Personal Guarantor – A Stakeholder?

-By Simran Pahwa,
4th year student at Institute of Law, Nirma University

Introduction:

The Insolvency and Bankruptcy Code, 2016 is a comparatively new law and hence, one can say that it’s still on an experimental clock. Therefore, all its recent amendments are one step towards establishing a more comprehensive and feasible statute which caters to the needs of every party involved in the process of the Insolvency or Bankruptcy of an entity or an individual. This process tries to gain maximization of value for all stakeholders. However, it still hasn’t been able to maintain its ‘maximum’ standards and there have been several cases of shortfall in the same. The MCA (Ministry of Corporate Affairs), by a notification dated 15^th November, 2019 brought Part III of the Code into effect, which deals with the Insolvency and Bankruptcy of individuals as well as partnership firms.[1] The essential point added by this notification is with respect to the extended specification i.e. this shall ‘only be applicable so far as personal guarantors of a Corporate Debtor are concerned’.

Issues and Analysis:

This Notification was challenged on various platforms by several promoters and individuals on the ground that the promoters alone cannot be held liable for the default and compensation of the debt as the management board was also involved, rather more involved in the company and should be equally liable for the same. But a question arises, that if both- Personal guarantors and the management of the company is equally liable for the debts, then won’t this lead to double jeopardy? According to Section 128 of the Indian Contract Act, 1872, the liability of the Guarantor and Principal Debtor is Co-extensive, which means that the creditor can compensate for his/her dues from both the parties simultaneously.[2] However, in the Contract Act, the concept of subrogation was used conjointly so as to implement such coextensive liability smoothly. Section 140 and 141 of the Indian Contract Act define Subrogation.[3] This concept simply means that the Guarantor, after paying the debt of the Principal debtor against the creditor, shall take the position of the Creditor and be compensated by the Principal debtor for the same amount. In the case of ‘Morgan Vs Seymore’[4], it was held that a surety i.e. guarantor who has performed his obligation and paid up his dues, is entitled to ‘stand in the shoes’ of the creditor and have the same rights as the creditor against the Principal debtor.

In the case of ‘Lalit Mishra Vs Sharon Bio Medicine’[5], it was held that the Personal Guarantor’s Right to subrogation is not an absolute right. Further, it was elaborated that the debt recovery of the Personal Guarantor would in fact be antithetical to the objective of maximization of assets by further encumbering the assets of the company.[6] Moreover, it cannot to be denied that the Guarantors also had some involvement in the management of the company, which eventually led to such insolvency. In the recent judgment with respect to challenge of provisions related to Personal Guarantors in the ‘Anil Ambani case’[7] in 2019, it was held that the provisions in the code, specifically Section 14 and Section 31(1), have been structured in a way so as to indicate that the guarantor’s rights to subrogation cannot be taken away if in case he/she settles the debts of the Corporate Debtor before or during the CIRP, but before the passing of the Resolution plan. Post passing of the Resolution Plan, as per Section 31(1) of the Code, it shall be binding on all stakeholders including the guarantors.[8] Section 31(1) of the Code stipulates that once a Resolution plan is approved by COC, it shall be binding on all stakeholders including the Creditors. Approval of a Resolution Plan would tantamount to extinguishment of all outstanding claims against the Corporate Debtor. As such, the liability of the Personal Guarantor would also be extinguished. This is to ensure that the Personal guarantors do not altogether escape the liability of doing their part by seeking refuge under the veil of CIRP.

Section 1(3)[9] of the Code enables the Central Government to enforce different provisions of the Code at different points in time. However, it does not in any way, permit the Central Government to notify parts of a provision of the Code or otherwise limit the scope and application of a provision to only certain categories of persons. In this case, it is with regard to Personal guarantors. Therefore, the action of the Central Government in notifying Sections 78,79, 94 to 187. etc, vide Notification dated 15/11/2019, only insofar as they relate to Personal Guarantors to Corporate Debtors is bad.

Rule 7 read with Rule 3(e) of the ‘Insolvency and Bankruptcy (Application to Adjudicating Authority for insolvency Resolution Process for Personal Guarantors to Corporate Debtors) Rules, 2019’ are apparently ultra vires Section 95 of the Code for the reason that these rules purport to permit a Demand Notice and application u/s 95 to be issued against a Guarantor. Whereas, Section 95(1) of the Code only applies to Partnership firms. Rules cannot enlarge the scope and go beyond what has been provided in the Parent provision. It is thus clear that Rules 7 and 3(e) of the Rules are ultra vires Section 95 of the Code as a subordinate legislation cannot override the Parent Legislation.

The Notification is also arbitrary and violative of Art 14 for the simple reason that there is no intelligible differentia or rational basis on which Personal Guarantors have been singled out for being covered under various provisions notified by the said Notification, particularly when the provisions do not separately apply to the Personal Guarantors. The term ‘individuals’ is a general category and if the legislature intended, Personal Guarantors would have been specifically provided. In such a case, narrowing down a general category of individuals is going beyond the intention of the Code. Personal Guarantors form a separate class by themselves. As per the scheme of the Code, once Insolvency proceedings are initiated against the Corporate Debtor, the guaranteed debt is part of the Resolution process provided under Part II of the Code. Parallely, a Personal Guarantor is also liable for the guaranteed debt. No such action however, is contemplated insofar as Partnership firms are concerned.

Further, an examination of the provisions of Sections 99 and 100 of the Code read with Regulations 7 of the Rules and Regulations would show that these provisions enable initiation of action against the Personal Guarantors, notwithstanding whether the Principal Debt stands extinguished or discharged. This is despite the fact that the liability of a Guarantor is coextensive with that of the Principal Debtor u/s 28 of the Indian Contract Act, 1872.[10] It is also relevant to mention that the notified provisions tend to create a situation where the creditor can unjustly enrich itself by making a claim in the insolvency process of the Guarantor without accounting for the amount realised by it in the CIRP of the Corporate Debtor under Part II of the Code.

Section 239(1) of the Code provides for an enabling power to the Central Government to formulate rules and regulations to carry out and execute provisions entailed in the Code with respect to Personal Guarantors to Corporate Debtors.[11] The Code doesn’t define the term ‘Guarantor’ anywhere, and therefore to the extent that the Rules provide for the definition of Guarantors, it is a clear case of ‘excessive delegation’ and hence, ultra vires the Code. Moreover, the Central Government failed to add section 243[12] in the Code via its Notification, which has led to a major loophole with regard to applicability of law on Personal Guarantors. To initiate Insolvency proceedings against Personal Guarantors, the Presidency Towns Insolvency Act, 1909[13] and Provincial Insolvency Act, 1920[14] were applied. Now that Part III has also been made applicable to initiate such proceedings against Personal Guarantor, two self contradictory legal regimes have been established for the same purpose. Hence, the Government should have brought a balance when introducing Part III, by repealing the applicability of the previous Acts on the same by inserting Section 243 in the Code.

As far as the applicability of Section 14 is concerned with regard to this Notification, there is an urgent need for reconsideration. Section 14 defines Moratorium, which states that within the time frame of commencement of insolvency proceedings and its completion, the following shall not take place against the Corporate Debtor[15]:

• Institution of Suits or continuation of pending suits against the Corporate Debtor
• Transferring, encumbering or alienating the assets of the Corporate Debtor
• Any action under the SARFAESI Act
• Recovery of any property by an owner or lessor, which has been occupied by the Corporate Debtor.[16]

However, as per the 2018 Amendment, Section 14 shall not be applicable in case of Personal Guarantors. Section 14(3) was added, which states that the provisions of sub-section (1) shall not be applicable in case of a surety in a contract of guarantee to a Corporate Debtor.[17] However, while amending Section 14, the Legislature has apparently missed on the Right of Subrogation of a guarantor. Any action against the guarantor during CIRP of the Corporate Debtor, does not contemplate any protection in favour of the Guarantor on the basis of the Right of Subrogation. Considering the scheme of the code, in the light of various judgments including the judgment in  the case of COC of ‘Essar Steel India Ltd. Vs Satish Kumar Gupta & Ors[18], ‘Maharashtra State Electricity Board, Bombay Vs Official Liquidator’[19]  and ‘Lalit Mishra Vs Sharan Bio Medicine Ltd’[20] , on approval of the Resolution Plan, the liability of Surety remains but he may not be able to exercise the Right of Subrogation unless the Resolution Plan so stipulates. On the contrary, a Creditor may still initiate recovery proceedings against the Personal Guarantor for the balance amount by initiating SARFAESI or DRT proceeding or even initiate proceedings for Insolvency under the Code. The Amendment to Section 14 should have made a provision to address this right of the Guarantor. In a given case, it may so happen that by virtue of any action against the Guarantor, the entire debt of a Creditor may get discharged or extinguished. However, in absence of any enabling provision under the Code, a Guarantor may not be able to step into the shoes of such Creditor.

Conclusion:

Therefore, a window should be made available to a Guarantor at any time during CIRP to stake a claim on the basis of Subrogation. Such a Guarantor should have an absolute right to participate and conduct in the meetings of COC. The definition of a Creditor as per Section 3(10)[21] of the Code is required to be enlarged so as to also include a Guarantor. It would have been appropriate to amend the definition of the word ‘Creditor’ simultaneous with the addition of Sub-section 3(b) to Section 14 of the Code.

It is needless to state that the Personal Guarantors are liable towards the Creditors in respect of the outstanding dues of the Corporate Debtor. It is however equally important to recognize the rights of the Personal Guarantors and treat them at par with the rest of the management of the Company. The purpose of the Code is revival and restoration of the Company and Personal Guarantors being a part and parcel of the whole process, need due consideration.

Reference:

[1]Ministry of Corporate Affairs, 2019, Official Gazette of India (November 15, 2019).

[2] Indian Contract Act, 1872, §128, Acts of Parliament (India)‘MCA Notification, 15/11/2019hirajlal Ambaniarliament, 2015 0 (India).g a part and parcel of the whole process need equal amount

[3] Indian Contract Act, 1872, § 140, §141, Acts of Parliament (India)

[4] Morgan Vs Seymore, (1638) 1 Rep Ch 120.

[5] Lalit Mishra Vs Sharan Bio Medicine, 2018 SCC OnLine NCLAT 862

[6] Lalit Mishra Vs Sharan Bio Medicine, 2018 SCC OnLine NCLAT 862

[7] State Bank of India Vs Anil Dhirajlal Ambani, 2019 SCC OnLine SC 240

[8] Insolvency and Bankruptcy Code, 2016, §31(1), Acts of Parliament (India)

[9] Insolvency and Bankruptcy Code, 2016, §1(3), Acts of Parliament (India)

[10] Indian Contract Act, 1872, §28, Acts of Parliament (India).

[11] Insolvency and Bankruptcy Code, 2016, §239(1), Acts of Parliament,2016 (India).

[12] Insolvency and Bankruptcy Code, 2016, §243, Acts of Parliament, 2016 (India).

[13] The Presidency Towns Insolvency Act, 190, Acts of Parliament, 1909 (India).

[14] The Provincial Insolvency Act, 1920, Acts of Parliament, 1920 (India).

[15] Insolvency and Bankruptcy Code, 2016, §14, Acts of Parliament, 2016 (India).

[16] Insolvency and Bankruptcy Code, 2016, §14, Acts of Parliament, 2016 (India).

[17] Substituted by the Insolvency and Bankruptcy Code (Second Amendment) Act, 2018, w.e.f 06.06.2018 (see State Bank of India Vs Ramakrishnan &Anr – SC)

[18] Essar Steel India Vs Satish Kumar Gupta [2019] ibclaw.in 07 SC

[19] Maharashtra State Electricity Board, Bombay Vs Official Liquidator’ 1982(2) SCC 358

[20] Lalit Mishra Vs Sharan Bio Medicine Ltd, 2018 SCC OnLine NCLAT 862

[21] Insolvency and Bankruptcy Code, 2016, §3(10), Acts of Parliament, 2016 (India).