Introduction
In a seminal decision1, the Supreme Court of India ("Supreme Court") upheld the notification dated 15 November 2019 ("Impugned Notification") issued by the Ministry of Corporate Affairs and the Insolvency and Bankruptcy (Application to Adjudicating Authority for Insolvency Resolution Process of Personal Guarantors to Corporate Debtors) Rules, 2019 that brought into effect certain provisions of Part III of the Insolvency and Bankruptcy Code, 2016 ("IBC") pertaining to the insolvency resolution of personal guarantors to corporate debtors ("personal guarantors").
Facts
The Impugned Notification brought into force Sections 2(e), 78 (except with regard to fresh start process), 79, 94-187, 239(2)(g),(h)&(i), 239(2)(m) to (zc), 239(2)(zn) to (zs) and 249 to the extent that it was applicable to personal guarantors. Subsequently, many parties/guarantors were served with demand notices based on various counts, leading to initiation of insolvency resolution process under Part III of the IBC.
Grounds of challenge
One of the main arguments advanced was that the Impugned Notification amounted to excessive delegation by the Central Government and is ultra vires the powers granted to the Central Government under Section 1(3) of the IBC. It was argued that provisions of the IBC under the Impugned Notification are not severable, as they do not specifically apply to insolvency proceedings against personal guarantors but only pertain to insolvency resolution of individuals and partnership firms.
The Impugned Notification suffers from non-application of mind, because the Central Government failed to bring into effect Section 243 of IBC, which would have repealed the Presidency Towns Insolvency Act, 1909 ("PTI Act") and the Provincial Insolvency Act, 1920 ("PIA Act"). This allows action to be initiated against personal guarantors under the IBC as well as under the PTI Act/PIA Act. It was argued that 'personal guarantors' stand excluded from the definition of 'individuals' under Section 2(g) of the IBC, thereby arguing that the Impugned Notification is manifestly arbitrary and discriminatory as (i) there is no intelligible differentia for carving out personal guarantors; and (ii) a single procedure is provided irrespective of whether the creditor is financial or operational, despite there being fundamental differences in the nature of loan provided by financial/ operational creditors2.
It was also argued that the liability of a guarantor is co-extensive with that of the principal debtor3. However, the Impugned Notification allows creditors to unjustly enrich themselves by claiming in the insolvency process of the personal guarantor without accounting for the amount realized by them in the proceedings pertaining to corporate insolvency resolution ("CIRP") of the corporate debtor. Since the claims against the principal debtor is extinguished upon the conclusion of the insolvency process, any liability owed by its guarantors must also be extinguished4.
Arguments by Union of India
IBC was amended in 2018 to introduce three classes of debtors, namely personal guarantors, partnership firms and proprietorship firms. This was done so as to have a clear division between corporate debtors, personal guarantors and other individuals under the IBC. This was in tandem with amendment to Section 60(2)5 of the IBC, which was made applicable to personal guarantors as well. If the Impugned Notification was not enacted, the resolution applicant wishing to bid for takeover of the corporate debtor and operate it as a running concern would be faced with a huge liability. The personal guarantor in most cases would be one of the individuals primarily responsible for the insolvency of the corporate debtor, but would be out of the resolution process and would have to be separately proceeded against.
Further, it was argued that unifying the process for corporate debtors and its personal guarantors would enable the adjudicating authority to have a clear picture of the situation of the debtor. The executive has the power to bring into force any one provision of a statute at different times for different purposes6. Section 1(3) of the IBC has to be interpreted to give flexibility to the Central Government to implement provisions of the IBC, in furtherance to the value maximization objective of the IBC. The change was brought about given the dynamics and the interwoven connection between the corporate debtor and a guarantor. The liability of a guarantor is co-extensive, joint and several with that of the principal borrower unless the contrary is provided by way of a contract. Hence, until the debt is paid off to the creditor in entirety, the guarantor's liability is not absolved7.
Judgment of the Supreme Court
Aim of the IBC
The Supreme Court observed that the aim of the IBC is to (a) promote entrepreneurship and availability of credit; (b) ensure the balanced interests of all stakeholders; and (c) promote time-bound resolution of insolvency for corporate persons/partnership firms/individuals.
Amendments to the IBC
Initially, personal guarantors were a part of the larger category of persons under Section 2(e)8. Expert bodies had recommended that personal guarantors should be involved in the proceedings by the same adjudicator. Consequently, Section 2(e) was amended [resulting in coming into force of Sections 2(e), (f) and (g)] to ensure that the adjudicating body dealing with the insolvency of corporate debtors also deals with insolvency proceedings of its personal guarantors.
The Supreme Court observed that Section 2(e) and Section 60(2) were amended to strengthen the CIRP process and since initially the IBC was not made applicable to individuals, the court had no occasion to consider the validity and effect of exercise of the power under Section 1(3). It was noted that Section 60(4) vests the NCLT with all powers of the DRT for the purposes of Section 60(2) and thus also showers the NCLT with powers under Part III of the IBC.
Power of Central Government
On a reading of the judgments9 tendered by the petitioners, the Supreme Court noted that in the past, the power to extend laws has been upheld. The Supreme Court analyzed the judgments10 tendered by the respondent and noted that the staggered implementation was undertaken to fulfill the objectives of the IBC. It was observed that there is no constitutional imperative that a law or policy should be implemented all at once11. There is a close proximity and inter-relatedness between corporate debtors and personal guarantors. All matters that were likely to impact, or have a bearing on a corporate debtor's insolvency process were sought to be clubbed together.
It was observed that the parliamentary intent was to treat personal guarantors differently from other category of individuals. However, given the interconnectedness between corporate debtors and their personal guarantors, it was realized that there would be uncertain outcomes if two forums were designated for the insolvency process of corporate debtors and its personal guarantors. Thus, the applicability of Part III to individuals and Part II to corporate persons, does not lead to incongruity; and there is sound reason why the forum for the process is to be common. Relying upon Sections 2(e), 60 and 179 of the IBC, the Supreme Court held that the Impugned Notification does not amount to impermissible and selective application of the IBC. There is no compulsion in the IBC that it must be applicable to all individuals or not at all. Thus, the exercise of power in issuing the Impugned Notification under Section 1(3) was held not to be ulta vires.
Repeal of personal insolvency laws
The Supreme Court noted that Section 243, which provides for the repeal of the personal insolvency laws has not been notified. It was noted that Section 238 gives the IBC an overriding effect over the other prevailing enactments and may be this is the rationale for not notifying Section 243. Section 243(2) saves pending proceedings under PTI Act and PIA Act and if Section 243 is notified, the Impugned Notification would not cover pending proceedings against personal guarantors in other forums, thereby defeating the purpose of bringing the proceedings under the scope of adjudicating authorities/IBC.
Protection afforded under the Contract Act, 1872 ("Contract Act")
Section 31 of the IBC provides that the resolution plan shall be binding on the corporate debtor and its employees, members, creditors, guarantors and other stakeholders. After analyzing various sections12 of the Contract Act, it was reaffirmed that the language of Section 31 makes it clear that the approved plan is binding on the guarantor, to avoid any attempt to escape liability under the Contract Act13. The rationale for allowing directors to participate in meetings of the CoC is for the directors' liability as personal guarantors to persist against the creditors, and that an approved resolution plan can only lead to a revision of the amount of exposure, but not absolve liability. The Supreme Court held that "the sanction of a resolution plan and finality imparted to it by Section 31 does not per se operate as a discharge of the guarantor's liability." Relying upon its earlier decisions14, the Supreme Court noted that "an involuntary act of the principal debtor leading to loss of security, would not absolve a guarantor of its liability".
The Supreme Court relied upon a UK judgement15 to explain that a creditor can proceed against either or both, i.e., the corporate debtor and/ or the surety. It was observed that approval of a resolution plan does not ipso facto discharge a personal guarantor of his liabilities under the contract of guarantee, which is an independent contract in itself.
Conclusion
The judgment is a welcome move being in furtherance of the objectives of the IBC. This judgment gives NCLTs the jurisdiction to deal with personal guarantors of corporate debtors alongside the CIRP proceedings of corporate debtors/principal borrowers, thereby having a more comprehensive system in place for recovery of debts. The combined process would also ensure that those responsible do not skirt their liabilities, which was previously possible due to the separate frameworks that existed for recovery of dues from borrowers and their guarantors.
Footnotes
1. Lalit Kumar Jain v. Union of India and Ors., Transferred Case (Civil) No. 245/2020
2. (2019) 4 SCC 17
3. Section 128 of Indian Contract Act, 1872
4. (2012) 171 Comp Cas 94, (2019) SCC Online NCLAT 542
5. Section 60(2) mandates that where a corporate insolvency resolution process or liquidation proceeding of a corporate debtor is pending before the NCLT, an application relating to the insolvency resolution or bankruptcy of a personal guarantor of such corporate debtor shall be filed before the NCLT.
6. (1964) 6 SCR 913, 1954 SCR 842, (2008) 10 SCC 368, (1988) 2 SCC 433
7. AIR 1969 (1) SCR 620, AIR 1992 SC 1740, (2009) 9 SCC 478, (2002) 5 SCC 80, 2019 SC Online Cal 7288 at para 34 and 35, 2018(17) SCC 394
8. Partnership firms and individuals
9. State of Bombay v. Narothamdas Jethabai 1951 2 SCR51, Re The Delhi Laws Act, 1912 ([1951] S.C.R. 747), 1960 (2) SCR 671, (1998) 1 SCC 318, (2006) 12 SCC 753, (1949-50) 11 FCR, 595.
10. 1954 SCR 842, (1964) 6 SCR 913, (1976) 2 SCC 953
11. (2003) 8 SCC 369
12. Sections 128, 129, 130, 131, 133, 134, 140 and 141 of the Indian Contract Act, 1872.
13. SBI v. V. Ramakrishnan, (2018) 17 SCC 394
14. 1982 (3) SCC 358, (2002) 5 SCC 54, (2002) 5 SCC 80
15. 2012 (1) All ER 883 Paras 11, 12, 53-54
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