The provisions to enforce guarantees, given to creditors/lenders either by individuals (generally promoters, directors, partners of LLP with their Spouse / relatives) or by corporate for credit facilities extended to borrowers, are governed by the Insolvency and Bankruptcy Code, 2016 (IBC)[1]. This write-up takes stock of some of the important rulings and attempts to bring to the fore, the settled position of law.
Now the law is settled in respect of –
(A) “personal guarantors to corporate borrower”. Where individuals give personal guarantees to lenders for credit facilities extended to limited companies and limited liability partnerships (corporate persons) is governed by the IBC; and
(B) “corporate guarantors to non-corporate borrower” to lenders for credit facilities extended to partnership firms or proprietorship to corporate persons is also governed by the IBC.
(A) Personal Guarantors (PGs):
(i) Applicability of IBC to PGs across India:
The bankruptcy of individuals, HUF and partnership firms, where they are not guarantors to corporate person, continues to be governed by archaic laws. And hence Creditors can recover debt dues from such persons either by filing recovery suits or filing an application under the Presidency Towns Insolvency Act, 1909 (applies to presidency towns of Kolkata, Mumbai and Chennai) and the Provincial Insolvency Act, 1920 where such persons reside or carries on business in other areas.
However, IBC is applicable where individuals give personal grantees to lenders for credit facilities extended to corporate persons (i.e. where principal borrowers are with limited liability). Part III of the IBC provides for the same and is made applicable with effect from December 1, 2019, by notification number S.O. 4126(E) dated November 15, 2019 (except fresh start process under Chapter II of Part III).
The constitutional validity of the said notification was under challenge before different High Courts. The same has now been upheld by Hon’ble Supreme Court of India[2] by holding that personal guarantors, although forming part of the larger grouping of individuals, were to be dealt with differently, considering their intrinsic connection with corporate debtors. As a result, lenders/creditors who have obtained personal guarantees from directors/partners and promoters for extending credit facilities to corporate persons, can initiate insolvency proceedings against such personal guarantors under the IBC.
(ii) Protection of moratorium under Section 14 IBC not available to Personal Guarantors:
An attempt was made to extend protection of moratorium u/s.14 IBC (which is available to corporate debtor under insolvency resolution process) to personal guarantors to corporate persons, probably to maintain the effect similar to Section 22 of SICA which extended protection to personal guarantors (i.e. after industrial unit is declared sick, prior permission of BIFR was required to proceed against personal guarantors). However, Hon’ble Supreme Court considering that there is no mention of personal guarantor in section 14 IBC and therefore held that a plain reading of it leads to the conclusion that the moratorium referred to in Section 14 can have no application to personal guarantors of a corporate debtor[3].
(iii) NCLT is having exclusive jurisdiction:
An application relating to the “bankruptcy” of a personal guarantor of a corporate debtor shall be filed only before the National Company Law Tribunal (NCLT), as provided under Section 60(2) IBC. And, where a bankruptcy proceeding of a personal guarantor of the corporate person is pending in any court or tribunal, the same shall stand transferred to the NCLT dealing with the insolvency resolution process or liquidation proceedings of such corporate person – section 60(3).
Proceedings against personal guarantors to corporate persons shall be before the NCLT, having territorial jurisdiction over the place where the registered office of the corporate persons is located[4].
(iv) PGs can be proceeded against by lenders without clubbing it with action or inaction against corporate person:
Relying on section 60(2) IBC, several personal guarantors questioned the commencement of insolvency resolution of personal guarantors if corporate insolvency resolution process or liquidation not having commenced or concluded. Hon’ble Supreme Court in Mahendra Kumar Jajodia v. State Bank of India[5] upheld decision of National Company Law Appellate Tribunal (NCLAT)[6] and ruled that the NCLT is the appropriate adjudicating authority for initiation of all insolvency proceedings against personal guarantors, even if there were no pending corporate insolvency resolution process or liquidation against the corporate person. The said judgement also provided clarity on the (a) right of creditors to initiate insolvency resolution process against personal guarantors to the principal borrower who is corporate person u/s.95 IBC; and (b) timing and jurisdiction to exercise such a right u/s.60(1) IBC.
Hon’ble Supreme Court has also made it clear in SBI v. V. Ramakrishnan[7] that when there is a proceeding pending against the corporate person under IBC, then any bankruptcy proceeding against the individual personal guarantor will, if already initiated before the proceeding against the corporate person, be transferred to the NCLT or, if initiated after such proceedings initiated against the corporate person, be filed only in the NCLT. Recovery action against personal guarantors to a corporate person can also be brought even while the corporate person is under CIRP or ordered liquidation.
Thus, lenders can take recovery action against personal guarantors to a corporate person without first putting the corporate debtor under CIRP or even if application of lender(s) against corporate person is pending before NCLT. It also means that even after invoking personal guarantee, creditor may still go after corporate person under IBC.
In short, a right or cause of action enure to the lender (financial creditor) to proceed against the principal borrower, as well as the guarantor in equal measure in case they commit default in repayment of debt acting jointly and severally.
(v) Action against PGs to a corporate debtor can be brought despite approval of resolution plan for corporate debtor:
In Ramakrishnan Supreme Court held that the resolution plan, even on its approval under Section 31(1), does not necessarily end in discharge of the guarantor; on the other hand, it may well permit the creditors of corporate person to continue to pursue the guarantor for recovering whatever gap or shortfall remains to be filled up in the recovery of their dues from the CD.
As regards legal rights as a surety (guarantor) to get discharge from personal guarantee under Sections 128, 133 and 140 of the Contract Act, the Supreme Court in Lalit Kumar Jain v. UOI held that the guarantor gets relieved of his obligations under the said provisions only if (i) the terms of the contract are not worded otherwise; and (ii) if it is the consequence of a voluntary act of release/discharge/composition or variance of contract of guarantee by the principal borrower. The guarantor does not get relieved when the principal borrower (corporate person) itself is subjected to any variation of the contract on account of operation of law such as a resolution plan being approved by the adjudicating authority under Section 31(1) IBC.
(v) Procedure of personal insolvency law applies until relevant provisions are brought to force:
Hon’ble Supreme Court has clarified in SBI v. V. Ramakrishnan[8] that NCLT is to decide proceedings against PGs only in accordance with the Presidency Towns Insolvency Act, 1909 or the Provincial Insolvency Act, 1920, as the case may be.
The Apex Court also clarified that section 60(4) IBC states that the NCLT shall be vested with all the powers of the Debts Recovery Tribunal (DRT), as contemplated under Part III of IBC, however, the same would not take effect, as the DRT has not yet been empowered to hear bankruptcy proceedings against individuals, as (i) Section 179 of IBC has not yet been brought into force, and (ii) Section 249 IBC, dealing with the consequential amendment of the Recovery of Debts Act to empower Debts Recovery Tribunals to try such proceedings, has also not been brought into force.
Thus, IBC has no application where lenders initiate action against personal guarantors to non-corporate persons. And action by lenders/creditors against individuals (other than guarantor to corporate persons) and partnership firms continued to be governed by the Presidency Towns Insolvency Act, 1909 and the Provincial Insolvency Act, 1920.
(B) Corporate Guarantors to non-corporate borrower:
The Amendment to IBC in 2018 has made it clear that lenders can act against corporate guarantor under IBC if they fail to pay the debt of the borrower.
Where borrower is a partnership firm and a proprietor, who fails to repay loans, then lender may invoke corporate guarantee (if given by LLP or Limited company) without taking steps to recover from partnership firm and/or proprietors. And if such corporate guarantor fails to honour the guarantee, lender may initiate action under IBC against the corporate guarantor.
Very recently Hon’ble Supreme Court in Laxmi Pat Surana[9] held that an action under Section 7 of the IBC can be initiated by a Financial Creditor, against a corporate person, in relation to a corporate guarantee given by that corporate person, in respect of a loan advanced to the principal borrower, who is not a corporate person.
Thus, the principal borrower may or may not be a corporate person, but if a corporate person extends guarantee for the loan transaction concerning a principal borrower not being a corporate person, it would still be covered within the meaning of the expression “corporate debtor” in Section 3(8) IBC.
[1] Section 2(1)(e) of the IBC substituted by Act No. 8 of 2018 states it applies to personal guarantors to corporate debtors, with retrospective effect from November 23, 2017.
[2] Lalit Kumar Jain v. Union of India, (2021) 9 SCC 321 : 2021 SCC OnLine SC 396 at page 394
[3] SBI v. V. Ramakrishnan, (2018) 17 SCC 394 : (2019) 2 SCC (Civ) 458 : 2018 SCC OnLine SC 963 at page 410
[4] under the amended Section 60(1) and (2) read with Sections 94 and 95 of the IBC.
[5] Mahendra Kumar Jajodia v. SBI, 2022 SCC OnLine SC 908
[6] SBI v. Mahendra Kumar Jajodia, 2022 SCC OnLine NCLAT 58
[7] (2018) 17 SCC 394 : (2019) 2 SCC (Civ) 458 : 2018 SCC OnLine SC 963 at page 411
[8] (2018) 17 SCC 394 : (2019) 2 SCC (Civ) 458 : 2018 SCC OnLine SC 963 at page 411
[9] Supreme Court in Laxmi Pat Surana v. Union Bank of India and Another (2021) 8 SCC 481.
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