Supreme Court upholds provisions relating to Corporate Debt Recovery from Personal Guarantors

The Supreme Court Bench comprising of Justices L. Nageswara Rao and Ravindra Bhat, vide its judgment dated May 21, 2021 in the matter of Lalit Kumar Jain vs. Union of India and Ors.[1], upheld the validity of the notification dated November 15, 2019[2] issued by the Government of India (the “impugned notification”) which enforced certain provisions of the Insolvency and Bankruptcy Code, 2016 (the “Code”) relating to initiation of insolvency proceedings against the personal guarantors of a corporate debtor.

BACKGROUND

The present case arose out of multiple petitions concerning the vires and validity of the impugned notification; together with other reliefs and claims concerning the validity of the Insolvency and Bankruptcy (Application to Adjudicating Authority for Insolvency Resolution Process for Personal Guarantors to Corporate Debtors) Rules, 2019 (“2019 Rules”) issued on November 15, 2019, and of the Insolvency and Bankruptcy Board of India (Insolvency Resolution Process for Personal Guarantors to Corporate Debtors) Regulations, 2019 (“2019 Regulations”) notified on November 20, 2019. However, decision in the present case is confined only to challenge to the validity of the impugned notification. The factual conspectus leading to the present case is as follows:-

Issuance of the impugned notification– On November 15, 2019, the Ministry of Corporate Affairs, in exercise of the powers conferred by Section 1(3) of the Code, issued the impugned notification bringing into force Section 2(e), Section 78 (except with regard to fresh start process), Sections 79, 94-187 (both inclusive); Section 239(2)(g), (h) & (i); Section 239(2)(m) to (zc); Section 239 (2)(zn) to (zs) and Section 249 of the Code from December 1, 2019. However, the aforementioned provisions were enforced only in so far as they related to personal guarantors to corporate debtors, in effect enabling lenders to initiate insolvency proceedings against personal guarantors. This was followed by notification of the 2019 Rules and the 2019 Regulations, to come into effect from December 1, 2019.

Invocation of the impugned provisions against the petitioners– After publication of the impugned notification, many petitioners, who had at some stage, furnished personal guarantees to banks and financial institutions for loans to various companies in which they were associated as directors, promoters etc. or had some direct or indirect interest; were served with demand notices on various counts, proposing to initiate insolvency proceedings under the Code. This led to initiation of insolvency resolution process under Part III of the Code against some of the petitioners, which in turn, compelled them to challenge the impugned notification before various High Courts[3].

Transfer of petitions and present case– Since most petitions arising in various proceedings preferred under Article 32 of the Constitution of India in this regard involved common questions of law in relation to provisions of the Code; the Supreme Court transferred all these petitions under Article 139A to dispose them off vide this judgment.

GROUNDS FOR CHALLENGE

Exercise of excessive delegation by Union of India– The principal ground on behalf of the petitioners was that the impugned notification is an exercise of “excessive delegation”. It was contended that the power delegated under Section 1(3) is only as regards the point(s) in time when different provisions of the Code can be brought into effect, and does not permit the Central Government to notify parts of provisions of the Code, or to limit the application of the provisions to certain categories of persons. Since the impugned notification notified various provisions of the Code only in so far as they relate to personal guarantors to corporate debtors, it was argued that the same was ultra vires the proviso to Section 1(3) of the Code and amounts to an unconstitutional usurpation of legislative power by the executive.

Selective application to personal guarantors: arbitrary and discriminatory– It was contended as a corollary, that the provisions of the Code brought into effect by the impugned notification when enforced only in respect of personal guarantors to corporate debtors, are manifestly arbitrary and discriminatory and violative of Article 14 of the Constitution of India because:-

(i) there is no rationale for singling out the personal guarantors to corporate debtors for being covered by the impugned notification, particularly when the provisions of the Code do not separately apply to one sub-category of individuals;

(ii) the provisions the Code, including those under Part III, which are partly brought into effect by the impugned notification, provide a single procedure for the insolvency resolution process of a personal guarantor, irrespective of whether the creditor is a financial creditor or an operational creditor. This is in contrast to the corporate insolvency resolution process set out in Part II of the Code, which provides different sets of procedures for different classes of creditors.

Inconsistency between provisions enforced vide the impugned notification and the Code

· Self-contradictory legal regimes for insolvency proceedings against personal guarantors–  The impugned notification fails to bring into effect Section 243 of the Code, which would have repealed the Presidency Towns Insolvency Act, 1909 and the Provincial Insolvency Act, 1920 (collectively, “erstwhile legislations”). Thus, it was contended that the impugned notification has the effect of creating two self-contradictory legal regimes for insolvency proceedings against personal guarantors to corporate debtors, i.e. under the provisions of the Code enforced vide the impugned notification as well as under the erstwhile legislations.

· Application of Part III in respect of personal guarantors contradictory to the Code– It was pointed out that Part III of the Code governs only ‘Insolvency Resolution and Bankruptcy for Individuals and Partnership Firms’, and personal guarantors are specifically excluded from the ambit of ‘individuals’ as defined under Section 2(g) of the Code. Additionally, Section 95 of the Code permits a creditor to invoke insolvency resolution process against an individual only in relation to a partnership debt. Thus, there is no specific provision in Part III of the Code which permits the initiation of the insolvency resolution process against a personal guarantor, and accordingly, the impugned notification, which alludes to the contrary, is ultra vires and liable to be set aside.

Liability of a guarantor co-extensive with that of the principal debtor– The other question which the petitioners had urged before the Supreme Court was that the impugned notification, by applying the Code to personal guarantors only, takes away the protection afforded by law; reference was made to Sections 128, 133 and 140 of the Indian Contract Act, 1872 (“ICA”). It was argued that the liability of a personal guarantor is co-extensive with that of the corporate debtor, and conclusion of insolvency proceedings against a corporate debtor amounts to extinction of all claims against the corporate debtor, except to the extent admitted in the insolvency resolution process itself. This is clear from Section 31 of the Code, which makes the resolution plan approved by the Adjudicating Authority binding on the corporate debtor, its creditors and guarantors.

SUPREME COURT RULING ON MAJOR ISSUES

Impugned notification not an instance of excessive delegation and selective application– It was held that the impugned notification is not an instance of legislative exercise, or amounting to impermissible and selective application of provisions of the Code. There is no compulsion in the Code 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 Code, i.e. by Section 2(e), Section 5(22), Section 60 and Section 179 indicating 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 notifications under Section 1(3), that were issued before the impugned notification, disclose that the Code was brought into force in stages, regard being had to the categories of persons to whom its provisions were to be applied. The impugned notification, similarly, inter alia makes the provisions of the Code applicable in respect of personal guarantors to corporate debtors, as another such category of persons to whom the Code has been extended. It is held that the impugned notification was issued within the power granted by Parliament, and in valid exercise of it. The exercise of power in issuing the impugned notification under Section 1(3) is therefore, not ultra vires; the notification is valid.

No incongruity in provisions enforced by the impugned notification and the Code– The argument that the insolvency processes, application of moratorium and other provisions are incongruous, were held in the opinion of the court, to be insubstantial. Parliament merged the provisions of Part III with the process undertaken against the corporate debtors under Part II, for the purpose of Section 60(2), i.e., proceedings against personal guarantors along with corporate debtors. The court held that there appear to be sound reasons why the forum for adjudicating insolvency processes – the provisions of which are disparate- is to be common, i.e. through the National Company Law Tribunal (“NCLT”). This is because the NCLT would be able to consider the whole picture, as it were, about the nature of the assets available, which would facilitate the committee of creditors in framing realistic plans, keeping in mind the prospect of realizing some part of the creditors’ dues from personal guarantors.

Sanction of resolution plan does not discharge personal guarantor’s liability– As regards the argument pertaining to liability of personal guarantor being co-extensive with that of the corporate debtor, the Supreme Court held that the sanction of a resolution plan and finality imparted to it by Section 31 does not per se operate as a discharge of the personal guarantor’s liability. As to the nature and extent of the liability, much would depend on the terms of the guarantee itself. In coming to this decision, the court made reference to several judgments including Vijay Kumar Jain vs. Standard Chartered Bank[4] wherein the Supreme Court held that the rationale for allowing directors to participate in meetings of the committee of creditors is that the directors’ liability as personal guarantors persists against the creditors and an approved resolution plan can only lead to a revision of amount or exposure for the entire amount.

DECISION

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. It was held that the impugned notification is legal and valid.

PAVING WAY FOR MORE RECOVERIES

Although a wide view prevailing was that the judgment will lead to several insolvencies against personal guarantors. That may not necessarily be the case. The judgment clears the air surrounding liability of personal guarantors by extending the provisions of the Code to them, and resultantly, also enhances the position of the creditors significantly by granting them the option to initiate concurrent insolvency proceedings against personal guarantors and the stressed corporate companies for which they issue guarantee. As reasoned in the judgment, roping in personal guarantors would also increase the likelihood of arrangement of funds for debt resolution by such personal guarantors, to obtain discharge and prevent adverse consequences.

The position prior to this verdict had ambiguities on the ultimate liabilities of the personal guarantors to a corporate debtor and the path to follow for recoveries against such personal guarantor, like a civil suit, which could take ages to mature and yield desired results to lenders. The shift in position ushered in by this judgment, besides ensuring strict credit behavior, will hold personal guarantors accountable and make them more assiduous in extending guarantees. There will certainly remain challenges in concurrent insolvency proceedings and implementation of insolvencies against individuals, as we are getting into uncharted territories.

Nonetheless, watch this space for more, as we continue to track them…

Authors:

Hardeep Sachdeva, Senior Partner
Gautam Kumar Bhargava, Senior Associate
Isha Singh, Associate

Footnotes:

[1] Transferred Case (Civil) No. 245/2020.
[2] S.O. 4126 (E) dated November 15, 2019 issued by the Ministry of Corporation Affairs, Government of India.
[3] High Courts of Madhya Pradesh, Telangana, Delhi etc.
[4] 2019 SCC OnLine SC 103.

Date: May 31, 2021