Personal Guarantee and The Dynamics in the Process of Insolvency
The main aim of this article is to understand how personal insolvency plays a role in the current resolution process against the personal guarantors can be an effective mechanism for the resolution of the loan account. But however, the law or the framework to conduct the process have certain drawbacks where the chance of the insolvency process becomes less and time consuming. Before looking at the drawbacks and challenges of the personal guarantor insolvency resolution process it is important to understand the personal guarantee, it provisions under IBC and how the resolution of such cases is taken place as under:
Who is a personal guarantor:
[1]“Personal guarantor” means an individual who is the surety in a contract of guarantee to a corporate debtor;
[2]A “contract of guarantee ” is a contract to perform the promise, or discharge the liability, of a third person in case of his default. The person who gives the guarantee is called the ” surety”; the person in respect of whose default the guarantee is given is called the ” principal debtor “, and the person to whom the guarantee is given is called the ” creditor “. A guarantee may be either oral or written.
Let us try to understand the term personal guarantor and in terms of the contractual obligation, which states that the liability of personal guarantor is co-extensive that with the main party in whose favour the guarantor has given his/her personal guarantee[3]. In the cases where there is a guarantee given which makes the individual personally liable is a separate contract in itself which is a continuation to the main contract and whenever the obligation in the main contract is not fulfil then the creditor can invoke the personal guarantee and can enforce the contract entered for the fulfilment of the obligations as given through the personal guarantee. Hence, the creditors may initiate legal proceedings against both the parties i.e., the creditor as well as its personal guarantor simultaneously.
Personal Guarantor and its Relation to Insolvency and Bankruptcy Code 2016:
The provisions in relation to personal guarantee insolvency resolution process is covered under Chapter III from Section 94 to Section 120 of the Insolvency and Bankruptcy Code read with Insolvency and Bankruptcy Board of India (Insolvency Resolution Process for Personal Guarantors to Corporate Debtors) Regulations, 2019.
The validity of personal insolvency of corporate guarantors have been notified vide notification dated 15.11.2019, along with rules and regulations for insolvency and bankruptcy process of Personal Guarantors whereas the Supreme Court, in its judgement dated November 9, 2023, in the matter of [4]Dilip B. Jiwrajka v. Union of India and Others (2023) ibclaw.in 147 SC has upheld the constitutional validity of provisions of the Insolvency and Bankruptcy Code, 2016 (“IBC”) pertaining to insolvency resolution process of personal guarantors.
Current Scenario of Personal Guarantor Insolvency Resolution Process:
[5]There have been total 2800 application filed for initiation of persona insolvency application filed under section 94 and 95 on the Insolvency and Bankruptcy Code, 2016 (“IBC/Code”), out which total 401 application is filed by the debtors and 2399 applications by the creditors respectively. Out of this data 50 application have been filed before DRT and 2750 have been filed before Hon’ble National Company Law Tribunal. Of the total applications 93 applications have been withdrawn/ rejected/ dismissed before the appointment of RP and RPs have been appointed in 1359 cases, however after appointment 70 cases have been withdrawn/rejected/dismissed and 383 have been admitted out of which 124 have been closed, 12 have been withdrawn, 86 where closed due to non-submission or rejection of repayment plan and 26 have yielded.
Unaddressed ISSUES: Need for the Court’s or IBBI Assessment:
⇒ Moratorium and its applicability:
Part III of the IBC deals with the insolvency resolution and bankruptcy process for individuals and partnership firms. Section 96(1) provides that upon the filing of an application to initiate the insolvency resolution process either by a debtor or a creditor, an interim moratorium comes into effect. The following is captured in the below provision of the IBC:
[6](1) When an application is filed under section 94 or section 95 –
(a) an interim moratorium shall commence on the date of the application in relation to all the debts and shall cease to have effect on the date of admission of such application; and
(b) during the interim-moratorium period –
(i) any legal action or proceeding pending in respect of any debt shall be deemed to have been stayed; and
(ii) the creditors of the debtor shall not initiate any legal action or proceedings in respect of any debt
Whereas section 100 of the code states that when the application is admitted under section 100, a moratorium shall commence in relation to all the debts and shall cease to have effect at the end of the period of one hundred and eighty days beginning with the date of admission of the application or on the date the Adjudicating Authority passes an order on the repayment plan under section 114, whichever is earlier.
The drawback or the challenge which is faced by the creditor that once the application is admitted the moratorium commenced and the financial creditor cannot avail any other resolution mechanism to resolve the debt for e.g. Enforcing the sale of assets through SARFAESI or filling of Original Application before DRT or initiating commercial suit, etc. However, in many cases it is seen that the promoter who has enforced their personal guarantee takes shelter of this provision of the code to restrict the borrower for initiating any other action, which is a drawback and hinderance in the resolution process.
⇒ Can a Creditor who does not want to file a claim stays outside the resolution process?
A resolution professional is appointed by the Hon’ble NCLT whenever the application under section 94 and 95 is admitted, the resolution professional shall invite the claim from the through [7]public notice and claim from the creditors and the same is to be required to be registered.
However, what if the creditor who has exclusive charge on the assets of the personal guarantor decides to stay outside the resolution process? and decides to enforce the security through other resolution mechanism? However, if we broadly analysis the current framework moratorium restricts such sale of the assets from the date when the application is admitted or listed before Hon’ble NCLT further, the code is also silent on the framework where the creditor dose not want to file the claim.
⇒ Repayment Plan and its Approval:
The Code specifies that the personal guarantor who wants to resolve the debt or to engage on a settlement terms the personal guarantor is entitled to submit a repayment plan basis on the current net worth of such individual or the guarantor.
The issues or the challenges faced during this process can be categorize as:
- Can the personal guarantor extinguish the liability of all the creditor even if they have not filed the claim?
- Can the personal guarantor extinguish the claim of the creditor who have exclusive charge on the property of the personal guarantor where the creditor decided to disapprove the resolution plan.
Let us try to understand the provision of such repayment plan as captured in the Code:
[8]The debtor shall prepare the repayment plan in consultation with the resolution professional, a repayment plan containing a proposal to the creditors for restructuring of his debts or affairs. The repayment plan shall include justification for preparation of such repayment plan and reasons on the basis of which the creditors may agree upon the plan.
In respect to the issues raised above the following can be consider:
- When we overlook the section for the repayment plan the contends required for the plan does not specifically address the issue on the extinguishment of the security interest of the creditors however the same can be put forth by the personal guarantor in the repayment plan but the same can be the rejected or approved by the creditor in their commercial decision. The same is still a debatable topic since the code is silent on this part but however when we look the provisions of the corporate insolvency resolution plan the contents of the plan clearly provides for the extinguishment of the charge created on the assets of the corporate debtor.
- The code is completely silent on the question but however section 110 of IBC states as follows:
(2) A secured creditor participating in the meetings of the creditors and voting in relation to the repayment plan shall forfeit his right to enforce the security during the period of the repayment plan in accordance with the terms of the repayment plan.
(3) Where a secured creditor does not forfeit his right to enforce security, he shall submit an affidavit to the resolution professional at the meeting of the creditors stating –
(a) that the right to vote exercised by the secured creditor is only in respect of the unsecured part of the debt; and
(b) the estimated value of the unsecured part of the debt.
(4) In case a secured creditor participates in the voting on the repayment plan by submitting an affidavit under sub-section (3), the secured and unsecured parts of the debt shall be treated as separate debts.
On analysing the provision of the section 110 it states that where the secured creditor does not forfeit his security interest then he must provide an affidavit stating the right with respect to unsecured creditor and right till secured creditor. Which can be understood that if the creditor does not forfeit the security, then he can enforce the security up to the security amount. The code still required more clarification on this part of the provisions.
When we look further into the provisions of the code the regulatory body requires to specifically address more points or the factors on the contents of the repayment plan just the way they have mentioned for the resolution plan of the corporate debtor, relinquishment of securities, stand of the creditor disapproving the plan of abstain[9] from voting on the plan, discharging the personal guarantor obligations towards the payment to creditor who has not filed claim.
Role of Mediation and Settlement:
Mediation and Settlement can be a game changing concept which is required to be introduced during the process and the same shall be introduced at the time when the application has been listed before the tribunal itself, this will not only help to achieve the resolution and also the objectives of the code and avoid the unnecessary litigation costs. This approach can be achieved only when there is an understanding between the creditors and the personal guarantee with a strong mediator which should be appointed by the adjudicating authority itself.
On the concluding note if the regulators and the adjudicating authority comes out with more clarification on the issues and challenges which are faced practically in their own powers can lead to a more assertive approach by creditors in initiating insolvency proceedings against guarantors, fostering a sense of financial security. The resolution process of individual is just on the dawning stage which will see more changes when the Chapter III of the code will be applicable on all types of individuals including the partnership firms. If a governing amendment to the regulations and code on the above issues will bring more clarity which will lead towards smoothening the process of insolvency resolution of personal guarantor.
References:
[1] As per Section 5(22) of Insolvency and Bankruptcy Code, 2016
[2] As per section 126 of the Indian Contract Act 1872
[3] As per section 128 of the Indian Contract Act 1872
[5] IBBI Quarterly Newsletter for Jan-Mar, 2024
[6] Section 96 Interim- moratorium & Section 100 Moratorium IBC 2016
[7] Section 102. Public notice and claims from creditors.
[8] Section 105. Repayment Plan.
[9] State Bank of India Vs Mr. T Sri Ganesh (Chadalavada Infratech Limited) where SBI abstain from voting on the repayment plan, but the resolution professional report stated that the plan is viable and taking into consideration the Hon’ble NCLT approved the repayment plan.
