Personal Guarantor Insolvency insights, through case laws – CA. IP Rajesh Kumar Sehrawat and CA. IP Prakash V. Kukreja

Personal Guarantor Insolvency insights, through case laws

– By Rajesh Kumar Sehrawat, CA, Insolvency Professional and Prakash V. Kukreja, CA, CMA, Insolvency Professional, Registered Valuer(SFA)

Recently, a personal guarantor (Mr. Sodhi) filed a writ petition with Supreme Court under Article 32 (High Court judgment reported at (2021) 26 HC). He contended that the impugned provisions did not provide any right or opportunity to the Personal Guarantor to be heard before accepting the insolvency petition filed by the creditor and appointment of a resolution professional, thus violating his fundamental right to natural justice.

Apex court, considering this, on 15th May 2022, put a stay on the case related to Personal Guarantor (PG). This stay may likely be a temporary relief for other ongoing/pending Personal Guarantor cases.

Another insight is sourced from IBBI. The number of applications against Personal Guarantors has significantly increased since the notification of related Insolvency related to Personal Guarantors against Corporate Debtors in December 2019 was released. 

Year on year number of applications looks from 16 in FY20 to 191 in FY21 and 637 in FY22, with a debt of approx. INR 95.7k crores, the guaranteed amount is approx. INR 71.7k crores, i.e., 75%.

With these two interesting perspectives, let’s look at some more insights related to Insolvency provisions related to Personal Guarantors with the help of court judgments.

Basics first, Who is a Personal Guarantor (PG)? 

‘Guarantee’ as per section 126 of the Indian Contracts Act, 1882, is ‘an obligation on a surety to honor the promise of the principal debtor by paying the principal debtor’s present or future debts.’ 

As per Sec 5(22) of IBC, Personal Guarantor is an individual who is the surety in a contract of guarantee to a corporate debtor. ‘Corporate Debtor’ means a corporate person who owes a debt to any person. Also, Personal Guarantor will be in respect of whom the guarantee has been invoked by the creditor and remains unpaid, whole or part.

Important to note that the guarantee has been invoked, and total debt shall remain unpaid.

Why did Government choose to notify provisions related to Personal Guarantors?

There could be many reasons, but one could be that banks in India are the primary or critical funding sources for most corporates. Also, before extending credit lines or issuing loans, Banks always seek a personal guarantee from the company’s promoters. This guarantee can be an additional cushion for the lender if CIRP or Liquidation does not yield much. Hence, now lenders can go after the Personal Guarantors also in case Corporate Debtor defaults. This also ensures that the promoters responsible for the Corporate Debtor’s situation do not escape due to different frameworks for the borrowers and guarantors. 

What options did the lenders have before Personal Guarantor notification?

Banks or Creditors could choose any of the following options:

  1. The civil courts under the Presidency Towns Insolvency Act, 1909 or the Provincial Insolvency Act, 1920
  2. A civil suit enforcing their contractual remedies
  3. Other specialized legislations, among other things, include the Securitization and Reconstruction of Financial Assets and Enforcement of Securities Interest Act, 2002  

Does Personal Guarantors liability extinguish once the debtor’s debt is extinguished?

Sections 133, 134, 135 & 140 of the Contract Act envisage that the liability of a guarantor, being co-extensive with that of the debtor, would stand extinguished if the debtor’s debt is also extinguished. However, the Supreme Court in the Lalit Kumar Jain (2021) 61 SC case held that if the debt of a corporate debtor is extinguished by ‘operation of law’ as opposed to a contractual arrangement, the guarantor’s liability is not extinguished.

This is a tricky situation from Personal Guarantors perspective, where the lender can proceed against the Personal Guarantor along with the CIRP of Corporate Debtor.

Should the Personal Guarantor application be filed after CIRP is initiated or before or simultaneously, or independent of CIRP?

Supreme Court, in the case of Mahendra Kumar Jajodia vs. SBI (2022) 32 SC, held that even in the absence of any pending CIRP or Liquidation proceedings, the application under Section 95(1) of IBC, 2016 against the Personal Guarantors of the Corporate Debtor is maintainable by Section 60(1) of the Code. This application can be filed before the NCLT having territorial jurisdiction over the place where the Registered office of the Corporate Person is located. Therefore, two important takeaways from this judgment: 

  1. Sec.95 application can be filed against the Personal Guarantor of the Corporate Debtor before NCLT. Instead of DRT, the application can be filed directly with NCLT having territorial jurisdiction of Corporate Debtor’s registered office.
  1. And importantly, even if there are no CIRP or Liquidation proceedings against the Corporate Debtor before such NCLT. Hence it is independent of CIRP/Liquidation.

Can an insolvency application be filed against the legal heirs of the deceased Personal Guarantor?

NCLT Kolkata, in the case of BoB vs. Divya Jalan (2022) 180 NCLT, held that the application could not be maintained or accepted against the legal heirs of the Personal Guarantor under the Code, and the remedies may lie elsewhere. The lender can take appropriate steps to recover the guaranteed amount from the assets/estates of the deceased Personal Guarantor rather than the personal assets of the legal heirs of the Personal Guarantor. Further, the legislature is apparent in defining the term ‘Personal Guarantor.’ The Code talks about the estate/assets of the Personal Guarantor only.

In another case, i.e., Alchemist Asset Reconstructions Company Vs. Mr. Deepak Puri (2022) 112 NCLT, NCLT Delhi held that due to the demise of the Personal Guarantor, the question of continuing the proceedings against such a dead person would not arise. Since the proceedings abate, the Section 95 application must also be closed.

Is the service of demand notice to Personal Guarantor should be in person, specifically?

NCLT Mumbai, in the case of Union Bank of India vs. Dheeraj Wadhawan (2022) 186 NCLT, clarified that it is essential to differentiate between issuance of demand notice and service of summons on defendants in jail. Notice need not be sent in person unless provided in the regulations or instructions. Hence, it can be interpreted that both the Code and Personal Guarantor Rules 2019 do not prescribe personal service of the demand notice. Therefore, serving demand notice at the residence of Personal Guarantor is valid irrespective of him being in judicial custody at the time of service.

Does Personal Guarantor have the right to debt recovery as per IBC?

There is no direct case under IBC, but in one of the case laws under the Contract Act, Supreme Court held that If the guarantor pays the defaulted amount/debt to the creditor on behalf of the Corporate Debtor, then the guarantor is invested with all the creditor’s rights against the debtor. In other words, Personal Guarantor will be entitled to every remedy which the creditor had against the principal debtor. Personal Guarantor can enforce every security and all means of payment; stand in the creditor’s place; have the securities transferred to him, though there was no stipulation for that; and avail himself of all those securities against the debtor. This right of surety stands not merely upon a contract but also on natural justice.

With this, we conclude this article and note that Personal Guarantor space is still evolving, and there will be more changes expected in the act/rules to strengthen the purpose of IBC 2016

(This article is only for academic reference and is intended to provide a general guide to the subject matter. Based on specific situations, professional advice should be sought)

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