Lalit Kumar v. UOI: Personal Guarantors Under Bankruptcy Code

*Anushka Juneja

Through the Supreme Court’s recent verdict in the Lalit Kumar v. Union of India case, the journey determining the treatment of personal guarantors under the Insolvency and Bankruptcy Code( “the Code” or “IBC”) has finally come to an end. This piece attempts to provide a critical analysis of the said judgment.

Facts

The petitioners in their capacity as promoters, directors or chairman had furnished personal guarantees to financial institutions and banks. This had led to release of advances to various companies. On Nov 15,2021, the Central Government released a Notification under section 1(3) of the Code bringing into force part III of the Code which deals with insolvency of individuals. The Notification enabled the creditors to initiate insolvency proceedings against the personal guarantors to the corporate debtors.

The Personal guarantors were now to be treated as “separate species” under IBC. As a consequence, demand notices proposing to commence insolvency proceeding were delivered to the petitioners. This led to commencement of resolution process under part III of the code against some of the petitioners. Subsequently, a clutch of petitions were filed before several High Courts challenging the legality of the impugned Notification. At the Government’s request, the Apex Court transferred the petitions to itself.

Judgement

One of the major contentions of the petitioners was that the proviso to section 1(3) of the Code vested power with the government to bring in force distinct provisions of the code at different points in time. Hence, the power under the said code was a function of conditional legislation. Whereas the action of the government was an exercise of legislative power which is impermissible in law. The said section did not grant any power to the executive to adopt a selective approach and bring in force the provisions of the code only in relation to personal guarantors to corporate debtors. Therefore, it was asserted that the notification is an exercise of excessive delegation.

To determine the scope of conditional and delegated legislation, a number of precedents were analyzed by the court. Further, to answer the above question as raised by the petitioners, the court took into account the stage by stage operationalization of different provisions of the code and went on to determine the objective of the legislature.

The insolvency proceeding relating to individuals is regulated by part III of the code. Section 2 of the Code entails the provisions on which the code applies. Unamended Section 2 did not subcategorize “individuals”, all of them fell under one descriptive description and hence were treated the same. The Adjudicating Authority for all individuals according to part III is Debt recovery tribunal whereas the unamended Section 60 which falls under part 2 provided NCLT as the Adjudicating Authority in relation to personal guarantors. Hence, there was a clear ambiguity in relation to treatment of personal guarantors.

This inconsistency was solved through the Insolvency And Bankruptcy Amendment Act, 2018 (“2018 Amendment”). Section 2(e) was altered and the individuals were subcategorized into: (a) personal guarantors (b) partnership firms and proprietorship firms and (c) other individuals. This move was brought in light by the Working Group’s Report On Individual Insolvency which had recognised the intrinsic connection between the corporate debtors and personal guarantors. Section 60 of the Code was also altered through the 2018 amendment. Section 60(2) was made applicable to insolvency proceedings of a corporate guarantor or a personal guarantor to a corporate debtor. As a result, unified adjudication through NCLT was achieved for resolution of disputes in relation to personal guarantors to corporate debtors.

Through the 2018 amendment, same forum was provided to all the stakeholders involved. The creditors could now consider a more holistic picture in terms of availability of assets. It was, hence, held that the amendment sought to streamline the resolution process.

The court therefore taking into account the step-by-step implementation of the Code and acknowledging that legislature’s intent was never to make the code applicable on all the individuals, held that the Notification was valid.

Guarantor’s rights: Contracts vs IBC

The liability of the corporate debtors comes to an end once the resolution process has been approved by the adjudicating authority. However, the code does not bar the creditor from moving against the guarantor for the recovery of the remaining amount. It is laid down in Section 133 of the Contract Act that if any alteration is made in terms of the contract without the guarantor’s acquiescence then the liability of the said surety would be discharged.

In this context, the second issue that was raised by the petitioners was that the protection that is provided to the personal guarantors under Law of Contracts is taken away through the impugned Notification. The court while relying on State Bank Of India vs V. Ramakrishnan held that an approved resolution plan is binding on all stakeholders including the guarantors. The liability of the personal guarantors under section 31 of the code won’t ipso facto be discharged because the extinguishment of the debt was through an involuntary process i.e. by operation of law, liquidation or insolvency.

The legality of the notification was hence upheld by the apex court. The transferred cases, transferred petitions and writ petitions were therefore, dismissed.

Analysis

No doubt, this judgement is magnificent in terms of its ripple effects and will have a significant impact on the financial system which is already reeling under bad loans, by helping expedite the resolution process. Parallel proceedings against the corporate debtor and the guarantor would also aid the NCLT “consider whole picture about availability of assets during the insolvency process.” Hence, to a large extent, the judgement settles the dust pertaining to legality of the impugned notification.

However, there are some questions that have not been catered to and more clarity is sought on these specific points. There is no clear position of law as to whether, after the approval of the Resolution plan but before it actually pays off, the creditors are allowed to proceed against the personal guarantors for the entire amount or the balance amount. This ambiguity may lead to unjust enrichment of the creditors if they are allowed to proceed for the entire amount or the resolution applicant may benefit hugely. Since at this stage the subrogation rights of personal guarantors are taken away by the law, suffering would befall the personal guarantors.

For initiation of corporate insolvency resolution process against debtors and personal guarantors, the minimum threshold is rupees one crore and rupees hundred respectively. The said Notification does not consider this disparity and this may lead to harassment of guarantors because the resolution process against the debtor might be stopped owing to the application of Section 101 of the Code.

The Notification has not been laid down in any of the parliamentary houses till date. This is a clear violation of Section 241 of the Code which provides for every rule and regulation made under it to be laid before each house of the Parliament.

Conclusion

This judgement is no doubt magnanimous and will ring loud in the ears of the people involved in the business community. It marks an end to the protracted personal guarantor’s saga. However, for the implementation of the provisions of the Code in line with the intention of the lawmakers, clarity must be provided on the points that have been pushed by the author and the pointed lacunae must be filled up.

*The author is a first-year student at Gujarat National Law University.