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In a recent decision of the Hon’ble Supreme Court in Lalit Kumar Jain v. Union of India, the provisions of the Insolvency and Bankruptcy Code, 2016 (IBC) concerning the liability of the personal guarantors to the corporate debtors were upheld. With the decision in place, the creditors can now initiate insolvency proceedings against individuals such as promoters, managing directors and chairpersons who stand as personal guarantors on the monies lent or goods and services extended to the corporate debtors. The decision concerns the challenge brought to the notification (Notification) dated 15 November 2019 issued by the Ministry of Corporate Affairs, which introduced a host of provisions making personal guarantors liable to insolvency proceedings under the IBC. The present article briefly summarises the findings of the Hon’ble Supreme Court in the decision mentioned above.
Facts of the case:
On 15 November 2019, the Ministry of Corporate Affairs issued the Notification vide which the personal guarantors were brought within the scope of the insolvency proceedings under the IBC. The instant judgment pertains to the common question of law that arises in multiple legal proceedings preferred under Article 32 and the cases transferred from several High Courts filed under Article 139A of the Constitution of India. The common question in the instant matter relates to the vires and validity of the Notification.
The petitioners, in the capacity of directors, or promoters, or in some instances as chairman or managing directors, had furnished personal guarantees to the banks and financial institutions, which led to the release of advances to various companies. Presently, the petitioners are facing insolvency proceedings which are at different stages. The principal ground of attack of the petitioners is that the executive could not have selectively brought into force the Code and applied some of its provisions to one sub-category of individuals, i.e., personal guarantors to corporate creditors. Hence, the present case.
Contentions from the petitioners:
The petitioners argued that the Notification is ultra vires based on, amongst other things, the following arguments:
- The Central Government has acted in excess of the powers vested in it under Section 1(3) of the IBC
The petitioners argued that Section 1(3) of the IBC was a conditional legislation where the legislature enacted law, and the only function assigned to the executive was to bring the law into operation at such time as it may decide. Such law was termed “conditional” instead of “delegated” because the legislature itself made the law in all its completeness, leaving nothing for the executive to legislate upon. The petitioners submitted that the Central Government by the Notification exceeded the power conferred upon it and modified the provisions of Part III of the IBC, which was not permissible. The petitioners relied upon a catena of decisions to buttress their submission that the government while exercising power conferred by a conditional legislation, cannot legislate in any manner.
2. The Notification metes out similar treatment to both financial and the operational creditor
The petitioners submitted that the provisions of Part III of the IBC, partly brought into effect by the Notification, provide a single procedure for the insolvency resolution process of a personal guarantor, irrespective of whether the creditor is a financial creditor or operational creditor. The petitioners relied on the decision in Swiss Ribbons (P.) Ltd. v. Union of India to contend that there was a fundamental difference in the nature of the loan agreements that a corporate debtor signed with the financial creditors from contracts with operational creditors for the supply of goods and services. It was further argued that clubbing financial creditors and operational creditors in relation to the insolvency resolution of personal guarantors to corporate debtors amounts to treating unequals equally and a collapse of the classification carefully created by the Parliament.
3. The failure of the Central Government to bring into effect Section 243 of the IBC
The petitioners argued that the Central Government should have brought into effect Section 243 of the IBC, which would have repealed the Presidency Towns Insolvency Act, 1909 and Provincial Insolvency Act, 1920. Before the Notification, the insolvency proceedings against an individual could be initiated only under the said enactments. Thus, the petitioners submitted that not bringing Section 243 into effect had the illogical effect of creating two self-contradictory legal regimes for insolvency of the personal guarantors.
4. The Notification overlooks the co-extensive nature of the liability of the personal guarantor
The petitioners relied upon the decision in Committee of Creditors of Essar Steel India Ltd. v. Satish Kumar Gupta to contend that an approval of a resolution plan in respect of a corporate debtor amounted to the extinction of all outstanding claims against the debtor. Further, given that the guarantor’s liability was co-extensive to that of the corporate debtor, on the approval of a resolution plan, the liability of a personal guarantor would stand extinguished as well.
Contentions from the Union of India and other respondents:
The respondents argued that the Parliament always wanted to deal with personal guarantors differently from partnership firms and proprietorship firms, and other individuals. Thus, in 2018, the IBC was amended to include three classes of debtors, which were personal guarantors to the corporate debtor under Section 2(e), partnership firms and proprietorship firms under Section 2(f) and individuals Section 2(g) of the IBC. The respondents submitted that the intention was to distinguish between personal guarantors and the corporate debtor from other individuals.
Along with the amendments brought in Section 2, the respondents stated that Section 60 of the IBC was also partially amended in 2018 to include the words a “corporate guarantor or personal guarantor as the case may be.” The amendment of Section 60(2) meant that a personal guarantor could be subjected to insolvency proceedings which could be resolved and decided by the NCLT. The respondents argued that if the insolvency resolution proceedings against the corporate debtor were continued without this amendment and the unification of the adjudicatory body, the personal guarantors would remain outside the scope of the entire machinery of the IBC.
The respondents then submitted that a segmented or stage-wise implementation of laws was held valid in multiple decisions since it provided a better understanding of the impact the laws might have on the subject matter. Further, according to the respondents, there was a need to interpret Section 1(3) of the IBC flexibly to meet the objectives of the IBC. Thus, the respondents submitted that the Notification was valid and in furtherance of the spirit of the IBC.
Summary of the judgment:
The Hon’ble Supreme Court took note of all the provisions introduced in the IBC at various stages. The Apex Court observed that it was pretty evident that the method adopted by the Central Government to bring into force different provisions of the Act had a specific design: to fulfil the objectives of the IBC having regarding to the priorities.
The Hon’ble Supreme Court then observed that the amendment of 2018 brought in the IBC was in furtherance of the object of extending the provisions of the IBC to personal guarantors of the corporate debtors to strengthen the insolvency resolution mechanism further. According to the Apex Court, it was interesting to note that even in the unamended IBC, the adjudicating authority for insolvency and liquidation for corporate persons, including corporate debtors and personal guarantors, was NCLT.
The Hon’ble Supreme Court opined that there appeared to be sound reasons why the forum for adjudicating insolvency processes must be common, i.e., through the NCLT. It was observed that the NCLT would then be able to consider the whole picture, as it were, about the nature of the assets available, either during the corporate debtor’s insolvency process or even later. According to the Apex Court, a complete picture would facilitate the Committee of Creditors in framing realistic resolution plans, keeping in mind the prospect of realising some part of the creditor’s dues from personal guarantors. Based on this discussion, the Apex Court held that the impugned notification was not an instance of the legislative exercise or amounting to impermissible and selective application of the provisions of the IBC.
The Hon’ble Supreme Court then referred to the petitioners’ argument that the Notification took away the protection afforded by law to personal guarantors and looked over the co-extensive nature of the liability of a guarantor and principal borrower. The Hon’ble Supreme Court held that the sanction of a resolution plan and the finality imparted to it by Section 31 of the IBC did not per se operate as a discharge of the guarantor’s liability. The Apex Court relied upon multiple decisions to hold that the release or discharge of the corporate debtor from the debt owed by it to its creditor, by an involuntary process, i.e., by the operation of law or due to liquidation or insolvency does not absolve the surety/ guarantor of his or her liability which arises out of an independent contract. As to the nature and extent of the liability of the personal guarantor, it was held that much would depend on the terms of the guarantee itself.
Therefore, the Notification was held legal and valid, and the writ petitions, transferred cases and transfer petitions in the instant matter were dismissed accordingly.
The decision did not uphold the constitutional values of delegated legislation. The proviso of Section 1 (3) of the Code empowers the central government to enforce various provisions of the code at different points in time, however it does not permit the government to classify a part of the provisions of the code or to apply the provisions on certain categories of persons. The “conditional legislation” permits the executive to bring the law into force at times it may decide. In such legislation, the law has been made in its completeness and with very limited scope for further legislation. The duty of the central government is to determine the time and manner for the law to apply in the country and not to choose the subjects to which the law will apply.
The second issue dealt with the sanction of the resolution plan which results in the discharge of the principal borrower. The resolution plan, once approved, becomes binding on the corporate debtor, members, guarantors, and other stakeholders involved in the resolution plan. Going by the provision of contact law as the “liability of the surety is co-extensive with that of the principal debtor” if the latter’s liability is discharged or extinguished the liability of surety should also be extinguished as the resolution plan is a contract. Section 140 of the Indian Contract Act, 1872, provides for subrogation rights which the personal guarantor cannot avail of after the approval of the resolution plan. However, the court in the present case relied on the ratio of V. Ramakrishnan where the court observed that the object of the Insolvency and Bankruptcy Code was not to allow personal guarantors to evade their liability once the resolution plan is approved. This, in turn, affects the right of a third party who is not even a party to the contract by not allowing him to file for subrogation rights and not discharging him of the co-extensive liability, thereby contradicting Section 30 (2) (e) of the Code. A balance has to be drawn between the interests of the corporate debtor and the rights of a personal guarantor. In most cases the directors are personal guarantors and their right to recover from the corporate debtor should not be taken away indifferently.
Our final contention against the rationale of this judgment is that it uses the Code for the purpose of debt recovery, which, as held in various instances, is against the ethos and legislative intent of the code. The appropriate mechanisms for debt recovery are through the SARFAESI, RDDBFI, or money suits, but the code should not be used as an alternative mechanism for debt recovery.
In the present case, the court had to decide between two rights – the contractual right of the personal guarantor and the right of the creditors, which are generally public sector banks. The court chose the latter as a public policy decision. The court in the present case seems to have followed the Benthamite approach of justice. As the debt recovery rates of Indian banks have been abysmal in recent years, the burden ultimately falls on the taxpayers. This judgment will take some of that burden off from the shoulders of the taxpayers and will put it on the personal guarantors who are generally financially strong and have agreed to repay the sum in case of default.
The repercussions this judgment will have on the future of personal guarantors can be far-reaching. While we may see a dip in the number of defaults by personal guarantors, it might become difficult to find a personal guarantor for a business and therefore limiting the opportunities of finance. It will also increase the burden on NCLT as more cases of debt recovery will find their way to NCLT instead of approaching traditional recovery tribunals and courts.
The instant judgment would bring a sigh of relief to many creditors for whom the gateway to the asset pool of the personal guarantors has been thrown open under the IBC. The judgment would be a cause of concern for many prominent industrialists who are the promoters of debt-laden companies. According to several reports, personal guarantees amounting to INR 1.8 lakh crores have been given by promoters of top companies facing huge debts. Thus, it is clear that the instant decision adds to the bite power of the IBC since the creditors of a corporate debtor will now have the option to proceed simultaneously against the corporate debtor and its personal guarantor. The instant judgment is yet another decision in furtherance of the spirit of the IBC and is a welcome move.