Position of a Personal Guarantor under the Insolvency and Bankruptcy Code

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Introduction

The concept of contract of guarantee revolves around the principle that a Personal guarantor shall perform the promise or discharge the liability of the principal debtor towards a creditor, in the event, such principal debtor has failed to perform its promise or discharge its liability.[1] The Insolvency and Bankruptcy Code, 2016 (“IBC”) defines a personal guarantor as an individual who is the surety under a contract of guarantee to a corporate debtor.[2] IBC was promulgated in August 2016. However, the provisions of IBC pertinent to insolvency resolution process of personal guarantors to corporate debtors were not.

This article will discuss the position of a personal guarantor under the regime of IBC, various decisions of the courts and the implications of the Insolvency and Bankruptcy (Application to Adjudicating Authority for Insolvency Resolution Process for Personal Guarantors to Corporate Debtors) Rules, 2019 (“2019 Rules”) notified on 15th November 2019.

Personal guarantor vis-à-vis CIRP against a Corporate Debtor

The IBC provides rights to a creditor to initiate corporate insolvency resolution process (“CIRP”) against both the debtor and the guarantor. The Supreme Court of India (“Supreme Court“) in the matter of State Bank of India v. V. Ramakrishnan and Others[3] (“Ramakrishnan judgment”) concluded that in a contract of guarantee, the liability of the guarantor and that of the principal debtor are co-extensive, and therefore, the creditor can simultaneously sue either the corporate debtor, the guarantor, or both, in no particular order.

Relying on the recommendation in the report of the Insolvency Law Committee (“ILC”) dated 26 March, 2018, and post the Ramakrishnan judgment, the Government amended Section 14(3) of the IBC which provided that the period of moratorium operating against the corporate debtor shall not be applicable to a guarantor in a contract of guarantee to a corporate debtor.

Section 60(2) of the IBC provides that if the CIRP or liquidation of a corporate debtor is pending before the National Company Law Tribunal (“NCLT“), any application pertaining to the CIRP, liquidation or bankruptcy of a guarantor of such corporate debtor is liable to be filed before to the same NCLT. Section 60(3) of the IBC provides that in the event CIRP or liquidation or bankruptcy proceeding of a corporate guarantor or a personal guarantor of the corporate debtor is pending before any court or tribunal, it shall stand transferred to the same NCLT dealing with CIRP or liquidation proceeding of such corporate debtor. Insolvency proceedings can be initiated against any personal guarantor under Section 95 of the IBC by filing an application before the NCLT. 

Understanding the standpoint of a personal guarantor under the new insolvency rules

The Ministry of Corporate Affairs notified the 2019 Rules which became effective from 1st December 2019. Under the 2019 Rules, Section 2(e) of the IBC was notified which made Part III of IBC separately applicable to personal guarantors to corporate debtors. As a result of the same, a creditor can initiate CIRP against a personal guarantor before the Debt Recovery Tribunal. The notification of the 2019 rules triggered the initiation of CIRP against many personal guarantors to corporate debtors. This action against the personal guarantors culminated in the 2019 Rules getting challenged before various High Courts across the country.

The Supreme Court finally settled the controversy apropos the position of personal guarantors in Lalit Kumar Jain vs Union of India & Ors [4](“Lalit Kumar Jain”). The Supreme Court upheld the validity of the 2019 Rules inter alia holding that the intention to insert Section 2(e) and alter Section 60(2) was directed to strengthen the CIRP and IBC keeping in mind the intrinsic connection between a personal guarantor and a corporate debtor. It further held that an approval of a resolution plan does not necessarily discharge a personal guarantor of its liabilities under the contract of guarantee.

Personal Guarantor’s right of subrogation under the IBC

The right of subrogation is an equitable right available to a guarantor as it steps into the shoes of the creditor upon performing the obligations on behalf of the principal debtor, and is invested with all the rights that the creditor possessed as against the principal debtor[5]. Therefore, the guarantor upon performing the obligations of the principal debtor must be indemnified. Nonetheless, under the IBC, the personal guarantor does not possess this right to proceed against the corporate debtor once the personal guarantor has paid the corporate debtor’s debts to the creditors.

In Lalit Mishra and Others v. Sharon Bio Medicine Limited[6] (“Lalit Mishra”)NCLAT held that the guarantors cannot exercise the right of subrogation conferred upon them under contract law, since the proceedings under IBC are not recovery proceedings which was further affirmed by the Supreme Court[7]. This stance of the Supreme Court was also affirmed in the case of Committee of Creditors of Essar Steel Ltd. vs Satish Kumar Gupta[8] (“Essar Steel”).

Conclusion

The Ramakrishnan judgment along with Lalit Kumar Jain paved the way for initiation of insolvency proceedings against the personal guarantor to a corporate debtor under the IBC, thus protecting the rights of the creditors. It is trite that, a guarantor, as a right under the law of equity and natural justice can recover the quantum of money paid on behalf of the principal debtor. However, the rulings of Indian courts viz. Lalit Mishra and Essar Steel will shake the confidence of a personal guarantor who are generally the promoters/directors of a corporate debtor to act as a surety to the corporate debtor.


[1] Indian Contract Act, 1872, S. 126.

[2] Insolvency and Bankruptcy Code, 2016, S. 5 (22).

[3] AIR 2018 SC 3876.

[4] (2021) 9 SCC 321.

[5] Indian Contract Act, 1872, S. 140.

[6] [2019] 148 CLA 154.

[7] Civil Appeal No.1603 of 2019.

[8] 2019 (16) SCALE 319.

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