Personal Guarantors’ Insolvency: An Analysis of Recent Judicial Trends
Authored by:
– Akshay Goel and Nipun Gautam (Advocates practicing Civil & Commercial Litigation)
While nowhere near as raging a success as the enactment of the Insolvency and Bankruptcy Code back in 2016, the relatively newer legal regime of Insolvency Resolution of Personal Guarantors has finally started picking up in 2022, about 2 years after the same coming into force.
As has been almost customary when it comes to the IBC laws, as soon as the number of applications against Personal Guarantors picked up, so did the confusion regarding the applicability of seemingly mutually inconsistent provisions of IBC, and the statutory tribunals, NCLT and NCLAT, had to step in to iron out these inconsistencies by reading down the strict interpretation of provisions and to give out a golden interpretation to deal with the practical aspect of the laws. For instance, in the matter of SBI vs. Mahendra Kumar Jijodia (2022) ibclaw.in 89 NCLAT, the NCLAT took the view that even in situations where corporate insolvency of a corporate debtor has not been initiated, an application for initiation of personal insolvency of the guarantor can be entertained by the Adjudicating Authority. The necessity of this interpretation is unquestionable considering that the alternative would be to send such applications to the Debt Recovery Tribunal, even though NCLT benches are more adept in dealing with applications under IBC as on date. Even the Hon’ble Supreme Court, in Mahendra Kumar Jijodia vs. State Bank of India (2022) ibclaw.in 32 SC, seems to have taken a consistent view while dismissing an appeal in the said judgment, despite the fact that such interpretation is arguably not in strict adherence with the provisions of Section 79(1) read with Section 60(4) of the Insolvency and Bankruptcy Code.
Apart from the above, what has further been customary with IBC, as soon as the number of applications against the Personal Guarantors picked up, so did the Petitions challenging the constitutionality of the law before the Hon’ble Supreme Court.
The first round of the challenge was when the singling out of personal guarantors was challenged, with the lead matter being Lalit Kumar Jain vs. Union of India (2021) ibclaw.in 61 SC. The Hon’ble Supreme Court had dismissed the challenge and upheld the intelligible differentia between individuals and personal guarantors to corporate debtors.
The second comes up with the petitions challenging provisions pertaining to the insolvency of Personal Guarantors under the Insolvency and Bankruptcy Code itself, with the lead matter being Gurmeet Sodhi vs. Union of India [W.P. (C) 307 of 2022].
There is, of course, no doubt that there is something problematic about the provisions and their interpretation, which, in essence, allow the appointment of a Resolution Professional against Personal Guarantors without an opportunity of being heard to the Personal Guarantors which requires adjudication and determination by the apex court. But these petitions before the apex court have been handled in a rather peculiar fashion.
These writ petitions challenging provisions pertaining to the insolvency of Personal Guarantors were put up largely before two separate benches of the Hon’ble Supreme Court. The peculiarity was, while one Bench1 was pleased to pass an interim order, in effect allowing a status quo on the proceedings once the Resolution Professional had been appointed, the other Bench2 refused any such interim protection (pertinently, while keeping the applications for interim prayers pending). As a result, as on date, the situation is that out of over 150-200 petitions currently pending, while most petitioners have been granted interim protection, some have been left in a lurch.
Closer to home, the different benches of the National Company Law Tribunal dealing with these petitions have also started taking a different route pertaining to these petitions. For instance, the Principal Bench has preferred the route of simpliciter renotification of applications seeking initiation of personal insolvency, notwithstanding the stage such petitions are at. On the other hand, some regional benches have continued with the proceedings and have only stopped the proceedings upon arriving at the stage where, in that particular matter, an interim protection from the Hon’ble Supreme Court is presented before the Bench.
The important aspect to note here, however, is that the statute itself provides a special protection to any and all personal guarantors against whom insolvency proceedings are sought to be commenced. As per Section 96 of the Insolvency and Bankruptcy Code, 2016, as soon as an application is filed seeking the commencement of insolvency proceedings against an individual, an interim moratorium comes into play, which provides for a stay on all legal proceedings in respect of any debt of such individual, as well as a restraint on any creditor initiating any fresh proceedings for such debt.
While this protection may have been a saving grace to an otherwise helpless Personal Guarantor, the judiciary is working towards drawing exceptions to the said interim moratorium. One such important exception has been drawn by the Hon’ble NCLAT in Ashok Mahindru vs. Vivek Parti (2022) ibclaw.in 967 NCLAT wherein NCLAT has allowed proceedings under Section 66-67 of the Insolvency and Bankruptcy Code, dealing with fraudulent transactions, to continue despite an interim moratorium being in place. Succinctly stated, the reasoning given by NCLAT behind the order is that the provisions of Section 96 only cover such debt and liability due from a personal guarantor as on the date of the interim moratorium, and cannot be construed to extend to such debt and liability which is not due as such, including such liability as may arise by virtue of the Section 66-67 Application.
The problem with this interpretation of Section 96 is two fold; firstly, the presumption that a liability under Section 66-67 of IBC is a future debt, and secondly, a practical impossibility arising out of the judgment.
Addressing the first, it is pointed out that under Section 66, a resolution professional reports such transactions which in his opinion are fraudulent in nature and seeks a direction that the management of the corporate debtor be directed to make contribution to the assets of the corporate debtor to the extent of the impact of such fraudulent transactions. Hence, the entire premise of such transactions is that the same had been undertaken prior to the insolvency commencement date. Terming such liability as non-existent as on the date of the interim moratorium, especially when the date of the interim moratorium is after the insolvency commencement date of the corporate debtor would, in the humble opinion of the authors, amount to a presumption in turn that there are no fraudulent transactions undertaken by the management, despite the same having been determined by the resolution professional.
Secondly, even if it is assumed that the erstwhile management of corporate debtors deserve the benefit of the principle of ‘innocent until proven guilty’, NCLAT, in the humble opinion of the authors, overlooked the consideration of what happens once the management is actually proven guilty and the interim moratorium is still in place. Would such contributions be sought from the personal guarantor in supersession of all such other creditors who have not been able to commence/ prosecute legal proceedings in relation to their debts against the individual?
It is clarified here that the principle, notwithstanding the facts, may be considered fair to a certain extent. For instance, in a situation where an individual purchases goods/ services after the imposition of the interim moratorium, it may be considered reasonable to allow such vendor to collect their rightful dues from the individual, since unlike the corporate insolvency regime, there is no concept of “CIRP cost” in the personal guarantor regime, especially at the time of imposition of the interim moratorium. However, applying this to a Section 66 scenario would amount to putting the liability towards the creditors of the corporate debtor above the liability towards other creditors of the individual.
As a closing remark, it is clear that the personal insolvency enactments require a serious consideration by both, the legislature as well as the judiciary, to be viable for practical purposes. However, in the meantime, it is imperative that an already puzzling legislation may not be confused further by the judicial inconsistencies, in the interest of all stakeholders involved. It is not to state that the concerned judicial authorities should not exercise their powers in strengthening this law against personal guarantors, but while this exercise is being carried out, the interests of all stakeholders involved should be balanced with a uniform ad interim approach.
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