Personal Guarantors under the New Insolvency Regime and The Way Ahead- Mr. Arihant Samdaria & Mr. Akshansh Shanker

Personal Guarantors under the New Insolvency Regime and The Way Ahead

 By Mr. Arihant Samdaria & Mr. Akshansh Shanker,
B.A. LL.B(Hons.) at Dr. Ram Manohar Lohia National Law University, Lucknow

Introduction

The Insolvency and Bankruptcy Code (hereinafter “Code”) was enacted in the year 2016 overhauling the entire insolvency regime in India. Under Section 1(3)[1] of the Code, powers were given to the government to notify different provisions of the Code at different dates. Using these powers, the government notified insolvency process under Part-II on 30th November 2016 leaving Part-III dealing with individual insolvency in the books only.[2]

In order to bolster the recovery process which was not being carried out at the requisite speed, the government always wanted to tighten the liability around promoters who were responsible for the actions of the company and hence to ensure their accountability, the government on 15.11.2019 issued a notification allowing the application of Part-III of the Code to personal guarantors to the corporate debtor.[3]  A restrictive application was given to Part-III because of the similarity between the functioning of a Corporate Debtor and Personal Guarantors and due to inherent distinctions between liabilities undertaken by guarantors and other entities as referred to in Part-III of the Code.

By virtue of this notification, the banks were strong armed into moving applications against personal guarantors to the corporate debtors under Part-III of the Insolvency and Bankruptcy Code. However, as a consequence, multiple conundrums with respect to personal guarantees have arisen under the new insolvency regime which has ultimately led to plethora of conflicting opinions by the NCLT’s and NCLAT’s on the issues dealt under part-III of the Code.

Owing to the principle of Co-extensive liability, the personal guarantors can always be proceeded against under IBC before proceeding against the Corporate Debtor. However, the complexity arises when the Insolvency Proceedings are initiated against the guarantors pendente lite Corporate Insolvency Resolution Process (hereinafter CIRP) of the corporate debtor or when they are made liable after the approval of the resolution plan of corporate debtor.

Assuming the constitutionality of the notification dated 15.11.2019, it is imperative to deliberate upon the critical legal questions that may arise qua insolvency resolution process of personal guarantors. This article relying upon the mandate of IBC and the decisions rendered by Supreme Court and the Company Tribunals seeks to argue that personal guarantors can be proceeded against under IBC simultaneously with corporate debtor and the liability of personal guarantors does not extinguish even after the approval of the resolution plan of the Corporate Debtor.

The Parallel Proceeding Conundrum under IBC

In a contract of guarantee under the Indian Contract Act, 1872, it is a settled principle of law that the liability of a guarantor is co-extensive with that of the principal debtor as laid down in Section 128[4] of the Indian Contract Act, 1872. However, when it comes to initiation of parallel insolvency proceedings against the Principal Debtor and the Guarantor under the Insolvency and Bankruptcy Code, 2016, there is ambiguity in this regard for which certain provisions of the Code need to be looked into .

Section 60(2) of the Code[5] expressly states that insolvency proceedings against the guarantors can be initiated in the same adjudicating authority where the CIRP of corporate debtor is pending. Similarly, Section 60(3)[6]  mandates that any insolvency proceedings pending against the guarantor before any court or tribunal has to be transferred before the same adjudicating authority which is handling the Insolvency proceedings of the corporate debtor with respect to the same debt.

Further, Sec 14(3) of the Code was amended w.e.f. 28.12.2019 wherein it was clarified that the moratorium provisions under clause (1) of section 14 will not be applicable to a surety in a contract of guarantee.[7] As a result, initiation of CIRP against the corporate debtor would not impose moratorium against the personal guarantor and parallel proceedings can be initiated against them. The law in this regard was laid by the bench of the Hon’ble Supreme Court well before the amendment in the case State Bank of India v V. Ramakrishnan[8] where in the Hon’ble Apex Court was of the view that the assets of the surety can be distinguished from that of the corporate debtor and hence the insolvency proceedings against corporate debtor may not be impacted adversely by the actions against assets of third parties like sureties.

In the matter of ICICI Bank v. CA Ritu Rastogi[9] while adjudicating upon this question for the first time, the NCLAT permitted ICICI Bank to initiate parallel insolvency proceedings against the corporate debtor and the personal guarantor. However, later in the judgement of Vishnu Kumar Agarwal v Piramal Enterprises[10], the NCLAT took a contrary view and it was stated that once an application under section 7 of the code has been admitted for a particular set of claims against a corporate debtor then under no circumstance another application filed by the same financial creditor for the same set of debt be permitted against the guarantors under the Insolvency and Bankruptcy Code. While an appeal against this order of NCLAT is pending before the Hon’ble Supreme Court, various NCLT’s has started following the NCLAT order in Piramal Case whereas many still follow the earlier approach which has led to utter confusion and chaos among the stakeholders.

The issue again came up before NCLAT recently in the case of State Bank of India v Athena Energy Ventures Pvt Ltd.[11] where the NCLAT took a view contrary to one held in the Piramal Case and also stated that the tribunal in Piramal Case failed to correctly appreciate the various provisions of the Insolvency and Bankruptcy Code and as a consequence directed the NCLT to institute insolvency proceedings against personal guarantor despite pending CIRP of the corporate debtor.

The Insolvency Law Committee after taking into account the judgement of NCLAT in the Piramal Case, took a view that restricting a creditor from initiating simultaneous insolvency proceedings against the debtor and the surety would not only be detrimental to the creditor but also cause prejudice to his right provided under contract of guarantee. Hence, the committee provided that the creditor is at liberty to move against the debtor or the surety or both. The committee further, in para 7.9 at page 33 clarified that the creditors should be permitted to file their legitimate claim in both the proceedings because simultaneous remedy is the most fundamental element of the contract of guarantee and moreover, since there is nothing in the code which prohibits the same. However it was provided that whenever the creditor recovers a portion of claim from any of the proceedings, there has to be a corresponding revision of the claim amount in the other proceedings [12]

Even the Working Group Committee on Individual Insolvency[13] is of the view that commencement of parallel proceedings against the Debtor and the guarantor was envisaged by the Code and hence, the Committee recommended that a creditor should not be occluded from proceeding against both the corporate debtor and its sureties under the Code.

Liability of Personal guarantors after the approval of Resolution Plan

The Approval of Resolution Plan of a corporate debtor under Section 30(2) of IBC extinguishes all liability of principal debtor and the resolution applicant starts on a fresh slate but still if the entire debt is not satisfied through resolution plan, personal guarantors of the said loan can be proceeded against, according to the mandate of IBC and because of the reason that the corporate debtor is discharged due to operation of law.

Mandate of IBC

The Insolvency and Bankruptcy Code envisages to safeguard the interests of the creditors of and prohibits the promoters from exploiting the Insolvency Resolution Process or its outcome.[14] Furthermore, its object is to protect the interests of Creditors ahead of the interest of promoters and not allowing the guarantors to get away with their independent and coterminous liability to discharge the entire remaining debt.[15].

To interpret any proposition, intention of legislature and the rule making authority has to be given paramount importance.[16] Clause 14 of Form-B[17] of Insolvency regulations of personal guarantors to corporate debtor states that the creditor while submitting his claim needs to disclose information relating to:

(i) “The amount claimed by him in the corporate insolvency resolution process / liquidation process of the corporate debtor

(ii) The amount admitted by the resolution professional / liquidator of said process and

(iii) The amount realised by him in the said process, if any”

The purpose of this information is to calculate the amount for which the personal guarantor could be made liable which reflects the intention of legislature that the proceeding could be initiated against the Personal Guarantor even after the completion of CIRP of the corporate debtor. Hon’ble NCLAT in Lalit Mishra v. Sharon Bio Medicine[18] dilated that the legislature never intended to exclude exercise of legal remedies available in law against personal guarantors or to restraint bona fide creditors from realising their lawful dues by enforcing the personal guarantees, which are independent contracts.

The Supreme Court in the case of Committee of Creditors of Essar Steel v. Satish Kumar Gupta[19] refused to stay the proceedings against personal guarantors which were initiated after the approval of resolution plan of the corporate debtor. However, the refusal of stay was based on peculiar facts and circumstances and was not the ratio of the judgement. In Vijay Kumar Jain v. Standard Chartered bank[20] while allowing the directors to participate in the Committee of Creditors (COC)meeting, the Court held that a resolution plan while scaling down the debt of principal debtor may not scale down the debt of personal guarantor, leaving them exposed for the entire debt. It was dilated that a resolution plan vitally affects the personal interest of a director who may be a guarantor. The foundation of the Supreme Court’s rationale to allow directors to participate in meetings of the Committee of Creditors is based on the understanding that the directors’ liability as personal guarantors persists against the creditors even after the CIRP of corporate debtor and an approved resolution plan can only lead to a revision of amount.

Discharge of Principal Debtor by operation of law does not ipso facto discharge surety

There is stark difference between the release of principal debtor by creditor through his acts or omissions and his release due to operation of law. The surety is discharged only in circumstances where there is an overt act on behalf of creditor releasing the principal debtor and not in circumstances where his release is due to operation of any statute[21]. The Supreme Court scotched the law in Maharashtra State Electricity Board v. Official Liquidator[22] in most unambiguous terms and stated that the liability of the surety is not absolved when the principal debtor is discharged by operation of law in bankruptcy or liquidation proceedings.

Insolvency petition under Part-II of the code is only an exercise of statutory right of the creditor. The outcome of the insolvency proceedings is a product of statute. It was expatiated in Gouri Shankar Jain v. Punjab National Bank[23] by the Calcutta High Court that the eventual outcome of the insolvency proceedings of the corporate debtor does not obliterate or modify the contractual obligations between the surety and the financial creditor and therefore the surety continues to remain liable even after the CIRP of the corporate debtor.

Moreover, it is a matter of public policy that the debt of creditor is secured and recoverable in accordance with law and the debtor or the surety is not absolved from his liability to discharge the debt except in accordance with law[24].The proposition if construed otherwise could lead to unfavourable consequences. Guarantors are generally the promoters of the company and hold significant decision powers regarding the working of the company. Benefit of Section 10[25] of the Code could be taken to file insolvency applications in order to absolve themselves from the liability. It would defeat the whole purpose of IBC as there would be frivolous insolvency applications only to satiate the personal interest of promoters who had given guarantee at the risk of taking financial loan. Thus, the proposition should be interpreted in the manner that guarantors are not relieved of their liability once a resolution plan against corporate debtor is approved and the creditors can enforce the guarantee for the unsatisfied claims. 

Effect of denial of Right of Subrogation

The guarantor enjoys the right to get into the shoes of creditor once he has made the payment under Section 140 of Indian Contract Act. This right in legal parlance is known as Right of Subrogation. Under Insolvency regime, the approval of resolution plan discharges all the liabilities of the corporate debtor and no fresh claims can be raised against the corporate debtor. Thus, those claims which are not dealt in the resolution plan stands extinguished automatically[26].

This impairs the right of guarantor to recover the disbursed amount back from the principal debtor, however the guarantor cannot claim immunity on this ground. In Punjab National Bank v. State of U.P.[27] the Supreme Court expounded that the right of creditors to recover from persons who stood as guarantors arises out of deed of guarantee and cannot be rendered otiose because surety may not be able to recover money from the principal debtor.

Moreover, provisions enumerated in ICA regarding discharge of surety are not applicable in matters pertaining to IBC. The entire insolvency regime in India was overhauled by IBC that is complete in all sense[28]. It is a comprehensive code which delineates every aspect regarding the Insolvency Resolution Process of the corporate debtor or personal guarantor. Section 238[29] of the code expressly states that “the provisions of this code shall have an overriding effect, notwithstanding anything inconsistent therewith contained in any other law for the time being in force.” This section was enacted to rule out any inconsistency of other law that in contradiction to IBC. Therefore, the provisions of IBC which advances liability on guarantors after the approval of the resolution plan have to be given way over the provisions of Chapter VIII of Indian Contract Act, 1872.

Bare perusal of above-mentioned authorities would reflect that the liability of surety does not cease to exist if the Principal debtor has undergone CIRP. It is the insolvency law that has made the debt unenforceable against principal debtor and not the creditor. Therefore, the liability of Personal Guarantors should continue to exist even though resolution plan against Corporate debtor has been approved. This means that personal guarantors of corporate debtors can be made liable under IBC after the issuance of notification dated 15.11.2019 even after resolution plan of corporate debtor stands approved by the NCLT.

Conclusion

IBC since enacted has proved to be a beneficial legislation for creditors as it allows the recovery of credit within a stipulated time period. Until 15.11.2019 the code was only restricted to corporate entities however after the said date the legislature has wisely decided to extend the operation of code to personal guarantors to the corporate debtors.

Analyzing the law relating to co-extensive liability and relying upon the mandate of IBC and the decisions delivered by various courts it can be readily comprehended that the independent liability of guarantors continues to persist irrespective of the position of the corporate debtor. This certainly means that the creditor should be allowed to initiate insolvency proceedings against guarantor before, after, and during the resolution process of the corporate debtor.

This interpretation would uphold the cardinal principle of guarantee i.e. to make good to creditor in case of default committed by the principal debtor. Any other interpretation would be deviation from this cardinal principal and a tool in the hands of personal guarantors to evade their lawful liability.

The above discussion leaves no manner of doubt that even upon approval of the resolution plan the liability of personal guarantors is not extinguished and parallel proceedings against the Debtor and the guarantor is permissible. However, at the same time, the right of subrogation of the personal guarantors should not be taken away under the garb of superior interests of the corporate debtor and care should also be taken that that the provisions of the code are not abused by the creditors in order to unjustly enrich themselves. The time is ripe for the Supreme Court to conclusively determine the liability of the personal guarantors before and after the approval of resolution plan under the insolvency regime and make sure that interest of all the stakeholders is balanced according to the object of IBC.

Reference

[1] The Insolvency and Bankruptcy Code, 2016, § 1(3), No. 31, Acts of Parliament, 2016 (India).  

[2] Ministry of Corporate Affairs, Notification, Ministry of Corporate Affairs (Nov 30, 2016), http://www.mca.gov.in/Ministry/pdf/CommencementNotification_01122016.pdf.

[3] Ministry of Corporate Affairs, Notification, Ministry of Corporate Affairs (Nov 15, 2019), http://www.mca.gov.in/Ministry/pdf/Notification_18112019.pdf.

[4] Indian Contracts Act, 1872, § 128, No. 9, Acts of Parliament, 1872 (India).  

[5] The Insolvency and Bankruptcy Code, 2016, § 60(2), No. 31, Acts of Parliament, 2016 (India).

[6] The Insolvency and Bankruptcy Code, 2016, § 60(3), No. 31, Acts of Parliament, 2016 (India).

[7]The Insolvency and Bankruptcy Code, 2016, § 14(3), No. 31, Acts of Parliament, 2016 (India).

[8]SBI v. V. Ramakrishnan, (2018) 17 SCC 394.

[9] I.C.I.C.I. Bank v. CA Ritu Rastogi, C.A 366 (PB)/2017

[10] Dr. Vishnu Kumar Agarwal v. Piramal Enterprises, 2019 SCC Online NCLAT 81.

[11] State Bank of India v Athena Energy Ventures Pvt Ltd, Company Appeal (AT) (Ins) No. 633 of 2020.

[12] Ministry of Corporate Affairs, Report of the Insolvency Law Committee, Ministry of Corporate Affairs (Feb 20, 2020), http://www.mca.gov.in/Ministry/pdf/ICLReport_05032020.pdf.

[13] Insolvency and Bankruptcy Board of India, Report of the Working Group on Individual Insolvency, IBBI.gov.in (Feb 20, 2020), https://ibbi.gov.in/uploads/resources/Final_report_of_WG_on_Individual_insolvency-Oct18.pdf.

[14] Lalit Mishra v. Sharon Bio Medicine Ltd., 2018 SCC OnLine NCLAT 862.

[15] SBI v.  Ramakrishnan, (2018) 17 SCC 394.

[16] Delhi Transport Corporation v. D.T.C. Mazdoor Congress, AIR 1991 SC 101.

[17] Insolvency and Bankruptcy (Application to Adjudicating Authority for Insolvency Resolution Process for Personal Guarantors to Corporate Debtors) Regulations, 2019, Form B.

[18] Lalit Mishra v. Sharon Bio Medicine Ltd., 2018 SCC OnLine NCLAT 862.

[19] Committee of Creditors of Essar Steel India Ltd. v. Satish Kumar Gupta, 2019 SCC OnLine SC 1478.

[20] Vijay Kumar Jain v. Standard Chartered Bank, 2019 SCC OnLine SC 103.

[21] Aypunni Mani v. Devassy Kochousep, AIR 1966 Ker 203.

[22] Maharashtra State Electricity Board v. Official Liquidator High Court, (1982) 3 SCC 358.

[23] Gouri Shankar Jain v. Punjab National Bank, AIR 2020 Cal 90.

[24] Raju Setty v. Bank of Baroda, AIR 1992 Kar 108.

[25] The Insolvency and Bankruptcy Code, 2016, § 10, No. 31, Acts of Parliament, 2016 (India).

[26]Committee of Creditors of Essar Steel India Ltd. v. Satish Kumar Gupta, 2019 SCC OnLine SC 1478.

[27] Punjab National Bank v. State of Uttar Pradesh, (2002) 5 SCC 80.

[28] Innoventive Industries Ltd. v. I.C.I.C.I. Bank, (2018) 1 SCC 407.

[29] The Insolvency and Bankruptcy Code, 2016, § 238, No. 31, Acts of Parliament, 2016 (India).

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