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Insolvency Of Personal Guarantors To Companies: An Atmosphere Of Uncertainty

Anjali Jain & Swati Sood
27 April 2021 10:44 AM GMT
Insolvency Of Personal Guarantors To Companies: An Atmosphere Of Uncertainty

Corporate Insolvency Resolution Process can now be triggered against the personal guarantors of a corporate debtor including the promoters of a corporate person by its creditors through rules notified on 15.11.2019 by the Ministry of Corporate Affairs. The entire set of rules have flooded the gates of Courts all over against the constitutionality of the new provisions with the notification being challenged by almost 100 promoters including the billionaire Industrialists like Arvind Dham, Anil Ambani, Sanjay Sehgal etc. The logic for inclusion or extensiveness of the personal guarantors in the CIRP relates to Section 126 of the Indian Contract Act, 1872 wherein the concept of co-extensive liability of surety has been epitomised but the incorporation of this concept in the insolvency regime has invoked a legal quagmire.

Transitional Trail of the Forum

The Insolvency and Bankruptcy Code had no provision with regard to enforcement proceedings against the personal guarantors. Through the new rules, the National Company Law Tribunal has now been vested with competent jurisdiction over proceedings against personal guarantors falling within the ambit of Section 60(2)/60(3) of the Code. In all other cases of individuals and firms including personal guarantors, the forum having jurisdiction shall be the DRT. Hence, both NCLT and DRT have jurisdiction over proceedings against personal guarantors but in different scenarios under the Code.

Legal Embargos

Invocation of insolvency proceedings against a personal guarantor is based on the contract of guarantee but the legal entitlements have been swayed when it comes to the protection of personal guarantors in the contract of guarantee. For instance, when in Essar Steel, the financial creditors invoked the guarantee for the remaining amount after receiving the haircut amount, the Supreme Court relying upon its earlier decision in SBI vs. V. Ramakrishnan held that the guarantor's liability remains intact even after the approval of the resolution plan and that the guarantors cannot file their claims as creditor after the resolution plan is approved. The Supreme Court clearly deviated from the settled principles under the Contract Act and held that the guarantors are not entitled to the right of subrogation, if the resolution plan does not state so. Thus, in effect, a guarantor's remedy against the borrower, i.e. a statutory right which is the substratum of a contract of guarantee, has been eroded. The judiciary has been denying the rights of the guarantors leaving them in a situation with no remedy. Furthermore, the NCLAT in SBI vs Athena Energy Ventures allowed simultaneous insolvency proceedings against the principal borrower and the corporate guarantor on the pretext that the liability of the Principal Borrower and the Guarantor is co-extensive as per Section 128 of the Indian Contract Act. Though some deviation has been taken up from the present stand in Vishnu Kumar Agarwal vs Piramal Enterprises but the legal principle settled till date is where the principal borrower and guarantor are undergoing the CIRP, the creditor should be able to file claims against both of them, and the IBC cannot prohibit the same.

The Cacophonies of Rights

The creditors rely upon the idea of non-subrogation of the rights against the guarantors to the new resolution applicant while approving a resolution plan under the IBC and since they undergo huge haircuts and waivers, the same are tend to be recoverable at the stance of guarantee agreements under the Contract Act. The bifurcation of the amount which are to be received from the corporate debtor and the personal guarantor is not yet guided by certain pedestals. Also, the stage of invocation of rights against the guarantors remains to be explored as once the resolution plan is approved the lenders are assumed to have subsumed their legal rights to the new avatar of the corporate debtor and then deviation from the IBC regime and relying upon the Contract Act would bring out some inconsistencies in such scenario. In the looming threat of personal insolvency, even the guarantors may try to siphon off the funds which ultimately will make the insolvency proceedings against the personal guarantors futile. The IBC is constantly being used as a recovery mechanism which is definitely taking the spirits off roads. These rules being a part to the phased introduction of individual insolvency laws have proved to be incongruent to the existing regime and the continued inefficiency of the same is going to do more harm than the good as continuous deterioration of the assets is akin to the insolvency proceedings.

Anjali Jain is a Partner & Head & Swati Sood is an Associate – Insolvency & Corporate Practice at Areness. Views are personal.

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