Understanding the excluded assets and Liabilities: Insolvency Process of Personal Guarantor under the Code – By CS. Gaurav Joshi

Understanding the excluded assets and Liabilities: Insolvency Process of Personal Guarantor under the Code

By Gaurav Joshi, CS, Ll.b, I.D

The provisions under Insolvency and Bankruptcy Code’ 2016 with respect to insolvency resolution and bankruptcy process for Individuals have been rolled out in first phase as the individual who have provided guarantee towards debt of a corporate debtor, can now be subjected to Insolvency proceedings in case they default on their obligations given under the contract of guarantee. Albeit, for all other cases pertaining to Individual Insolvency, same are yet to be made enforceable, still Insolvency proceedings with respect to personal guarantors have been faced with positive as well as negative feedbacks  with 2 rounds of litigations upto the Supreme Court already having completed in short span of about 2 years. The challenge made to the vires and validity of insolvency provisions for personal guarantors made before Supreme Court was turned down in May’ 21 by Apex Court in Lalit  Kumar Jain vs Union of India (2021) ibclaw.in 61 SC. With Hon’ble Supreme Court paving way for better debt resolution for banks and Financial institutions by upholding insolvency provisions for personal guarantors, a surge in filing of petitions against personal guarantors before NCLT has been witnessed. Insolvency resolution of individual who have extended guarantees to the lenders (who happens to be director, chairman, managing director of borrower) and failed in discharging liability of corporate debtor, is fundamental for effective corporate insolvency resolution process under the Code.

Insolvency Resolution and Bankruptcy process of Individuals under the Code provides for insolvency resolution of personal guarantor’s liabilities by providing them opportunity to come up with repayment plan and in case same is not agreed by their creditors, bankruptcy of such personal guarantor can be initiated. It is in this context that a clear understanding is required to be developed by all the stakeholders regarding what assets and liabilities are kept out of the Insolvency proceedings of personal guarantors. Present article therefore throws light on excluded debt and excluded assets in provisions for insolvency resolution of Individual guarantors under the Code.

Assets of Personal Guarantor which can not be subjected to Insolvency Proceedings

A person triggering insolvency provisions under Section 94 or 95 of the Code is expect to make an assessment of assets owned by personal guarantors which are to be kept out of insolvency proceedings and also liabilities that will not be discharged through the insolvency framework under the Code in order to take a rational decision before approaching the adjudicating authority. It is therefore for the said reasons, while an application is being made by creditor or guarantor under Section 94 or 95 of the Code, details of excluded assets are to be disclosed to the adjudicating authority.

What assets can be kept out of insolvency proceedings of personal guarantor can be found under Section 79 of the Code and Rules framed thereunder. A list of excluded assets is as under –

S. No. Asset type Remarks
1. Unencumbered tools, books, vehicles and other equipment as are necessary to the debtor or bankrupt for his personal use or for the purpose of his employment, business or vocation

These assets are to be kept outside the Insolvency proceedings subject to 2 conditions namely:

a. The asset should not be encumbered.
b. The asset can be kept out of insolvency proceedings only to the extent necessary to debtor for personal use, his employment, business or vacation.

Vocation would ordinarily mean a way of life that one believes to be suitable for him. 

2. Unencumbered furniture, household equipment and provisions as are necessary for satisfying the basic domestic needs of the bankrupt and his immediate family

These assets are to be kept outside the Insolvency proceedings subject to 2 conditions namely:

a.  The asset should not be encumbered.
b. The asset can be kept out of insolvency proceedings only to the extent necessary to debtor for himself and his immediate family domestic needs. 

Immediate family” of the debtor means his spouse, dependent children and dependent parents;

3. Any unencumbered personal ornament

These assets are to be kept outside the Insolvency proceedings subject to 3 conditions namely:

a. The asset should not be encumbered. 
b. Only to the extent of value of Rs. 1 Lakh
c. The asset can be kept out of insolvency proceedings only if same can not be parted with in accordance with religious usage.

4. Any unencumbered life insurance policy or pension plan Life insurance policy and pension plan, irrespective of any amount can be kept out of insolvency proceedings subject to condition that it is unencumbered. 
5. An unencumbered single dwelling unit owned by the debtor

Single dwelling unit/ residential house are to be kept outside the Insolvency proceedings subject to 2 conditions namely:

a. The dwelling unit should not be encumbered. 
b. Only to the extent of value of Rs. 25 lakh in case dwelling unit is in urban area and Rs. 10 Lakh in case dwelling unit is in Rural area “Rural area” shall have the same meaning as assigned to it in clause (o) of section 2 of the National Rural Employment Guarantee Act, 2005 and all other area is to be considered as Urban area. 

Therefore, legislature has consciously kept certain assets which are necessary of livelihood of insolvent individual and no security interest has been created on them. It is for this reason, an assessment is required to be made before provisions of code can be used for initiating Insolvency provisions against Individual guarantors.

Liabilities of Personal Guarantor which cannot be discharged under Repayment Plan or Discharge order under Bankruptcy Process

Similarly, code provides certain liabilities which a personal guarantor can not get discharge of even under repayment plan or discharge order and same can not form part of insolvency proceedings of personal guarantor. Provisions under the Code also prohibits a personal guarantor to file application under Section 94 for initiating insolvency process in respect of excluded debts. A list of excluded debt is as under –

S. No. Nature of debt Remarks
1.  Liability to pay fine imposed by a court or tribunal Fine imposed by court or tribunal can not be part of insolvency proceedings. 
2. Liability to pay damages for negligence, nuisance or breach of a statutory, contractual or other legal obligation

Liability for damages arising out of

a. Negligience
b. Nuisance
c. Breach of statutory, contractual or legal obligations

can not be part of insolvency proceedings.

3. Liability to pay maintenance to any person under any law for the time being in force

Liability to pay maintenance to any person can arise under various statute such as – 

a. Maintenance under Hindu Law. 
b. Maintenance under Muslim Law. 
c. Maintenance under Christian Law. 
d. Maintenance under Parsi Law. 
e. Maintenance under Code of Criminal Procedure 1973.
f. Maintenance under Protection of women from Domestic violence Act, 2005. 
g. The Maintenance and Welfare of Parents and Senior citizens Act, 2007

These liabilities can not be part of Insolvency proceedings. 

4. Liability in relation to a student loan Liability on debtor in relation to student loan can not be part of Insolvency proceedings. 

The provisions of Code do not provide for discharge of above liabilities even though individual may get a discharge order from all other debts. Therefore, it becomes necessary to take into account excluded debts while invoking section 94 or 95, finalizing repayment plan or taking a decision with respect to initiation of bankruptcy process of the personal guarantor.

Conclusion

A clear understanding of assets and liabilities of debtor is fundamental for effective insolvency resolution process which would include assessment of excluded assets and excluded debts under Insolvency proceedings. While Hon’ble Supreme Court had already upheld the provisions of Insolvency proceedings against personal guarantors contained in the code, however certain provisions which were not dealt by Supreme Court in Lalit Kumar Jain vs UoI, have been now subject matter of challenge in another writ petition filed in the matter of Gurmeet Sodhi which might derail process of lenders dragging the promoters of bankrupt Corporates to recover their due, to a certain degree and for next few months. It would be in fitness of things if all the controversy are settled once and for all by Supreme Court for smooth implementation of the provisions of Code leading to better recovery for lenders and increase in credit in the market.

 

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