A Checkmate to the Guarantor’s Gambit?
Divya Sree Kamana
Final Year B.A. LL.B, Damodaram Sanjivayya National Law University
Consider a scenario where an individual assumes responsibility for covering a friend’s loan if they default. Initially straightforward, this commitment becomes complex when the friend does default and the lender seeks repayment. Primarily, who wants to be on the hook for someone else’s financial mishaps, especially as a mere director in a company?
And here’s where it gets even trickier: the guarantors could try to escape the guarantee by claiming technicalities. Maybe the guarantee wasn’t properly registered or stamped, or perhaps the terms were altered.
But wait, there’s more. Guarantors may find themself in a tug-of-war between the lender and the original borrower. The lender might try to squeeze more out of them than what they owe, while also going after the borrower. In essence, personal guarantees often come with a host of practical and legal implications that can make them anything but simple.
The Insolvency and Bankruptcy Code, 2016 primarily provides for Insolvency proceedings against personal guarantors under Part III. The Apex Court in the judgement of Dilip B. Jiwrajka[1] upheld the Constitutional Validity of the Sections 94 to 100. Though there is no specific discussion on the ingredients of Section 95, in practice,[2] NCLT after receiving the report of IRP is considering;
- Whether there is a valid guarantee agreement? If yes,
- Whether there is a liability arising out of the agreement? If yes,
- Whether there is a demand for payment? If yes,
- Whether the repayment is done or any plan of repayment was communicated? If no, It initiated Insolvency Resolution Process and Moratorium.
It is to be noted that section 95 application must be filed before the AA where IRP against the Corporate Debtor is pending.[3]
When faced with this application, guarantors often exhaust all available avenues to evade liability. When it comes to objections that personal guarantors may rise, firstly the guarantors may outright deny that they have guaranteed the transaction. They can say, the signature was forged or the terms of the deed were not made known to the guarantor. Proper registration and stamping of the deed of guarantee can put an end to such arguments by the guarantor, but what if the deed of guarantee is not stamped or registered? The Delhi High Court in this regard observed that though the agreement was not properly stamped, it is a curable defect and on payment of amount of duty along with the penalty, the same was admitted in evidence.[4] I haven’t come across judgements that talk about compulsory registration of the deeds of guarantee, but the bare reading of the provision doesn’t say that they are compulsorily registrable under section 17.[5] Also, the tribunals are not bound by the strict and technical rules of Evidence, but their decision must be consistent with the general principles of natural justice.[6] The principle of “qui approbate non reprobate” highlights that one cannot both accept the benefits of a situation and then later reject its associated responsibilities. It holds relevance in cases of personal guarantors as they cannot solely reap the benefits of a guarantee agreement while subsequently disclaiming liability when a default arises.[7]
It often happens that the financial creditors assign their debts to third parties. In applications by such assignees, personal guarantors can argue that only creditors can file an application as there is no mention of assignees specifically under section 95.[8] Under Section 95(1), A creditor may apply either by himself, or jointly with other creditors to the AA for initiating an IRP. Section 3(10) defines Creditor as any person to whom a debt is owed and includes a financial creditor, an operational creditor, a secured creditor, an unsecured creditor and a decree-holder. The term Financial Creditor is not defined under Part-III but is defined in Part-II under Section 5(7) to include a person to whom such debt has been legally assigned or transferred to. In order to be a “debt”, there ought to be a liability or obligation in respect of a “claim” which is due from any person.[9]
Unlike Section 7 which uses the term “Financial Creditor”, Section 95 uses the term “Creditor” which has a broad and inclusive meaning and does not exclude the possibility of their being other forms of ‘Creditors’.[10] There is no prohibition in the IBC from continuing the proceeding by an assignee.[11] Thus, it can either be submitted that when Financial Creditor is not defined in Part III, the meaning has to be taken from Part I and thus Creditor includes a person to whom such debt has been legally assigned or transferred to. Or alternatively that because of the broad and inclusive definition of Creditor, an assignee is to be treated as a creditor.
Personal Guarantor can also argue, that when the CIRP against corporate debtor is pending or is approved, IRP against personal guarantor can’t be initiated. Law on extinguishment of claim against personal guarantor on approval of Resolution Plan has been settled, that approval of resolution plan of corporate debtor does not ipso facto discharge the personal guarantors of their liabilities under the contract of guarantee.[12] But questions like, can the proceedings run parallelly even if payment of total debt is provided for in the resolution plan against corporate debtor, when will there be extinguishment of debt and so on, remain to ponder the advocates arguing in matters of personal guarantees.
To conclude, once an individual guarantees a transaction, it is almost impossible for them to get out of the Padmavyuham created by the IBC.
References:
[1] Dilip B. Jiwrajka v. Union of India, (2023) ibclaw.in 147 SC.
[2] State Bank of India vs Shri Nenshi Ladhabhai Shah NCLT, Mumbai; Pridhvi Asset Reconstruction and Securitisation Company Ltd VS Mr. Kongara Naveen (14.06.2023) NCLT Hyd; State Bank Of India vs Naresh Babulal Sanghvi (27/02/2024) .
[3] Arvind Dham vs SBI, (2024) ibclaw.in 249 NCLAT.
[4] Rasmala Trade Finance Fund v. Raman Gupta, 2019 SCC OnLine Del 9285; Omprakash v. Laxminarayan, (2014) 1 SCC 618.
[5] S. 17(c), Registration Act, 1908; Ajay kumar singh vs Basant Borukha, 2016.
[6] S. 424(1) of the Companies Act, 2013; Engineering Mazdoor Sabha vs Hind Cycles Ltd AIR 1963 SC 874;
[7] State Bank of India vs. Sudip Bijoy Dutta, Director of Ess Dee Aluminium Ltd. (16.06.2022 – NCLT – Kolkata) : (2022) ibclaw.in 683 NCLT
[8] S. 95, the Insolvency and Bankruptcy Code, 2016.
[9] S. 3(11), the Insolvency and Bankruptcy Code, 2016.
[10] Nishit B Patel Shareholder of Peacock Construction Pvt. Ltd. v. Good Value Financial Services Pvt. Ltd. and Anr. Company Appeal (AT)(Insolvency) No.198/2020 Decided on 14-Feb-22. (2022) ibclaw.in 154 NCLAT
[11] Siti Networks Ltd. Vs. Assets Care and Reconstruction Enterprises Ltd. & Anr. (2022) ibclaw.in 1034.
[12] Lalit Kumar Jain vs. Union of India and Ors. – (2021) 9 SCC 321; Vikram Babulal Sanghvi v. State Bank of India – NCLAT [08-05-2024]; Company Appeal (AT) (Insolvency) No. 975 of 2022 – UV Asset Reconstruction Company Limited vs. Electrosteel Castings Limited; Bank of Baroda vs Mr. Amir Jamal Dodhia (01.02.2024); Ajay Kumar Radheyshyam Goenka vs. Tourism Finance Corporation of India Ltd:(2023) ibclaw.in 30 SC.
