This article is written by Vishwanath Bahuguna, pursuing a Certificate Course in Insolvency and Bankruptcy Code from LawSikho.
Table of Contents
Introduction
Personal guarantors under bankruptcy and insolvency laws refers to an individual who is the surety in a contract of guarantee to a corporate debtor[1]. Furnishing a personal guarantee in simpler words refers to a situation wherein, a corporate debtor becomes unable to repay the debt, the individual assumes personal liability for the outstanding arrears/dues.
Section 126 of the Indian Contracts Act, 1882[2] (hereinafter referred to as “the Act,1882”) deals with the concept of guarantee and explains it as an obligation on a surety to honour the promise of the principal debtor by paying the principal debtor’s present or future debts.
Let us cite an instance to understand the concept more clearly. In January, 2020, Mr. Jayde Robin gave personal guarantees for two loans worth nearly 5 crores and 10 crores extended to his companies Xicom Private and Strata Dot Tel, respectively by KBC Bank. That loan accounts of Xicom Private and Strata Dot Tel had been declared non-performing assets in September 2020 after companies failed to repay its pay debt. In such a case, Section 128 of the Act, 1882[3] creates a co-extensive liability between the surety (Mr. Jayde Robin) and the debtor (KBC bank). Hence, Mr. Jayde Robin is liable towards outstanding debts of the KBC Bank. It is to be noted here that any legal proceedings for recovery against the principal debtor shall include personal guarantor.
This article tries to analyse and discuss the status of a guarantor under the Insolvency & Bankruptcy Code, 2016 (hereinafter referred to as “Code”). The Parliament to deal with bankruptcy and insolvency issues introduced and passed the Code. However, after 3 (three) years post passing of the Code, provisions rendering insolvency and bankruptcy proceedings against personal guarantors were notified vide Gazette Notification dated 15.11.2019 commencing effective from 01.12.2019. An instance of personal guarantee and remedies for creditors is explained below herein for better understanding of the concept.
Let us now discuss the guarantor’s liability under the moratorium period.
Guarantor’s liability under moratorium period
The period of moratorium under Section 14 of the Code[4] would not apply to personal guarantors of a corporate debtor. This view was taken by the Hon’ble Bombay High Court in Alpha & Omega Diagnostics (India) Limited v. Asset Reconstruction Company of India & Ors.[5] Further, the same view was upheld by the Hon’ble Supreme Court Of India in State Bank of India v. Ramakrishnan & Anr.[6]
Upon looking closer to the concept of guarantor’s liability during the moratorium period, Sections 96 and 101 have to be contrasted with Section 14 of the Code. When an application is filed under part III of the Code, an interim-moratorium or a moratorium is applicable in respect of any debt due. However, when we talk with regard to applicability of period of moratorium on personal guarantee/liability it is completely separate moratorium, applicable separately in the case of personal guarantors against whom insolvency resolution process may be initiated under Part III of the Code. It is to be noted herein that the protection of the moratorium under relevant section of the Code is far greater than of section 14 in that pending legal proceedings in respect of the debt and not the debtors are stayed. The difference in language between Sections 14 and 101 is for a reason. Section 14 refers only to debts due by corporate debtors, who are limited liability companies, and in the vast majority of cases, personal guarantees are given by directors who are in management of the companies. Therefore, it can be safely stated that the object of the Code is not to allow such guarantors to escape from an independent and co-extensive liability to pay off the entire outstanding debt, which is why section 14 is not applied to them.
Now comes the question as to who has jurisdiction to determine guarantor’s liability, whether the NCLT or the Debt Recovery Tribunal. To answer it, the article discusses prior scenarios with regard to provision rendering insolvency and bankruptcy proceedings against personal guarantors which was notified vide Gazette Notification dated 15.11.2019. Since, at that time, Part III of the Code was not notified and brought into force and the same is entitled as “Insolvency Resolution and Bankruptcy for Individuals and Partnership Firms” under the Code. The repealing provision, namely Section 243[7] of the Code which repeals the Presidency Towns Insolvency Act, 1909 (hereinafter referred to as “the Act, 1909”) and the Provincial Insolvency Act, 1920 (hereinafter referred to as “the Act, 1920”) was not been brought into force. Section 249[8] of the Code, which amends the Recovery of Debts Due to Banks and Financial Institutions Act, 1993, (hereinafter referred to as “the Act, 1993”) so that the Debt Recovery Tribunals (hereinafter referred to as “the DRT”) under the Act, 1993 can exercise the jurisdiction of the Adjudicating Authority conferred by the Code, was also not been brought into force. Accordingly, as far as personal guarantors were concerned, they continued to be proceeded against under the Act, 1909 and the Act, 1920 prior to commencement of above-mentioned Notification dated 15.11.2019. Hence, at that relevant time, stakeholders who intend to pursue their insolvency cases may approach the appropriate authority/court under the existing enactments, instead of approaching the DRT. Therefore, proceedings under the Securitisation and Reconstruction of Financial Assets and Enforcement of Securities Interest Act, 2002 against the guarantors can be continued. The same has been reiterated by the Hon’ble Delhi High Court in its order dated 02.11.2020.[9]
The above situation with respect to jurisdiction to determine liability of guarantor widened after commencement of Notification dated 15.11.2019. The DRT was defined as an “Adjudicating Authority” within Section 3(a)(ii) of the Code[10] for cases other than sub-clause 3 (i) of the Code. Say for instance, the dispute with respect to breach of contract of guarantee can be brought before the DRT for adjudication purposes. It would not be inappropriate herein to state that the sole purpose of the Act, 1993 is recovery of debts. On the contrary, the Code deals with other things as well.
Guarantors right to debt recovery via insolvency proceedings
If the guarantor pays the defaulted amount/debt on behalf of the principal debtor to the creditor. In such a situation, the principal debtor now owes the amount of repaid debt by the guarantor to the principal debtor’s creditor. Further, resulting in the guarantor now becoming the creditor of the principal debtor. Say for instance, Mr. Joe White has given personal guarantee for a credit facility worth 2 crore extended to his company M/s Mitubhushi Private Limited by XYZ Bank. That in March, 2017 the company is unable to repay its debts towards the loan account. Now, following the settled principal proposition in view of Section 128 of the Act, 1881 the liability of the guarantor/surety is co-extensive with that of the principal debtor towards the loan account. Owing to the same, Mr. Joe White repays the defaulted amount. In such a scenario, after disposing off the obligations of the company, Mr. Joe White acquires the right to stand in the shoes of the company. The same view was first evolved by the Court in Morgan v. Seymone[11].
Further, in the case Amrit Lai Goverdhan Lalan v. State Bank of Travancore[12] held that the guarantor is invested with all rights of the creditor against the debtor.
Welcome deviation from the SICA practices
The Parliament of India in the year 1985 introduced and passed a legislation namely, the Sick Industrial Companies Act, 1985 (hereinafter referred to as “the Act, 1985”). The objective of the Act, 1985 was to timely detection of sick and potentially sick companies owning industrial undertakings and helping them in its revival and for matters connected therewith or incidental thereto. Under the Act, 1985 a Board was made to take preventive, ameliorative, remedial and other measures to secure the sick company from liquidation. It is to be noted that the regime of the Act, 1985 if a sick company was going through any rehabilitation procedure as mentioned therein, then such proceedings were kept suspended.
Thereafter, the Parliament of India in the year 1993 introduced another legislation namely, the Act, 1993 with sole purpose of recovery of debts. The problem started when the above stated provision of suspension barred proceedings before the DRT under the Act, 1993 subject to prior permission of the Board for Industrial and Financial Reconstruction established under the Act, 1985. The issue was dealt by the Hon’ble Supreme Court in KSL & Industries Ltd. v. Arihant Threads Ltd. & Ors.[13] Wherein, it was held that section 34(2) of the Act states that the provisions of the Act, 1993 shall be in addition to and not in derogation of the Act, 1985.
Conclusion
This article concludes by laying emphasis and an attempt to show a holistic contrast between the Code and liability of a guarantor upon default committed by the principal debtor arises when the same has been admitted by the Adjudicating Authority under the Code.
References
[1] Section 5(22) of the Insolvency & Bankruptcy Code, 2016
[2] https://indiankanoon.org/doc/53550/
[3] https://indiankanoon.org/doc/1377136/
[4] https://www.mca.gov.in/Ministry/pdf/TheInsolvencyandBankruptcyofIndia.pdf
[5] Company Appeal (AT) (Insol.) No. 116 of 2017
[6] (2018) 17 SCC 394
[7] https://www.mca.gov.in/Ministry/pdf/TheInsolvencyandBankruptcyofIndia.pdf
[8] https://www.mca.gov.in/Ministry/pdf/TheInsolvencyandBankruptcyofIndia.pdf
[9] Kiran Gupta v. State Bank of India & Anr. W.P.(C) 7230/2020
[10] http://www.mca.gov.in/Ministry/pdf/BankruptcyRulesPGCD_15112019.pdf
[11] (1638) 1 Rep Ch 120
[12] 1968 AIR 1432
[13] (2015) 1 SCC 166
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