SC Verdict for Personal Guarantors – Boon or Bane?

Prashansa Singh*

The Insolvency and Bankruptcy Code [“IBC”] was enacted in 2016 as a measure to overhaul the entire insolvency regime and consolidate the varied laws governing it in India. On 30th November 2016, the Central Government had notified the provisions under Part-II of the Code vide Section 1(3) of IBC and then, eventually, on 15th November, 2019 issued a notification enabling the application of provisions of Part-III of IBC to personal guarantors to the corporate debtor. However, application of Part-III was restricted, wherein it was made applicable only to personal guarantors to corporate debtors.

The Hon’ble Supreme Court, on 21st May, 2021, decided the case of Lalit Kumar Jain v. Union of India.[i]It was held that the existence or conclusion of Corporate Insolvency Resolution Process [“CIRP”]against a Principal Debtor will not be considered a bar on initiation of insolvency resolution process of personal or corporate guarantors to corporate debtors. This means that creditors have the right to initiate insolvency resolution process against personal guarantors to a corporate debtor, even when the corporate debtor is already undergoing CIRP. Prima facie, this may appear to create an anomalous situation, which could go against the idea of having a unified CIRP under IBC and could also discourage guarantors from entering into guarantee contracts with the debtor, but there are other aspects which must be considered while examining this issue. This article analyses the aforementioned judgment of the Supreme Court.

A contract of guarantee is a contract in which a natural or an artificial person, i.e. the guarantor or surety, promises the creditor to discharge the liability of a principal debtor in case of default on part of the debtor. In case of a default on part of the debtor, the guarantor’s liability is co-extensive with that of the principal debtor, unless otherwise mentioned in the contract. This means that it is not necessary for the creditor to proceed against the principal debtor before he can proceed against the guarantor; and the creditor may directly proceed against the guarantor for the amount that is owed to them.

Through the Impugned Notification, certain provisions of Part III of IBC concerning individuals and partnership firms were made applicable to personal guarantors to corporate debtors and not the other entities of Part III, thus enabling the creditors to proceed for insolvency resolution of personal guarantors to corporate debtors. Since this would put guarantors at greater risk, the constitutional validity of the Impugned Notification was challenged, and adjudicated by the Supreme Court in Lalit Kumar Jain v. UOI.

The Judgment

• Section 1(3) of IBC

Section 1(3) of IBC states- “IBC shall come into force on the date decided by the Central Government, provided that different dates may be appointed for different provisions of the Code and any reference in any such provision to the commencement of the Code shall be construed as a reference to the commencement of that provision.” The Petitioners contented that the Executive was stepping outside the ambit of this section and was exploiting the powers given under it. According to them, Section 1(3)only empowers the Executive to bring the law into force at different points of time, but does not give it the power to pick and choose the subjects it will govern i.e. personal guarantors to corporate debtors in the present scenario. In reply, the Respondent stated that the ambit of powers given by Section 1(3) of IBC is wide and permits the Executive to implement IBC according to subjects.

The Supreme Court took into consideration the previous phased implementation of provisions of IBC and referred its own case SBI v. V Ramakrishnan[ii]to hold that the Central Government has followed a phased implementation of provisions of IBC in order to pay heed to the similarities or differences of various subjects concerned. Therefore, there has not been any excessive exercise of powers by the Executive in issuing the notification.

• Rights and Liabilities of Guarantor

The Petitioners contended that as per Section 31(1) of IBC, a resolution plan approved by the Adjudicating Authority becomes binding on all stakeholders, and therefore, prevents creditors from initiating insolvency proceedings against the personal guarantor after the resolution plan is approved.

The Court again placed reliance on SBI v. V. Ramakrishnan(also followed in Essar Steel v. Satish Kumar Gupta[iii]), and held that the discharge of the corporate debtor from the debts owed to creditor by an involuntary process or an operation of law does not discharge the guarantor’s liability as well, which is an independent contract. Moreover, considering the binding nature of Section 31(1) of IBC and its intent to protect the corporate debtor or the new resolution applicant from any previous claims, the guarantor will not be able to initiate proceedings against the corporate debtor for satisfying its claims in future.

• Section 101: Moratorium

The petitioners contended that the application to initiate insolvency process against personal guarantors filed under Sections 94 or 95 of IBC triggers interim moratorium under Section 96 and moratorium under Section 101 against the guarantor, which would appear to put a stay on the insolvency proceedings against the corporate debtor, and this was against the intent behind IBC. The Court disagreed, and held that the provisions of moratorium under Sections 96 and 101 are not against the guarantor as an entity, but only with regards to the specific debts for which the guarantor has furnished guarantee.

• Adjudicating Authority for personal guarantors

The petitioners opposed the 2018 Amendment that altered Section 2(e) to give 3 categories of individuals-(1) personal guarantors, (2) partnership firms and proprietorship firms, (3) other individuals, and modified Section 60 to clearly make National Company Law Tribunal the Adjudicating Authority for insolvency proceedings of personal guarantors, while for all other individuals the Dispute Resolution Tribunal remains the Adjudicating Authority. In response to this, the Respondent stated that the aim behind these amendments was to emphasize the inherent relationship between personal guarantors and corporate debtors and that the insolvency resolution process of the corporate debtors would in a way remain incomplete if the personal guarantors are not brought under its scope.

The Court agreed with the Respondent and held that the 2018 amendment to the provisions of IBC were meant to bring all the stakeholders under a single Adjudicating Authority, in order to streamline and simplify the whole resolution process; and would help creditors make better resolution plans as they would now have a better and more holistic idea of the assets available for the insolvency resolution.

• Section 243 of IBC

The Petitioners expressed that Section 243 of IBC, which is supposed to repeal the Presidency Towns Insolvency Act, 1909[“PTI Act”]and the Provincial Insolvency Act, 1920[“PIA”]has not been notified and presently, with the issuance of the Impugned Notification, the insolvency proceedings against a set of individuals i.e. personal guarantors to corporate debtors can be conducted under three different statutes i.e. before the earlier mentioned statutes as well as under IBC. Supreme Court shot down these contentions and stated that Section 243(2) of IBC seeks to preserve the continuity of proceedings before the respective authorities under the PTI Act and PIA, even after their repeal. According to the Court, notifying Section 243 would bar the Impugned Notification from covering the insolvency processes of personal guarantors, which were already going on under PTI Act and PIA. The Court also observed that the non-obstante clause under Section 238 gives overriding effect to the Code over other active legislations. Hence, the Apex Court held that not notifying Section 243 doesn’t undermine the impugned notification.

Analysis

The Supreme Court, by upholding the constitutional validity of the Impugned Notification, while clarifying the status of insolvency regime for personal guarantors to corporate debtors, has also put personal guarantors at risk of incurring huge liabilities. However, this apparent advantage given to the creditors is rational as the creditors will not be able to gain more than what the corporate debtor actually owes them, even if the creditors pursue parallel insolvency proceedings against both the corporate debtor and the personal guarantor, as NCLT will be the adjudicating body for both the proceedings, leading to greater coordination and minimal chances of any discrepancies.

Section 140 of the Indian Contract Act,1872, provides for subrogation rights which will not be available to the personal guarantor the resolution plan gets approved. The Court in the present case relied on the V. Ramakrishnan case where the Court observed that the personal guarantors cannot be allowed to evade their liability under IBC once the resolution plan is approved. This would affect the right of this third party personal guarantor by not allowing him to avail their subrogation rights and holding on to the co-extensive liability, thereby disregarding Section 30(2)(e) of IBC. A guarantor’s rights cannot and must not be disregarded in such a manner and a balance must be struck between the rights of a personal guarantor and the corporate debtor.

It is also concerning that, since guarantee has been defined as an extension of only financial debts and not operational debts under Section 5(8) of the Code, it can be debated that only financial creditors and not operational creditors can pursue CIRP against personal guarantors for debts due to them.

It would be interesting to see the implications of this judgment wherein the creditors will now proceed against personal guarantors to corporate debtors who have given guarantees to several enterprises. It is likely that personal guarantors will now limit the guarantees they give out, in order to moderate the risk to their own selves. While this judgment has been a step forward in the development of IBC, and has answered several questions, there are still certain issues that need to be addressed, which the author hopes shall be done expeditiously in order to prevent unnecessary litigations.

The author is fourth-year student at Dr. Ram Manohar Lohiya National Law University, Lucknow.

[i]2021 SCC OnLine SC 396.

[ii] (2018) 17 SCC 394.

[iii] 2020 8 SCC 531.