Lenders To Initiate Insolvency Proceedings Against Personal Guarantors

Petitions before various High Courts were filed challenging the Government Notification dated November 15, 2019, the Insolvency and Bankruptcy (Application to Adjudicating Authority for Insolvency Resolution Process of Personal Guarantors to Corporate Debtors) Rules, 2019 and Section 95, 96, 99, 100, 101 of the Code as unconstitutional in so far as they apply to the personal guarantor of the corporate debtor. The bone contention of the promoters was that they alone should not be held liable for the default on debt repayment.

In October 2020, the Supreme Court of India transferred all Writ Petitions that were pending before different High Courts, and by this time there were more than seventy-five (75) petitions that had already been filed.

Six months after the transfer, the Supreme Court has finally put an end to an anomalous situation. Recently in "Lalit Kumar Jain vs. Insolvency and Bankruptcy Board of India" the Bench comprising of Justices L Nageswara Rao and Ravindra Bhat upheld the Government Notification and provisions of the Code, allowing creditors, usually financial institutions and banks, to move against personal guarantors under the Code. During the hearing, Justice Ravindra Bhat observed that-

"The approval of resolution plan relating to the corporate debtor does not operate so as to discharge the liabilities of the personal guarantor."

The preliminary plea raised by the Petitioners was that the notification is an exercise of excessive delegation as the Central Government had no authority to impose conditions on the enforcement of the Code. It was further argued that the enforcement of few sections of the Code in terms of the impugned notification, only in relation to personal guarantors is ultra vires the powers granted to the Central Government. The Court negating this plea observed-

"impugned notification is not an instance of legislative exercise or amounting to impermissible and selective application of provisions of the Code. There is no compulsion in the Code that it should, at the same time, be made applicable to all in individuals, (including personal guarantors) or not at all. 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."

Further, agreeing with Parliamentary intent to treat personal guarantors differently from other categories of individuals, the Bench observed:

"100. The intimate connection between such individuals and corporate entities to whom they stood guarantee, as well as the possibility of two separate processes being carried on in different forums, with its attendant uncertain outcomes, led to carving out personal guarantors as a separate species of individuals, for whom the Adjudicating authority was common with the corporate debtor to whom they had stood guarantee. The fact that the process of insolvency in Part III is to be applied to individuals, whereas the process in relation to corporate debtors, set out in Part II is to be applied to such corporate persons, does not lead to incongruity.
On the other hand, there appear to be sound reasons why the forum for adjudicating insolvency processes – the provisions of which are disparate- is to be common, i.e through the NCLT. As was emphasized during the hearing, the NCLT would be able to consider the whole picture as it were, about the nature of the assets available, either during the corporate debtor's insolvency process, or even later; this would facilitate the CoC in framing realistic plans, keeping in mind the prospect of realizing some part of the creditors' dues from personal guarantors."

The Petitioners even contended that once a resolution plan is accepted, the corporate debtor is discharged of liability. As a consequence, the guarantor whose liability is co-extensive with the principal debtor, i.e., the corporate debtor, too is discharged of all liabilities. In this regard the Bench reiterated the legal position that release or discharge of a principal borrower from the debt owed by it to its creditor, by an involuntary process, i.e., by operation of law, or due to liquidation or insolvency proceeding, does not absolve the surety/guarantor of his or her liability, which arises out of an independent contract. Based on the precedents and law laid down, the Court held-

"that 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 other words, if the debt owed by a company is not repaid under the resolution plan, the personal guarantor would not only not stand discharged but could find himself taken into bankruptcy proceedings by the creditors.

The verdict is definitely a boost for lenders as it allows them to seek recovery of dues from guarantors of loans even while bankruptcy processes against the companies are pending. The judgement clearly spells out that by initiating the insolvency proceedings against personal guarantors, there is a greater likelihood that they would 'arrange' for the payment of the debt to the creditor bank in order to obtain a quick discharge. The creditor bank would be prepared to take a haircut or forego the interest amounts so as to enable an equitable settlement of the corporate debt, as well as that of the personal guarantor thereby resulting in maximizing the value of assets and promoting entrepreneurship.

Snidha Mehra, Senior Associate and Hardik Harjani is an Associate at Century Maxim India. Views are personal.