On May 21, 2021, the Apex Court of India, in the case of Lalit Kumar Jain vs. Union of India & Ors.1, upheld the validity of the Centre’s notification dated November 15, 2019, allowing banks to proceed against personal guarantors for recovery of loans given to a company under the Insolvency and Bankruptcy Code, 2016 (IBC) (“Notification”).
The Notification had brought into effect Part III of the IBC dealing with the insolvency and bankruptcy of individuals and partnership firms in so far as it is applicable to personal guarantors of a corporate debtor.
As per the IBC, ‘Personal Guarantor’ means an individual who is the surety in a contract of guarantee to a corporate debtor. ‘Corporate Debtor’ means a corporate person who owes a debt to any person.
Prior to the Notification, the jurisdiction for insolvency and bankruptcy proceedings against Personal Guarantors vested with the Debt Recovery Tribunal. While the Notification brought a wave of joy amongst the creditors on account of greater accountability of the Personal Guarantors, various writ petitions were filed in different High Courts challenging the Notification and the associated rules thereto. At some stage or the other, these petitioners (compendiously termed as “the Writ Petitioners”) had furnished personal guarantees to banks and financial institutions which led to release of advances to various companies which they were associated with as directors, promoters or in some instances, as chairman or managing directors. In many cases, the personal guarantees furnished by the Writ Petitioners were invoked, and proceedings are pending against companies which they are or were associated with, and the advances for which they furnished bank guarantees. In several cases, recovery proceedings and later insolvency proceedings were initiated. In a few cases, the resolution plans have not yet been approved by the adjudicating authority and in some cases, the approvals granted are subject to attack before the appellate tribunal. While transferring all petitions to itself in October, 2020, the Supreme Court ruled that the IBC was in its infancy and that the interpretation of the IBC provisions should be taken up by the Supreme Court in order to avoid any uncertainty and to authoritatively establish the law.
The main contention raised by the Writ Petitioners was that the Notification is an exercise of excessive delegation as the Central Government has no authority to impose conditions on the enforcement of the IBC. It was further contended that the enforcement of the provisions in terms of the Notification only in relation to Personal Guarantors is ultra vires the powers granted to the Central Government. It was argued that the provisions of the IBC brought into effect by the Notification are not in severable, as they do not specifically or separately deal with or govern insolvency proceedings against Personal Guarantors to Corporate Debtors.
The Supreme Court held that the Notification is not an instance of legislative exercise, or amounting to impermissible and selective application of provisions of the IBC. There is no compulsion in the IBC that it should, at the same time, be made applicable to all individuals, (including Personal Guarantors) or not at all. There is sufficient indication in the IBC that Personal Guarantors, though forming part of the larger grouping of individuals, were to be, in view of their intrinsic connection with Corporate Debtors, dealt with differently, through the same adjudicatory process and by the same forum (though not insolvency provisions) as such Corporate Debtors. The Court clarified that the parliamentary intent was to treat Personal Guarantors differently from other categories of individuals. The intimate connection between such individuals and corporate entities to whom they stood guarantee, as well as the possibility of two separate processes being carried on in different forums, with its attendant uncertain outcomes, led to carving out personal guarantors as a separate species of individuals, for whom the adjudicating authority was common with the Corporate Debtor to whom they had stood guarantee.
Another contention urged before the Court was that the Notification, by applying the IBC to Personal Guarantors only, takes away the protection afforded by law, reference was made to the Indian Contract Act, 1872. The Writ Petitioners submitted that once a resolution plan is accepted, the Corporate Debtor is discharged of liability. As a consequence, the Personal Guarantor whose liability is co-extensive with the principal debtor, i.e. the Corporate Debtor, too is discharged of all liabilities. It was urged therefore, that the Notification which has the effect of allowing proceedings before the National Company Law Tribunal by applying provisions of Part III of the IBC, deprives the Personal Guarantors of their valuable substantive rights.
The Court held that approval of a resolution plan does not ipso facto discharge a Personal Guarantor (of a corporate debtor) of her or his liabilities under the contract of guarantee. The release or discharge of a principal borrower from the debt owed by it to its creditor, by an involuntary process, i.e. by operation of law, or due to liquidation or insolvency proceeding, does not absolve the surety/guarantor of his or her liability, which arises out of an independent contract.
The concept of ‘guarantee’ is derived from Section 126 of the Indian Contract Act, 1872. A contract of guarantee is made among the debtor, creditor and the guarantor. If the debtor fails to repay the debt to the creditor, the burden falls on the guarantor to pay the amount. In view of the above decision, the creditor reserves the right to begin insolvency proceedings against the Personal Guarantor if the latter does not pay.
1 Transferred Case (Civil) No. 245/2020