Insolvency Proceedings Against Personal Guarantors Under The Insolvency And Bankruptcy Code - Missed Opportunity By The Allahabad HC?

Insolvency and Bankruptcy Code, 2016 (the, "Code") is a crucial legislation passed by the Parliament which has the potential to be a game changer in the insolvency and bankruptcy regime in India. Since the Code is in its nascent stage, it is of paramount importance that interpretational issues are settled at the earliest in order to facilitate smooth functioning of resolution and liquidation proceedings.

In absence of requisite notifications and clarifications, the responsibility rests with the higher judiciary to bring clarity on various unsettled issues pertaining to the Code. In this regard, Sanjeev Shriya v. State Bank of India & others (1) before the Allahabad High Court was a fit case to settle the issue regarding initiation of insolvency process against the personal guarantors before National Corporate Law Tribunal (the, "NCLT") in accordance with provisions of section 60(2) (2) of the Code.

With due respect to the order passed by the Hon'ble single judge bench of the Allahabad High Court in Sanjeev Shriya v. State Bank of India & others (the, "Sanjeev Shriya Order"), in the personal opinion of the authors the Hon'ble Court failed to take into account several crucial factors while staying the proceedings filed against the personal guarantors/promoters before Debt Recovery Tribunal, Allahabad (the, "DRT") by the creditors of LML India Limited (the, "Corporate Debtor") till the finalization of corporate insolvency resolution process (the, "CIRP") of the Corporate Debtor or till the NCLT approves the resolution plan under section 31 of the Code or passes an order of liquidation of the Corporate Debtor under section 33 of the Code.

The authors have attempted to analyze various aspects of the Sanjeev Shriya Order in this article.

A. Part-III of the Code

Part-III (Insolvency resolution and bankruptcy for individuals and partnerships firms) of the Code deals with the insolvency and bankruptcy of individuals and the adjudicating authority for the purposes of Part-III of the Code is DRT. However, section 60(2) of the Code makes an exception for the personal guarantors who have guaranteed obligations on behalf of a corporate debtor which is under the CIRP and for the purposes of section 60(2) of the Code the adjudicating authority under the Code is NCLT.

However, at this stage, Part-III of the Code has not been notified and hence, there is a lack of clarity on the process to be followed under section 60(2) of the Code. The Hon'ble High Court in the Sanjeev Shriya Order while appreciated that the Code provides separate provisions for the personal guarantors under section 60(2) of the Code, the Court failed to appreciate that in the absence of notification of Part-III of the Code, the creditors have no option but to approach DRT against such personal guarantors. Arguendo, if in the considerate opinion of the Hon'ble Court, procedure mentioned under Part-II of the Code should be followed for section 60(2) of the Code, which is the view taken by many experts, it would have been fitting for the Hon'ble Court to clarify the same and settle the position of law in this regard. However, it should also be taken in to the consideration that as per section 60(4) of the Code, the NCLT shall be vested with all the powers of the DRT as contemplated under Part-II of the Code for the purposes of section 60(2).

However, it seems that the Hon'ble Court has not given much weightage to the provisions of section 60(2) of the Code and at para 31 of the Sanjeev Shriya Order, the Court has concluded that the stay over the proceedings against the personal guarantors/promoters of the Corporate Debtor before DRT shall be in force till the finalization of the CIRP of the Corporate Debtor or till the NCLT approves the resolution plan

under section 31 of the Code or passes an order of liquidation of the Corporate Debtor under section 33 of the Code. Whether DRT shall have the authority to entertain proceedings against personal guarantors on the occurrence of any one of the aforesaid events or creditors should initiate insolvency proceedings against the personal guarantors before NCLT after the finalization of CIRP of the Corporate Debtor? The Hon'ble Court has not provided any views in this regard.

Since, the Hon'ble Court has not given any view on the procedure to be followed under section 60(2) of the Code and since the creditors cannot approach DRT against the personal guarantors during the moratorium period under section 14 of the Code (the, "Moratorium"), does this mean that the creditors shall have no recourse against the personal guarantors till the time the Moratorium period is over?

B. Crystallization of liability

The Hon'ble Court observed that since the liability of the Corporate Debtor is still in fluid state and the same has not been crystalized [as the CIRP is still going on], two parallel proceedings should be avoided. It is humbly submitted that the determination of debt is not the scope of the Code. As Hon'ble Supreme Court has also elucidated in Innoventive Industries Limited vs. ICICI Bank Limited and Anr (3), the scheme of the Code, is to make an attempt, by divesting the erstwhile management of its powers and vesting it in a professional agency, to continue the business of the corporate body as a going concern until a resolution plan is drawn up, in which event the management is handed over under the plan so that the corporate body is able to pay back its debts and get back on its feet, and in case it is unable to do so within the stipulated timelines, the liquidation process begins.

Additionally, the role of the adjudicating authority (i.e. NCLT) under the Code is limited to ascertaining existence of default for admitting the application under section 7 of the Code. Unlike DRT, the adjudicating authority under the Code is not required to determine the debt.

It is a well settled principle of law that the liability of the personal guarantor and the borrower is co-extensive and there is no bar on the creditor to initiate simultaneous proceedings against the guarantor as well as the borrower.

C. Moratorium

It seems that the Hon'ble Court has relied on the Moratorium under section 14 of the Code to put a stay on the DRT proceedings initiated against the personal guarantors. With due respect to the views of the Hon'ble Court, section 14 of the Code only applies to institution of suits or continuation of pending suits or proceedings against the corporate debtor. In Scheweitzer Systemtek India Private Limited v. Phoenix ARC Private Limited (4), while discussing the scope of Moratorium, the NCLT, Mumbai observed that the Moratorium has no application on the properties beyond the ownership of the corporate debtor. The NCLT further observed that the Moratorium is an effective tool, sometimes being used by the corporate debtor to thwart or frustrate the recovery proceedings. If the observation of the Hon'ble Court in the Sanjeev Shriya Order is to be accepted, the scope of the Moratorium shall extend beyond the properties of the corporate debtor and suits/proceedings pertaining to the corporate debtor. Additionally, would proceedings against the personal guarantors under section 60(2) of the Code also be hit by the Moratorium?

The views of the Hon'ble Court in the Sanjeev Shriya Order seem to broaden the scope of section 14 of the Code, which otherwise in our view is restricted to the corporate debtor only. At this stage, with limited judicial pronouncements under the Code and the jurisprudence in this regard rapidly evolving, the view of Supreme Court would be very crucial in determining to what extent are banks and financial institutions going to be affected with respect to any on-going action or proceeding against third party guarantors and security providers.

Additionally, it is imperative for the Insolvency and Bankruptcy Board of India to come up with clarifications/guidelines/rules with respect to section 60(2) of the Code to settle the issue regarding action against the personal guarantors of the corporate debtors who are under CIRP.

 The views expressed in this article are the personal views of the authors and do not reflect the views/stand of ICICI Bank or constitute as legal advice.

 Rishi Thakur has over six years of experience in the field of banking and finance and is at present working as a legal manager with ICICI Bank Limited. Mithila Bhati has over four years of experience in banking and finance and is working as a legal manager with ICICI Bank Limited.

 References:

(1) C. No. 30285 of 2017

(2) Section 60(2) of the Code states that where a corporate insolvency process or liquidation proceedings of a corporate debtor is pending before NCLT, an application relating to the insolvency resolution or bankruptcy of a personal guarantor of such corporate debtor shall be filed before such NCLT.

(3) Supreme Court, Civil Appeal Nos. 8337-8338 OF 2017

(4) T.C.P. No. 1059/I&BP/NCLT/MB/MAH/2017

[The opinions expressed in this article are the personal opinions of the author. The facts and opinions appearing in the article do not reflect the views of LiveLaw and LiveLaw does not assume any responsibility or liability for the same]