Basic of Personal Guarantors Insolvency under IBC
Table of Contents
Concept of Personal Guarantors (Promoter) under IBC
- The concept of ‘guarantee’ as defined in the Indian Contracts Act, 1872 refers to an agreement of assurance made among the debtor, guarantor and creditor. If the debtor fails to repay the debt to the creditor, the burden falls on the guarantor to pay the amount and failing to do which the creditor reserves the right to begin insolvency proceedings against the personal guarantor.
- We can say that, a principal debtor has gone into liquidation would absolve the guarantors of their liability.
- Following a review of the aforementioned components of the case at hand, we can safely conclude that the IBC has a wide range of extensive reach, and the fact that the Promoter is a personal guarantor means that, due to the nature of the guarantee contract and the Promoter’s relationship to the Company, insolvency proceedings can be initiated against the Promoter in the event of any debt default.
Legal Position under Personal Guarantors (Promoter) under IBC
- A promoter is someone who has substantial amount over the company’s operations. It should also be noted that a promoter is a separate legal entity from the Company. The question remains, however, whether; the Promoter can be held liable separately for the IBC Acts of the Company.
- While holding a promoter personally liable to a third-party in the case of D.R Patel v. A.S Dimellow, the Hon’ble Madhya Pradesh High Court relied on the sayings of D.M Ghosh, who stated that “a promoter is personally liable to third parties, unless such Company takes over their liability with their consent.” To appreciate the relationship between the aforementioned and the Supreme Court ruling in question, we must first understand the concept of Personal Guarantee.
- the IBC envisages to provide a ‘Clean Slate’ to the Corporate Debtor, But, such a luxury is not afforded to the Promoter as his relationship is one defining the eventual state of Corporate Debtor. In addition, aforesaid is via to be in perfect alignment with inherent object of the IBC Code i.e., maximisation of the value of assets & promotion of entrepreneurship.
- Creditors now have the option to file for insolvency against the promoter, saving the company from going into liquidation in several cases.
- This choice was made to provide banks and financial organisations a prominent and powerful position, enabling them to avoid bearing the brunt of losses to a degree. But one concern that may arise amid the celebration of the ruling is the possibility of banks & financial institutions abusing their control over debt recovery.
- Banks must use these provisions cautiously so that small corporate entities do not face undue hardships, as this decision may have an impact on their risk-taking capacity, causing them to reconsider contacting financial institutions. However, it is fair to conclude that the Supreme Court’s decision was based on strong legal principles and a critical evaluation of the IBC’s scale and scope.
Insolvency Resolution Process for Personal Guarantors
Ruling under Lalit Kumar Lain v. Union of India
The Hon’ble Supreme Court of India upheld the Insolvency & bankruptcy (Appeal to governing and decision making authority for Insolvency Resolution Process for Personal Guarantors to Corporate Debtors) Rules, 2019 (Rules) informed by Govt of India dated 15 November 2019 as per the Supreme Court judgement in the matter of Lalit Kumar Lain v. Union of India, 2021, case number 396.
The IBC (Appeal to governing and decision making authority for Insolvency Resolution Process for Personal Guarantors to Corporate Debtors) Rules, 2019, inter alia notified Section 2(e) of the IBC, 2016. The Code in relation to personal guarantors to corporate debtors, who were recognized as separate category of individuals in the IBC Amendment Act 2018, The IBC Amendment Act 2018 established three different categories of persons:
- Partnership firms & Proprietorship firms
- Personal guarantors to corporate debtors.
- Individuals, with the goal of treating each one differently under the Code.
Part III of the Insolvency & bankruptcy Code was made separately applicable to personal guarantors of corporate creditors in the 2019 Rules. As a result, a creditor could file a corporate insolvency resolution process (CIRP) petition before the Debt Recovery Tribunal against personal guarantors to corporate debtors.
Furthermore, under the amended Section 60 of the Insolvency & bankruptcy Code (as amended by (Second Amendment) Act, 2018, effective June 6, 2018), if corporate insolvency resolution process is initiated against a corporate debtor before the NCLT, any recovery proceedings initiated against personal guarantors to corporate debtors undergoing CIRP in any Court or Tribunal would be transferred to the National Company Law Tribunal, and any further activities set out to be initiated to oppose personal guarantors to corporate debtors must be look out before the National Company Law Tribunal.
The Petitioners -Lalit Kumar challenged the 2019 Rules primarily on the grounds that:
- The Govt of India has exceeded the power conferred to it U/s 1(3) of the Insolvency & bankruptcy Code by modifying Code provisions & creating them selectively applicable to a specific group of people, which it was not authorised to do.
- Initiating proceedings against both the personal guarantor to a corporate debtor and the corporate debtor would constitute “double recovery,” which is prohibited by the Insolvency Resolution Process Code.
If a resolution plan extinguishes a corporate debtors existing debts, the personal guarantors liability to corporate debtors, which is co-extensive U/s 128 of the Indian Contract Act, 1872, must also stand extinguished.
The Hon’ble SC, rejected the petitioners arguments and upheld the Insolvency & bankruptcy Code 2019 Rules on the grounds that:
- The Central Govt planned a stage-by-stage implementation of the IBC code while keeping in mind the purpose & object, which is allowable in law.
- When a debt is discharged by operation of law, the personal guarantor’s liability remains independent from the corporate debtor’s liability. The Hon’ble S.C stated that the rules were intended to strengthen the corporate insolvency resolution process and that, given the close relationship between corporate debtors & personal guarantors, allowing proceedings in separate forums in relation to the aforementioned parties could result in uncertain result outcomes & defeat the IBC Code’s Objective.
Implications
The Petitioners -Lalit Kumar is as a welcome step because it allows them to recover their debts from both the corporate debtors and the personal guarantors in the same forum respectively. Furthermore, The Petitioners -Lalit Kumar reiterates the position in Creditor’s Committee of Essar Steel v. Satish Kumar Gupta, 2019. Namely, that upon completion of a corporate debtor’s corporate insolvency resolution process, creditors who would otherwise be taking a haircut are entitled to separately proceed against the corporate debtor’s personal guarantor to recover the remaining amounts, assuming the resolution plan does not extinguish the guarantors’ liability. But This implication will disincentivize individual personal guarantors from providing extending guarantees to corporate debtors.
Position of personal guarantors Before to the Insolvency & bankruptcy Code 2019 Rules
Part III of the Insolvency & bankruptcy Code was inapplicable to personal Guarantors to corporate debtors prior to the notifications of the IBC 2019 Rules. Creditors could then proceed via :
- A Civil suit enforcing their contractual remedies,
- The Provincial Insolvency Act, 1920 or the civil courts under the Presidency Towns Insolvency Act, 1909;
- Other specialized legislations inter alia such as the SRFAESIA, 2002.
But, Post Notifications of IBC 2019 Rules, creditors may also approach the Debt Recovery Tribunal under part III of the code along with the National Company Law Tribunal under part II of the code for recovery of dues from personal guarantors. Furthermore, continue to subsist as Section 243 of the IBC Code, which seeks to repeal the Presidency Towns Insolvency Act, 1909 and the Provincial Insolvency Act, 1920 has not yet been notified, the directions of recovery that existed prior to the 2019 Rules continue to exist.
Simultaneous Proceedings
- According to the section 128 of the Contract Act, A guarantor’s liability is co-extensive with that of the principal debtor. In other words, because personal guarantor and the corporate debtor are separately or jointly liable to repay the Creditors debt, the Contract Act allows a creditor to proceed against a guarantor before exhausting his remedies against the principal debtor.
- This contract law principle is also incorporated into the Code. The SC in the case of SBI Vs. Ramakrishnan & Others (2018) and The NCLAT in State Bank of India v. AEVPL, 2020 cases Online NCLAT 774, have both stated that creditors have the right to file parallel procedures before the National Company Law against the corporate debtor and the relevant forum against the personal guarantor.
- Taking a different view, In the matter of Dr Vishnu Kumar Agarwal v. Piramal Enterprise Ltd, 2019, the NCLAT held that once a claim filed by a creditors U/s 7 of the IBC code is admitted as against the personal guarantor or the corporate debtor, as the case may be, no further proceedings for the same set of claims may be brought against the other.
- While the Piramal adjudication is being challenged in the Supreme Court, taking the consideration of The Petitioners – Lalit Kumar & Section 60 of IBC code, it is apparent that, While simultaneous proceedings against both the personal guarantor and the corporate debtor are permissible, they must be brought before the NCLT, and creditors cannot collect more than their entire claim amount. The Insolvency Law Committee’s February 2020 report further emphasises the significance of allowing simultaneous recovery while ensuring that no creditor has an unjustly enriches over the amount owed to them.
Personal guarantor’s right of subrogation
- According to Section 140 of the Contract Act, “When a guaranteed debt becomes due, or the principal – debtor fails to complete a guaranteed duty, the surety is invested with all the rights that the creditor had against the principal – debtor upon payment or performance of all that is liable for.”
- The above right of the subrogation mentioned above is an important element of guarantee law since it makes the latter commercially viable. But, as noted by the Hon’ble SC in Lalit Kumar and the NCLAT in Lalit Mishra & Ors. v. Sharon Bio Medicine Ltd. & Ors., 2018 NCLAT, the right of the personal guarantor to recover the guarantee from the corporate debtor ceases to exist upon of the guarantee by a creditor, in furtherance of the the code’s larger purpose of the IBC Code to reviving corporate entities.
- The Hon’ble Supreme Court has thus selectively applied the principle of guarantee, holding that the IBC Code U/s 238, has overriding powers over other statutes. As a result, while a personal guarantor’s liability under the Contract Act is kept, his corresponding privilege is limited, which is contrary to recognised fundamental principles of law & equity and would amount to ‘unjust enrichment’ by the corporate debtor.’
Personal guarantor’s liability to be extinguishes upon the extinguishment of the principal debt
Sections 133, 134, 135 & 140 of the Contract Act provide that a guarantor’s liability, which is co-extensive with the debtor’s, will be extinguished if the debtor’s debt is also extinguished. But in the Lalit Kumar case, the Hon’ble Supreme Court stated that if a corporate debtor’s debt is discharged by ‘operation of law’ rather than a contractual arrangement, the guarantor’s liability is not extinguished.
Conclusion
The Hon’ble Supreme Court took this approach, In order to benefit creditors, which has put personal guarantors in a perilous situation. The Supreme Court declared in the Swiss Ribbons Private Limited v. Union of India, (2019), that the IBC Code’s purpose and object is to assure the corporate debtor’s revival, and warned against using it as a simple “recovery tool.”
But, the current creditor-centric approach has resulted in just that, at the expense of general contract and legal norms.. IBC code has become an instrument for recovery benefiting creditors by allowing creditors to pursue the personal guarantor for recovery of their dues without providing the personal guarantor with the appropriate right.Furthermore, the creditors approve the resolution plan U/s 30 of the IBC Code via the committee of creditors (CoC), leaving the guarantor with no recourse if his contractual rights are terminated.
That said there are a few methods to change the current situation to favour personal guarantors from a commercial point of view while retaining the IBC code’s purpose & objective of IBC Code which would leave the guarantor with no recourse if his contractual rights are extinguished.
In cases where a corporate insolvency resolution process is filled against both the corporate debtor and the personal guarantor, the NCLT may first issue appropriate orders against the personal guarantors, allowing the corporate debtors to include his claim in the resolution plan in his new capacity as a creditor exercising his right of subrogation. Under Section 21(2) of the IBC code also offers a safe guard in the event that the personal guarantor is the promoter, preventing a related party financial creditor from participating in the committee of creditors.
Alternatively, the National Company Law Tribunal could try to distinguish between personal guarantors who are promotors of the corporate debtor (or in any way related to the firm’s promoters) and independent personal guarantors who have issued a guarantee from a business standpoint under corporate insolvency resolution process. Creating a separation like this would prohibit promoters who may have contributed to the corporate debtor’s insolvency from benefiting from it, while incentivizing independent guarantors to continue providing guarantees.
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