Novation, Settlement, And Guarantee Obligations: A Study Of NCLAT's Recent Judgment

Introduction:

In a significant ruling of Jagtar Singh vs Gagan Gulati, the National Company Law Appellate Tribunal (NCLAT), Principal Branch, New Delhi reflected on an important question under the Insolvency and Bankruptcy Code (IBC) : Whether a settlement between a Corporate debtor and a Creditors discharge the personal guarantor from his liability?

Background Of Case:

The dispute arose out of two loan facilities extended to the Corporate Debtor one in 2013 and another in 2016. The Appellant executed a personal guarantee in respect of the first loan, whereas the second loan was allegedly unsupported by any guarantee from him.

When the Corporate Debtor experienced financial difficulties, the creditor issued a recall notice, pursued arbitration, obtained an award, and ultimately initiated CIRP in 2019. The matter then went to the NCLAT, where, under mediation supervised by Justice A.K. Sikri (Retd.), the parties entered into a structured Settlement Agreement dated 02.12.2019, which was expressly incorporated into NCLAT orders of 06.12.2019 and 15.03.2021.

The Settlement Agreement fixed revised payment terms and included personal undertakings by the promoters including an undertaking to personally ensure the fulfilment of obligations. However, when the Corporate Debtor defaulted on the settlement, the CIRP stood revived. Several years later, the creditor invoked the guarantee and filed a Section 95 IBC petition against the Appellant.

The core issued before the is "Whether the earlier guarantee stood discharged by virtue of the 2019 settlement or nor?"

Appellant' Arguments:

The Learned Counsel for the Appellant contended that the personal guarantee executed by the appellant related exclusively to the first loan granted in March 2013 and not to the second Loan sanctioned in May, 2016. It is also argued that the settlement agreement entered into in December 2019 created a new contract between the Corporate debtor and the creditor. By virtue of Section 63 and 133 of the Contract Act, the Appellant argued that this new arrangement extinguished or discharged his earlier guarantee. According to

the Appellant, the restructuring of liability under the settlement amounted to a novation that released him from his obligations.

Respondent's Arguments:

The Respondent, on the other hand, submitted that the guarantee executed by the Appellant was a continuing guarantee, covering all dues under the principal loan agreement until they were fully discharge. It was also argued on behalf of the Respondent that the 2019 settlement did not substitute or replace the original contract, but merely afforded the Corporate Debtor an opportunity to clear the dues through instalments. Moreover, the settlement provided that if the Corporate Debtor defaulted in payment, the entire outstanding debt would automatically revive. According to the Respondent, this demonstrated that the underlying contract remained intact. The Respondent also emphasised that there was never any explicit agreement to release the Appellant from his guarantee, and therefore, his liability continued.

Analysis By The Tribunal:

The Tribunal examined whether the 2019 settlement constituted a new contract which replaced the old one under Section 62 of the Contract Act? It was observed that novation requires the original contract to be clearly and explicitly extinguished and replaced by a new one. In the preset case, no such substitution occurred. The settlement agreement of 2019 did not cancel the original loan obligations; rather, it only modified the mode and timeline of repayment. The Tribunal noted that the settlement provided a concession to the Corporate Debtor by allowing repayment through instalments and stated that compliance with these instalments would result in satisfaction of the original dues.

Significantly, the Settlement Agreement contained a clause stating that if the Corporate Debtor defaulted even in the first instalment or in two consecutive instalments, the entire unpaid amount would automatically become the admitted debt. This clause, by itself, indicated that the original rights of the creditor were never surrendered. A contract cannot be said to be substituted when the original obligations spring back into force the moment the new arrangement is breached. Therefore, the Tribunal held that no novation had taken place.

The Hon'ble Tribunal further observed that under the law, a guarantor is not discharged merely because the principal debtor enters into a settlement or compromise with the creditor. The law is clear that the guarantor is discharged only if the creditor grants the debtor some benefit or alters the terms of the contract in a manner that causes prejudice to the guarantor. In present case, the settlement did not impose any new burden on the guarantor; rather, it provided relief by reducing the payable amount and permitting instalment payments. It was analysed that a concession given to the debtor cannot be described as a variation that harms the guarantor. Therefore, the guarantor cannot claim discharge under Section 133. The Tribunal also noted that

any release or waiver of the guarantee must be expressly granted by the creditor, which was not the situation here.

Decision:

The Tribunal held that the personal guarantee executed by the Appellant was never extinguished, substituted, or discharged. The settlement of 2019 did not replace the original contract, nor did it release the guarantor from his obligations. Upon breach of the settlement terms, the entire outstanding liability revived in accordance with the settlement's express provisions. Resultantly, the Appellant continued to remain liable as a personal guarantor, and the creditor was entitled to proceed under Section 95 of the IBC.

Anhad Law's Perspective:

The decision is consistent with the evolving jurisprudence under the IBC, which aims to reinforce financial discipline and deter strategic defaults. For guarantors, this judgment is a reminder that liability endures unless clearly and unequivocally released. For creditors, it reaffirms that settlements do not weaken security rights unless they intentionally choose to relinquish them. The case serves as a cautionary and instructive precedent. While a settlements may ease the manner in which repayment is made, they rarely extinguished the fundamental obligations arising out of a guarantee.

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