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Personal Guarantors Under The Insolvency And Bankruptcy Code, 2016

Personal Guarantors Under The Insolvency And Bankruptcy Code, 2016

The Supreme Court of India in Lalit Kumar Jain vs. Union of India & Ors.[1] has dismissed a challenge to a notification dated 15.11.2019 issued by the Ministry of Corporate Affairs,[2] which brought into force the following provisions of the Insolvency and Bankruptcy Code (hereinafter referred to as the 'Code'), 2016: Clause (e) of Section 2Section 78 (except with regard to...

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The Supreme Court of India in Lalit Kumar Jain vs. Union of India & Ors.[1] has dismissed a challenge to a notification dated 15.11.2019 issued by the Ministry of Corporate Affairs,[2] which brought into force the following provisions of the Insolvency and Bankruptcy Code (hereinafter referred to as the 'Code'), 2016:

  • Clause (e) of Section 2
  • Section 78 (except with regard to fresh start process) and Section 79
  • Sections 94 to 187 (both inclusive)
  • Clause (g) to clause (i) of sub-section (2) of Section 239
  • Clause (m) to clause (zc) of sub-section (2) of Section 239
  • Clause (zn) to clause (zs) of sub-section (2) of Section 240
  • Section 249

These provisions broadly were specifically brought into force only in so far as they relate to personal guarantors to corporate debtors. In furtherance of the notification, the Insolvency and Bankruptcy (Application to Adjudicating Authority for Insolvency Resolution Process for Personal Guarantors to Corporate Debtors) Rules, 2019, and the Insolvency and Bankruptcy (Application to Adjudicating Authority for Bankruptcy Process for Personal Guarantors to Corporate Debtors) Regulations, 2019 were brought into force.

Contentions by the Petitioners

The petitioners argued that an executive government cannot selectively bring certain provisions of the Code and then have it apply only to a certain class. Thus, in this case, vide the notification, the aforementioned provisions applied only to personal guarantors to corporate debtors. This argument hinges on the petitioners' claim that Section 1(3) of the Code characterizes the law as conditional legislation. The Union has the power to bring to force provisions at different dates, but it cannot decide to have provisions brought into force to only apply certain classes, such actions are impermissible legislation. Thus, it was argued that there was no intelligible differentia or rational basis for personal guarantors to corporate debtors being covered by the provisions, especially when the provisions themselves are not limited to a sub-category of individuals.

It was also argued that the Central Government had not applied its mind to notify Section 243 of the Code, which would have repealed all other insolvency laws in force. As these laws had not been repealed, the Presidency Town Insolvency Act, 1909 and the Provincial Insolvency Act, 1920, were also applicable to guarantors. This could lead to simultaneous proceedings under different insolvency laws at the same time.

Additionally, the petitioners argued that the notification, which brings certain provisions of Part III of the Code, allows for a single procedure for insolvency proceedings against a personal guarantor. However, this procedure does not make a distinction between a financial and operational creditor. This differs from the apparent distinction between a financial and operational creditor in Part II of the Code, wherein they are separate categories and do not stand on equal footing with each other.

Importantly, it was contended that a guarantor's liability is co-extensive with that of the corporate debtor, by applying contract law.[3] Therefore, when insolvency proceedings have finished, and the corporate debtor's liability has been extinguished to the extent as acknowledged in the insolvency process, the guarantor's liability would be to such extent. If the guarantor's liability is more than that of the principal debtor, it would lead to the unjust enrichment of creditors.

Supreme Court upholds the notification dated 15.11.2019

However, the Supreme Court recognized that there is no constitutional imperative that a law or policy should be implemented at once. Citing Javed v. State of Haryana[4] and Pannalal Bansilal Pitti v. State of A.P.,[5] it was stated by the Court that imposition of a uniform law, depending on areas or subject, may be counterproductive and contrary to public interest. Thus, the Court concurred with the government that such a decision was in the nature of policy applied with sound reasons.

Exploring the history of the Code, the Supreme Court stated that before the 2018 amendment to the Code, individuals, including personal guarantors to corporate debtors, partners to partnership firms, fell under one class as per Section 2(e), before it was amended. Moreover, Section 60, before it was amended, stated that the NCLT was the Adjudicating Authority for personal guarantors, making it difficult for the Central Government to bring into force Part III provisions of the Code only in respect to personal guarantors.

As a corporate debtor and a guarantor's relationship stands on a different footing, as opposed to individuals and partnership firms, the Court went on to state that the 2018 amendment to the Code added corporate guarantors to corporate debtors as a category under Section 60, thereby leading to the sub-categorization of individuals into Sections 2(e), (f) and (g). The amendment's object was to show that all matters likely to impact, or have a bearing on a corporate debtor's insolvency were to be clubbed together and brought before the same forum. Importantly, the Court referred to Sections 234 and 235 of the Code to state that the Code envisioned a scheme wherein assets of a corporate debtor or its personal guarantor situated abroad would be dealt in a matching manner during insolvency proceedings.

Therefore, the Parliamentary intent was to treat personal guarantors differently from other categories of individuals. The intent of the Central Government in enacting the impugned notification was to allow for pending proceedings to be decided in terms of the Code. As per Section 60(2) of the Code, where an ongoing resolution process or liquidation proceeding is present against a corporate debtor, an application can be filed against the personal guarantor before the NCLT before which the resolution process or liquidation proceeding of the corporate debtor is taking place. As Section 243 of the Code, which allows for the repealing of personal insolvency laws, is yet to be notified, Adjudicating Authority designated for personal guarantors is the relevant NCLT.

Consequently, the Supreme Court concluded that the impugned notification is not a legislative exercise and does not amount an impermissible and selective application of provisions to a sub-class. The petitioners did not establish any ground that the provisions should apply to all individuals or not at all.

Another question raised before the Supreme Court was whether a resolution plan would discharge the liabilities of a personal guarantor. The Court held that Section 31 of the Code does not per se lead to a discharge of the liabilities of a guarantor. Maharashtra State Electricity Board v. Official Liquidator, High Court, Ernakulum & Anr.[6] was examined by the Court. This was a case wherein the liability of the debtor had been discharged under insolvency law but as the guarantee as unequivocal, it was held that the liability of the guarantor continues and the creditor could realize the same as per Section 128 of the Indian Contract Act, 1872, as no discharge, as envisioned under Section 134 of the same Act, did not occur.

The release or discharge of the principal borrower from the debt owed to the creditor through an involuntary process such as liquidation or insolvency would not release the surety/guarantor from their liability, as this liability arises from an independent contract. Thus, a resolution plan dos not ipso facto discharge a personal guarantor's liability in a contract for guarantee. One would be required to examine the terms of the specific guarantee to assess whether the guarantor's liability has been discharged.

The way forward

The Supreme Court has provided the creditors with great relief by allowing them to pursue insolvency proceedings against guarantors, while also reaffirming that the guarantor's liability will not be ipso facto discharged upon the conclusion of insolvency proceedings. The ruling negates the judgment of the National Company Law Appellate Tribunal wherein it had been held that while there would be no restriction in filing simultaneous applications under section 7 of the Code against the corporate debtor and guarantor, once an application under Section 7 filed by a creditor is admitted, then another application with the same set of claims cannot be filed.[7] Thus, the Adjudicating Authority will have to examine the terms and conditions in the guarantee as agreed between the creditor and the guarantor to determine the guarantor's liability.

However, while the judgment is a positive sign for creditors, guarantors may be posed with several problems. Ordinarily, once a guarantor has discharged their liability towards a creditor, they may recover such amount from the principal borrower. However, in terms of the Code, the guarantor may not be able to recover the full amount paid to the creditor from the corporate debtor. Section 31(1) of the Code states that any resolution plan approved by the Adjudicating Authority shall be binding on the guarantor along with the other stakeholders in the resolution plan. This may force guarantors, who are usually promoters or directors of their own companies, to evaluate the status of their standing guarantees while also seeking draft their future guarantees to expose them to less risk.

Abhinav Shrivastava is Co-Founding Partner of GSL Chambers and an Advocate on Record of Supreme Court of India. Nirmal Prasad is an Associate with GSL Chambers.Views are personal.

[1] Transferred Case No. 245 of 2020.

[2] S.O. 4126(E) dated 15th November, 2019.

[3] Section 128. Indian Contract Act.

[4] AIR 2003 SC 3057.

[5] AIR 1996 SC 1023.

[6] 1982 (3) SCC 358.

[7] Dr. Vishnu Kumar Agarwal vs. M/s. Piramal Enterprises Ltd., Company Appeal (AT) (Ins.) No. 346 of 2018.

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