2025 (6) TMI 689 - AT - IBC

Dismissal of application filed under Section 95 of IBC - Consent Decree constitutes a valid contract of guarantee under Section 126 of the Indian Contract Act 1872 or not - invocation of personal guarantee is a precondition for initiating insolvency proceedings against the personal guarantor - allegations of fraud in obtaining the Consent Decree. Whether the Consent Decree dated 05.03.2020 constitutes a valid contract of guarantee under Section 126 of the Indian Contract Act 1872? - Whether the invocation of personal guarantee is a precondition for initiating insolvency proceedings against the personal guarantor? - HELD THAT - In the present case there is no independent documentary evidence establishing that Respondent No. 1 voluntarily undertook the role of a personal guarantor. The decree does not state that the liability of Respondent No. 1 arises only upon default of the corporate debtor. A perusal of the decree reveals that it does not contain any express promise by Respondent No. 1 to act as a guarantor; rather it records a joint and several liability - It is a settled principle of law that a Consent Decree does not establish fresh financial liability but merely records a private settlement. A decree-holder may qualify as a creditor only if the decree conclusively determines liability after due judicial scrutiny which is absent in this case. Hon ble Supreme Court in Pulavarthi Venkata Subba Rao v. Valluri Jagannadha Rao 1963 (3) TMI 62 - SUPREME COURT held that a Consent Decree is merely a formal acknowledgment of an agreement between parties and does not create fresh legal obligations unless explicitly stated. It ruled that limitation periods for enforcing a debt are not automatically extended by a Consent Decree unless it contains a clear acknowledgment of liability. The respondent cited this case to argue that the Consent Decree dated 05.03.2020 relied upon by the appellant was only a recorded settlement and did not establish fresh liability against Respondent No. 1 as a personal guarantor. Just as the Supreme Court in this case ruled that a Consent Decree cannot extend the limitation period the present decree cannot serve as conclusive proof of debt under the Insolvency and Bankruptcy Code (IBC). The Hon ble Supreme Court in Laxmi Pat Surana v. Union Bank of India 2021 (3) TMI 1179 - SUPREME COURT held that the liability of a guarantor arises only upon invocation. Since there was no invocation in the present case the insolvency application is defective and not maintainable. It is an admitted fact that the Directors of the appellant and the Corporate Debtor are related to one another and both are family run businesses. Similarly the plaintiffs and decedents in Consent Decree including the Directors of the companies involved are all related to each other - the Consent decree cannot be treated as a contract guarantee document within the framework of IBC - the contract guarantee should be separately documented with clear laid down provisions for invoking the said guarantee and same should have been duly invoked which is not the case here. Whether the insolvency application under Section 95 of IBC is maintainable given the allegations of fraud in obtaining the Consent Decree? - HELD THAT - The suit against CD was filed by the appellant during the moratorium period when IRP was in control of the CD. The Directors of the CD were not authorized to sign any document during the moratorium period on behalf of the CD. The consent decree was obtained by collusion and fraud by plaintiffs and defendants who are related to each other. Hon ble Supreme Court in Sri Krishna Khanna v. Additional District Magistrate Kanpur Ors. 1975 (2) TMI 120 - SUPREME COURT held that a Consent Decree obtained through fraud coercion or undue influence is void and unenforceable emphasizing that courts must scrutinize such decrees to prevent circumvention of statutory protections. The principle that fraud vitiates all judicial proceedings including compromise decrees was reinforced. The Consent Decree in the present case was executed without disclosing the Corporate Debtor s ongoing CIRP it violated the moratorium under Section 14 of IBC. Therefore the decree was legally void and could not establish any enforceable liability against Respondent No. 1. In the present case the appellant failed to disclose the CIRP status of the corporate debtor when obtaining the decree. Further the decree purportedly imposed obligations on mortgaged properties without the consent of SBI the secured creditor in violation of contractual terms. Given these facts the Consent Decree is prima facie vitiated by fraud and cannot be the basis for insolvency proceedings. Conclusion - The consent decree was vitiated by fraud and is ab-initio void and unenforceable in IBC proceedings. All issues decided against appellant. There are no infirmity in the orders of the Adjudicating Authority - appeal dismissed.

Summary

Issues Presented and Considered

(i) Whether the Consent Decree dated 05.03.2020 constitutes a valid contract of guarantee under Section 126 of the Indian Contract Act, 1872;

(ii) Whether invocation of the personal guarantee is a precondition for initiating insolvency proceedings against a personal guarantor under Section 95 of the Insolvency and Bankruptcy Code, 2016 (IBC);

(iii) Whether the insolvency application under Section 95 of the IBC is maintainable given the allegations of fraud in obtaining the Consent Decree;

(iv) Whether adverse remarks and penalty imposed on the Resolution Professional (RP) for recommending initiation of insolvency proceedings without proper examination of facts and documents were justified;

(v) Whether a decree-holder qualifies as a creditor under Section 95 of IBC and can initiate insolvency proceedings;

(vi) The applicability and scope of moratorium under Section 14 of IBC during the Corporate Insolvency Resolution Process (CIRP) and its impact on the validity of the Consent Decree.

Issue-wise Detailed Analysis

Issue (i) & (ii): Validity of Consent Decree as Contract of Guarantee and Invocation Requirement

The legal framework relevant to this issue is Section 126 of the Indian Contract Act, 1872, which defines a contract of guarantee as an agreement where a guarantor undertakes to discharge the liability of a third person in case of default. The contract may be oral or written, but it must be clear, unequivocal, and show specific intention to assume secondary liability. Further, Rule 3(e) of the IBBI Rules, 2019 mandates that the guarantee must be invoked and remain unpaid for initiating insolvency proceedings against a personal guarantor under Section 95 of IBC.

The appellant contended that the Consent Decree dated 05.03.2020, signed by Respondent No. 1, constituted a valid contract of guarantee. The decree contained an assurance by the defendants including Respondent No. 1 to pay the legal dues with interest and to refrain from disposing or encumbering specified properties. The appellant argued that this decree crystallized the liability and constituted invocation of the guarantee, making the date of the decree the date of default.

However, the Court noted that the Consent Decree did not explicitly state that Respondent No. 1 assumed the role of a personal guarantor. It recorded a joint and several liability of all defendants rather than a secondary liability contingent upon the default of the corporate debtor. The decree's language, particularly the phrase "as soon as possible," indicated an open-ended timeline for payment, inconsistent with the fixed obligations characteristic of a guarantee. There was no independent documentary evidence or separate guarantee agreement evidencing Respondent No. 1's intention to act as a guarantor.

Precedents such as the Supreme Court's decision in Pulavarthi Venkata Subba Rao v. Valluri Jagannadha Rao clarified that a consent decree is a recorded settlement and does not create fresh legal obligations or extend limitation periods unless expressly stated. The Court relied on this to hold that the Consent Decree was not a valid contract of guarantee under IBC.

Moreover, the Court emphasized that invocation of the guarantee is a mandatory precondition for initiating insolvency proceedings against a personal guarantor. The appellant failed to produce any evidence of invocation of the guarantee prior to filing the Section 95 application. The Supreme Court in Laxmi Pat Surana v. Union Bank of India held that liability of a guarantor arises only upon invocation, which was absent here.

Therefore, the Court concluded that the Consent Decree neither constituted a valid contract of guarantee nor was there any invocation of guarantee, rendering the insolvency application under Section 95 not maintainable on this ground.

Issue (iii): Maintainability of Insolvency Application in Light of Alleged Fraud in Obtaining Consent Decree

The moratorium under Section 14 of IBC prohibits institution or continuation of suits against the corporate debtor during CIRP. The corporate debtor was admitted into CIRP on 20.11.2019, and the moratorium was in force until 12.03.2020. The appellant filed the civil suit on 02.01.2020 and obtained the Consent Decree on 05.03.2020 during the moratorium period.

The respondent (State Bank of India) alleged that the Consent Decree was obtained fraudulently without disclosing the ongoing CIRP and moratorium to the civil court, violating Section 14(1)(a) of IBC. The decree purportedly imposed restrictions on mortgaged properties without SBI's consent, contrary to contractual terms.

The Court examined these allegations and found that the Consent Decree was executed during the moratorium period without the IRP's or the Adjudicating Authority's knowledge or consent. The directors of the corporate debtor were not authorized to execute such documents during moratorium. The Court relied on Supreme Court precedents such as Sri Krishna Khanna v. Additional District Magistrate and Ajanta LLP v. Casio Keisanki Kabushiki Kaisha, which held that a Consent Decree obtained by fraud, misrepresentation, or suppression of material facts is void and unenforceable.

Accordingly, the Court held that the Consent Decree was vitiated by fraud, ab initio void, and could not be the basis for insolvency proceedings under IBC.

Issue (iv): Adverse Remarks and Penalty on Resolution Professional

Section 99(4) of IBC empowers the RP to seek further information or explanation from relevant parties to examine an insolvency application. The RP submitted a report recommending initiation of insolvency proceedings against the personal guarantor based on the Consent Decree without adequately verifying the nature of the decree or the relationships among parties.

The Court observed that the RP failed to exercise due diligence, as the Consent Decree was executed during moratorium and involved related parties, indicating potential conflict of interest and collusion. The RP's report recommending insolvency initiation without proper examination amounted to negligence or incompetence.

While the appellant RP argued that any error was a legal mistake without mala fide intent and cited a Supreme Court judgment to that effect, the Court distinguished the present case due to the professional's statutory duties under IBC requiring strict compliance. The Court held that the adverse remarks, penalty of Rs. 1 lakh, and referral to the Insolvency and Bankruptcy Board of India (IBBI) were justified to maintain the integrity of the insolvency process.

Issue (v): Whether a Decree-holder Qualifies as a Creditor under Section 95 of IBC

The appellant relied on the Tribunal's decision in Ashok Agarwal v. Amitex Polymers Pvt Ltd., which held that a decree-holder qualifies as a creditor under Section 95 of IBC and can initiate insolvency proceedings. However, the Court distinguished that case on facts, noting that the decree in Ashok Agarwal was a judicial determination of liability after due process, unlike the present Consent Decree, which was a settlement without adjudication of liability.

The Court held that only a decree conclusively determining liability after judicial scrutiny qualifies for such treatment. Since the present Consent Decree was a compromise, not a final adjudication, it did not confer creditor status under IBC for initiating insolvency proceedings.

Issue (vi): Impact of Moratorium under Section 14 of IBC on Validity of Consent Decree

The moratorium prohibits institution or continuation of suits against the corporate debtor during CIRP. The Consent Decree was obtained during the moratorium period without disclosure of CIRP status, violating Section 14(1)(a). The Court held that such a decree is void and unenforceable, citing Supreme Court precedents emphasizing the sanctity of moratorium and prohibition of acts circumventing it.

Significant Holdings

"A contract of guarantee must be clear, unequivocal, and made with the specific intention of assuming secondary liability in case of default by the principal debtor. A consent decree, being a recorded settlement, does not establish fresh financial liability or extend limitation periods unless expressly stated."

"Invocation of the guarantee is a mandatory precondition for initiating insolvency proceedings against a personal guarantor under Section 95 of the Insolvency and Bankruptcy Code, 2016. Absence of invocation renders the application not maintainable."

"A consent decree obtained during the moratorium period under Section 14 of IBC without disclosure of the ongoing CIRP and without authorization of the IRP or Adjudicating Authority is vitiated by fraud and is ab initio void and unenforceable."

"A decree-holder qualifies as a creditor under Section 95 of IBC only if the decree conclusively determines liability after judicial scrutiny. A compromise decree or settlement recorded without adjudication does not confer such status."

"Resolution Professionals are under a statutory duty to diligently verify facts and applicable law before recommending initiation of insolvency proceedings. Negligence or failure to do so justifies imposition of penalties and referral to the Insolvency and Bankruptcy Board of India."

"The moratorium under Section 14 of IBC is sacrosanct and any act or decree circumventing it without proper authorization is void."

The Court dismissed all three connected appeals, upheld the Adjudicating Authority's orders dismissing the insolvency applications against the personal guarantors, affirmed the penalty and adverse remarks against the Resolution Professional, and closed pending applications with no order as to costs.