SC JUDGEMENT ON PERSONAL GUARANTORS OF CORPORATE DEBTOR UNDER THE INSOLVENCY AND BANKRUPTCY CODE, 2016

The Supreme Court of India in its landmark judgment in the case of Lalit Kumar Jain v. Union of India and Others has validated the sections related to personal guarantors enforced via notification dated November 15, 2019 and the Insolvency and Bankruptcy (Application to Adjudicating Authority for Insolvency Resolution Process of Personal Guarantors to Corporate Debtors) Rules, 2019.

The concept of guarantee is covered under the provisions of Indian Contract Act, 1872. A contract of guarantee is made among debtor, creditor and the guarantor. So now if the debtor fails to repay the debt then the guarantors will have to repay the debt.

Insolvency and Bankruptcy Code with wooden gavel, Business concept

Thereby now the personal guarantor shall also be accountable in cases under the Insolvency and Bankruptcy Code, 2016 and as per the ruling it will led cases getting resolved quickly and ultimately the recovery amount will increase due to this.

Now under this article we try cover the facts and major arguments from the judgement delivered by the Supreme Court:

FACTS OF THE CASE

In 2019, a notification was issued by Ministry of Corporate Affairs (MCA) which states that the insolvency proceedings were applicable to personal guarantors under Insolvency and Bankruptcy Code, 2016 (hereinafter referred to as “the Code”). The Petitioners (Directors, Managing Directors, Promoters and Chairman) furnished guarantees to banks and financial institutions leading to advance releases to the companies. The Petitioners are facing various insolvency proceedings at different stages currently. The present case ascertains the validity of the notification that arose in multiple legal proceedings under Article 32 of the Indian Constitution and transferred cases from several high courts under Article 139A of the Indian Constitution.

ISSUES

1. What are the relevant provisions of personal guarantors under the Insolvency and Bankruptcy Code, 2016?

2. What is the liability of personal guarantor to the corporate debtor if a resolution process is approved?

PETITIONER’S ARGUMENTS

The following are the arguments which were raised by the Petitioner:

1. The Central Government has exercised more than power than it was conferred upon it as per Section 1(3) of the Code. Section 1(3) of the Code allows the government to notify various provisions and different dates can be specified for the same.

The Petitioners have challenged this notification as having been issued with excessive authority than it was vested in the Union of India. This notification has brought into force Section 2(e)- personal guarantors to corporate debtors, Section 78 (except the fresh start process), Section 79, Sections 94-187 (both inclusive), Section 239(2)(g), (h) & (i), Section 239 (m) to (zc), Section 239 (2) (zn) to (zs) and Section 249 of the Code. The Petitioners further submitted that the Central Government has modified Part III which deals with Insolvency Resolution and Bankruptcy for the Individuals and Partnership Firms of the Code, which was not allowed.

2. The power delegated under Section 1(3) is only related to different provisions which can be brought into effect and it does not allow the Central Government for notification of certain provisions of the Code or limitation to apply the provisions to certain categories of people. This notification however notified only those provisions of the Code which are related to personal guarantors which is ultra vires to the power of the Central Government.

3. The Central Government failed to bring Section 243 of the Code which would have repealed the Presidency Towns Insolvency Act, 1909 and the Provincial Insolvency Act, 1920. Before the issue of the notification, insolvency proceedings against the individual could only be initiated under the aforementioned Acts. After the Code came into force, the insolvency proceedings against the personal guarantors would be initiated under Section 60 of the Code even though they would be governed under the aforementioned Acts.

4. The notification is ultra vires to the purpose of enforcement of the Code which is that the company is prevented from liquidation by ensuring its revival and survival. The cases of Swiss Ribbons (P) Ltd. v. Union of India and Babulal Vardharji Gurjar v. Veer Gurjar Aluminium Industries Pvt. Ltd. & Anr. were relied on for this purpose.

5. There was a common misunderstanding that on approval of a corporate debtor’s resolution plan, the personal guarantor’s liability would also be diminished. Since the approval of the plan means clearing off all the outstanding claims against the debtor then the guarantor’s liability which is co-extensive will be overlooked.

RESPONDENTS’ ARGUMENTS

The following are the arguments raised by the Respondents: –

1. Section 2 of the Code was amended to include 3 (three) types of debtors such as personal guarantors under Section 2(e), partnership firms and proprietorship firms under Section 2(f) and individuals under Section 2(g) of the Code. The intention behind this was to differentiate between personal guarantors and corporate debtor from other individuals. Likewise, Section 60 of the Code was partially amended in 2018 to include corporate guarantor for the purpose of subjecting the personal guarantor to insolvency proceedings which could be resolved by the National Company Law Tribunal. If Section 60 had not been amended then the insolvency proceedings would have been proceeded against the corporate debtor and the personal guarantors would have remained outside the scope of the Code.

2. The Parliament felt that if the need to separate personal guarantors from other individuals through the amendment in 2018 were not realized, the insolvency resolution process of corporate debtors would have been dealt with separately and independently of its promoters, directors and managing directors who had furnished their personal guarantees for securing debts of corporate debtors.

3. The guarantor’s liability is co-extensive, joint and several unless the contrary is provided by the contract. Therefore, until the debt is paid off entirely, the guarantor is not free of its joint and several liability in the payment of the outstanding amount to the creditor. By approval of a resolution plan, any release secured by the principal borrower or entering into a composition with the principal borrower as per Section 135 of the Indian Contract Act, 1872 cannot discharge the guarantor. Reliance was placed on the practice of “double dip” or the notion of dual nature of recovery by a creditor for the same debt from 2 (two) entities such as principal borrower and guarantor or coo-guarantors or co-debtors. When two entities are liable of a single claim, the creditor can assert a claim for the full amount owed against each debtor until full payment is done i.e. it can double dip. This means that if a part of a debt is recovered from one of the entities then the other would be liable for the balance amount of the claim. This practice is opposed to the practice of “double proof” wherein the same debt is owed against the same estate twice leading to double payment of debt.

4. Section 1(3) of the Code needs to be determined flexibly and not by literal construction as done by the Petitioner. All provisions of the Code, including the enforcement provision should be construed in the context of the entire enactment and the approach should be schematic, structural and purposive. Furthermore, Section 1(3) should not be construed in isolation. It has to be read wholly.

JUDGMENT

After going through the arguments given by the Petitioner and the Respondent and held that the notification is legal and valid and the petitions were dismissed accordingly. Approval of a resolution plan with relation to corporate debtor does not discharge the personal guarantors to corporate debtors. The court observed that the 2018 amendment was for the purpose of extending the provisions of the Code to personal guarantors of the corporate debtors for strengthening the insolvency resolution mechanism.

The court relied on a plethora of judgments to come to the conclusion that if a debtor owes money to the creditor due to involuntary process i.e. liquidation or insolvency or by operation of law then the surety/guarantor’s liability arising out of an independent contract is not absolved. Regarding the nature and extent of liability of a personal guarantor, it would depend on the terms of the guarantee.

CONCLUSION

This judgment is a solace for the Banks and Financial Institution who can claim their money from the personal guarantors to the corporate debtors under the Code. This will also bring some credit discipline among the Promoters from taking undue risk while deploying the debt capital. Further the personal property of the Promoters, Directors and others will be attached and their personal wealth will also part of the recovery process.

The Judgement implications will be huge as many Business families like Reliance (ADAG) Anil Ambani, DHFL promoters and others have their personal guarantee to the Banks for availing the loans. But it will surely help the creditors to recover more amounts and the process will get speedier as the guarantors otherwise would lose their wealth.

The way Banks and Financial Institution proceed ahead to recover the dues from the guarantors will also determine the success of this judgement.

BIBLIOGRAPHY

Lalit Kumar Jain v. Union of India and Ors. (Supreme Court), Transfer Case (Civil) No. 245/2020.

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