Incorrigible Ramifications of the Lalit Kumar Jain v. Union of India Decision – By Mr. Umang Pathak & Ms. Anushka Agarwal

Incorrigible Ramifications of the Lalit Kumar Jain v. Union of India Decision

Introduction

In its order dated 21^st May 2021, the Supreme Court of India set a landmark precedent by upholding the constitutionality of the Central Government’s 2019 Notification (“Notification”) that had made Personal Guarantors (“PG”) accountable under various provisions of the Insolvency and Bankruptcy Code (“I&B Code”). This judgement paves the way for lenders to simultaneously invoke proceedings against the PG while the proceedings against the companies are pending, to speed up the recovery of dues. The apex court has dealt with questions concerning the validity of the Notification and the liability of the personal guarantor post the acceptance of the resolution plan (“Plan”).

In this article, the authors shall attempt to address the convoluted questions of law that arose before the Court and to critically reprise its decision while assessing the ramifications that are to follow. The first part shall provide an overview of the decision, following up with the critical analysis. The final part shall conclude the article with a possible way forward.

Preface – The Lalit Kumar Case

The Notification was initially challenged before various High Courts across the country. However, the Apex Court transferred all these petitions to itself as they felt that the I&B Code was at a nascent stage which made it advisable to avoid confusion and to authoritatively settle the law regarding the Notification.

The main argument alleged by Lalit Kumar Jain was that there was excessive delegation exercised by the Central Government to selectively bring in provisions for only PGs to the Corporate Debtors (“CD”). On the contrary, the bench felt that I&B Code did not need to be made applicable for all individuals at the same time. The Parliamentary intent was to treat PGs differently from the others due to the intimate connection which exists between them and the entities that serve as guarantees. Sections 5(22), 234, 235 and unamended Section 60 of the I&B Code were emphasized to indicate that the legislature intended to carve out PGs to the CD from the homogenous class of individuals under Part III of the I&B Code. To curb uncertain outcomes arising of two separate proceedings in different forums, there was a need for a common adjudicating authority (“AA”) with the CD. It was clarified that the insolvency proceedings under Part III for individuals is not incongruous with the proceedings for CDs is set out in Part II. The bench felt that a common AA can facilitate the Committee of Creditors (“CoC”) in framing realistic plans while keeping in mind the creditors’ dues from PGs. Lalit Kumar was lastly worried that once the insolvency process is accepted, the liability of the personal guarantor that is co-extensive with that of the CD will be discharged too as per Sections 128, 133 and 140 of the Indian Contracts Act, 1872 (“ICA”), thereby extinguishing the creditors’ claims. Nevertheless, the court believed that the approval of the resolution plan would not ipso facto discharge the liabilities of the personal guarantor nor absolve the guarantor from its liabilities arising out of an independent contract. Hence, dismissing all the petitions, the Apex court upheld the notification as valid and legal.

Critical Overview

The apex court recognized the lacunae concerning the Notification, yet it failed to consider its implications that may lead to practical inconsistencies. The possible contingencies are present in three-fold arguments below: –

Right of Subrogation

Section 140 of the ICA places the surety in the shoes of a creditor with similar rights to enforce the debt against the principal debtor, post-payment of all liabilities encumbered upon himself by the guarantee. The application of this provision has been in contention ever since the notification. Due to the applicability of Section 31 of the I&B Code and the decision in Committee of Creditors of Essar Steel v Satish Kumar Gupta [2019] ibclaw.in 07 SC, post the acceptance of a resolution plan, any past, present or future liabilities encumbered upon the CD stands extinguished. However, if the personal guarantor has the liability to pay off the dues owed by the CD to its creditors, then as per the right of subrogation, the former must also have the right to enforce the same debt against the latter. Therefore, what happens to this debt owed to the personal guarantor is unclear. Further, the objectives of the I&B Code also extend to balancing the interests of all the stakeholders which the decision seems to vitiate, concerning the treatment of PGs.

The apex court held that post-acceptance of resolution plan, PGs do not get absolved from their liabilities arising out of the contract of guarantee. They gave an example of an unequivocal guarantee and upheld the decision of Maharashtra State Electricity Board Bombay v. Official Liquidator [2017] ibclaw.in 19 SC that opined that the creditors can still enforce full payment from the personal guarantor. However, that does not certainly mean that the debt that is owed to the personal guarantor by the CD gets vanished in thin air. Further, the right of subrogation is an equitable right, and Section 31 cannot operate post the insolvency resolution process. If Section 134 that grants the creditors of the CD the right to enforce their dues from the personal guarantor, then Section 140 should also not be left superfluous as it deals with enforcement of the debt of the latter from the former.

The Power of the Adjudicating Authority

The apex court held that the AA would be able to facilitate the CoC in framing “realistic plans” as it would have a clear picture of the financial situation of the personal guarantor. However, it raises suspicion as to how does the AA have the authority to comment on the resolution plans submitted by the CoC to the Resolution Professional (“RP”). It certainly cannot intervene within the commercial wisdom of the CoC, nor can it comment upon any other commercial aspect with regards to the Plans. Thus, this assertion seems nugatory, as the AA only has limited vires to comment upon the validity of a Plan as per Section 30(2) (a-e) of the I&B Code.  

Some other remarks

The Apex court upheld the decision in the case of SBI v. V. Ramakrishnan [2018] ibclaw.in 29 SC, to state that a moratorium applied under Section 14 of the I&B Code shall not apply to PGs to the CDs. But for other individuals and firms, the moratorium under Section 101 shall be operative. However, this does not answer the contention as to whether Section 101 will be applicable to legal actions pursued by the creditors of the CD against its PGs. Unless the principal debtor fails to pay the amount, there exists no legal action against the surety as per Section 140 of the Contracts Act. The court has not clearly clarified this aspect, but it can be understood through the intrinsic connection that the court found to exist between the two, that section 101 will also not apply to the CD to the PGs.

Another dubiety that arises from this judgment is the transfer of proceedings under the individual insolvency acts – the Presidency Towns Insolvency Act, 1909 (“PTI Act”) and the Provincial Insolvency Act,1920 (“PIA”) to the bankruptcy procedure under Part III of the I&B Code. The Court does not answer Lalit Kumar’s contention on whether there will be a creation of two self-contradictory insolvency proceedings as Section 243 of the I&B Code that repeals the aforementioned statutes has not been brought into force. In arguendo, a sudden halt and change in the insolvency process altogether can cause a myriad of a dilemma concerning the respective authorities and the impugned procedural differences. For instance, the concept of excluded debts (Section 79(15) of the I&B Code) does not exist in either PTI or PII act. Also, the power of the AA is far limited in contrast with the courts under the statutes. Additionally, the apex court does not answer on the contention submitted by Lalit Kumar Jain – that an AA does not have to consider whether the underlying debt owed by the CD to the creditor stands discharged or extinguished by Sections 99 and 100 of the I&B Code.

Conclusion

The apex court has adjudicated that the motive of chiseling out the PGs to the CDs from all individuals, was to effectuate the objective of maximization of assets. However, it failed to consider that objective equally applies not only to the CDs but also to its PGs. It failed to consider that such a decision can deteriorate the assets of the PGs, that further conflicts with balancing the interests of all the stakeholders under the I&B Code. While this judgement is fresh on the market, the legislature needs to act expeditiously to clarify on these grey areas and inconsistencies to strengthen the insolvency resolution process. At the outset, the legislature should amend the provisions under the ICA and the I&B Code respectively in order to provide clarity regarding the liability of personal guarantors post the acceptance of the Plan.

With the suspension of the Code being lifted, the tribunals are already burdened with an influx of cases. If such issues are recognized and rectified as soon as possible, the insolvency process in India could set a precedent for other countries.