Insolvency And Liability Of Personal Guarantors

The judgment by the court in the case of Lalit Kumar Jain v Union of India and Ors. has created buzz in the business community.

INTRODUCTION

Since the inception of the new Insolvency and Bankruptcy Code (IBC), the same has continued to remain in legal discussions. The main reason behind the debates and pending cases revolving around IBC in India is the lack of clarity and ambiguity on several legal points inadequately elucidated in the legislation.

To do away with the same, the Supreme Court of India has time and again intervened and clarified the legal position. A landmark case in IBC which was pronounced by the Hon’ble Supreme Court was of Swiss Ribbons Pvt. Ltd. v Union of India. The case provided clarity on the difference between financial creditors and operational creditors. It has also upheld the constitutionality of the code.

Once again, the apex court has endeavoured to clarify the disputes arising out of the Insolvency and Bankruptcy Code by answering certain issues of law in its latest judgment in the case of Lalit Kumar Jain v Union of India & Ors.

The much-talked about judgment of 2021 has finally put to rest the long due argument skirting around the constitutionality of the notification which was supposed to bring into effect the provisions of the IBC which relate to personal guarantors of corporate debtors. The judgment also elucidated on the point of treatment of personal guarantors in terms of their liability in case of insolvency.

Facts of the Case

The Ministry of Corporate Affairs, on 15th November 2019, issued a notification. The notification was intended to bring personal guarantors of corporate debtors within the ambit of the Insolvency proceedings initiated under the provisions of the Insolvency and Bankruptcy Code. The amendment was brought in part III of the IBC whereby insolvency and bankruptcy of individuals and partnership firms has been dealt with, in so far that the notification is applicable on the personal guarantors of corporate debtor.

A ‘personal guarantor’, as per Section 5(22) of the code, refers to a person who acts as a surety in the contract of guarantee to a corporate debtor. This is to say that in case the corporate debtor fails to pay back the sum taken by him as debt, in that situation, the guarantor shall assume personal liability for paying the dues. The personal guarantee is mostly furnished by, and accepted of a person who has good repute and financial stability.

After the notification was published, several demand notices were issued against personal guarantors. The demand notices proposed proceedings under the Insolvency and Bankruptcy Code. They also mentioned of recovery proceedings after invocation of guarantee in the Part III of the code.

The petitioners in the present matter had furnished personal guarantees to bank and other financial institutions in various capacities, like director, promoter, chairman and managing director. On the basis of the guarantee so furnished, these banks and financial institutions released advances to several companies.

However, once the insolvency proceedings were initiated against several such companies, the petitioners also became a party to the same. Thus, they approached the apex court. 

Consequentially, the petitioners along with the Insolvency and Bankruptcy Board of India (IBBI) contested the validity of the notification in the court. Apart from this, the issues pertaining to this common question of law were pending in several legal proceedings under several high courts. These cases were transferred to the Hon’ble apex court and tagged together.
 
LEGAL SITUATION BEFORE NOTIFICATION

Before the notification came into picture, the legal situation was that right to prosecute or initiate proceedings against the personal guarantor under IBC exclusively rested in the hands of the Debt Recovery Tribunal (DRT). The notification extended the right to prosecute to the banks and financial institutions as well, which increased the risk and liability of the personal guarantors of the corporate debtors multifold. This also increased the accountability of the personal guarantors, which wasn’t taken well by them.
 
ISSUES RAISED BY THE PETITONERS AGAINST THE NOTIFICATION

Contesting the notification issued by the Central Government’s Ministry of Corporate Affairs in the Hon’ble Supreme Court of India, the petitioners raised the following issues:-
  1. The Central Government cannot selectively bring into force certain provisions of the Code and apply them to a class or sub-category of individuals, i.e. the personal guarantors. This is so because personal guarantors in general weren’t targeted by the notification, rather the personal guarantors of corporate debtors were included.
  2. The notification is in violation of the power of the Central Government, prescribed under Section 1(3) of the Code.
  3. The notification is constitutionally invalid and ultra-vires.
 
QUESTIONS OF LAW INVOLVED
  1. What is the position of law in terms of insolvency of personal guarantors in the Insolvency and Bankruptcy Code?
  2. What is the liability of the personal guarantor to the corporate debtor in case of approval of resolution plan?
 
ARGUMENTS RAISED BY THE PETITIONERS

The issue-wise arguments raised by the petitioners are as follows:-
 
  1. The Central Government’s Actions Are Exceeding The Powers Vested In It As Per IBC’s Section 1(3)
The petitioners argued before the apex court that Section 1(3) of the Code makes it a conditional legislation where the sole function of the executive is to bring the law into operation as per the procedure prescribed in the Constitution of India and the code itself. The petitioners claimed that the present legislation is conditional, as against a delegated legislation because the legislation isn’t delegating the law-making responsibility on the executive, rather they are making law in their own competent capacity. 

The petitioners presented before the court that by releasing a notification which modified Part III of the IBC, the executive is invoking the legislative powers which aren’t vested in them. The Central government is exceeding its power as the release of notification isn’t permissible which amends the law isn’t allowed in a conditional legislation. Thus, the impugned notification and enforcement of Section 78, 79, 94-187 apart from the others is ultra-vires to the powers conferred on the Central Government by the act.
 
  1. Notification Brings into Effect Section 2(e) of the Code
As per the notification, Section 2(e) has been brought into effect from 01.12.2019. However, the petitioners argue that it is non-application of mind on the part of the government as in the case of State Bank of India v Ramakrishnan, the Supreme Court had said that the substituted Section 2(e) came into force with effect from 23.11.2017. It was a blatant oversight on the part of the respondents.
 
  1. The Notification Ignores The Extensive Nature of Liability of Personal Guarantor
As per the petitioners, reliance was placed on the case of Committee of Creditors of Essar Steel India Ltd. v Satish Kumar Gupta. The contention raised by the petitioner here was that the resolution plan for a corporate debtor amounts to the extinguishing all outstanding claims against such debtor. This, thus extinguishes the personal guarantor too from their liability. This is so because the liability of the personal guarantor is co-extensive to the liability of the corporate debtor. Punjab and Haryana High Court’s judgment in the case of Kundanlal Dariwala v Haryana Financial Corporation was cited here.
 
  1. The Treatment Met Out to Financial And Operational Creditors is Similar
Citing the landmark Swiss Ribbons (Pvt) Ltd. v Union of India’s judgment, the petitioners submitted before the court that the provisions modified and partly brought into effect of Part III of the IBC via the notification provide a single procedure for insolvency resolution process of personal guarantor. However, no distinction here has been made between a financial creditor and an operational creditor. The difference was elucidated by the Supreme Court in the Swiss Ribbons case, whereby the court had said that there is a fundamental difference between the operation and the financial creditor and both of them can’t be treated as one and the same.

The petitioners further argued that the similar treatment met out to both financial and operational creditors isn’t any less than treating unequals equally and this would eventually lead to the collapse of classification fabricated by the legislature.
 
  1. The Notification is Against the Object of the Code
The petitioners claim that the legislative object of the code is to ensure that the company isn’t liquidated, rather it is revived and continued under the protection of the management, and saved from liquidation as much as possible. The cases relied on by the petitioners were the Swiss Ribbons case and the Babulal Vardharji Gurjar v Veer Gurjar Aluminium Industries Pvt. Ltd. & Anr. The notification, on the other hand, increases liability in event of insolvency proceedings which defeats the purpose of the Code.
 
  1. The Central Government Failed To Bring Section 243 of the IBC into Effect
The petitioners submitted before the court that the government should have brought Section 243 of the code into force, which would have resulted in repealing the Presidency Towns Insolvency Act 1909 and the Provincial Insolvency Act 1920. Before the notification was passed, insolvency against an individual could be initiated under the said enactments.

The petitioners contend that it is illogical of the government to leave out the enforcement of Section 243 of the code and bring out the notification as it’ll create two self-contradictory legal regimes for invocation of insolvency proceedings against personal guarantors.
 
ARGUMENTS PRESENTED BY UNION OF INDIA AND OTHER RESPONDENTS
 
  1. The respondents presented that the intent of the Parliament has always been to deal with personal guarantors of partnership firms differently from that of proprietorship firms and other individual. The 2018 amendment to the IBC included three classes of debtors, which included personal guarantors to corporate debtors under Section 2(e), partnership firms and proprietorship firms under Section 2(f) and individuals under Section 2(g). Thus, the intention to distinguish personal debtors from corporate debtors and other individuals has been clear from the very beginning.
  2. The respondents further stated that Section 60 of the Code, which was partially amended in 2018 to include “a corporate guarantor or a personal guarantor, as the case maybe”, portrays the legislative intent to bring personal guarantor in the purview of insolvency proceedings. Section 60(2) means to involve the personal guarantor in the proceedings under IBC which are resolved and concluded by the National Company Law Tribunal. The submission made by the respondents is that if the insolvency resolution proceedings against corporate debtor were continued excluding the amendment and unification of adjudicatory body, the personal guarantors had remained outside the scope of IBC machinery.
  3. While justifying the segmented or stage-wise implementation of the code as valid, the respondents contended that there are multiple decisions of the court which have allowed segmental implementation. Furthermore, stage-wise implementation enables all the concerned parties to understand and evaluate the impact of the law on the subject matter dealt with.
  4. The Attorney General of India argued that the definition of “Provision” under Section 2(e) is different from that under Section 1(3). For this, reliance was placed on the definition of “Provision” under Black’s Law Dictionary and the case of Cheettiam Veetil Ammad v Taluk Land Board & Ors. Since the definitions are separate, the respondents claimed that it was intra-vires for the government to bring into force Section 2(e) and Part III of the Code against personal guarantors to corporate debtors.
  5. The respondents stated that the government has statutory powers to interpret the Section 1(3) of the Insolvency and Bankruptcy Code leniently so as to meet the objectives of the enactment. This would make the notification valid as the same is in the spirit of furthering the objective of the code.
  6. Commenting on the liability of guarantor, the respondents claimed that the liability is co-extensive, several and joint of the personal guarantor with the corporate debtor only when nothing contrary is provided in the contract. Therefore, the liability of the guarantor isn’t absolved till the time the creditor doesn’t pay off entirely. The rights which a creditor has against the personal guarantor extend to even bankruptcy or  liquidation proceedings, and the same was also mentioned in the case of Maharashtra State Electricity Board Bombay v Official Liquidator, High Court, Ernakulum & Anr. Therefore, it can be concluded that the approval of resolution plan through discharges the principal borrower cannot discharge the personal guarantor. For this, again the judgment of State Bank of India v V. Ramakrishnan & Ors. was referred.
 
 
DECISION OF THE APEX COURT
 
  1. The Hon’ble Supreme Court decided the question of stage-wise introduction of the provisions of the IBC to state that the method of adoption of the code by the government makes it evident that the motive was to bring into force important provisions before other provisions, on the basis of priority, thus the design of specific design of enforcing different provisions was adopted.
 
  1. The court stated that the 2018 amendment to the act was brought forth to extend the application of the provisions of IBC to personal guarantors of corporate debtor. The motive behind it was to strengthen the insolvency resolution mechanism.
 
  1. The Hon’ble apex court observed that the reasons for unifying the forum of adjudication of insolvency processes to make it common through National Company Law Tribunal are sound and sage. The amendment would enable the NCLT to look at the entire scenario in terms of nature of assets available, either during corporate debtor’s insolvency process or even later. This would facilitate the Committee of Creditors in framing a realistic and practical resolution plan, considering the prospects of realizing some dues from the personal guarantors of the corporate debtors.
 
  1. The court held that the impugned notification does not amount to legislative exercise of powers and is not impermissible under the code. The court said that it is so because the code imposes no compulsion for it to be applicable together on all parties mentioned in the code.
 
  1. Referring to the petitioner’s argument relating to the protection afforded by law to personal guarantors and the co-extensive liability of the corporate debtor and the personal guarantor, the court observed that the approval of resolution plan and the finality imparted under Section 31 of the code doesn’t intent to mean a discharge of guarantor’s liability. While observing that there is an intrinsic connection between personal guarantor and their corporate debtor. the court held that the release of corporate debtor’s liability from the debt owned by it from the creditor wouldn’t absolve the personal guarantor from its liability and the same would depend on the terms of guarantee.
 
  1. The court held that an involuntary act of principal debtor leading to loss of security won’t absolve the personal guarantor, as was stated in the case of Maharashtra State Electricity Board. In unequivocal guarantee, the liability remains continued and the creditor is free to realize the same as per Section 128 of Contract Act, deeming that there was no discharge in the first place as per Section 134 of the same act.
 
  1. The notification was upheld by the court as legal and valid and the present matter along with tagged and transferred petitions and cases were dismissed.
 
ANALYSIS
 
The present judgment has finally put to rest some blazing questions regarding the liability of the personal guarantors of the corporate debtor, by pronouncing in favour of the liability of the guarantors.

The pronouncement also comes as a sigh of relief for those creditors who were otherwise in a questionable condition owing to lack of express liability of personal guarantor after approval of the insolvency resolution plan. The judgement has provided access of asset pool of the personal guarantors of corporate debtors to the creditors, who in turn can endeavour to realize their dues.

However, the judgment might cause some worry-lines for those prominent industrialists and businesspersons who act as promotors and guarantors of debt-laden firms and companies. Several reports suggest that top companies facing huge debt issues have secured a personal guarantee of over INR 1.8 Lakh Crores. The amount is doubtlessly big and in event of insolvency proceedings against such companies, the personal guarantors would also be roped in and held liable.

Though the judgment has attempted and succeeded in bringing in clarity and accountability on part of personal guarantors and corporate debtors, by extending the powers of creditors, it has also added to the powers of the creditors since they will have an option to proceed against both corporate debtor and personal guarantor simultaneously.

Regardless, the judgment furthers the spirit of the Insolvency and Bankruptcy Code and brings forth the concept of much-needed accountability which would have otherwise been ignored. It is a long shot which would hamper irresponsible guarantee agreements and make sure that insolvency proceedings and liquidation will be reduced in the future, as guarantees would be realized aptly.

RBI’s Financial Stability Report 2019 had forecasted a 0.6 per cent rise in non-performing asset ratio, which is bad for the health of the economy. The code has been an effort to ensure the survival of economy and reduction of non-performing assets. The instant judgement is contributing towards this motive and would ensure better recovery of loans in the future.
 
CONCLUSION

The judgement has created a buzz in the business community, as several people are lauding and welcoming the judgment, hailing it as sound and rational. Earlier in October 2020, the court had said that the code is at an important and infancy stage but is portraying promising results for the future. The court had also said that the judiciary should endeavour in order to clarify the disputes and ambiguity arising from the application of the code.

This judgement is a stepping stone towards rectifying the anomalies and clarifying the legal condition pertaining to the code, which will leave a positive impact on the insolvency regime of the country and on the Indian economy.