India: Recourse Against Personal Guarantors Upheld: Analysing The Supreme Court's Decision

I. Introduction

On November 9^th, 2023 the Hon'ble Supreme Court of India ("the Court") in Dilip B Jiwrajka v. Union of India & Ors.¹ decided a batch matter comprising of three hundred and eighty-four Writ Petitions, challenging the constitutional validity of Sections 95 to 100 under Part III of the Insolvency and Bankruptcy Code, 2016 ("the Code"). The impugned provisions deal with the insolvency of individuals, including personal guarantors.

Personal guarantors are individuals who, by way of a contract, undertake to fulfil the obligation of debt repayment of a corporate debtor in the event that such corporate debtor fails to do so. The creditors in such cases can pursue action against the corporate debtor and the personal guarantor since the latter's liability is an extension of the former's, subject to the conditions stipulated in the contract.² The jurisprudence regarding this practice required some clarity, as there were multitudes of applications pending before judicial forums concerning personal guarantors.

The Court upheld the validity of the aforementioned provisions in this much-awaited decision. The major concern of the petitioners was the appointment of the Resolution Professional ("RP") immediately after the filing of the application and the automatic imposition of interim moratorium under Sections 95 and 96 of the Code, without any adjudication regarding the nature of the 'debt', and the RP's power to seek information from the debtor or the personal guarantor. While comparing the insolvency proceedings against a corporate debtor and an individual, and discussing the legislative intent behind the impugned provisions, the Court rejected the contentions of the Petitioners. In this article, we discuss the concerns raised by the Petitioners, the Court's response, and the practical implications of the decision.

II. A Brief of Submissions

1. Submissions on behalf of the Petitioners

a. The major challenges raised by the Petitioners against the provisions in question were as follows:

b. judicial in nature, thereby violating the object behind the Code. Such information is sometimes confidential, which violates the fundamental right of privacy of the debtors, and principles of natural justice.

2. Submission on behalf of Respondent

The Respondents, defending the provisions, argued that:

a. The distinction in Part II and Part III for the appointment of RP is a distinction created by the legislature based on an intelligible differentia, i.e., the procedure followed in corporate insolvency is different from the procedure followed in the insolvency of an individual. A moratorium under Part II is imposed against a Corporate Debtor, which prohibits the Corporate Debtor from transferring, encumbering, alienating, or disposing of any of its assets. Whereas the interim moratorium under Part III does not impose any such embargo on the alienation of assets, legal rights, or beneficial interest of the debtor.

b. The Solicitor General of India submitted that the moratorium under Section 96 of the Code is for the benefit of the debtor. Unlike the moratorium under Section 14, Section 96 does not impose any embargo on the alienation of assets, legal rights, or beneficial interests of the debtor.

III. The Court's Interpretation

1. Role of the Resolution Professional

The Court observed that an RP appointed under Section 97 of the Code is a facilitator and can only provide information and make recommendations to the Adjudicating Authority after collating all the facts. Further, there is a significant distinction in the powers conferred upon the RPs appointed under both the Parts of the IBC. Unlike in Part II, in an application under Part III, the RP does not have the power to take over the assets or the business of the debtor. It can only gather information and make its recommendation to the adjudicating authority. Therefore, its role is limited only to facilitating the Adjudicating Authority in arriving at its decision with respect to the application. It opined that the language of the Code clearly delineates that the role of the RP isn't adjudicatory in nature.

The Court also noted that as per Section 78 of the Code, an application under Section 94 or 95 can be moved if the default is of more than INR 1000/- (Rupees One Thousand) and less than INR 1,00,000/- (Rupees One Lakh) or any other amount set by the Central government. Considering the same, the adjudicating authority will be overwhelmed with the number of cases filed for any amount as low as INR 1000/- (Rupees One Thousand).

2. The Impact of Moratorium under Sections 14 and 96 of the Code

The Court emphasised the phrase "in respect of any debt" used in clauses (b)(i) and (b)(ii) of Section 96 of the Code, and observed that the purpose of the moratorium under Part III is only to restrain the initiation of any proceedings against the debtor concerning the debt, and not the debtor. Whereas a moratorium under Section 14 of Part II is implemented by the adjudication authority, which prohibits any fresh or continuing legal action against the debtor. Consequently, the Court created an important distinction between the two types of moratoriums under Sections 96 and 14 respectively. The Court opined that the former was provided as a protective measure, while the latter is intended to restrain corporate debtors from transfer, encumbrance, alienation, or disposal of assets, legal rights, or beneficial interests.

3. Principle of Natural Justice

The contention of the Petitioners that the automatic initiation of a moratorium and appointment of RP is an ex parte proceeding and is in violation of audi alteram partem, was rejected. Relying on Swiss Ribbons Private Limited v. Union of India³, the Court observed that the proceeding before the RP is not adjudicatory and is only administrative. Further, the Court observed that during the proceedings before the RP, the debtor is given an opportunity to prove that no such alleged debt exists, therefore there is no violation of principles of natural justice.

4. Right to Privacy viz. Personal Insolvency

While dealing with the argument pertaining to infringement of privacy, the Court held that the information that the RP is entitled to seek shall be relevant to the examination of the application. As per Regulation 7(2)(h) of the Insolvency and Bankruptcy Board of India (Insolvency Professionals) Regulations, 2016 read with para 21 of the First Schedule, the RP is obligated to maintain the confidentiality of the information related to the insolvency proceedings. Relying on the Constitution Bench judgment in K.S. Puttaswamy v. Union of India⁴, the Court held that the legitimate state interest behind Section 99(4) of the Code is to establish a comprehensive framework for individual insolvency and to aid the adjudicating authority. Hence there is a balance created between the object and the privacy rights.

5. The Constitutional Validity of the Provisions

The Hon'ble Supreme Court of India upheld the constitutional validity of Sections 95 to 100 of IBC. It held that the role of the RP, the powers conferred upon it, and the legitimate aim sought to be achieved by the said provisions brings the Court to the conclusion that the impugned provisions comply with Article 14 of the Constitution of India.

IV. Conclusion

The present judgment has clarified the position of law concerning the initiation of insolvency proceedings against personal guarantors, thereby settling a widely debated issue.

Furthermore, in upholding the validity of the impugned provisions, the Court also clarified the role and nature of the authorities that are the cornerstones of the IBC ecosystem in India. The Court also concluded that the provisions were within the ambit of the principles of natural justice and did not violate the Constitution of India. It highlighted that the procedure provided by the Code allowed all parties to the case to present their contentions before the proper authorities adequately.

Therefore, this decision supplies clarity as to the various challenges that have arisen in the IBC regime over the last few years, providing greater procedural and rational understanding to all the stakeholders. This significantly relieves credit market participants, specifically lenders, who could have otherwise lost their recourse to personal guarantors. Consequently, the Court's decision affirms the faith of the creditors in the ecosystem and ensures that the flow of credit remains intact.

Footnotes

1. Writ Petition (Civil) No. 1281 of 2021.

2. Section 128 of the Indian Contract Act, 1872.

3. (2019) 4 SCC 17

4. (2017) 10 SCC 1, para 310

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