This article has been written by Aditya Saurabh pursuing the Diploma in Business Laws for In-House Counsels from LawSikho.
It is generally known in the Indian context that banks are the primary source of funding for any firm, large or little and that they have their own criteria for issuing loans or credit facilities, often requiring the personal guarantee of the promoter-directors as additional security for the loans. When the corporate debtor becomes ill, the guarantor should become more vulnerable, as banks will line up to take action against him under the Insolvency and Bankruptcy Code, 2016 (“Code” or “IBC”), making him a target like the corporate debtor.
This proceeding against the guarantor under the IBC legislation dealing with corporate insolvency was extended by a Notification dated 15 November 2019 (“Notification”), which brought into effect provisions of Part III of the Code, but exclusively in relation to personal guarantors to corporate debtors. The Notification exclusively applied the provisions of Part III of the Code to personal guarantors of corporate debtors, despite the fact that Part III of the Code provides for insolvency and bankruptcy for individuals and partnership firms.
Earlier, banks had to proceed before the Debt Recovery Tribunals to recover money from their debtors (including personal guarantors) under the Securitisation and Reconstruction of Financial Assets and Enforcement of Securities Interest Act, 2002 (“SARFAESI Act”). Unfortunately, the Debt Recovery Tribunals (“DRT”) have been beset by judicial delays, which have hampered the process efficiency. As a result, creditors received the Notification with zeal, hoping for a faster and more efficient recovery of their debts from personal guarantors.
However, a number of prominent company’s promoters who had provided personal guarantees for their corporations filed applications in various High Courts challenging the Notification. The Supreme Court moved all of these applications filed in various High Courts to itself in order for the Apex Court to settle the meaning of the Code’s provisions relating to personal guarantors once and for all, avoiding any confusion caused by the High Courts’ differing opinions. Therefore, the petitioners in this recent case of Lalit Kumar Jain v. Union of India raised numerous doubts before the SC about the applicability of the III chapter to individual directors-guarantors (who are non-corporate entities). The Supreme Court of India in which ultimately affirmed the provisions of the Insolvency and Bankruptcy Code, 2016 (“Code”) that allowed banks to pursue personal guarantors for debt repayment.
Grounds for challenge
The petitioners asserted that the notification was invalid and arbitrary based on the following contentions, among others:
- That the Central Government exercised excessive delegation: The petitioners argued that the power delegated under Section 1(3) only applies to the point in time when distinct provisions of the Code can take effect and that it does not allow the Central Government to notify specific provisions of the Code or to limit their application to specific groups of people. Because the contested Notification was used to change the provisions of Part III of the Code to apply only to personal guarantors of corporate debtors, it was argued that it was done in violation of the provision to Section 1(3) of the Code and amounted to an unjust executive abuse of legislative power.
- That the Notification is arbitrary and discriminatory: The petitioners argued that under Section 2(g) of the IBC, ‘personal guarantors’ are excluded from the definition of ‘individuals,’ arguing that the Notification is manifestly arbitrary and discriminatory because there is no discernible differentia for carving out personal guarantors, and a single procedure is provided regardless of whether the creditor is financial or operational. This was in contrast to the CIRP, which is outlined in Part II of the Code and includes distinct procedures for different types of creditors.
- That the Notification creates self-contradictory legal regimes for insolvency proceedings against personal guarantors: The petitioners argued that Section 243 of the Code, which repeals the Presidency Towns Insolvency Act of 1909 and the Provincial Insolvency Act of 1920 (collectively, “erstwhile legislations”), was not included in the Notification. Individual insolvency proceedings were controlled by the previous legislations prior to the issue of the Notification. The Presidency Towns Insolvency Act of 1909 applies to the former presidency towns of Calcutta, Bombay, and Madras, whereas the Provincial Insolvency Act of 1920 applies to the rest of India, with the exception of these towns. Thus, it was argued that the Notification is unreasonable because it creates two incompatible legal regimes for insolvency actions against personal guarantors to corporate debtors by not repealing the stated statutes.
- That there is the co-extensive liability of a guarantor and a principal debtor: The petitioners argued that by extending the code to personal guarantors, the notification merely removes the protection provided by law; they cited Sections 128, 133, and 140 of the Indian Contract Act, 1872. It was argued that a personal guarantor’s liability is co-extensive with that of the corporate debtor; and that once a corporate debtor’s resolution plan is approved, any past, present, or future liabilities encumbered on the corporate debtor are dismissed, except to the extent committed in the insolvency resolution process itself. As a result, the end of insolvency proceedings against the corporate debtor would also mean that any claims against the personal guarantor would be canceled. This is obvious from Section 31 of the code, which makes the adjudicating authority’s resolution plan enforceable by the corporate debtor, its creditors, and guarantors.
Supreme Court’s verdict
In this landmark case, the Hon’ble Supreme Court examined all of the provisions incorporated into the IBC at different phases and concluded that the strategy used by the Central Government to bring various provisions of the Act into force had a clear purpose: to achieve the IBC’s objectives in relation to the priorities. The Supreme Court went on to say that the IBC’s objectives are to foster entrepreneurship and credit availability, to guarantee the interests of all parties are balanced, and to promote timely bankruptcy resolution for corporations, partnership businesses, and individuals.
Thus in order to fulfill the objectives of IBC, the apex court held:
- That there was no excessive delegation and selective application exercised by the Union of India: The court determined that the Code does not require that it be applied to all individuals (including personal guarantors) at the same time or not at all. Sections 2(e), 5(22), 60, and 179 of the Code provide sufficient indication that personal guarantors, despite being part of a larger grouping of individuals, were to be treated differently, through the same adjudicatory process and by the same forum as corporate debtors, due to their intrinsic connection with them. The Notification likewise makes the Code’s requirements applicable to personal guarantors to corporate debtors, another group of people to whom the Code has been expanded. As a result, the Notification was issued within the scope of Parliament’s authority and in good faith. As a result, the power exercised in issuing the Notification under Section 1(3) is not ultra vires; the notification is legal.
- That there is no incongruity in provisions enforced by the Notification: The Court noted that the Code’s structure presumed that a corporate debtor’s assets and those of its personal guarantor would be treated similarly throughout bankruptcy proceedings. As a result, various amendments to the Code were made in a timely manner, such as Section 2(e) being amended, resulting in Sections 2(e), (f), and (g) coming into force, to make sure that the adjudicating body dealing with the insolvency of corporate debtors also deals with the insolvency of its personal guarantors. In addition, for the purposes of Section 60(2), the Parliament integrated the provisions of Part III with the procedures against corporate debtors under Part II, i.e., proceedings against personal guarantors as well as corporate debtors.
The court concluded that there appear to be reasonable reasons for the National Company Law Tribunal (NCLT) to be the forum for adjudicating insolvency processes, which have divergent requirements. This is because the NCLT would be able to look at the big picture, so to speak, of the nature of the assets available, making it easier for the creditors’ committee to come up with realistic plans while keeping in mind the possibility of recovering some of the creditor’s dues from personal guarantors.
- That there is no reason to repeal the personal insolvency laws: The Court held that the provisions of the Presidency Towns Insolvency Act, 1909, and the Provincial Insolvency Act, 1920, did not overlap with those of the Code. The Court held that the Code has an overriding effect over other existing and conflicting legislation by relying on Section 238 of the Code, which has a non-obstante clause, and that this could be the basis for not notifying Section 243.
- That the sanction of resolution plan does not itself discharge the personal guarantor’s from its liabilities: In response to the argument that a personal guarantor’s liability is co-extensive with that of the corporate debtor, the Supreme Court ruled that the approval of a resolution plan and the finality conferred on it by Section 31 do not function as a discharge of the personal guarantor’s liability. Because the guarantor’s liability originates from an independent contract, the type and scope of the liability will be largely determined by the conditions of the guarantee. As a result, an involuntary process, such as by operation of law or owing to liquidation or insolvency proceedings, will not acquit the guarantor of his or her duty, when the debtor is discharged.
The Supreme Court also cited several decisions, including Vijay Kumar Jain v. Standard Chartered Bank, in which the Supreme Court held that the justification for permitting directors to take part in committee of creditors meetings is that the directors’ liability as personal guarantors continues to be held against the creditors and that an authorized resolution plan can only result in a revision of the amount owed.
Therefore, the Notification was held legal and valid.
Persisting issues : analysis
While the Supreme Court may have resolved an important issue, it has also caused personal guarantors to have other worries. The idea of bringing legal action against the corporate debtor and personal guarantors at the same time could result in a cascade of legal actions. Overly concerned creditors would be compelled to file applications against both personal guarantors and corporate debtors at the same time in order to increase their prospects of early recovery, causing turmoil. Only the adjudication forum’s consolidation of procedures will serve as a remedy for multiplicities of proceedings.
The IBC expressly states in Section 60 that insolvency resolution or bankruptcy proceedings involving a personal guarantor must be conducted before the same NCLT as a CIRP or liquidation proceeding involving the corporate debtor. The IBC further states that the proceedings must be brought before the NCLT in the territorial jurisdiction where the corporate person’s registered office is situated. However, how the relevant NCLT would be decided in a scenario where the personal guarantor has issued a guarantee for more than one entity and such entities are simultaneously subjected to the CIRP in separate NCLTs remains to be seen.
Aside from that, the form of procedures has not been specified, such as whether the actions against the corporate debtor and the personal guarantor can be merged or must be conducted separately. It’ll also be interesting to see if the adjudicating authority can choose a single resolution professional to handle both cases.
Furthermore, if personal guarantees advanced by the company’s promoters or directors violate the limited liability principle by having made them personally liable, including the binding of their personal assets, this will affect the decision to extend personal guarantees, making guarantors hesitant and risk-averse.
Despite several inconsistencies, the Supreme Court’s decision serves as a stimulant for the Insolvency Proceedings to be completed on schedule. Directors or promoters acting as personal guarantors for corporate debtors would be required to consider and execute Resolution Schemes that are acceptable to the Committee of Creditors to avoid personal liability, thereby giving the Resolution process the needed energy.
As the Supreme Court’s verdict might be considered a substantial triumph for the lenders, the image of IBC being creditor-friendly law is confirmed, as is an underlying goal of the legislators to deal with problematic loans and their economic impact. It will enable creditors to recover any deficit amounts not covered by the corporate debtors’ resolution plan from the personal guarantors of such corporate debtors by instituting separate insolvency proceedings against such personal guarantors.
Earlier, company directors or promoters would agree to act as personal guarantors for loans taken out by their companies, only to later squirm out of their obligations, owing to an inefficient debt collection mechanism. This was partly due to banks’ lack of due diligence and the mechanized manner in which big loans were provided to corporations, which far outstripped the guarantor’s financial net worth by considerable multiples.
However, such practices are expected to alter in the future, as directors and promoters will be leery of providing personal guarantees at the request of corporations that could put them in jeopardy of going bankrupt. As the law governing the implementation of a personal guarantee provided to a corporate debtor becomes clearer, the terms and conditions governing the granting of personal guarantees will undoubtedly change!
Nonetheless, it is clear that the legislature has once again failed to examine the real complexities of the insolvency process. In order for the regime to function effectively, courts and tribunals must be on their toes. The practical features of caseload on NCLT as a result of simultaneous procedures are at odds with the purpose of speedy debt recovery for lenders, which we believe requires another modification. Furthermore, creditors have a stronger responsibility to make a meaningful effort to resolve debts before proceeding against personal guarantors, as the objective of the code cannot be to short-change the guarantor. As a result, the only way to address the decision’s unintended repercussions is for the law to be clarified or changed.
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