India: Understanding The Liability Of Personal Guarantors Under The Insolvency And Bankruptcy Code, 2016

Introduction:

The enactment of the Insolvency and Bankruptcy Code, 2016 (IBC) revolutionized India's insolvency landscape by providing a comprehensive framework for resolving corporate insolvencies. Alongside this, the IBC also introduced significant changes concerning the liability of personal guarantors. This article aims to shed light on the liability of personal guarantors under the IBC and the implications it carries for them.

The Concept of Personal Guarantors:

A personal guarantor is an individual who provides a guarantee to secure the obligations of a borrower, typically a corporate entity, towards a lender. When the borrower defaults on its obligations, the personal guarantor becomes liable to repay the dues on behalf of the borrower.

Bird's view of Courts/Tribunals of India before the Notification dated 15.11.2019:

1. State Bank of India vs V. Ramakrishnan and Anr.¹

(Decided on August 14, 2018)

The issue that came for consideration in State Bank of India vs V. Ramakrishnan and another before the Hon'ble Supreme Court of India ("Ramakrishnan Judgment") was if section 14 of the IBC, which provides a moratorium for the limited period, would apply to a personal guarantor of a corporate debtor as well?

In Ramakrishnan Judgment dated August 14, 2018, the Hon'ble Supreme Court clarified that the moratorium is applicable only on the corporate debtor and not the personal guarantors.

2. Vishnu Kumar Agarwal vs Piramal Enterprises Ltd.²

(Decided on January 8, 2019)

The questions that arose for consideration before the Hon'ble National Company Law Appellate Tribunal in the matter of Dr. Vishnu Kumar Agarwal vs Piramal Enterprises Ltd [2019] ("Piramal Judgment") were:

i) Whether the Corporate Insolvency Resolution Process can be initiated against a corporate guarantor, if the principal Borrower is not a corporate Debtor or corporate Person; and

ii) Whether the Corporate Insolvency Resolution Process can be initiated against two corporate guarantors simultaneously for the same set of debt and default?

While answering the first question, the Hon'ble National Company Law Appellate Tribunal held that before initiating the CIRP against the corporate guarantors, it is not necessary to initiate CIRP against the Principal Borrower.

While considering and answering the second question, Hon'ble National Company Law Appellate Tribunal held if CIRP has been initiated against one of the "Corporate Debtors", then after such initiation, CIRP cannot be triggered for the same debt against the other "Corporate Debtor".

However, the Hon'ble National Company Law Appellate Tribunal gave a contrary view in its judgment in the matter of "State Bank of India vs. Athena Energy Ventures Private Limited"³ dated November 24, 2020 wherein it held that simultaneous initiation of CIRP against a Principal Borrower and its Corporate Guarantor is permissible under the IBC.

The Hon'ble NCLAT noted that the issue under the Piramal Judgment was whether CIRP could be initiated against two Corporate Guarantors simultaneously for the same set of debt and default and not if the application can be filed against the Principal Borrower as well as the Corporate Guarantor. Also, NCLAT observed that Piramal Judgment did not notice Section 60(2) and 60(3) of the IBC.

Notification no. S.O. 4126 (E) dated 15.11.2019, an amendment to the Insolvency & Bankruptcy Code of India:

In November 2019, the Government of India introduced a significant amendment to the IBC, bringing personal guarantors within its purview and the same was enforced from 01.12.2019. Prior to this amendment, personal guarantors were not directly subjected to the insolvency process. The impugned notification dated 15.11.2019 read as under:

"In the exercise of the powers conferred by sub-section (3) of section I of the Insolvency and Bankruptcy Code, 2016 (31 of 2016), the Central Government hereby appoints the 1st day of December 2019 as the date in which the following provisions of the said code only in so far as they relate to personal guarantors to corporate debtors shall come into force:

a. Clause (e) of section 2;

b. Section 78 (except with regard to fresh start process) and section 79;

c. Sections 94 to 187 (both inclusive);

d. Clause (g) to clause (i) of sub-section (2) of section 239;

e. Clause (m) to clause (zc) of sub-section (2) of section 239;

f. Clause (zn) to clause (zs) of sub-section (2) of section 240;

g. Section 249."

Insolvency Process for Personal Guarantors:

With the amendment, a creditor now has the option to initiate insolvency proceedings against the personal guarantor of a corporate debtor under Chapter III of the Insolvency & Bankruptcy Board of India. The process for personal guarantors closely aligns with the corporate insolvency resolution process under the IBC.

Implications for Personal Guarantors:

The inclusion of personal guarantors under the IBC has significant implications for individuals who have given personal guarantees. They are now exposed to the risk of insolvency proceedings, leading to potential loss of personal assets. Personal guarantors must be cautious when providing guarantees and fully comprehend the financial risks involved.

Effect & Chaos of Notification dated 15.11.2019:

The notification dated 15.11.2019 amending the Insolvency & Bankruptcy Code, 2016 created a lot of chaos in the financial and the corporate market and therefore various petitions challenging were filed by the promoters, directors etc., in various High Courts of the country raising the question on vires and constitutionality of the said notification.

All this chaos caused, made the Insolvency and Bankruptcy Board of India to move an application before the Hon'ble Supreme Court of India and asked to solve all the chaos and to take it at utmost importance. The Hon'ble Supreme Court while exercising its powers under Article 139A⁴ to transfer cases and to settle the common question of law under Article 32⁵ concerning the interpretation of the provisions of the Code, presided on this matter.

Ruling of Hon'ble Supreme Court of India in the case of "Lalit Kumar Jain vs. Union of India & Ors." ⁶:

The Hon'ble Supreme Court of India held as under:

The Supreme Court clarified that the sanction of a resolution plan and its finality under Section 317 IBC does not per se discharge the guarantor's liability. Relying on the judgement titled "Maharashtra SEB v. Official Liquidator", the Court held that within the meaning of Section 128 of the Contract Act, in a case of an unequivocal guarantee, the liability of the guarantor continues as there is no discharge under Section 1349 of the Contract Act. It was observed that the principal debtor is discharged by an involuntary process of operation of law and not by an act or omission of the creditor and thus the creditor can proceed against the guarantor.

Therefore, the discharge of liability of the corporate debtor due to an operation of law in liquidation proceedings does not ipso facto absolve the personal guarantor from its liability.

Reliance was also placed upon case titled "SBI v. V. Ramakrishnan" wherein the Supreme Court held that a discharge of liability could not be sought by the guarantor upon approval of a resolution plan which could contain terms allowing continuation of debt of the guarantors. Moreover, since the liability of the personal guarantor arises from an independent contract, the nature and extent of the liability would depend on the terms under the contract.

That the impugned notification was not an instance of legislative exercise amounting to impermissible and selective application of provisions of Code. It further observed that the legislative intent was to treat the personal guarantors differently from other class of individuals provided in the Code. Section 179 of the Code provides that subject to Section 60 of the Code, the adjudicating authority for bankruptcy matters relating to individuals would be Debt Recovery Tribunals. However, the above provision is subject to Section 60, which provides that adjudicating authority for insolvency matters relating to corporate persons would be NCLT.

The Supreme Court held that Section 31(1) of the Code makes it clear that the guarantor cannot escape payment, since the resolution plan, which has been approved by NCLT, may also include the provisions of payments to be made by such guarantor. Therefore, finality to the insolvency proceedings per se does not operate as a discharge of guarantors' liability under the contract of guarantee. The Court, therefore, held that the abovementioned provisions and the amendment of 2018 clearly establishes the legislative intent of unification of the resolution process of corporate debtors as well as bankruptcy process of its guarantors i.e., corporate and personal, before the same adjudicating authority. The Court then upheld the impugned notification and dismissed the writ petitions.

Proceedings pending before Hon'ble Supreme Court of India:

However, the constitutional validity of the provisions of Chapter III of Insolvency & Bankruptcy Code, 2016 have been challenged by various writ petitions under Article 32 of the Constitution of India, leading matter titled as "Dilip B. Jiwrajka Vs. Union of India" ⁽⁷⁾ before the Hon'ble Supreme Court of India raising following objections:

The Writ petitions are still pending before the Hon'ble Supreme Court of India and decision on the validity of Chapter III of the Insolvency & Bankruptcy Code of India can provide a major chapter to begin the short span of Insolvency laws in India.

Conclusion:

The liability of personal guarantors under the Insolvency and Bankruptcy Code, 2016 has introduced a paradigm shift in India's insolvency landscape. The amendment has expanded the scope of the IBC to include personal guarantors and subjected them to the insolvency process. It is crucial for individuals acting as personal guarantors to fully understand the risks involved and seek professional advice when entering into such agreements. As the IBC evolves, further clarification and judicial precedents will continue to shape the liability of personal guarantors and provide a more comprehensive framework for their protection and resolution.

Footnotes

1 3(2018) 17 SCC 394

2 Company Appeal (AT) (Insolvency) No. 346 of 2018

3 Company Appeal (AT) (Ins.) No. 633 of 2020

4 Article 139 A of the Constitution of India, 1949: Transfer of Certain Cases

• Where cases involving the same or substantially the same questions of law are pending before the Supreme Court and one or more High Courts or before two or more High Courts and the Supreme Court is satisfied on its own motion or an application made by the Attorney General of India or by a party to any such case that such questions are substantial questions of general importance, the Supreme Court may withdraw the case or cases pending before the High Court or the High Courts and dispose of all the cases itself: Provided that the Supreme Court may after determining the said questions of law return any case so withdrawn together with a copy of its judgment on such questions to the High Court from which the case has been withdrawn, and the High Court shall on receipt thereof, proceed to dispose of the case in conformity with such judgment.

• The Supreme Court may, if it deems it expedient so to do for the ends of justice, transfer any case, appeal or other proceedings pending before any High Court to any other High Court

5 Article 32 of the Constitution of India, 1949: Remedies for enforcement of rights conferred by this Part?.

6 (2021) 9 SCC 321

7 W.P. (C) No.1281/2021

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.