Bar on Personal Guarantors as Resolution Applicants: Understanding the Implications of Invoking Guarantee

Adv. Yash Gupta and Adv. Nitish Gajraj
(Pursuing Graduate Insolvency Programme (GIP) at IICA)

Introduction

The Insolvency and Bankruptcy Code, 2016 (IBC) is a comprehensive legislation that aims to consolidate and amend the laws relating to reorganization and insolvency resolution of corporate persons, partnership firms, and individuals in a time-bound manner. The Code has undergone several amendments since its inception, and one such amendment that has been introduced is the insertion of Section 29A, which has garnered considerable attention and criticism alike. Further, a specific provision was included in Sub-Section (h) of Section 29A to address the eligibility of Guarantors to Corporate Debtor (CD). This Sub-Section aims to disqualify any “person” who has provided a personal guarantee to a creditor from becoming a resolution applicant once the creditor invokes their personal guarantee. This article aims to discuss Section 29A of the IBC concerning the ineligibility of personal guarantors as a resolution applicant.

Resolution Applicant

The definition of “resolution applicant” was amended through the Amendment Act, 2018 and states that “resolution applicant” means a person, who individually or jointly with any other person, submits a resolution plan to the resolution professional pursuant to the invitation made under clause (h) of sub-section (2) of Section 25. Section 25(2)(h) mandates the resolution professional to invite resolution plans from prospective resolution applicants who meet the criteria established by the resolution professional with the approval of the committee of creditors. The criteria should take into account the complexity and size of the business operations of the corporate debtor, and other conditions specified by the Board.

Section 29A lays down a restrictive provision where any person falling within the negative list is ineligible to submit a resolution plan. Therefore, for an individual to be eligible to submit a resolution plan, they must satisfy the criteria established by the resolution professional with the committee of creditors’ approval and should not suffer from any disqualification mentioned under Section 29A.

Genesis of Section 29A of IBC

Section 29A was introduced into the IBC through the Insolvency and Bankruptcy Code (Amendment) Act, 2018 to plug the gaps and iron out the teething issues faced by the Insolvency and Bankruptcy Board of India (IBBI) in the implementation of the Code. The Insolvency and Bankruptcy Code (Amendment) Bill, 2017, which became Amendment Act of 2018, aimed to address concerns regarding the insolvency resolution and liquidation of corporate entities. The original provisions of the Code did not place any restrictions on who could submit a resolution plan or participate in the acquisition process during liquidation. However, there were worries that individuals who had contributed to a company’s default or were otherwise undesirable could exploit this situation and regain control of the corporate debtor, which would undermine the Code’s processes and unfairly reward unscrupulous actors at the expense of creditors.

To prevent this outcome, the Act introduced provisions to restrict the participation of such individuals in the resolution or liquidation process. The committee of creditors was also given the responsibility of assessing the eligibility of resolution plans and allowing a reasonable period for overdue amounts to be repaid in order to ensure that undesirable persons did not gain control of the corporate debtor.

It was evident that the Parliament was concerned about individuals who had contributed to defaults in bidder companies misusing the lack of restrictions on their participation in the resolution process. The Parliament recognized that allowing such persons to participate would undermine the objectives of the Insolvency and Bankruptcy Code (IBC) and viewed their participation as undesirable. To ensure that the IBC achieves its purpose of sustainable revival, Section 29A was introduced to restrict the eligibility of certain persons from participating in the resolution process. The intention was to prevent individuals who had contributed to the problem, either through design or default, from being part of the solution. It is worth noting that Section 29A applies not only to conduct related to the corporate debtor but also to conduct related to other companies.

Decoding the Section 29A(h) of IBC

Section 29A of the Insolvency and Bankruptcy Code (IBC) is an important provision that limits the eligibility of potential resolution applicants in the insolvency resolution process. The provision stipulates that a person shall be deemed ineligible to submit a resolution plan if they, or any other person acting in concert with them, have executed a guarantee in favour of a creditor in respect of a corporate debtor against whom an application for insolvency resolution has been admitted under the IBC. Additionally, the guarantee must have been invoked by the creditor and remains unpaid either in full or part. In simpler terms, if a person has provided a guarantee to a creditor in relation to a corporate debtor, and the creditor has made an application for insolvency resolution against that debtor, then the person providing the guarantee cannot participate in the insolvency resolution process as a resolution applicant. The prohibition extends to any other person acting jointly or in concert with the person providing the guarantee.

The Report of the Insolvency Law Committee (2018) raised concerns specifically regarding the ambiguity of whether a guarantor would be disqualified only if the guarantee provided by them had been invoked and dishonoured, or even if the guarantee had not been invoked at all. While it is true that the commencement of a guarantor’s liability depends on the terms of the contract, a notice to the surety is typically required. The Committee recognized that disqualifying every guarantor solely for issuing an enforceable guarantee would be discriminatory, and concluded that the intention of the provision could not have been such.

To address the issue, the Committee recommended the removal of the words “an enforceable” from clause (h) and the addition of the following phrase at the end of the clause: “and such guarantee has been invoked by the creditor and remains unpaid in full or part by the guarantor.” The suggestive changes were made by the legislation in pursuit to the recommendation by the committee.

The rationale behind this provision is to ensure that the insolvency resolution process is not compromised by individuals who have a vested interest in the outcome of the resolution. A guarantee in favour of a creditor establishes a financial relationship between the guarantor and the creditor, and this relationship may potentially influence the guarantor’s participation in the resolution process. By preventing guarantors from becoming resolution applicants, the provision aims to maintain the integrity of the resolution process and ensure that the interests of all stakeholders are protected. It is important to note that the provision only applies to guarantees that have been invoked by the creditor and remain unpaid. Guarantees that have not been invoked, or those that have been invoked but have been paid in full, do not disqualify a person from participating in the resolution process. This ensures that individuals who have provided guarantees in good faith and have fulfilled their obligations are not unfairly criticized.

Bank of Baroda & Anr. Vs. MBL Infrastructures Ltd – Supreme Court to the Rescue

Bank of Baroda & Anr. Vs. MBL Infrastructures Ltd. & Ors. (2022) ibclaw.in 05 SC case concerns the interpretation of Section 29A(h) of the IBC by the Supreme Court. M/s. MBL Infrastructures Limited (“Respondent No. 1”) was established by Mr. Anjanee Kumar Lakhotiya (“Respondent No. 3”), and obtained loans/credit facilities from a consortium of banks. When Respondent No. 1 failed to comply with the repayment terms, some of the banks invoked the personal guarantees provided by Respondent No. 3 for the credit facilities obtained by Respondent No. 1. M/s. RBL Bank and M/s. State Bank of Bikaner and Jaipur issued a notice under Section 13(2) of the SARFAESI Act, after invoking the personal guarantee of Respondent No. 3. Subsequently, M/s. RBL Bank filed an application under Section 7 (Initiation of CIRP by financial creditor) of the IBC before the National Company Law Tribunal, Kolkata (“NCLT”), to initiate CIRP against Respondent No. 1, which was accepted by the tribunal.

The case involves MBL Infrastructures Limited, which obtained loans/credit facilities from a consortium of banks, and failed to repay according to the terms, resulting in the invocation of personal guarantees extended by Anjanee Kumar Lakhotiya. RBL Bank and State Bank of Bikaner and Jaipur issued a notice under Section 13(2) of the SARFAESI Act after invoking the personal guarantee, and RBL Bank initiated CIRP under Section 7 of the IBC against MBL Infrastructures Limited. Two resolution plans were received, one authored by Anjanee Kumar Lakhotiya. Section 29A was introduced to the IBC by way of an amendment, disqualifying certain persons from submitting a resolution plan. Anjanee Kumar Lakhotiya filed an application for a declaration that he was not disqualified from submitting the plan under Section 29A(c) and Section 29A(h) of the IBC. The NCLT held that Anjanee Kumar Lakhotiya was eligible to submit a resolution plan despite extending personal guarantees that were invoked by some creditors. Punjab National Bank appealed to the NCLAT, which passed an interim order allowing the RP and CoC to go through with the Plan, but prohibiting the NCLT from accepting it without prior approval of the NCLAT. The Plan was put to vote and received 68.50% of the CoC’s vote share. The NCLT approved the Plan, and the same was upheld by the NCLAT. The Appellant filed an appeal before the SC on issue that the Anjanee Kumar Lakhotiya (Respondent No. 3) being the guarantor was ineligible under Section 29A(h) of the IBC to submit the Plan.

Interpretation on Section 29A (h) of IBC

Section 29A(h) of the Code sets forth another category of individuals who are not eligible to be resolution applicants. Aside from those specified, there may not be any disqualifications. The term “person” encompasses promoters and directors, among others, and is not restricted by the definition provided in Section 3(23) of the Code. The persons listed in Section 29A alone are ineligible to be resolution applicants.

If a person has executed a guarantee in favour of a creditor for credit facilities obtained by a corporate debtor, and the guarantee has been invoked following admission of an insolvency resolution application by a creditor, the eligibility bar will come into effect. Once an application for insolvency resolution has been admitted on behalf of “a creditor,” all creditors of the same class have equal rights, and the word “such creditor” in Section 29A(h) should be understood to refer to similarly placed creditors after the application for insolvency resolution has been admitted by the adjudicating authority. Once an application for insolvency resolution is admitted on behalf of ‘a creditor’ then the process would be one of rem, and therefore, all creditors of the same class would have their respective rights at par with each other.

To qualify for disqualification under this provision, it is sufficient for a personal guarantee to exist that has been invoked by a single creditor, regardless of which creditor filed the insolvency resolution application. However, compliance with the invocation of the personal guarantee by any other creditor is also required. The Court’s concern is solely for the benefit of two entities: Committee of Creditors and the Corporate debtor. Any other interpretation would be absurd and undermine the objective of Section 29A and the Code. Ineligibility must be assessed in the context of the resolution process, and it cannot be said that one creditor is ineligible while others are eligible. Rather, the exclusion is intended to ensure a fair and transparent resolution process.

The provision specifies “invocation by a creditor,” and the method of invocation should not be a factor for the adjudicating authority to consider in comparison to its existence. The latter part of the provision, which disqualifies a person whose liability under the personal guarantee remains unpaid, either in full or in part, for the amount due from them upon invocation, must also be given due consideration.

It is evident that only certain entities, namely financial creditors under Section 7, operational creditors under Section 8, and corporate debtors under Section 10, have the right to protect their own interests in the resolution process. This is why Section 29A excludes certain categories of persons and has the aim of balancing the interests of the committee of creditors and the corporate debtor while preventing others from influencing the process. Section 29A(h) specifically pertains to creditors who are either already under the insolvency resolution process or are entitled to go under it.

Decision of the Supreme Court on Section 29A of IBC

According to the Supreme Court, the resolution plan submitted by Respondent No. 3 should not have been considered. The NCLT and NCLAT were wrong to dismiss the Appellant’s arguments on the grounds that the issue of eligibility had already been decided in an earlier appeal that was withdrawn without liberty. The SC clarified that since the Appellant was not a party to the previous NCLT decision, the principle of res judicata and issue estoppel did not apply in this appeal where the Appellant only applied for impleadment. Therefore, the NCLAT’s reasoning in this regard was invalid. However, due to the unique circumstances of the case, the SC dismissed the appeal to avoid disrupting the ongoing operations of Corporate debtor, despite their disagreement with the acceptance of the plan submitted by the Personal Guarantor

Conclusion

The provisions of Section 29A of the Insolvency and Bankruptcy Code (IBC) have been a significant obstacle for promoters who wished to maintain ownership and control of their business despite defaulting on payments to creditors, resulting in the initiation of the resolution process. The Supreme Court has issued numerous judgments on this issue, particularly regarding “related parties” or “connected persons” who seek to become resolution applicants of the corporate debtor (CD).

In the aforementioned case the Supreme Court provided an exceptional judgment to clarify the true intent and purpose of the amendments made to Section 29A(h) of the IBC. The court considered all issues related to the invocation of personal guarantees by guarantors to the creditors of the CD, providing much-needed guidance on this contentious issue. The judgment explains in great detail the effects of the invocation of a personal guarantee by any creditor in the same class and the resulting ineligibility of the guarantor from becoming a resolution applicant.

The Supreme Court has achieved a delicate balance between providing clarity on the interpretation of Section 29A(h) of the IBC and ensuring that the corporate debtor is successfully revived without getting entangled in the IBC process again. The court has achieved this by clarifying the eligibility criteria for resolution applicants while also ensuring that the resolution process moves forward smoothly and efficiently, with the ultimate goal of reviving the corporate debtor. The judgment provides important guidance for all stakeholders involved in the resolution process, while also keeping in mind the larger goal of reviving the corporate debtor and preventing further disruption to its operations.

References

The Insolvency and Bankruptcy Code, 2016
Report of the Insolvency Law Committee (2018)
(2022) ibclaw.in 05 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.

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