Liability of Personal Guarantors under IBC: Clearing the Smokescreen
In India, Chapter VIII of the Indian Contract Act, 1872 (“ICA”) deals with the provisions relating to the Contract of Guarantee. As per Section 128 of the ICA, “The liability of the surety is coextensive with that of the principal debtor unless the contract otherwise provides it.” The provisions relating to personal guarantors are provided under Part III of the Insolvency and Bankruptcy Code, 2016 (“IBC”). However, since the implementation of IBC, various situations have caused ambiguity and confusion vis-a-vis the nature of guarantor’s liability, which inevitably created a smokescreen. This article attempts to clear the smokescreen by decoding authority case law on the liability of personal guarantors under IBC. In the end, we have shared take away from the authority case law concerning the personal guarantee.
Section 14 of the IBC provides for the declaration of a moratorium by adjudicating authority during which there is a prohibition on institution/ continuation of suits or proceedings against the corporate debtor, transferring, alienating or disposing of any assets as well as any action to foreclose, recover or enforce any security interest created by the corporate debtor in respect of its property. In this regard, the primary legal focal point is whether the moratorium under section 14 of the IBC applies to the guarantor of a corporate debtor undergoing Corporate Insolvency Resolution Process (“CIRP”) as well.
State Bank of India vs V. Ramakrishnan and Anr. [i]
(Decided on August 14, 2018)
The issue that came for consideration in State Bank of India vs V. Ramakrishnan and another  ibclaw.in 29 SC (“Ramakrishnan Judgment”) was if section 14 of the IBC, which provides a moratorium for the limited period, would apply to a personal guarantor of a corporate debtor as well?
In Ramakrishnan Judgment dated August 14, 2018, the Hon’ble Supreme Court clarified that the moratorium is applicable only on the corporate debtor and not the personal guarantors. The Court relied on the report of the Insolvency Law Committee (“ILC”) dated March 26, 2018. In its report, ILC recommended adding a clarification by way of an explanation to the effect that all assets of the guarantors shall be outside the scope of the moratorium imposed under the IBC. Based on the recommendation of ILC, the amendment was made to Section 14(3) of the IBC with effect from June 6, 2020 vide Insolvency and Bankruptcy Code (Second Amendment Act), 2018, stating that the moratorium shall not apply to the guarantor of a corporate debtor. Further, the Court noted that ILC in its report had recognized the coextensive nature of liability surety with that of the principal debtor in terms of Section 128 of the ICA. Accordingly, the creditor may go against either the principal debtor, or the surety, or both, in no particular sequence. The Hon’ble Court also noted that the object of the legislature was not to allow such guarantors to escape from coextensive liability to pay off the entire outstanding debt.
Dr. Vishnu Kumar Agarwal vs Piramal Enterprises Ltd [ii]
(Decided on January 8, 2019)
The questions that arose for consideration in the matter of Dr. Vishnu Kumar Agarwal vs Piramal Enterprises Ltd  ibclaw.in 16 NCLAT (“Piramal Judgment”) were:
i) Whether the ‘Corporate Insolvency Resolution Process can be initiated against a ‘Corporate Guarantor’, if the ‘Principal Borrower’ is not a ‘Corporate Debtor’ or ‘Corporate Person’? and
ii) Whether the ‘Corporate Insolvency Resolution Process can be initiated against two ‘Corporate Guarantors’ simultaneously for the same set of debt and default?
While answering the first question, the Hon’ble National Company Law Appellate Tribunal (“NCLAT”) held that before initiating the CIRP against the ‘Corporate Guarantors’, it is not necessary to initiate CIRP against the ‘Principal Borrower’.
While considering and answering the second question, NCLAT held if CIRP has been initiated against one of the “Corporate Debtors”, then after such initiation, CIRP cannot be triggered for the same debt against the other “Corporate Debtor”.
The Hon’ble NCLAT observed and held as follows at para 32 –
“There is no bar in the ‘I & B Code’ for filing simultaneously two applications under Section 7 against the ‘Principal Borrower’ as well as the ‘Corporate Guarantor(s)’ or against both the ‘Guarantors’. However, once for same set of claim application under Section 7 filed by the ‘Financial Creditor’ is admitted against one of the ‘Corporate Debtor’ (‘Principal Borrower’ or ‘Corporate Guarantor(s)’), second application by the same ‘Financial Creditor’ for same set of claim and default cannot be admitted against the other ‘Corporate Debtor’ (the ‘Corporate Guarantor(s)’ or the ‘Principal Borrower’). Further, though there is a provision to file joint application under Section 7 by the ‘Financial Creditors’, no application can be filed by the ‘Financial Creditor’ against two or more ‘Corporate Debtors’ on the ground of joint liability (‘Principal Borrower’ and one ‘Corporate Guarantor’, or ‘Principal Borrower’ or two ‘Corporate Guarantors’ or one ‘Corporate Guarantor’ and other ‘Corporate Guarantor’), till it is shown that the ‘Corporate Debtors’ combinedly are joint venture company.”
Accordingly, it was held that there is no bar for filing two applications simultaneously against the principal borrower and the corporate guarantor (s) or both the guarantors. However, once for the same set of default, an application is admitted against one of the corporate debtors (i.e. either principal borrower or corporate guarantor), a second application by the same creditor for the same set of debt and default cannot be admitted against the other corporate debtor (i.e. either principal borrower or corporate guarantor).
State Bank of India vs Athena Energy Ventures Pvt. Ltd.[iii]
(Decided on November 24, 2020)
While the Piramal Judgment is under challenge before the Hon’ble Supreme Court, the NCLAT gave a contrary view in its Judgment in the matter of State Bank of India vs. Athena Energy Ventures Private Limited (2020) ibclaw.in 344 NCLAT (“Athena Judgment”) dated November 24, 2020 wherein it held that simultaneous initiation of CIRP against a Principal Borrower and its Corporate Guarantor is permissible under the IBC.
The Hon’ble NCLAT noted that the issue under the Piramal Judgment was whether CIRP could be initiated against two Corporate Guarantors simultaneously for the same set of debt and default and not if the application can be filed against the Principal Borrower as well as the Corporate Guarantor. Also, NCLAT observed that Piramal Judgment did not notice Section 60(2) and 60(3) of the IBC.
While deciding the Athena matter, NCLAT relied upon Section 60(2) and 60(3) of the IBC. Section 60(2) of IBC provides that where CIRP or liquidation proceeding of a corporate debtor is pending before a National Company Law Tribunal (“NCLT”), an application relating to the insolvency resolution or liquidation or bankruptcy of a corporate guarantor or personal Guarantor, as the case may be, of such corporate debtor shall be filed before the NCLT. Further, Section 60(3) of the IBC provides that in case CIRP or liquidation or bankruptcy proceeding of a corporate guarantor or personal Guarantor, as the case may be, of the corporate debtor is pending in any court or tribunal, it shall stand transferred to the Adjudicating Authority dealing with CIRP or liquidation proceeding of such corporate debtor. NCLAT also relied on the report of ILC of February 2020. Finally, NCLAT noted that that simultaneous remedy is central to a contract of guarantee.
The NCLAT observed and held as follows at Para 19 of Athena Judgment –
“It is clear that in the matter of guarantee, CIRP can proceed against Principal Borrower as well as Guarantor. The law as laid down by the Hon’ble High Courts for the respective jurisdictions, and law as laid down by the Hon’ble Supreme Court for the whole country is binding. In the matter of Piramal, the Bench of this Appellate Tribunal “interpreted” the law. Ordinarily, we would respect and adopt the interpretation but for the reasons discussed above, we are unable to interpret the law in the manner it was interpreted in the matter of Piramal. For such reasons, we are unable to uphold the Judgment as passed by the Adjudicating Authority.”
Lalit Kumar Jain vs. Union of India & Ors [iv]
(Decided on May 21, 2021)
The Ministry of Corporate Affairs (“MCA”) by way of its notification no. S.O. 4126 (E), dated November 15, 2019 (“MCA Notification”), made specific provisions of the IBC applicable, only in so far as relating to personal guarantors to corporate debtor effective from December 1, 2019. After the publication of the MCA Notification, many demand notices were served to propose to initiate insolvency proceedings under the IBC. This led to the initiation of CIRP against promoters, directors of various companies, including Reliance Group’s Anil Ambani, Dewan Housing Finance Corporation Ltd.’s Kapil Wadhawan under Part III of the IBC. The said MCA Notification got challenged before various High Courts across the country. To avoid conflicting decisions by various High Courts, the Hon’ble Supreme Court, in October 2020, directed that all the writ petitions pending in the High Courts be transferred to the Supreme Court.
While adjudicating finally, the Supreme Court of India in Lalit Kumar Jain vs Union of India & Ors. (2021) ibclaw.in 61 SC (“Lalit Kumar Judgment”) vide its Judgment dated May 21, 2021 upheld the validity of MCA Notification, which brought the provisions relating to personal guarantors to corporate debtors into force with effect from December 1, 2019.
Arguments by Petitioners
One of the main arguments was that the MCA Notification is an exercise of excessive delegation by the Central Government. The Central Government could not have selectively brought into force the IBC and applied some of its provisions to one sub-category of individuals, i.e., personal guarantors to corporate debtors. It was also contended that the power as provided to the Central Government under Section1(3) of the IBC is only for providing flexibility concerning different dates on which different provisions of the IBC can be enforced, and it does not give the authority to limit the application of requirements to a certain class of people.
It was argued that provisions of the IBC made effective under the MCA Notification are not severable, as they do not deal separately with insolvency proceedings against personal guarantors but only pertain to insolvency resolution of individuals and partnership firms. It was argued that there is no intelligible differentia on the basis of which certain provisions are applied only to personal guarantors to corporate debtors and not to other classes of debtors like individuals and partnership firms. It was also contended that several provisions falling under Part III of the IBC are being applied to personal guarantors; however, Part III does not apply to personal guarantors to a corporate debtor at all.
It was also argued that the liability of a guarantor is coextensive with that of the principal debtor as per Section 128 of the Indian Contract Act, 1872. The MCA Notification allows creditors to unjustly enrich themselves by claiming in the insolvency process of the personal guarantor without accounting for the amount realized by them in the proceedings pertaining to CIRP of the corporate debtor. Since the claims against the principal debtor is extinguished upon the conclusion of the insolvency process, any liability owed by its guarantors must also be extinguished.
Arguments by respondents
It was contended that the executive has the power under Section 1(3) of the IBC bring into force a provision of the statute at different times for different purposes. It was contended that provisions of IBC were amended in 2018 for introducing three different classes of debtors, namely personal guarantors to corporate debtors [Section 2(e)], partnership firms and proprietorship firms [Section 2(f)] and individuals [Section 2(g)]. This was done so as to have a clear distinction between the personal guarantors to the corporate debtor and other individuals under the IBC. The intention behind such an amendment was that the Parliament wanted to deal with the personal guarantor of a corporate debtor differently from partnership firms and individuals. In this regard, an amendment was also made in 2018, wherein the personal guarantors to the corporate debtor were also included in Section 60 (2) of the IBC for the process of insolvency and bankruptcy. It was contended that though the procedure to be adopted by NCLT in relation to personal guarantor might be different from that of the corporate debtor, however unifying both the processes under one forum will enable adjudicating authority to have better visibility of the extent of debt of the corporate debtor, its available debts and resources as well as the assets and resources of personal guarantor. Further, the resolution applicant willing to take over the management will also find such process lucrative, and if the personal guarantor’s assets are also taken into account, total debt servicing of the corporate debtor might be lowered.
The decision of the Hon’ble Supreme Court
The Hon’ble Supreme Court observed that the amendment relating to the insertion of Section 2(e) and alteration of Section 60(2) was aimed at strengthening the CIRP. The Court held that different provisions of the IBC were enforced at different times by the Central Government depending upon the objective of the IBC with respect to a provision and priority assigned to it. It observed that the MCA Notification was issued within the power granted by Parliament and in valid exercise of it.
It observed that the connection between personal guarantor and corporate debtor to whom they stood guarantee, as well as the uncertain outcomes of as a result of two separate processes being carried on in different forums, led to carving out personal guarantors as a separate species of individuals with Adjudicating authority being common to the corporate debtor as well as personal guarantor. The exercise of power in issuing the notification under Section 1(3) is, therefore, not ultra vires; the notification is valid. It also held that approval of a resolution plan relating to a corporate debtor does not discharge the liabilities of personal guarantors to corporate debtors.
The Hon’ble Supreme Court observed and held as follows at Para 111 –
“In view of the above discussion, it is 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. As held by this Court, 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.”
Nitin Chandrakant Naik Vs. Sanidhya Industries LLP and Ors.[v]
(Decided on August 26, 2021)
Nitin Chandrakant Naik vs Sanidhya Industries LLP and Ors (2021) ibclaw.in 404 NCLAT case relate to a challenge by the promoter/suspended director against impugned order whereby application by resolution professional seeking approval of resolution plan was allowed.
The main issue, in this case, was relating to a challenge to the resolution plan, which contains a provision to transfer personal properties of the suspended director/promoter, who has given his personal properties as security in favour of the corporate debtor.
Appellant contended that the personal property of shareholder/director/guarantor couldn’t form part of the resolution plan under Regulation 37 of the Insolvency and Bankruptcy Board of India (Insolvency Resolution Process for Corporate Persons) Regulations, 2016 (“CIRP Regulations”). Thus, Appellant contended that the resolution plan could consider only properties of the corporate debtor and not of guarantor or director/shareholder.
Another vital contention was an option to the creditor to proceed against the guarantor under SARFAESI Act, 2002, Indian Contract Act, 1972 or other proceedings before DRT as part III of IBC, which then was yet to get notified. However, this objection was overruled given MCA Notification dated 15/11/2019 & Lalit Kumar Judgment.
Besides, other procedural arguments, such as the Information memorandum published by the resolution professional, did not show the personal properties director/guarantor as properties of the corporate debtor.
The Respondent countered these arguments based on Ramakrishnan Judgment, particularly Para 22 of this Judgment, where Supreme Court observed that Section 31 mandates a personal guarantor to pay for debts due without any moratorium applying to save him.
While allowing the appeal, NCLAT rejected the resolution plan and directed that all actions taken in consequences of the impugned order approving the resolution plan shall stand set aside.
1. Regulation 36(2)(f) of the CIRP Regulations provides that the Information Memorandum should give details of guarantees that have been shown concerning the debts of the Corporate Debtor, specifically if the Guarantor is a related party. Thus, the guarantor’s property is not envisaged to be considered as the property of Corporate Debtor to which Section 36(2) (a) is provided.
2. As far as Ramakrishnan Judgment’s relevance is concerned, the Apex Court made the pronouncement while part III of the IBC had not yet been applied to the personal guarantor to the corporate debtor.
The essence of Judgment in the matter of Nitin Chandrakant Naik vs Sanidhya Industries LLP and Ors (“Nitin Chandrakant Naik Judgment”) was when Part III of IBC had not been enforced, other provisions concerning personal guarantor to the corporate debtor as per Presidency Towns Insolvency Act, 1909, etc., are applicable.
Therefore, once Part III is in force, one would have to proceed as per Chapter III of Part III of IBC. Whereas, if the property of personal guarantor can be added to the resolution plan, then Part III is redundant, which can’t be the intent of IBC.
The IBC was enacted to provide a streamlined and faster process for dealing with the insolvency of individuals and corporate entities. With the introduction and implementation of IBC in 2016, India’s rank moved up from 136 to 52 in terms of ‘resolving insolvency’ in the last three years in the World Bank Group’s Doing Business Reports. India’s rank improved from 111 in 2017 to 47 in 2020 in the Global Innovation Index in ‘Ease of Resolving Insolvency’. Further, the implementation of provisions relating to the insolvency of personal guarantors will help optimize the resolution process. With this objectively, various judgments have tried to clarify the position of law vis-a-vis the nature of liability of guarantor. We are summarizing the key takeaways of these judgments, which are as follows-
- A moratorium is applicable only on the corporate debtor and not the personal guarantors (Ramakrishnan Judgment);
- Simultaneous initiation of CIRP against a Principal Borrower and its Corporate Guarantor is permissible under the IBC (Athena Judgment);
- MCA Notification, which brought the provisions relating to personal guarantors to corporate debtors into force, is valid. Approval of a resolution plan does not ipso facto discharge a personal guarantor of their liabilities under the contract of guarantee (Lalit Kumar Judgment);
- Personal property of the guarantors cannot be transferred during the CIRP of the corporate debtor (Nitin Chandrakant Naik Judgment).
Above conclusion clears the smokescreen as far liability of a Personal Guarantors under IBC is concerned, as Syd Field famous author once said, “Confusion is the first step toward clarity”.