Guarantor’s liability under the Insolvency and Bankruptcy Code- What Supreme Court has held?

Introduction

On 21st May, 2021, the Hon’ble Supreme court held in a case of Lalit Kumar Jain V. Union Of India, that the existence or conclusion of corporate insolvency resolution process (CIRP) against a principal borrower will not function as a bar to initiation of insolvency process of personal or corporate guarantors to corporate debtors. In other words, credits have full right to trigger insolvency resolution process against the personal or corporate gurators even when the principal borrower is undergoing CIRP simultaneously. There are other significant issues which need to be kept in mind while examining this issue. In this blog, we will analyze the judgment delivered by the Supreme Court of India.

Contract of Guarantee and its relevance under IBC

According to section 126 of Indian Contract Act, 1872, a contract of guarantee refers to a contract, wherein a natural or an artificial person guarantees or ensures to perform the promise or to discharge the liability of a third party (known as principal borrower) in case of his default, to another person known as creditor. It is to be noted that in case of default by the principal borrower, the liability of the guarantor is co-extensive and not alternative with that of a principal borrower. It means that the creditor can directly sue the guarantor instead of the principal borrower first for the amount due under the contract. Furthermore, the guarantor, after making the payment due to the creditor, is invested with all such rights that the creditor had against the principal borrower i.e. the guarantor can recover the said amount from the principal borrower, also known as the doctrine of subrogation.

It is worth mentioning that if the principal borrower (a corporate entity) defaults on debt of the creditor, then the creditor can also initiate CIRP against the borrower in addition to the guarantor. It gives the right to the creditor to initiate insolvency proceedings against the guarantor. 

The Central Government, through the notification dated 15th November, 2019, (“Impugned Notification”) inter alia made certain provisions of Part III of IBC (pertaining to insolvency resolution of individuals and partnership firms) applicable only to personal guarantors to corporate debtors. This notification, effective from 1st December, 2019, gave the creditors the right to initiate insolvency resolution of personal guarantors to corporate debtors. Since this exposed a lot of guarantors, majorly promoters, to extensive liabilities, they challenged the constitutional validity of the Impugned Notification, which was finally decided by the Supreme Court on 21st May, 2021.

Analysis of the Judgment

Section 1 (3) of IBC-

One of the contentions that petitioners put was pertaining to the excessive use of the power by the executive vide section 1 (3) of IBC, as according to them this section is an instance of conditional legislation which only grants the power to the executive to designate the time when the law would come into force and not the subject to which it would apply.

In this the Apex court has relied on the judgement of SBI V. Ramkrishnan stated that there is a stage to stage process of operationalizing different provisions of IBC.

Liability and Rights of Guarantor

The Petitioners argued that once the resolution plan of the corporate debtor/ principal borrower is approved it is binding on all stakeholders to proceed insolvency proceedings against the guarantors. They also contend that post approval of the resolution plan claims of personal guarantor against the borrower gets extinguished and he/she has no means to recover that debt. 

However the supreme court has held that discharging the principal borrower from the debts of the creditor does not mean that it also discharges the guarantors liability. 

Moratorium under section 101

Insolvency proceedings can be initiated against the personal guarantors as per section 34 and 35 of IBC. The petitioners contended that this application triggers an interim moratorium and moratorium against the guarantor, which has the effect of staying the CIRP against the corporate debtor. 

The apex court has stated  that the moratorium provisions under Sections 96 and 101 are only in relation to those debts, for which the guarantor has given his/her guarantee, and not against the guarantor. 

NCLT as the adjudication authority for personal guarantors

The petitioners also argued that making NCLT as the adjudicating authority for insolvency resolution of personal guarantors, as opposed to other individuals, is an exercise of legislative power which is not supported by any provision of law. In reply, the Respondent stated that Section 2(e) of the IBC was amended in 2018 to reflect that IBC applies to a separate entity i.e. personal guarantors to corporate debtors, as opposed to just individuals. Furthermore, the Respondent also focussed on purposive interpretation of IBC, saying that if guarantors, which are mostly the promoters/directors of the corporate debtor, are kept out of the CIRP, then it would lead to an unjustifiable conclusion of CIRP, and the guarantors would have to be proceeded against separately and therefore, a single adjudicating authority i.e. NCLT has been accorded for both the entities.

Here, the Apex Court agreed with the contentions of the Respondent and held that the 2018 amendment to the provisions of IBC were meant to carve out a separate exception for a certain class of individuals i.e. personal guarantors to corporate debtors. This is the reason why Section 60 of IBC was amended to make NCLT as the single adjudicating authority for coordinating the insolvency resolution processes of corporate debtors and personal/corporate guarantors to such debtors.

Conclusion

The apex court in its decision on one hand clarified the route for insolvency regime of personal guarantors to corporate debtors, but on the other hand has also exposed personal gurators to huge liabilities. 

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