This article has been written by Abhilekh Tiwari pursuing the Certificate Course in National Company Law Tribunal (NCLT) Litigation and Shreya Mishra pursing Diploma in Global Corporate Practices from LawSikho.
Table of Contents
Insolvency and Bankruptcy Code, 2016 (hereafter referred to as “Code”) was enacted in 2016 and is in its developing phase. With the landmark judgements like Swiss Ribbons, Bhushan Steel, Essar Steel, etc. have paved the way to give clarity on various aspects of the Code. In the same way, the Hon’ble Supreme Court through its latest judgement gave a new perspective to the Code. It highlighted the issue of insolvency of Personal Guarantors in Lalit Kumar Jain vs. Union of India & Ors. vide Order dated 21.05.2021. Before going ahead with the case, let’s first understand who is a Personal Guarantor? Section 5(22) of the Code defines – “Personal Guarantor.” It means an individual who is the surety in a contract of guarantee to a corporate debtor.
Personal guarantors for long were not included within the ambit of proceedings under the Insolvency and Bankruptcy Code, 2016 (IBC) until the recent judgement of Lalit Kumar Jain v. Union of India that dealt with the validity of impugned notification dated 15.11.2019. The notification was issued under Section 1(3) of the IBC which allows for certain provisions to come into effect when the Central Government issues the notification. The present article analyses the provisions in question in the case and argument of both the parties. The main issues that have been addressed in the case were pertaining to the liability of personal guarantors post approval of resolution plan and the extent of liability of personal guarantors to the corporate debtors.
The main crux of the case is the notification dated 15.09.2019 issued by the Government of India. The notification talks about Part III of the Code which broadly states the enforcement of certain provisions relating to the Personal Guarantor. The petitioners provided bank and financial institutions with guarantees in their capacities as directors, promoters, chairman and managing directors of the firms, and the guarantees have been invoked and procedures against the companies with which they are affiliated are pending. The cases that are still outstanding, at various phases such as insolvency filing, resolution plan, etc. Many demand notices were sent to petitioners after the notification was published, suggesting insolvency proceedings under the Code, and recovery actions commenced after the invocation of guarantees under Part-III of the Code. The Petitioners claimed that the power of the Government under Section 1(3) of the Code could not be used to limit the Code’s provisions to Personal Guarantors of corporate debtors. The challenged notification made Sections 2(e), 78 (except for the fresh start process), and Sections 79, 94-187 (both inclusive); Section 239(2)(g), (h) & (i); Section 239(2)(m) to (zc); Section 239 (2) (zn) to (zs) and Section 249.
The Ministry of Corporate Affairs (MCA) on 15.11.2019 issued a notification (Notification) regarding the implementation of certain provisions of IBC regarding liabilities of personal guarantors. The same was later challenged by the Insolvency and Bankruptcy Board of India (IBBI). Multiple petitions were filed before the Supreme Courts, out of which many were referred back to the respective High Courts except for the instant case of Lalit Kumar Jain v. Union of India which took the lead.
It was common at various instances that promoters and directors of the companies used to act as a guarantor to the banks for the companies. In the present case, after the notification was published, demand notices were served to the petitioners who later approached the Supreme Court, challenging the validity of the notification.
– Section 1(3) of IBC states that the Insolvency and Bankruptcy Code, 2016 shall come into effect as when the Central Government puts a notification in the Official Gazette. The provisions also mention that different provisions can come into effect at different commencement dates.
– Section 60(2) states that while a corporate insolvency resolution process or liquidation is pending, an application for insolvency or bankruptcy can be filed against the personal guarantors.
– Section 128 of the Indian Contracts Act, 1872 states about the surety’s liability being co-extensive with that of the debtor unless the agreement between the parties states otherwise.
– Section 134 of the Indian Contracts Act, 1872 states that surety is discharged if the debtor is released under the agreement between the creditor and the debtor.
– Section 135 of the Indian Contracts Act, 1872 states that surety shall be discharged of its liability if the creditors agrees to give time, or agrees not to sue, or compounds with the debtor unless surety has assented to the agreement.
Question of law
- What is the liability of personal guarantors post-approval of a resolution plan?
- Validity of the notification dated 15.11.2019 issued by the Government
- What is the extent of liability of personal guarantors to the corporate debtors?
- The powers exercised by the Central Government are ultra vires
Section 1(3) of the IBC states that the provisions under the code will come into force as when implemented by the central government. It is a conditional legislation in which only the executive is allowed to implement laws. The law was made by the legislature and was complete in itself and hence no delegation was required at the part of the executive. Petitioners contended that the central government has exceeded its authority and have made changes to the provisions of Part III of the IBC. While making this submission, Petitioners relied on the case of Delhi Laws Act, 1912, In re v. Part ‘C’ States (Laws) Act, 1950 and other similar judgements. In the case of the Delhi Laws Act, the Central Government was given power to repeal the previous laws which were ultra vires. Certain parts of Delhi Laws Act, the Ajmer-Mewar Act and Part C States laws Act were in question and later the first two acts were declared ultra vires.
- The notification does not differentiate between financial and operational creditors
Petitioners relied on Swiss Ribbons Pvt. Ltd. v. Union of India wherein the constitutional validity of different provisions of IBC was dealt with and the Supreme Court held the entire IBC to be constitutionally valid. The Petitioners contended that there is a difference between the nature of loan agreements signed by financial creditors and contracts of goods and services by operational creditors. Treating both classes of creditors equally will be disregard the differentiation and would treat the different class equally and hence would be against the distinction created by the parliament.
- The central government ought to bring Section 243 into effect.
Petitioner contended that insolvency proceedings against an individual are initiated under Presidency Towns’ Insolvency Act 1909 and Provincial Insolvency Act 1920 and to repeal this act, Section 243 of IBC should have been brought to the effect. Hence the notification has been released with a non-application of mind.
- The liability of the personal guarantor is co-extensive with that of the corporate debtor.
Petitioners relied on the case of Committee of Creditors of Essar Steel India Ltd. v. Satish Kumar Gupta and stated that post-approval of the resolution plan, all the claims are extinguished against the corporate debtor and since the guarantor has a co-extensive liability to the corporate debtor, the liabilities of guarantor also gets extinguished. The case of Committee of Creditors of Essar Steel India v. Satish Kumar Gupta dealt majorly with Section 29A of IBC and also stated that under Section 31(1) of the IBC if the resolution plan is passed then it would be binding on the guarantors and all other stakeholders.
- The legislative intent was to treat personal guarantors differently
Respondents contended that the legislature had the intent to treat personal guarantors differently from proprietorship and partnership firms. It was due to this reason that three classes of debtors were introduced in the 2018 amendment in (Section 2(e), 2(f) and 2(g)) which can act as a personal guarantor to the corporate debtor.
- The 2018 amendment to Section 60(2) permits insolvency proceedings against personal guarantors
It was further contended that Section 60 of IBC was also amended in 2018 and words included were “corporate guarantor or personal guarantor as the case may be.” Hence, it can be reasonably inferred that even personal guarantors can be subjected to an insolvency process. If acknowledgement to this amendment is not given then the personal guarantor would remain outside the purview of IBC. The amendment to Section 60(2) is to enable the dispute resolution of insolvency and bankruptcy through the same forum.
- Stage-wise implementation of IBC is valid
Relying on the case of Basant Kumar Sarkar v. Eagle Rolling Mills Ltd., Respondent contended that it has been established in the catena of decisions that segmented implementation of the laws is valid. Furthermore, Section 1(3) ought to be interpreted in a way to implement the objectives of the code. Therefore, considering the objective of the IBC, the notification is valid. In the case Basant Kumar Sarkar v. Eagle, the appellants were workmen of the respondents and were entitled for certain medical benefits but due to the notification issued by the Central Government under Section 1(3) of Employee State Insurance Act by which some more provisions were brought into force by which the employees were no more eligible for certain medical benefits. The Supreme Court held the notification valid and stated that Section 1(3) does not illustrate delegated legislation but a conditional legislation.
- The liability of personal guarantors is coextensive, joint and several
Respondents stated that liability of the personal guarantor can be joint and several or coextensive depending upon the agreement between the parties. Therefore, if the debt is not paid off completely, the liability of personal guarantors cannot be absolved from its liability. In the case of Maharashtra State Electricity Board Bombay v. Official Liquidator, High Court, Ernakulum & Anr., it was stated that the rights of creditors exist in the stage of liquidation and bankruptcy as well. In this case, as per the tender of the company a bank guarantee of 50,000 was offered and the bank took certain goods as securities.
The Supreme Court stated that liquidation will not affect the bank guarantee and it is certain that the liability of surety is coextensive with that of the principal debtor but the surety is not absolved if the discharge is due to operation of law. Hence, with reference to Section 135 of the Indian Contracts Act, 1872 (Contract Act), mere approval of a resolution plan which might secure discharge of some liability, do not absolve the personal guarantor. This was also upheld in the case of State Bank of India v. V. Ramakrishnan & Ors . that particularly dealt with applicability of moratorium to personal guarantors. The Supreme Court stated that Section 14 of the IBC does not mention the applicability of moratorium to personal guarantors.
What was held by the Apex Court?
Hon’ble Supreme Court held the notification to be valid. It was stated by the Supreme Court that the notification is not excessive legislation as there is no compulsive effect in the IBC for its application. There is an intrinsic connection between corporate debtors and personal guarantees. Hence power exercised under Aection 1(3) of the IBC is not ultra vires.
If the loss of security of a corporate debtor is due to any involuntary act then the personal guarantor will not be absolved of its liability. The guarantee can be realised under Section 128 of the Contract Act as discharge has not occurred under Section 134 of the Contract Act.
Hon’ble Supreme Court held that passing of resolution plan will not ipso facto discharge the personal guarantee. The discharge of liability of the borrower has occurred by the operation of law which is an involuntary process and hence will not absolve personal guarantee of its liability if it arose out of an independent contractor. The extent of liability for a personal guarantee would depend on the agreement between the borrower and guarantor.
The notification in question is valid. Further, the approval of the resolution plan is related to the corporate debtor and will not discharge the liabilities of the personal guarantor to the corporate debtor.
The Supreme Court stated certain reasons as to why the forum for adjudication of insolvency-related matters should be common. The NCLT, which is the adjudicating authority, would be able to acknowledge the entire issue as a whole. NCLT would have the knowledge of the assets of the corporate debtor which would help in making apt resolution plans and also using personal guarantee in realising the debt.
In my opinion, though this judgement has opened a new pathway under the Code but in practicality it can be challenging in the initial stage as in many cases where the Insolvency proceedings are initiated against the Personal Guarantors of the Corporate Debtor, either the Resolution Plan has already been approved by NCLT or is approved by the Committee of Creditors and is pending before NCLT for its approval. In that case, it is difficult to start the entire Insolvency process afresh and moreover, the object of the Code states that Insolvency Process is a time bound process and shall be completed within the stipulated time.
Secondly, the case clearly states that the Personal Guarantor is not ipso facto discharged from its liabilities on approval of the Resolution Plan. It is equally binding on every Creditor, Personal Guarantor or Stakeholder. The same is also reiterated in the Contract Act, 1872 that “the liability of the surety is co-extensive with that that of principle debtor”. Further, as per Section 140 of the Contract Act, 1872 Personal Guarantor cannot avail the subrogation rights after the approval of the Resolution Plan.
The present judgement can give restless nights to the chairman of various companies and will bring a sigh of relief to various banks. Previously, banks were unable to proceed against the personal guarantors of various companies who were majorly chairpersons, directors or promoters of the companies. One such example can be observed in the resolution of Bhushan Steel and Power, wherein the promoters have given guaranties of about 24,550 crores, however, the banks could not proceed against them simultaneously as the company was undergoing an insolvency resolution process. It was a required step and this upholding of the notification in this judgement is a welcome step in reducing the non-performing assets and in furtherance of the objectives of the IBC.
Finally, it was declared by the Supreme Court that the notification is not ultra vires as it was not excessive legislation and further held that stage-wise implementation of the IBC is valid. Petitioners stated that liability of the personal guarantor is coextensive with that of principal borrower, however, the liability is not merely co-extensive but also joint and hence passing of the resolution plan cannot absolve the personal guarantor entirely. It can be inferred from Section 60(2) of the IBC that personal guarantors are within the scope of liquidation or bankruptcy. The notification was held valid and all of the writ petitions in this matter were dismissed.
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