The evolving insolvency landscape has significantly altered the legal and financial obligations of personal guarantors, particularly with the introduction of specialized provisions under the Insolvency and Bankruptcy Code, 2016 (IBC). Traditionally, personal guarantors were considered secondary obligors, whose liability was contingent on the default of the principal debtor. However, recent legislative reforms and judicial pronouncements have redefined their role, making them directly accountable in insolvency proceedings. A personal guarantor is an individual who provides surety under contract of guarantee to secure the obligations of a borrower. Personal guarantors play a pivotal role in securing loans for businesses and facilitating economic activities. The liability pertaining to the personal guarantors under Insolvency Bankruptcy Code, 2016 has evolved significantly with the legal framework extending its reach to bring the personal guarantors at a similar pedestal as the corporate debtors. This significant shift has brought in an additional layer of protection to the creditors while severely limiting the rights available to the personal guarantors.
The creditors to recover their dues from the personal guarantor in case of a default by the corporate debtor before the introduction of IBC, had the following options:
- Approaching civil courts under the now repealed Provincial Insolvency Act,1920;
- Approaching the civil courts and filing a civil suit under the Indian Contract Act,1872;
- Approaching the Debt Recovery Tribunal (‘DRT’) under Securitization and Reconstruction of Financial Assets and Enforcement of Securities Act, 2002 (‘SARFAESI’).
Under the Indian Contract Act of 1872, a guarantor plays a crucial role in contracts of guarantee, which are governed by Sections 126 to 147 of the Act. A contract of guarantee is a legal arrangement wherein a guarantor undertakes to discharge the liability of a third party (the principal debtor) in case of default. As per Section 126, a guarantee involves three parties: the creditor, the principal debtor, and the guarantor. The guarantor’s liability is generally secondary, meaning it arises only when the principal debtor fails to fulfil their obligations. However, once the guarantee is invoked, the guarantor becomes liable to pay the outstanding dues to the creditor. Upon payment, the guarantor gains the right of subrogation, allowing them to recover the amount from the principal debtor. The Act also outlines various provisions related to the revocation of guarantees, discharge of liability, and co-extensive nature of the guarantor’s obligation, ensuring a balanced approach between creditor rights and guarantor protections. The liability of the principal debtor is coextensive with that of the guarantor, as stipulated under contract law. Under the Insolvency and Bankruptcy Code (IBC), 2016, the term corporate debtor is equivalent to the principal debtor in a contract of guarantee under the Indian Contract Act, 1872.
Liability of Guarantor under Indian Contract Act, 1872
Under the Indian Contract Act of 1872, the guarantor’s liability is coextensive with that of the principal debtor, meaning the guarantor is equally responsible for the debt unless stated otherwise in the contract. As per Section 128, the creditor can directly proceed against the guarantor without first exhausting remedies against the principal debtor. The guarantor’s obligation remains even if the creditor does not sue the principal debtor, reinforcing the principle of independent liability. However, upon repayment, the guarantor gains the right of subrogation under Section 140, allowing them to recover the amount from the principal debtor. In the case of Gouri Shankar Jain v. PNB,(2019) the High Court of Calcutta observed that even if the liabilities of the debtor are extinguished upon the acceptance of a resolution plan, the personal guarantor’s responsibility does not automatically cease. The Court referred to different provisions of the Indian Contract Act related to the release of a guarantee and made the following observations: As per Section 128 of the Contract Act, the guarantor’s liability is coextensive with that of the principal debtor, meaning it is linked to the total amount of the principal debt. However, if the resolution agreement is approved and the principal debtor’s liability is extinguished, the guarantor’s liability is also extinguished under Section 128. However, in contrast to this view, the court referred to the ruling in the Maharashtra State Electricity Board case, where it was held that a guarantor’s liability does not automatically extinguish in the case of release by operation of law. The principle here is that certain legal provisions, such as the IBC, do not necessarily discharge the guarantor, even if the primary debtor’s obligations are extinguished through a resolution plan. This view reinforces the idea that the personal guarantor’s liability is independent, and unless specifically addressed in the resolution plan or contract, they remain liable to the creditor for the debt, even if the principal debtor is absolved.
Insolvency Framework for Personal Guarantors: Evolution from Pre-IBC Laws To The Post-Notification Regime
IBC was enacted in 2016; however, not all the provisions of IBC were enforced at the time of enactment. The Parliament gave Central Government the power to bring different provisions of IBC into force at different dates. Judicial interpretations have played a crucial role in defining the extent of personal guarantor responsibility, with cases like Swiss Ribbons Pvt Ltd v. Union of India (2019) validating their inclusion in IBC, paralleling similar judgments in the UK and EU, such as Gibbs v. La Société Générale (2018), studies by Queirolo & Dominelli (2020) emphasize the role of the European Insolvency Regulation (EIR) in harmonizing enforcement across member states, ensuring that personal guarantors are not easily discharged from obligations during cross-border proceedings. The provisions relating to insolvency resolution and bankruptcy of personal guarantors which are covered under Part III of IBC were enforced when the Central Government notified the Insolvency and Bankruptcy (Application to Adjudicatory Authority for Insolvency Resolution Process for Personal Guarantee to Corporate Debtors) Rules, 2019 w.e.f. 1st December, 2019. The Rules brought the personal guarantors under IBC which exposed them to higher level of risk of losing their personal assets in case of insolvency proceedings.
Before the enactment of the Insolvency and Bankruptcy Code the insolvency and bankruptcy of personal guarantors were governed by the Presidency Towns Insolvency Act of 1909 and the Provincial Insolvency Act of 1920. These laws, which applied to individuals in different regions of India, were outdated and lacked efficient mechanisms for insolvency resolution. One of the significant shortcomings was the absence of a structured framework, including the appointment of professionals like resolution professionals, which led to delayed proceedings and inefficiencies. Furthermore, these laws were debtor-centric, giving minimal authority and involvement to secured and unsecured creditors, thereby making the resolution process ineffective. With the introduction of the IBC, a more structured and efficient insolvency framework was established, though its applicability to personal guarantors was initially limited. Only after the Ministry of Corporate Affairs issued a notification on November 15, 2019, were insolvency proceedings against personal guarantors brought under the purview of the IBC. This notification took effect on December 1, 2019, ensuring that a consolidated legal framework governed personal guarantors’ insolvency and bankruptcy processes. However, the notification explicitly limits the applicability of Part III of the Code only to personal guarantors and does not extend it to other individuals or partnership firms. Moreover, a guarantor only falls within the purview of the Code if the creditor has invoked the guarantee and remains unpaid in whole or in part. The shift of insolvency proceedings for personal guarantors from the archaic insolvency laws to the IBC signifies a progressive reform in India’s insolvency regime.
Including personal guarantors under the Insolvency and Bankruptcy Code in 2019 marked a significant shift in India’s insolvency landscape. Before this, personal guarantees were governed by the Indian Contract Act of 1872, which lacked a structured mechanism for their enforcement in insolvency scenarios. The 2019 amendment addressed this gap by allowing creditors to initiate insolvency proceedings against personal guarantors, ensuring that the recovery process is streamlined and creditors have a more straightforward path to pursue debts. The amendment also granted personal guarantors the opportunity to seek their own insolvency resolution, promoting a more comprehensive and equitable approach to insolvency. The 2019 amendment and subsequent judicial rulings have significantly enhanced the efficacy of the insolvency process in India by making personal guarantors directly liable within the IBC framework. Creditors now have a more efficient and structured mechanism to pursue claims against corporate debtors and their personal guarantors in the same forum, thereby avoiding the delays and inefficiencies of multiple legal proceedings. For personal guarantors, this change allows quicker resolution and discharge from their financial obligations, ultimately fostering a more transparent and effective insolvency resolution system in India.
Constitutional validity of the Provisions of Personal Guarantors under the IBC
Number of writ petitions challenging the constitutional validity of chapter III of IBC have been filed before the Hon’ble Supreme Court of India. The constitutional validity of Sections 95 to 100 of the Insolvency and Bankruptcy Code, 2016, concerning personal guarantors, was recently challenged in recent writ petitions filed under Article 32 of the Constitution. The petitioners argued that these provision violated the principles of natural justice by allegedly condemning personal guarantors unheard and granting excessive adjudicatory powers to the Resolution Professional. However, on November 9, 2023, in the case of Dilip B Jiwrajka v. Union of India & Ors., the Supreme Court upheld the constitutional validity of these provisions, ruling that they do not violate natural justice principles and ensuring that the insolvency resolution framework remains intact. The Court dismissed the petitions, reinforcing the legitimacy of the insolvency process for personal guarantors under the Code
Who is a personal guarantor under IBC?
A personal guarantor, as defined under Section 5(22) of the IBC, “personal guarantor means an individual who is the surety in a contract of guarantee to a corporate debtor;”. According to Rule 3(e) of the Insolvency and Bankruptcy (Application to Adjudicating Authority for Insolvency Resolution Process for Personal Guarantors to Corporate Debtors) Rules, 2019 “a guarantor means a debtor who is a personal guarantor to a corporate debtor and in respect of whom guarantee has been invoked by the creditor and remains unpaid in full or part.”
Legislative Provisions Related to Personal Guarantor under IBC
Implementing the Insolvency and Bankruptcy Code in India has significantly impacted the insolvency regime, particularly concerning the insolvency process for personal guarantors to corporate debtors. Section 2(e) of the IBC, introduced through the Insolvency and Bankruptcy Code (Amendment) Act, 2018, applies explicitly to personal guarantors, subjecting them to the insolvency process under the Code. Personal guarantors, as defined under Section 5(22) of the IBC, are individuals who act as sureties for corporate debtors in guarantee contracts, and the invocation of the guarantee by creditors triggers the insolvency proceedings against them. The rules regarding the insolvency process for personal guarantors, outlined explicitly in Rule 3(e) of the Insolvency and Bankruptcy (Application to Adjudicating Authority for Insolvency Resolution Process for Personal Guarantors to Corporate Debtors) Rules, 2019, further define the process and conditions for their insolvency resolution. The IBC also includes provisions for an adjudicating authority to handle the insolvency resolution of corporate debtors and personal guarantors, as outlined in Section 60(3) of the Code. This section ensures that if a corporate debtor undergoes an insolvency process, the personal guarantor is also subject to the same process, with the National Company Law Tribunal (NCLT) acting as the adjudicating authority. The Code also includes provisions regarding the insolvency resolution process for individuals, including Sections 94 to 187 of the Code, which cover the initiation of insolvency proceedings, interim moratorium, the submission of reports by resolution professionals, and the implementation of repayment plans. Following the 2019 notification, these provisions specifically apply to personal guarantors of corporate debtors, aligning their insolvency resolution process with that of corporate entities.
Section 60 of the IBC, the National Company Law Tribunal (NCLT) has territorial jurisdiction over insolvency resolution matters concerning corporate persons, including corporate debtors and their personal guarantors. A debtor who commits default may either personal or through a resolution professional can initiate the insolvency process under Section 94 of the IBC by filing an application before the NCLT. A creditor or a resolution professional can initiate the insolvency process against a personal guarantor under Section 95 of the IBC by filing an application before the NCLT, ensuring a structured resolution mechanism within the insolvency framework.
The process of initiating insolvency against a personal guarantor begins with serving a demand notice, requiring the guarantor to repay the defaulted amount within 14 days. If the guarantor fails to pay, the creditor can apply to the National Company Law Tribunal (NCLT) with necessary documents, such as the demand notice and income tax returns. Upon filing, an interim moratorium begins, suspending further legal actions. The NCLT appoints a resolution professional to submit a Report under section 99 recommending either the acceptance or rejection of an application under section 94 and 95, as the case maybe. On the admission of the application the Resolution Professional oversee the insolvency process. The resolution professional evaluates the case, formulates a repayment plan, and convenes a creditors’ meeting for approval. The plan, if approved by the majority, is submitted to the NCLT for confirmation. Once the NCLT approves the repayment plan, it becomes binding on the creditors and the debtor, and a 180-day moratorium period begins. During this time, claims from creditors are invited, and a list of creditors is compiled. A repayment plan is devised, outlining debt restructuring and repayment schedules, and presented to the NCLT. If the plan is not fully implemented within the agreed timeline, the repayment plan is considered prematurely ended, and creditors may file for bankruptcy. Ultimately, the resolution professional applies to the NCLT for a discharge order upon successful implementation or after the plan concludes, relieving the guarantor from the debts as specified in the repayment plan. The process allows creditors to seek repayment from the personal guarantor when the corporate debtor defaults on the loan.
Landmark Precedents on Personal Guarantor Liability
1. Lalit Kumar Jain Vs Union of India & Ors. Hon’ble Supreme Court of India held that the personal guarantors had an innate connection with the corporate debtors and that the liability of the personal guarantors did not stand discharged even after the resolution plan was approved. It was held that an Insolvency Resolution Process can be initiated against the personal guarantors by the creditors if they have agreed to excessive cuts in the CIRP, however, the Hon’ble Court clarified that the creditors cannot recover amount in excess to the claim amount.
2. State Bank of India Vs Mahendra Kumar Jajodia Hon’ble NCLAT held that the NCLT is the correct adjudicating authority for initiation of insolvency proceedings in case of personal guarantors. It was further held that even if there is no CIRP initiated against the corporate debtor before the NCLT even then Insolvency Resolution Process (IRP) could be initiated against the personal guarantor before the adjudicating authority having territorial jurisdiction. Hon’ble NCLAT’s order was challenged before the Hon’ble Supreme Court which held that the judgment did not warrant any interference.
3. State Bank of India Vs. V. Ramakrishnan Hon’ble Supreme Court held that the liability of Personal Guarantor under a contract of guarantee is not ipso facto discharged upon the approval of a resolution plan. It was further held that the liability of the personal guarantor arises from a contract which is independent, and the extent of the liability depends on the terms of the contract. The Hon’ble Court ruled that possession of the guarantor’s assets could be obtained under SARFAESI Act even if the CIRP had been initiated against the corporate debtor. It was held that the moratorium under IBC acts as no shield for the guarantor and extends only to the corporate debtor.
In conclusion, including personal guarantors under the Insolvency and Bankruptcy Code in 2019 has significantly reshaped India’s insolvency framework, offering a more structured and efficient process for creditors to recover dues from corporate debtors and their personal guarantors. This shift has enhanced the creditor’s ability to pursue claims in a unified forum and provided personal guarantors with an expedited resolution process, promoting a fairer and more transparent approach to insolvency. Despite the promising legal provisions, challenges such as delays in the resolution process, procedural complexities, and limited financial recovery persist. These challenges underscore the need for continuous refinement in the implementation of the IBC provisions to improve the overall effectiveness of the insolvency resolution system. The judicial interpretation of the IBC, especially in landmark cases, has reinforced the principle that personal guarantors’ liabilities remain independent of the corporate debtor’s resolution process. However, the evolving legal landscape and the empirical data suggest that while the legal framework has successfully created a more cohesive insolvency process, there is still room for improvement, particularly in terms of reducing delays and enhancing creditor recoveries.
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