Personal Guarantors and Moratorium under IBC

There was huge controversy with regards to the applicability of moratorium upon the personal guarantee of the corporate debtor as there were conflicting judgment of Bombay and Allahabad High Court. Furthermore, NCLAT held that moratorium will apply to personal guarantors. This controversy now settled by the Supreme Court.

I. Statutory Provisions

• As per section 128 of the Indian Contract Act, 1872, the liability of the surety is co-extensive with that of the principal debtor and the creditor may go against either the principal debtor, or the surety, or both, in no particular sequence. A contract of guarantee is between the creditor, the principal debtor and the surety, where under the creditor has a remedy in relation to his debt against both the principal debtor and the surety.[1]
• Section 5(22), IBC defines personal guarantor as an individual who is a surety to corporator debtor.
• Section 14 of IBC states that after the admission of the insolvency application there shall be moratorium prohibiting instituting of recovery proceedings against the corporate debtor but the section nowhere used the term “personal guarantor”
• Section 60(2) states that the insolvency proceeding against the personal guarantor shall be instituted in the same tribunal which admits the insolvency application against the corporate debtor.

II. Judicial Conundrum

In Sicom Investments and Finance Ltd. v. Rajesh Kumar Drolia and Anr.,[2] the Bombay High Court held that, Section 14 is as clear as it can be. On reading Section 14, it is clear that the benefits as well as the liabilities mentioned therein are only that of the corporate debtor and corporate debtor alone. As far as prohibiting the institution of suits or continuation of pending suits or proceedings are concerned, the same applies only against the corporate debtor in insolvency and not a third party such as a guarantor, be it an individual or a corporate guarantor.

The Allahabad High Court in Sanjeev Shriya v. State Bank of India,[3] held that moratorium will apply to enforcement of guarantee against personal guarantor to the debt. The rationale being that if a CRIP is going on against the corporate debtor, then the debt owed by the corporate debtor is not final till the resolution plan is approved, and thus the liability of the surety would also be unclear.

The Court took the view that until debt of the corporate debtor is crystallized, the guarantor’s liability may not be triggered. The Committee deliberated and noted that this would meant that surety’s liabilities are put on hold if a CIRP is going on against the corporate debtor, and such an interpretation may lead to the contracts of guarantee being infructuous, and not serving the purpose for which they have been entered into.

In State Bank of India v. V. Ramakrishnan and Veeson Energy Systems,[4] NCLAT, took a broad interpretation of Section 14 and held that it would bar proceedings or actions against sureties. While doing so, it relied on the Sec. 30, IBC and held that;

“From the aforesaid provisions, it is clear that ‘Resolution Plan’ if approved by the ‘Committee of Creditors’ under sub-section (4) of Section 30 and if the same meets the requirements as referred to in sub-section (2) of Section 30 and once approved by the ‘Adjudicating Authority’ is not only binding on the ‘Corporate Debtor’, but also on its employees, members, creditors, guarantors and other stakeholders involved in the ‘Resolution Plan’, including the ‘Personal Guarantor’.”

NCLAT has also rejected the stand taken by the NCLT, Mumbai in Schweitzer Systemtek India Private Limited v. Phoenix ARC Private Limited,[5] which had instead allowed invocation of personal guarantees during a moratorium under IBC, and has held otherwise.

III. Awaited Clarification

The Hon’ble Supreme Court in State bank of India v. V. Ramakrishna and Anr. ,[6] provided the requisite clarification to resolve the existing judicial conundrum pertaining to application of moratorium upon the personal guarantee.

The Court while upholding the reasoning of Bombay High Court in Sicom’s case, held that,

“Section 14 refers to four matters that may be prohibited once the moratorium comes into effect. In each of the matters referred to, be it institution or continuation of proceedings, the transferring, encumbering or alienating of assets, action to recover security interest, or recovery of property by an owner which is in possession of the corporate debtor, what is conspicuous by its absence is any mention of the personal guarantor. Indeed, the corporate debtor and the corporate debtor alone is\ referred to in the said Section. A plain reading of the said Section, therefore, leads to the conclusion that the moratorium referred to in Section 14 can have no manner of application to personal guarantors of a corporate debtor.”

The Court also further clarified the interpretation of Sec. 31 as the judgement of NCLAT was based on the same and held that;

“Section 31 only states that once a Resolution Plan, as approved by the Committee of Creditors, takes effect, it shall be binding on the corporate debtor as well as the guarantor. This is for the reason that otherwise, under Section 133 of the Indian Contract Act, 1872, any change made to the debt owed by the corporate debtor, without the surety’s consent, would relieve the guarantor from payment.”

IV.Conclusion

The decision of the Supreme Court came as much awaited relief for the Lender as while the haircut is increasing under IBC resolution they can realize their debt by initiating proceeding against the personal guarantor under the SARFESI.

[1] National Project Construction Corporation Limited v. Sandhu and Co., AIR 1990 P&H 300

[2] (2017) SCC Online Bom 9275

[3] 2017 (9) ADJ 723

[4] Company Appeal (AT) (Insolvency) No. 213/2017 [Date of decision – 28 February, 2018]

[5] 2017 140 CLA 121

[6] C.A. No. 3595 of 2018.