An Analysis Of The Supreme Court Verdict On Insolvency And Bankruptcy Of Personal Guarantors Of A Corporate Debtor

In response to demand notices, the aggrieved personal guarantors, approached various High Courts for holding the Notification as ultra vires and unconstitutional on the grounds of selective application of the provisions inasmuch as they only applies to the personal guarantors of the corporate debtor and not to the individuals and partnership firms amongst other grounds. Looking at the multiplicity and bulk of Writ Petitions filed before various High Courts, the Insolvency and Bankruptcy Board of India filed an application for transferring all such Writ Petitions before the Hon'ble Supreme Court of India for addressing the law point in the holistic manner. (See judgement here)

Grounds for challenging the Notification:

The personal guarantors before the Supreme Court urged and raised the following contentions challenging the Notification:

• That the power delegated under Section 1(3)^[3] of the Code is only as regards the point(s) in time when different provisions of the Code can be brought into effect and that it does not permit the Central Government to notify parts of provisions of the Code, or to limit the application of the provisions to certain categories of persons. The Notification, however, notified various provisions of the Code only in so far as they relate to personal guarantors of corporate debtors and it was therefore, alleged to be ultra vires the proviso of Section 1(3) of the Code.

• That Section 2(e)^[4] of the Code, as amended by Act 8 of 2018, came into force with retrospective effect from 23.11.2017 and therefore the Notification be set aside.

• The personal guarantors also challenged the Notification on the ground that it suffers from non-application of mind, because the Central Government failed to bring into effect Section 243 of the Code, which would have repealed the Presidency Towns Insolvency Act, 1909 and the Provincial Insolvency Act,1920, which only leads to the duplicity of insolvency proceedings under two separate statutes.

• After enactment of the Code, insolvency proceedings against personal guarantors to corporate debtors would lie before the NCLT, in terms of Section 60 of the Code, although they would be governed by Presidency Towns Insolvency Act, 1909 and the Provincial Insolvency Act,1920. With the enforcement of the provisions, rules and regulations, insolvency proceedings can now be initiated against personal guarantors to corporate debtors under Part III of the Code, and also under the Presidency Towns Insolvency Act, 1909 and the Provincial Insolvency Act,1920.

• Further, the personal guarantors contended that the Part III of the Code governs "Insolvency Resolution and Bankruptcy for Individuals and Partnership Firms" Part III of the Code does not contain any provision permitting initiation of the insolvency resolution process against personal guarantors to corporate debtors. The Notification providing the contrary the contrary, is therefore ultra vires.

• Further it was urged that the liability of a guarantor is co-extensive with that of the principal debtor (Section 128 of Indian Contract Act, 1872). Further, it is settled law that upon conclusion of insolvency proceedings against a principal debtor, the same amounts to extinction of all claims against the principal debtor, except to the extent admitted in the insolvency resolution process itself. This is clear from Section 31^[5] of the Code, which makes the resolution plan approved by the Adjudicating Authority binding on the corporate debtor, its creditors and guarantors.

Contentions in defense by the Central Government:

On the contrary, the Central Government through Ministry of Corporate affairs stated that:

• The Code was amended in 2018 Section 2(e) by introducing three different classes of debtors, which were personal guarantors to corporate debtors [Section 2(e)], partnership firms and proprietorship firms [Section 2 (f)] and individuals [Section 2(g)]. The purpose of splitting the provision and defining three separate categories of debtors was to cover three separate sets of entities.

• Parliament wanted to deal with personal guarantors [under Section 2(e)], differently from partnership firms and proprietorship firms [under section 2(f),] and individuals other than persons referred to in Section 2 (e) [under Section 2(g)]. The intention was to clearly distinguish personal guarantors to corporate debtors from other individuals. This was because Section 60 of the Code which deals with the adjudicating authority for corporate debtors too was partially amended in 2018. The amendment to Section 60(2) added that it applied to insolvency proceedings or liquidation/bankruptcy of a corporate guarantor or personal guarantor as the case may be, to a corporate debtor. The result of the amendment is that when a corporate debtor faces insolvency proceedings, insolvency of its corporate guarantor too can be triggered. Likewise, a personal guarantor to a corporate debtor, facing insolvency, can be subjected to insolvency proceedings. All this is to be resolved and decided by the National Company Law Tribunal.

• It was further stated by the Central Government that the Parliament felt compelled to separate personal guarantors from other individuals such as partnership firms, proprietorships and individuals. It was felt that if this separation, achieved through the amendment of 2018 were not realized, the insolvency resolution process of corporate debtors would have to be dealt with separately and independently of its promoters, managing directors, and directors who had furnished their personal guarantees to secure debts of corporate debtors. If insolvency resolution proceedings against corporate debtors were continued without this amendment, and without the unification, on the default of the corporate debtor to a debt owed to a financial creditor, the entire machinery of the Code relating to the corporate debtor would work itself out, to the exclusion of personal guarantors.

Observations made by the Supreme Court and the way forward:

The Supreme Court while upholding the provisions of the Code and dismissing the petitions filed by the personal guarantors to the Corporate Debtors has observed that the Central Government was concerned with triggering the insolvency mechanism processes in relation to corporate persons at the earliest. Therefore, the notifications were brought into force for establishing the necessary mechanism such as setting up of the regulatory body, provisions relating to its functions, powers and the operationalization of provisions relating to insolvency professionals and agencies were brought into force. These started the mechanism through which insolvency processes were to be carried out and regulated by law. In the next phase, the part of the Code dealing with one of its subjects, i.e., corporate persons [covered by Section 2(a) to 2(d) of the Code] was brought into force. The entire process for conduct of insolvency proceedings and provisions relating to such corporate persons were brought into force. The other notifications brought into force certain consequential provisions, as well as provisions which give overriding effect to the Code. All these clearly show that the Central Government followed a stage-by-stage process of bringing into force the provisions of the Code.

The Supreme Court paid reliance on SBI vs. V Ramakrishnan that when Section 60(2) alludes to insolvency resolution or bankruptcy, or liquidation of three categories, i.e. corporate debtors, corporate guarantors (to corporate debtors) and personal guarantors (to corporate debtors) they apply distributively, i.e. that insolvency resolution, or liquidation processes apply to corporate debtors and their corporate guarantors, whereas insolvency resolution and bankruptcy processes apply to personal guarantors, (to corporate debtors) who cannot be subjected to liquidation. (Judgement here)

It was further observed that Section 60 had previously, under the original Code, designated the NCLT as the adjudicating authority in relation to two categories: corporate debtors and personal guarantors to corporate debtors. The 2018 amendment added another category: corporate guarantors to corporate debtors. It was held that all matters that were likely to impact, or have a bearing on a corporate debtor's insolvency process, were sought to be clubbed together and brought before the same forum.

It was further observed that the provisions of section 234 and 235 of the Code also reveal that the scheme of the Code always contemplated that overseas assets of a corporate debtor or its personal guarantor could be dealt with in an identical manner during insolvency proceedings, including by issuing letters of request to courts or authorities in other countries for the purpose of dealing with such assets located within their jurisdiction.

It was held that there is sufficient indication in the Code- by Section 2(e), Section 5(22), Section 60 and Section 179 indicating that personal guarantors, though forming part of the larger grouping of individuals, were to be, in view of their intrinsic connection with corporate debtors, dealt with differently, through the same adjudicatory process and by the same forum (though not insolvency provisions) as such corporate debtors.

The rationale for allowing directors to participate in meetings of the Committee of Creditors is that the directors' liability as personal guarantors persists against the creditors and an approved resolution plan can only lead to a revision of amount or exposure for the entire amount. the sanction of a resolution plan and finality imparted to it by Section 31 of the Code does not per se operate as a discharge of the guarantor's liability. The approval of a resolution plan does not ipso facto discharge a personal guarantor of a corporate debtor of her or his liabilities under the contract of guarantee.

In the backdrop of the above critical analysis, the Supreme Court has upholded the constitutional validity of the notification and paved way for Banks and Financial Institutions for filing of insolvency of personal guarantors to a corporate debtor which is undergoing the insolvency or liquidation proceedings before the NCLT.

The present decision of the Supreme Court is very favorable for the Banks and Financial Institutions where public money is involved at large as this will work as yet another tool for effective recovery of their bad debts. The NCLT has vide powers to attach the foreign assets of the corporate debtor under insolvency and now coming in force of the notification dated 15^th November, 2019, any foreign assets held by the personal guarantor of a corporate debtor may also be attached for the purposes of insolvency or bankruptcy of such personal guarantor. Therefore, it will be valuable tool in the hands of Banks and Financial Institutions for recovery of their bad debts.

However, with such concentration of powers with the Banks and FIs, they have gained a dominant position amongst the lenders and borrowers. In that case the question which needs to be asked here is how prudent would Banks and FIs be while dealing with minor lapses or defaults made by small borrowers with limited resources, especially in charging interests at compounded rates. What will be the possibilities of settlement (One Time Settlement schemes etc.) with the small defaulters which Banks in normal course of business gets into?

Further, in transactions involving debt financing, it is a common feature for promoters/directors of a corporate debtor to provide personal guarantee. It will be significant to note how the interests of such personal guarantors ins protected in the light of extant legal position, where the entire stakes of the promoter/directors are involved while providing such guarantees.

If these provisions are not used wisely, it would only restrict the micro and small corporate entities and their promoter directors to expand their businesses at ease. This may also have an impact on risk taking capacities of a company and its promoter directors in the light of current position in legal system.

Views are personal.

The Author is an Advocate at Madhya Pradesh High Court and the Supreme Court of India.