Supreme Court's Verdict On The Constitutionality Of The Provisions Of Personal Guarantors Under The IBC

GENESIS OF IRP OF PERSONAL GUARANTORS

Prior to the introduction of the Code, insolvency resolution of individuals was governed by Presidency Towns Insolvency Act, 1909 and the Provincial Insolvency Act, 1920 which stands repealed with effect from 19.08.2016 by virtue of Section 243 of the Code.

The Amending Act 8 of 2018 amended Section 2(e) of the Code and made the provisions of the Code applicable to personal guarantors of corporate debtors. The unamended Section 2(e) of the Code which made provisions of the Code applicable to only 'partnership firms and individuals' was trifurcated with effect from 23.11.2017 into three sub categories namely: -

1. Personal guarantors to corporate debtors [Section 2(e)];
2. Partnership firms and proprietorship firms [Section 2(f)]; and
3. Individuals other than those referred to in Section 2(e) of the Code [Section 2(g)]

In exercise of the powers conferred under Section 1(3) of the Code, vide notification dated 15.11.2019 issued by the Ministry of Corporate Affairs, Part III of the Code relating to insolvency and bankruptcy of individuals and partnership firms insofar as applicable to personal guarantors to corporate debtors including the impugned provisions were notified.

The validity of the said notification was challenged before the Supreme Court in the case of Lalit Kumar Jain Vs. Union of India and Ors. ^[2]on the ground that, inter alia, the Central Government while issuing the notification had acted in excess of the powers conferred upon it under Section 1(3) of the Code. It was contended that the powers conferred upon the Central Government under Section 1(3) of the Code could not have been resorted to in a manner so as to only extend the provisions of Part III of the Code selectively in relation to personal guarantors of corporate debtors. The Apex Court in the case of Lalit Kumar Jain^[3], upheld the vires of the said notification dated 15.11.2019 and also held that the liability of a personal guarantor is not discharged merely on discharge of the liability of the principal debtor.

LIABILITY OF A PERSONAL GUARANTOR

In terms of Section 128 of the Indian Contract Act, 1872, the liability of the surety is co-extensive with that of the principal debtor. The Supreme Court in the case of Industrial Investment Bank of India Ltd. v. Biswanath Jhunjhunwala^[4] while examining the ambit of the term 'co extensive liability' has categorially held that the liability of a surety is not in alternative to the principal debtor. Thus, unless there is a contract to the contrary, it is not necessary for a creditor to first proceed against the principal debtor before initiating recovery proceedings against the surety.

Under the Code, Section 5(22) defines personal guarantor as an individual who is the surety in a contract of guarantee to a corporate debtor. A personal guarantor being an individual, provides guarantee in their personal capacity against the loans availed by the corporate debtor and as such, their liability is co-extensive with that of the corporate debtor.

In the case of Laxmi Pat Surana Vs. Union Bank of India & Anr.,^[5] which although dealt with the initiation of Corporate Insolvency Resolution Process (“CIRP”) under section 7 of the Code against a corporate guarantor in respect of a loan availed by the principal borrower, it was held by the Supreme Court that a financial creditor has the right to proceed against the corporate debtor and the corporate guarantor under the Code in equal measure.

Subsequently, in the case of the State Bank of India, Stressed Asset Management Branch Vs. Mahendra Kumar Jajodia,^[6] the National Company Law Appellate Tribunal (“NCLAT”) has held that proceedings against a personal guarantor under Part III of the Code can be initiated by a creditor without any pending CIRP or liquidation proceedings against the corporate debtor. The said judgment was challenged before the Supreme Court and the judgment of the NCLAT was reaffirmed.^[7]Thus, as on date, it is not a pre-requisite for a creditor to initiate the CIRP proceedings of a corporate debtor before initiating the insolvency of its personal guarantors.

IRP OF PERSONAL GUARANTORS

In terms of the provisions envisaged under Section 95 of the Code, creditor(s) may either through themselves or through the Resolution Professional, file an application before the National Company Law Tribunal (“NCLT”) for initiating IRP proceedings of a personal guarantor. The said application is accompanied by such documents evidencing existence of the debt and other details as prescribed therein. An interim moratorium under Section 96 of the Code is imposed upon the personal guarantor upon filing of the said application under Section 95 of the Code. Pursuant thereto, the NCLT is required to appoint a Resolution Professional under Section 97 of the Code.

According to Section 99 of Code, the Resolution Professional is mandated to examine the application filed under Section 95 of the Code within a period of ten days from the date of their appointment, and submit a report to the NCLT recommending for approval or rejection of the said application.

Thereafter, within a period of fourteen days from the date of submission of report by the Resolution Professional under Section 99 of Code, the NCLT shall as per the provisions of Section 100 of the Code pass appropriate orders either admitting or rejecting the said application.

In the event that the application under Section 95 of the Code is admitted by the NCLT, a moratorium under Section 101 of the Code is imposed. The aim and object of the moratorium under Section 101 of Part III and that of Section 14 under Part II of the Code which is applicable to CIRP of corporate debtors is similar. Pursuant to imposition of moratorium under Section 101 of the Code, no legal proceedings can continue or be initiated against the personal guarantor in respect of any debt; and the personal guarantor is barred from transferring, alienating, encumbering or disposing of any of his assets or his legal rights or beneficial interest therein.

GROUNDS OF CHALLENGE TO THE IMPUGNED PROVISIONS IN DILIP B JIWRAJKA

A. INTERIM MORATORIUM

In the recent challenge to the impugned provisions pertaining to IRP of personal guarantors under Part III of the Code, it was contended by the petitioners that Section 96(1) of the Code imposes the rigors of interim moratorium upon the personal guarantor, automatically, upon filing of the application under Section 95 of the Code, without any requirement of prior notice.

B. MANDATORY APPOINTMENT OF RESOLUTION PROFESSIONAL

It was argued that the scheme of Section 97 of the Code states that the NCLT 'shall' appoint a Resolution Professional on an application filed by a creditor under Section 95 of the Code. Thus, the NCLT, a judicial forum, has been deprived of its powers to adjudicate on the debt, default, jurisdictional or threshold issues qua a debt owed by a personal guarantor.

C. PRINCIPLES OF NATURAL JUSTICE: A COMPARISON BETWEEN PART II AND PART III OF THE CODE

It was contended before the Supreme Court that the impugned provisions do not contemplate any opportunity of hearing to the personal guarantor at the stage of admission of application under Section 95 of the Code and hence, are violative of the principles of natural justice. Further, the petitioners therein alleged that appointment of a Resolution Professional may have grave consequences to the fundamental rights of the personal guarantor and should not be done without affording an opportunity of hearing to the said guarantor. To buttress the said argument, the petitioners relied on the judgment of the NCLAT in the case of Mr. Ravi Ajit Kulkarni Vs. State Bank of India^[8] wherein it was observed that the law as it exists today does not warrant any opportunity to the personal guarantor to raise objections before the stage of appointment of Resolution Professional. It was contended that there is no discernible basis for denying a personal guarantor the right to repel an application for insolvency at the threshold under Section 95 of the Code by raising jurisdictional questions qua the existence of debt and default when the same procedure is recognized as a right in the context of the proceedings initiated under Part II of the Code. In the case of Innoventive Industries Limited Vs. ICICI Bank & Anr.,^[9] one of the earliest judgments on insolvency law rendered by the Supreme Court, it has been held that the existence of the debt and default can be disputed by a corporate debtor in an application filed under Section 7 of the Code against it and the NCLT may only admit the said application if it is satisfied that a debt exists and default in respect thereof has occurred on the part of the corporate debtor. Thus, it was argued that the pari materia provisions pertaining to initiation of CIRP of a corporate debtor under Part II of the Code affords an opportunity of being heard to the corporate debtor which in case of personal guarantors is missing. Hence, it was alleged that the impugned provisions are violative of Article 14 of the Constitution.

D. UNFETTERED POWERS VESTED WITH THE RESOLUTION PROFESSIONAL

The petitioners also argued that Resolution Professional is also performing judicial functions entrusted to the Adjudicating Authority, i.e., NCLT, in terms of the impugned provisions. It was argued that the impugned provisions essentially allow delegation of judicial jurisdiction to a non-judicial person, namely, the Resolution Professional, as the provisions of Section 99 of the Code grants the Resolution Professional the authority to provide a report on the debt claimed in the application filed under Section 95 of the Code. Thus, the petitioners also averred that the impugned provisions granted unfettered powers to the Resolution Professional as the report of the Resolution Professional was the sole basis for admission or rejection of an application filed under Section 95 of the Code.

Further, the Resolution Professional once appointed has the power to call for private financial documents and other personal details of the personal guarantor. Without examining the existence of a valid debt and default such an intrusion on the fundamental right to privacy of a personal guarantor was contended to be unconscionable, both in the eyes of law as well as equity.

RATIONALE OF THE SUPREME COURT

A. THE IMPACT OF INTERIM MORATORIUM QUA THE DEBT AND NOT THE DEBTOR

The Supreme Court in its judgment dated 09.11.2023 has observed that the provisions of Section 96 of Code which imposes an interim moratorium on the filing of an application under Section 95 of the Code is restricted to restraining any legal action or proceedings qua the debt. The interim moratorium under Section 96 of the Code commences from the time when an application filed under Sections 94 or 95 of the Code, and ceases to have effect on the date of the admission of the application.

It is essentially contra distinguished from the moratorium imposed on the corporate debtor under Section 14 of the Code by virtue of initiation of CIRP proceedings by the NCLT. Thus, the Supreme Court has held that the provisions of interim moratorium under Section 96 of Code are protective in nature and is respect of the debt as opposed to the debtor.

B. PART II AND PART III OF THE CODE: THE ROLE OF THE RESOLUTION PROFESSIONAL

The Supreme Court has elaborately examined the provisions pertaining to CIRP of a corporate debtor under Part II of the Code and the IRP of personal guarantors under Part III of the Code. Sections 7, 9 and 10 of Part II of the Code deals with initiation of CIRP proceedings by a financial creditor, operational creditor and corporate debtor, respectively. Sections 94 and 95 of Part III of the Code empowers a debtor or creditor respectively to initiate IRP of personal guarantors by filing an appropriate application before the NCLT. While the former deals with CIRP of corporate entities the latter deals with insolvency resolution of individuals.

Once an application under Sections 7, 9 and 10 of the Code is admitted by the NCLT, an Interim Resolution Professional is appointed who is entrusted to perform functions and manage the affairs of the corporate debtor as envisaged under Sections 17 and 18 of the Code. The Interim Resolution Professional is even empowered to take over the management and control of the assets of the corporate debtor. The NCLT under Part II has been contemplated to have an adjudicatory role at the very threshold when the CIRP proceedings is admitted against a corporate debtor within the scheme of the Code.

In contrast, under Part III of the Code dealing with IRP of personal guarantors, the NCLT is mandated to appoint a Resolution Professional under Section 97 and the duties of the Resolution Professional are detailed in Section 99 of the Code. Under Section 99, the Resolution Professional is required to examine the application within a period of 10 days from his appointment. The Resolution Professional affords the personal guarantor an opportunity to prove the repayment of the debt along with documentary evidence such as bank transfer, encashment of cheque, signed acknowledgment of receipt, etc. which is claimed to be unpaid by the creditor.

The Resolution Professional is empowered under Section 99 (4) of the Code to seek further information or an explanation in connection with the application from the personal guarantor, creditor or any other person who in the opinion of the Resolution Professional may provide the relevant information. Hence, the information which the Resolution Professional is empowered to seek aids in effectively examining the application and submitting a report under Section 99 of the Code. In the report, the Resolution Professional can recommend acceptance or rejection of the application filed under Section 95. Once the report by the Resolution Professional is submitted then the adjudicatory function of the NCLT commences under Section 100 of the Code.

The Apex Court upon examination of the provisions under Section 99 of the Code came to the conclusion that the Resolution Professional has not been vested with any adjudicatory functions. It has been categorically held that the provisions of Section 99 of the Code use expressions akin to “examine the application”, “ascertain” and “satisfies the requirements” and “recommend” the acceptance or rejection of the application which demonstrates that no adjudicatory powers are vested with the Resolution Professional. Thus, the role of the Resolution Professional is merely faciliatory in nature.

Considering the fact that Part III of the Code applies to individuals and not corporate entities and the threshold of default is contrastingly a meagre amount of rupees one thousand as opposed to the threshold of default of rupees one crore for corporate debtors, the legislature in its wisdom has intended to impose the faciliatory functions of the Resolution Professional even before the adjudication by the NCLT commences. The Supreme Court observed that- “The adjudicating authority would be inundated if all amounts of alleged defaults as low as one thousand rupees were to be judicially determined. Bearing in mind the nature and context of the insolvency resolution, the legislature has stepped in by providing an intermediate stage where the Resolution Professional will collate and compile the relevant materials and submit it in the form of a report to the adjudicating authority recommending either the acceptance or the rejection of the application for initiating insolvency.”

In fact, the Supreme Court further held that in contrast to the powers vested with the Resolution Professional under Part II of the Code whereby the Resolution Professional is entrusted to take over the assets of the corporate debtor, no such power has been vested with the Resolution Professional in cases of IRP of personal guarantors under Part III of the Code. Hence, keeping in mind the nature of CIRP and IRP proceedings envisaged under the Code there exists an intelligible differentia which forms the basis of the distinguished role, duties and powers of the Resolution Professional under Part II and Part III of the Code.

C. THE ADJUDICATORY FUNCTIONS OF NCLT AND THE PRINCIPLES OF NATURAL JUSTICE

The Supreme Court while examining Section 99 of the Code has come to conclusion that the report submitted by the Resolution Professional is purely recommendatory in nature and does not bind the NCLT. It was further held that the adjudicatory function of the NCLT commences under Part III of the Code after the submission of a recommendatory report by the Resolution Professional.

The twin fold principles of natural justice are audi alterum partem, i.e., affording a reasonable opportunity of hearing to the person who is liable to be affected by an investigation, enquiry, proceeding or action; and nemo judex in causa sua, which means that the person should not be a judge in their own cause.

The Apex Court has reiterated that principles of natural justice apply in the context of purely judicial or quasi-judicial proceedings as well as administrative action which has an adverse impact on the individual or entity against which the action is initiated.

However, the Supreme Court cautioned that the principles of natural justice cannot be mechanically applied in a straightjacket formula. It was observed that based on the facts and circumstances, principles of natural justice on some occasions may extend to the right to a full-fledged evidentiary hearing while in certain cases may be circumscribed to a bare minimum opportunity to furnish an explanation by the affected party.

While examining Section 99(2) of the Code, the Supreme Court noted that the Resolution Professional affords an opportunity to the personal guarantor to prove repayment of the debt along with documentary evidence backing the said repayment. Further, Section 99(4) of the Code empowers the Resolution Professional to seek 'further information or explanation' from a personal guarantor or creditor. Hence, Section 99 of the Code is not intended to be a unilateral ex-parte process and duly provides for the engagement of the debtor, i.e., the personal guarantor, with the Resolution Professional at various stages. Therefore, there is no infirmity with the provisions of Section 99 of the Code.

Further, it was remarked that the contours of the nature of information sought by the Resolution Professional from the personal guarantor is restricted to the application filed seeking IRP of the said personal guarantor. The said information provided by the personal guarantor to the Resolution Professional is also confidential. While relying on the landmark judgment of K.S. Puttaswamy Vs. Union of India^[10], the Apex Court reaffirmed that the right to privacy is subject to reasonable restraints. In context of Section 99(4) of the Code, the legitimate aims of establishing a comprehensive framework for IRP of individual and personal guarantors and aiding the NCLT to adjudicate and determine the existence of the debt and default justifies seeking personal financial information by the Resolution Professional.

The Supreme Court has categorically held that no judicial determination in the IRP of personal guarantors exists before the application is presented before the NCLT under Section 100 of the Code. Further, the Apex Court has directed that the NCLT is bound to observe the principles of natural justice under Section 100 of the Code.

THE WAY FORWARD

The Code is a beneficial legislation and not a recovery mechanism enacted to promote entrepreneurship and time bound insolvency resolution of corporate persons and individuals. The Supreme Court has minutely analyzed and upheld the validity of the impugned provisions in the significant judgment of Dilip B Jiwrajka^[11]. However, there is an urgent need to revisit the threshold for initiating the IRP of personal guarantors by the Central Government. At present, the threshold for default as per Section 78 of the Code for IRP is merely rupees one thousand while the same in respect of CIRP under Sections 7, 9 or 10 of the Code is rupees one crore. Hence, the threshold needs to be amended and brought in consonance with the current times. However, in absence of a higher threshold of default for IRP of individuals and personal guarantors may lead to floodgates of litigations even for minor defaults.

The judgment paves way for an effective mechanism for the creditors particularly banks and financial institutions to resolve their bad debts. More often than not, the ex-management of the corporate debtors furnish personal guarantees to secure the credit facilities availed from banks and financial institutions. As per the Insolvency and Bankruptcy Board of India, there are 2,289 cases pending before various tribunals in respect IRP of personal guarantors as on 30.09.2023 and the recovery of the admitted claims of the creditors by way of a repayment plan from personal guarantors under the Code is a mere 5.22%. Hence, in terms of the present judgment, the Supreme Court has paved way for a more vigorous regime of resolving insolvent personal guarantors whose labilities run co-extensively with the principal borrowers, i.e., the corporate debtors.

Authors: Sandeep Bhuraria, Senior Partner and Parijat, Senior Associate at Zeus Law Associates. Views are personal.

1. Writ Petition (Civil) No. 1281 of 2021 decided on 09.11.2023 ↑

2. (2021) 9 SCC 321 ↑

3. Ibid. ↑

4. (2009) 9 SCC 478 ↑

5. (2021) 8 SCC 481 ↑

6. Company Appeal (AT) Insolvency No. 60 of 2022 decided on 27.01.2022 ↑

7. Civil Appeal No. 1871-1872 of 2022 decided on 06.05.2022 ↑

8. Company Appeal (AT) Insolvency No. 316 of 2021 ↑

9. (2018) 1 SCC 407 ↑

10. (2017) 10 SCC 1 ↑

11. Ibid.,1. ↑