency proceedings can be initiated against personal guarantors who have committed a default of at least Rs 1,000 on account of a guarantee.

This regime, combined with the Supreme Court's Essar Steel ruling that has permitted creditors to file for claims that haven't been satisfied via resolution plans, is a huge positive for lenders, experts said.

Creditors will now be able to simultaneously proceed against the principal borrower and the personal guarantor under NCLT's umbrella, Sudipta Routh, partner at IndusLaw, said. Even in cases where resolution plans have been approved or implemented, lenders can use the personal guarantor insolvency regime to invoke guarantees, he added.

But Desai said that the language of the personal guarantor provisions isn't clear vis-à-vis the treatment for cases where the insolvency process has culminated. He said if the company has been actually resolved and if the resolution plan has been implemented, then the company is out of IBC. It can be argued that technically the recently notified provisions cannot apply since there is no longer a personal guarantor in a company that's under insolvency.

WATCH | AZB & Partners' Nilang Desai on implications of Supreme Court's Essar Steel ruling