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Insolvency and bankruptcy of personal guarantors of corporate debtors : analysis of Supreme Court’s recent verdict

September 03, 2021
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This article has been written by Aditya Saurabh pursuing the Diploma in Business Laws for In-House Counsels from LawSikho.

Introduction

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:

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:

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.

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.

Conclusion

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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