A CURSE TO PERSONAL GUARANTORS UNDER IBC
–Adv. Senguttuvan K
–Adv. Anu Viswanath
Advocates – SAPAA Law Firm, Chennai
Insolvency provisions under IBC were initially not enforced against non-corporates which includes individuals and partnerships. However, the Central Government has included individuals, who stood as a guarantee to corporates to repay debt issued by the creditor under a contract of guarantee.
In Halsbury’s Laws of England, a guarantee is stated as an accessory contract whereby the promisor undertakes to be answerable to the promise for the debt, default or miscarriage of another person, whose primary liability to the promise, must exist or be contemplated[1]. Sec 128 of the Contract Act[2] provides that, the liability of the guarantor is co-extensive with the liability of the Principal Debtor unless otherwise provided by the terms of the contract of guarantee. Further, U/s 137 of the Contract Act[3] stipulates that mere forbearance on part of the creditor to sue the Principal Debtor or to enforce any remedy against the Principal Debtor does not discharge the guarantor. Thus, the creditor has the right to proceed against both of them since the guarantor and debtor are equally liable to the creditor. This lays down the basic principle showing the liability of a guarantor in a contractual relationship with the creditor. The author is trying to analyse the plight of the personal guarantors after the IBC Amendment Act 2018.
Liability under the Insolvency and Bankruptcy Code
The creditor’s right to initiate insolvency provision against Personal Guarantor was enforced under IBC only on 01.12.2019. Prior to this, the IBC was amended by Amendment Act 08 of 2018, categorising u/s 2(e) into three newly framed clauses (e), (f) and (g), in which u/s 2(e) exclusively brought personal guarantors under the ambit of this code. After this trifurcation stood effectuated, the Central Government[4] through a notification dated 15.11.2019[5] enforced U/s 78, 79 and u/s 94 to 187 under Part III and certain clauses in u/s 239, 240 and 249 under Part V to be applied to personal guarantors[6]. In furtherance to this, ancillary rules were notified with regard to personal guarantors known as Insolvency and Bankruptcy (Application to Adjudicatory Authority for Insolvency Resolution Process for Personal Guarantee to Corporate Debtors) Rules, 2019. Pursuant to these major changes, the proceedings against the guarantors were regularly initiated before the Debt Recovery Tribunals (DRT) under part III of the code and NCLT under part II of the code.
The validity of the afore-mentioned notification was challenged before the Supreme Court in Lalit Kumar Jain v Union of India[7] and the Apex court ruled that the notification is legal and not ultra vires the Code. The judgement also confirmed the liability of personal guarantors under IBC:
“There is a sufficient indication in the Code- by U/s 2(e), U/s 5(22), U/s 60 and U/s 179 indicating that personal guarantors, though forming part of the larger grouping of individuals, were to be, in view of their intrinsic connection with corporate debtors, dealt with differently, through the same adjudicatory process and by the same forum (though not insolvency provisions) as such corporate debtors.”
Proceedings against the personal guarantor: an anomaly
U/s 95 of the Code[8], the creditor can initiate an application against the Personal Guarantor invoking insolvency provisions. The creditor‘s right to invoke personal guarantee contracts during insolvency proceedings, allows the creditor to recover the debt incurred to it as a last resort[9]. In Sanjeev Shriya vs. State Bank of India[10], the court interpreted u/s 60(2) and acknowledged the creditor’s freedom to proceed against the corporate debtor’s guarantor. The Court observed that “an application relating to the insolvency resolution or bankruptcy of a personal guarantor of such corporate debtor shall be filed before such NCLT” clearly brings out the intention of the legislature that the guarantor is equally liable for the debts of the debtor. It is also pertinent to note that the very object of the guarantee is defeated if the creditor is asked to postpone his remedies against the surety[11] until the proceedings against the corporate debtor cease.
The judgement in State Bank of India vs V. Ramakrishnan and anr.[12] gave credence to the confusion regarding whether proceeding against the personal guarantor can be initiated even before filing CIRP against the corporate debtor. Further, the Apex court noted that the moment any proceeding against the corporate debtor is initiated, any proceeding pending against the personal guarantor shall be transferred to the same NCLT or if any proceeding against the corporate debtor is existing then the proceeding against the personal guarantor shall be filed before the same NCLT.
The Hon’ble Supreme Court in the decision of Mahendra Kumar Jajodia vs. State Bank of India[13] held that the Financial Creditors especially Banks may now initiate Insolvency Proceedings directly against the Personal Guarantors of Corporate Debtors, irrespective of pending proceedings in the Court against the Corporate Debtor under Code. Such clarification was given by interpreting u/s 60(1) of the code[14] that no prerequisite initiation of CIRP against a corporate debtor is required to initiate IRP against a personal guarantor and only if CIRP or Liquidation Proceeding of a Corporate Debtor is already pending before ‘a’ NCLT then the application relating to Insolvency Process of a Corporate Guarantor or Personal Guarantor should be filed before ‘such’ NCLT. Thus, it is now settled law that an application to start insolvency proceedings against a personal guarantor cannot be denied only on the basis that the corporate debtor does not have an ongoing insolvency resolution or liquidation proceedings. By this, the Corporate Creditor recovers from the Personal Guarantor and Corporate Debtor can continue to run the company; in this scenario the existence of the Corporate Debtor allows the Corporate Guarantor to invoke rights of subrogation.
But if CIRP is initiated against the Personal Guarantor and Corporate Debtor simultaneously, post the CIRP due to non-existence of Corporate Debtor (as a whole or not in the same state), the Corporate Guarantor has no one to invoke rights of subrogation. Now the Corporate Guarantor is left handicapped and will have very serious impact.
A death blow to the right of subrogation
One of the important IBC goals includes balancing the interests of all stakeholders and to balance the interest of all stakeholders, there must be a fair and justifiable obligation on the part of both the stakeholders and the entity. But this goal appears to be vitiated when it comes to the protection of Personal Guarantors. The guarantor’s right to step into the shoes of the creditor and recover the amount settled on behalf of the creditor is founded on the notion of equity. The Supreme Court in Krishna Pillai Rajasekharan Nair (D) by Lrs. and Ors. vs. Padmanabha Pillai (D) by Lrs. and Ors.[15] observed that;
“A subrogation rests upon the doctrine of equity and the principles of natural justice and not on the privity of contract. One of these principles is that a person, paying money which another is bound by law to pay, is entitled to be reimbursed by the other. This principle is enacted in U/s 69 of the Contract Act, 1872. Another principle is found in equity: ‘he who seeks equity must do equity’”.
The Supreme Court has observed that it is the duty of the surety to pay the debt, and on such payment, the surety is entitled to recover the entire amount from the principal debtor[16]. The right of surety is not founded on the principles of contract but is rather based upon the principle of natural justice. This principle of equity is in a dilemma due to the following contradictory views in recent NCLT and NCLAT judgements:
- In Orbit Towers Pvt Ltd vs. Sampurna Suppliers Pvt Ltd[17], the NCLT Kolkata held that the right of subrogation is applicable as the guarantor succeeds to all the rights of the creditor with reference to the debt to the extent the guarantor settled to the creditor.
- In State Bank of India vs. Shri Ghansham Surajbali Kurmi[18], NCLT Hyderabad held that the right of subrogation is falling against the object of the insolvency process, thereby the personal guarantor is not entitled to act under it.
- In Jayaprakash vs. State Bank of India[19], NCLAT Delhi held that security interest in the name of the guarantor is a prerequisite for being a secured creditor which will be invariably absent in all the cases and rules that the right of subrogation is not available to the guarantor.
These judgments of NCLT and NCLAT are beneficial to the creditors as it opens doors for them to access the asset pool of personal guarantors for debt recovery which has given them an upper hand in their bargaining. It is true that the purpose of the resolution process is to provide the corporate debtor with a fresh start[20], which the Courts have rightly put as a clean slate theory. Giving the personal guarantor the right to proceed against the corporate debtor upon subrogation would go against the spirit of a fresh start.
Conclusion
- The basic purpose of the Code is to rescue Corporate Debtors in distress; it is achieved through the decisions of the Hon’ble Courts, who had shifted the responsibility from the Corporate Debtor to the Personal Guarantor. Achieving the purpose at the cost of Personal Guarantor is an injustice need to be looked upon by the Apex Court.
- The Corporate Debtors would increasingly rely on the personal guarantor’s assets if this right of the guarantors were to be eliminated which may enhance risk appetite for taking loans due to the additional safety. If this is how the personal guarantors to corporate debtors are treated by the law, then more and more individuals will refrain from entering into a guarantee agreement in the first place, causing a setback to the credit market of businesses in India. Also, the existing Personal Guarantors would find a way to get out of the contractual obligations.
- Personal Guarantors discharge the liability as co-extensive to the principal borrower; whereas they two are different parties in different capacity. In such scenario the rights of subrogation may not exist where the Corporate Debtor is also under CIRP, as the Corporate Debtor ceased to exist or exist in the different form fully immunised from all past actions. In the absence of such rights, the Guarantors are left with no options except expecting a thicker layer of protection from the Apex Court.
Reference
[1] Halsbury’s Laws of England, Volume 20. Fourth Edition, page 49, page 101
[2] Indian Contract Act, 1872, S.128
[3] Indian Contract Act, 1872, S.137
[4] Insolvency and Bankruptcy Code, 2016 – S.1(3)
[5] Ministry of Corporate Affairs. (2019). REGD. NO. D. L.-33004/99 Retrieved from: https://www.mca.gov.in/Ministry/pdf/Notification_18112019.pdf
[6] Ministry of Corporate Affairs. (2019). Notification S.O. 4126(E) Retrieved from: https://www.mca.gov.in/Ministry/pdf/Notification_18112019.pdf
[8] Insolvency and Bankruptcy Code, 2016 – S.95
[9] State Bank of India vs. V. Ramakrishna [[2018] ibclaw.in 29 SC]
[11] Investment Bank of India vs. Biswanath Jhunjhunwala [(2009) 9 SCC 478]
[14] Insolvency and Bankruptcy Code, 2016 – S.60(1)
[15] MANU/SC/1043/2003
[16] Bank of Bihar vs. Damodar Prasad [2017] ibclaw.in 21 SC
[17] (2022) ibclaw.in 610 NCLT
[18] (2022) ibclaw.in 635 NCLT
[19] (2022) ibclaw.in 783 NCLAT
[20] Committee of Creditors of Essar Steel Ltd. vs Satish Kumar Gupta [2019] ibclaw.in 07 SC
Disclaimer: The Opinions expressed in this article are that of the author(s). The facts and opinions expressed here do not reflect the views of IBC Laws (http://www.ibclaw.in). The entire contents of this document have been prepared on the basis of the information existing at the time of the preparation. The author(s) and IBC Laws (http://www.ibclaw.in) do not take responsibility of the same. Postings on this blog are for informational purposes only. Nothing herein shall be deemed or construed to constitute legal or investment advice. Discussions on, or arising out of this, blog between contributors and other persons shall not create any attorney-client relationship.