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Liability Of Personal Guarantors Under IBC: A Legal Quandary

Anjali Jain and Swati Sood
16 Sep 2021 5:35 AM GMT
Liability Of Personal Guarantors Under IBC: A Legal Quandary

Talking of the stature of a personal guarantor, the build might vary in the n number of cases, yet what would resonate to each of the descriptions and would make them stand in unison, with no second thoughts would be their 'plight'. Don't let those lines of worry rest on your forehead after reading this since we won't let you stay puzzled for too long. We promise! Wondering what made...

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Talking of the stature of a personal guarantor, the build might vary in the n number of cases, yet what would resonate to each of the descriptions and would make them stand in unison, with no second thoughts would be their 'plight'. Don't let those lines of worry rest on your forehead after reading this since we won't let you stay puzzled for too long. We promise!

Wondering what made our beliefs so firm regarding this concern? You'll get to know all of it within six to seven minutes of your dive into this article. By the end of this article, you will have all the substantial reasons supporting the whys behind the formation of such viewpoints, rather there is a high likelihood that your brain might begin to flood with all the processed information. So, we wish you all the luck!

The fragility of the position of a personal guarantor does indeed remind us of those cricket field scenes, where kids who did nothing would get to bear the punishment for someone else's act of breaking the glass of the windowpane. Not to forget, those kids' long unattended pleas of innocence. Consider these personal guarantors too standing at similar crossroads. It is indeed a matter of fact that a huge bombardment of amendments and modifications has been faced by Insolvency and Bankruptcy Code, 2016 ("Code") that too not just from Judiciary but also from Legislature. Let this be brought to your attention that when the laws pertaining to Personal Guarantors were announced, they did become a major highlight of the insolvency regime in India. However, it acted like those short lived crackers which die down soon after emitting few sparks. Why? Because the provisions failed to level up with the expectations thereby leaving the scholars to scratch their heads. Once you begin pondering over these provisions, multiple interrogations are sure to spring up in your mind concerning the fate of Personal Guarantors. All this, despite the long-awaited decision delivered by the Hon'ble Supreme Court in Lalit Kumar Jain v. Union of India[1] ("Lalit Kumar"). What makes us say so? It's because of several unanswered questions which still stand in line concerning the said decision which confined itself to the Notification date 15.11.2019 that made Personal Guarantors liable under the Code[2]. Gear yourselves up because through the course of this article we are going to attempt an understanding and analysis of the rights and status of the Guarantors under the Code.

  • Bifurcation of Claim of the Creditor Between Principal Borrower and Guarantor: Analysis Through the Lens of Practical Feasibility

In order to unscramble the tactics of its working, do make a note that a creditor is provided with an option of proceeding against two Corporate Debtors (i.e. either Principal Borrower or Guarantor) for the same debt simultaneously, under the current regime of the Code. Interestingly, in a very recent case, Kanwar Raj Bhagat v. Gujarat Hydrocarbons and Power SEZ Ltd.[3], while upholding the decision of NCLT, held that an application u/s 7 of the Code for the same debt, against Corporate Debtor, is maintainable by placing reliance on SBI v. Athena Energy Ventures[4]. It was finally held that a creditor can claim his remaining debt from the Principal Borrower which was not recovered from the CIRP of the Guarantor.

Allowing the creditors to file claims whenever unquestionably hints towards creation of 'double dipping of claims', where the creditor despite filing the claim before a resolution professional of the Corporate Debtor or Guarantor, can proceed to file its claims against the complete debt in the CIRP of another Corporate Debtor or Guarantor. Since, it becomes an easy peasy job to benefit from such a situation, it becomes mandatory to account the amount received by the creditor and adjust it in other CIRP. What is required out of such a situation is that The Resolution Professionals of the Corporate Debtor and the Personal Guarantor must work together to certify that there is no doubling of claims by any creditor. An appropriate arrangement for scrutinizing the bifurcation of claims is essential under the code which, knock-knock, hasn't even been addressed by the courts yet. The Insolvency Law Committee Report, 2020[5] also recognised this absurdity and suggested that once the creditor recovers its claim in one proceeding, there should be an equivalent revision in the claim filed in another proceeding.

Other controversial issues that need to be addressed include situations like where the amount due to the creditor by the Corporate Debtor is not entirely guaranteed by the Guarantor or in situation of priority rights of the creditors or cases when there is no clarity of amounts (Guaranteed amount/ entire amount) or the rank of priorities of such claims. The Code must have an explicit provision dealing with such situations which demand a great finesse.

  • Stage of Invocation of Right Against the Personal Guarantor: Buzz Start

Presently, a creditor is permitted to invoke his right to recover the amount due, from the personal guarantor, at any stage from invoking its right before invoking the same against the principal borrower to invoking it even after the conclusion of CIRP of the principal borrower (Corporate Debtor). In Alpha & Omega Diagnostics (India) Ltd. v. Asset Reconstruction Company of India Ltd. & Ors[6], the NCLAT, while examining the word 'its' u/S 14 of the Code, it was observed that moratorium shall not be available to Personal Guarantors during the Corporate Debtor's CIRP and held that creditors can proceed against Personal Guarantor to satisfy their debts. In Committee of Creditors of Essar Steel India Limited v. Satish Kumar Gupta[7], Supreme Court clarified the issue pertaining to Personal Guarantors while following its pervious decision in State Bank of India v. V. Ramakrishnan & Anr.[8]it confirmed the right of the creditor to invoke contract of guarantee during Corporate Debtor's CIRP. The creditor is in fact free to proceed against the personal guarantor without exhausting his remedy against the principal debtor as held by Supreme Court while affirming the landmark judgment passed by the NCLAT in Ferro Alloys Corporation Limited v Rural Electrification Corporation Limited[9]. The judiciary has been uninterruptedly denying the rights of the Guarantors that are challenging the invocation of the guarantee at a particular stage. In Rave Scans Pvt. Ltd.[10], a personal guarantor approached the tribunal challenging the proceedings initiated by the creditor against him post acceptance of the Resolution Plan for the Corporate Debtor. However, the tribunal outrightly dismissed the application by stating that the conclusion of the CIRP of the Corporate Debtor does not bar the creditors to proceed against the guarantor.

Invocation of creditors' right against the guarantor at any stage shall cause enormous burden on the guarantors and judiciary. Some valuable amendments must be incorporated in order to provide proper set of rules describing the stage at which insolvency can be initiated, that the guarantor must be dragged into insolvency along with the Corporate debtor or balance must be drawn to reduce the liability of the guarantor after the approval of resolution plan. We are of the opinion that strategizing some kinds of Limitations for the said invocations could surely bring in synergy to the creditor's rights and guarantor's liabilities.

  • Right of Subrogation and Indemnity- Absolutely Diffused for Guarantors

The guarantors' Right of Subrogation u/s 140 and Right to Indemnity u/S 145 of the Contract Act, 1872 ("Act") confers the guarantor with the rights of a creditor against the principal borrower after discharging the liabilities. Although, this right is not extended to the guarantor in view of furthering the object of the Code which is revival and not recovery. There are rulings, where the tribunal has recognized the rights of the guarantor, as in Davinder Ahluwalia v. Sumit Aviation [11], NCLT admitted the application filed by the personal guarantor, in view of his right of subrogation to initiate CIRP and recover dues from the Corporate Debtor. However, such rulings are, time to time, outrightly overruled by the apex court without paying empathy to the position of Guarantors.

The Code doesn't treat the Personal Guarantor's right to subrogation as an absolute right on the ground that the same would render the insolvency process meaningless by further hampering the assets of the Corporate Debtor. In Essar steel, the ArcelorMittal's resolution plan specifically provided that upon approval, all guarantees invoked prior to the approval of the plan and claims from guarantors on account of subrogation under such guarantee, would be deemed to be extinguished. Approval of such plan vouched that resolution plans would prevail over the contractual rights of a personal guarantor. The corporate debtor is unjustly enriched with the denial of this right and guarantor's corresponding rights have been diffused to lighten up the same contractual obligations arising under the similar watershed provisions. This muting of one set of guarantor's rights to give way to other set of creditor's rights is discriminatory and efficient safeguards to prevent unjust exploitation need to be imbibed.

  • Whether Alteration, Without Guarantor's Consent, in the Contract of Guarantee Binds Him?

The Contact of Guarantee, that governs the rights and liabilities of the guarantor, contains arbitrary and discretionary clauses such as any change or revision in rate of interest of the facility provided to the borrower, varying the amount of limit of the said facility, extending the time of repayment, a promise to not to sue the borrower or making any composition with the borrower, execution of any such change without the consent of the guarantor, such execution shall not affect the Guarantee of such facility which however under the law has the effect of releasing the Guarantor form the said contract or, that the admission or acknowledgement of debt by the principal borrower, shall be deemed to have been made by the guarantor and shall be binding on the Guarantor for the purpose of Section 18 & 19 of the Limitation Act, 1963. All these clauses are contrary to Section 133 of the Act which provides that any variance made in the terms of the contract between the principal borrower and creditor, without the guarantor's consent would discharge the latter. A guarantor shall be discharged of its obligations under a contract of guarantee in case, consequent to a contract between the principal borrower and the creditor, principal borrower itself stands discharged;[12] or the principal borrower and the creditor enter into a compromise or composition for extending time to the principal borrower or for not suing the principal borrower (without the guarantor's consent).[13] No contract shall be made in contradiction with any law and such contracts, if permitted, would defeat the provisions of law[14]. In case the express provisions of any law are violated by a contract, the interests of the parties, would be injuriously affected by its implementation. In Neminath v. Jamboorao[15], the court held that an agreement or contract is void, if it is expressly or impliedly prohibited by any law.

Such contracts, if made and executed contrary to law, will not only let the creditor exercise unjust enrichment but will add on to the misery of the Guarantors under the Code. However, in Lalit Kumar, the Supreme Court had to decide between the rights of the two i.e. the contractual right of the guarantor and the right of the creditor wherein the court indicated the latter in light of public policy decision.

  • Differential Treatment of Guarantors Under the Code: Explained!

The Code, since the guarantors were made liable, has failed to treat the guarantors at par with the corporate debtors or creditors. As drawn from the above discussion, the Code or the judiciary has been acting unfairly towards the Guarantors. To begin with, primarily, there seems to be no intelligible differentia or rational basis in enforcing the provisions under Part III of the Code only to 'Personal Guarantors to Corporate Debtors' vide the Notification dated 15.11.2019, and not to other individuals and partnership firms as referred to in Part III. In our opinion, the decision in Lalit Kumar did not uphold the true constitutional values.

Secondly, the minimum default to initiate CIRP against Corporate Debtors has been increased from Rs. 1 lakh to Rs. 1 crore, however, the threshold for default to initiate CIRP against personal guarantor remains untouched. To assume that the CoViD induced slowdown have not equally affected the corporates as well as individuals (Guarantors), at least insofar as their capacity to repay the debts is in question, would be utterly unfair. Also, the creditors have the option of proceeding against the Personal Guarantors even for defaults on account of COVID-19, but are statutorily barred from proceeding against the Principal Debtors for the same debt due to the ordinance inserting Section 10A which shielded the companies from the insolvency due to COVID-19 related defaults.

Thirdly, the amnesty clause that guards the companies from any default committed during the suspension period provided the much-needed respite to the companies but unsuccessful to take into consideration the economic hardship of the personal guarantors to corporate debtors. Since the principal debtor is discharged from the rigor of the Code, a personal guarantor shall also stand discharged as part of principle of equality. The manner in which the Government has undertaken this exercise of discrimination, this would unfairly and incorrectly stretch the outlines of the power of 'conditional legislation'.

Lastly, there appears to be no prompt provision under Part III of the Code that allows a guarantor to appeal against the order passed by the NCLT. The only provision which entitles an aggrieved party to file an appeal before the appellate authority is Section 61. However, Section 61 only relates to an appeal against the orders passed by the NCLT under Part II of the Code and not Part III hence, the remedy u/S 61 is not extended to Personal Guarantors under Part III.

If one would go and indulge into a religious inspection, one is bound to excavate lots and lots around the insolvency of Personal Guarantor. It could thus be concluded with such an assessment that The Lalit Kumar Judgement is nothing but an embodiment of the fulfilment of the sole purpose of debt recovery. Further, what grounds facilitate this discriminatory turnover of events towards Private Guarantors, does require a double checking. Finally, what remains suggestive in such scenarios is the facilitation of such unavoidable series of actions that would contribute in achievement of an equilibrium between the right of financial creditors and personal guarantors.

Anjali Jain is Partner (Insolvency & Restructuring) and Swati Sood is Associate (Insolvency & Restructuring) at Areness. Views are personal.

[1] Lalit Kumar Jain v. Union of India & Ors, Transfer Case (Civil) No. 245/2020

[2] S.O. 4126(E) -Notification - For personal Guarantor to Corporate Debtor

[3] Kanwar Raj Bhagat v. Gujarat Hydrocarbons and Power SEZ Ltd. (NCLAT) COMPANY APPEAL (AT)(Insolvency) No.1096 of 2020

[4] SBI v. Athena Energy Ventures (NCLAT) Company Appeal (AT) (Ins) No.633 of 2020

[5] Insolvency Law Committee Report, 2020 -

[6] Alpha & Omega Diagnostics (India) Ltd. v. Asset Reconstruction Company of India Ltd. & Ors Company Appeal (AT) (Insol.) No. 116 of 2017

[7] Committee of Creditors of Essar Steel India Limited Vs Satish Kumar Gupta & Ors. (Supreme Court) Civil Appeal No. 8766-67 of 2019

[8] State Bank of India v. V. Ramakrishnan & Anr. (Supreme Court) Civil Appeal No. 3595 of 2018

[9] Ferro Alloys Corporation Limited v Rural Electrification Corporation Limited (Comp. App (AT) (Ins) No. 92 of 2017)

[10] Rave Scans Pvt. Ltd.  (IB)-01(PB)- 2017

[11] Davinder Ahluwalia v. Sumit Aviation, NCLT, IB No. (IB)-229 (ND)/2017

[12] The Indian Contract Act, 1872, Section 134.

[13] The Indian Contract Act, 1872, Section 135.

[14] The Indian Contract Act, 1872, Section 23.

[15] Neminath v. Jamboorao, AIR 1966 Mys 154

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