On 21st May 2021, a two-Judge Bench of the Supreme Court (“SC“) decided the applicability of the Notification dated 15th November 2019 by the Ministry of Corporate Affairs, Central Government which stipulates that the personal guarantor shall be liable for the debts of the company. The SC held that the Notification in question is issued within the power of the Parliament, and hence, it cannot be deemed invalid on the grounds of being “ultra vires“.
The Petitioners in the present case alleged that the impugned Notification brought by the Central Government is ultra vires. The Petitioners contended that the government could not extend the provisions of Insolvency and Bankruptcy Code, 2016 (“Code“) only limiting to personal guarantors of corporate debtors. Therefore, according to them, this particular move by the Government per se is in excess of the authority conferred upon the Central Government under Section 1(3) of the Code.
A number of times previously as well, the Petitioners had furnished the personal guarantees to banks and financial institutions to get advances for their companies. The Petitioners were acting either in the capacity of directors, promoters or in some instances, as chairman or managing directors in their respective companies. Therefore, the government had always wanted to make promoters of loan defaulters accountable for their actions. Thus, as mentioned earlier, the Notification permits the banks to initiate insolvency proceedings against those promoters who had furnished personal guarantees for the loans taken by their firms. This is done to ensure the maximum recovery from the lenders and the resolution of companies’ debt.
After the Notification came into force, it was challenged by 19 promoters in different High Courts of India. The Petitioners contended that the companies were run by the management board and not just the promoters. Hence, the promoters alone cannot be held liable for the debt repayment.
The Notification laid down two different sets of regulations for non-corporate persons and their implementation.
- The Insolvency and Bankruptcy (Application to Adjudicating Authority for Insolvency Resolution Process for Personal Guarantors to Corporate Debtors) Rules, 2019
- The Insolvency and Bankruptcy (Application to Adjudicating Authority for Bankruptcy Process for Personal Guarantors to Corporate Guarantors) Rules, 2019
Soon after the Notification got published, all the promoters were served with a demand notice informing them about the initiation of insolvency proceedings.
Court’s observation and analysis
Two questions were considered by SC which have been discussed below –
- Whether or not the government can selectively enforce the Code and apply some of its provisions to specific groups of people, such as personal guarantors to corporate creditors?
In determining whether or not the Defendants have the authority to enact specific sections of the Code and apply some of its provisions to particular groups of people, such as personal guarantors, the Court read Section 1(3) of the Code. As per the mentioned Section –
“It shall come into force on such date as the Central Government may, by notification in the Official Gazette, appoint:Provided that different dates may be appointed for different provisions of this Code and any reference in any such provision to the commencement of this Code shall be construed a reference the commencement of that provision.”The Court determined that the power to enact specific provisions by making a sub-category of guarantors is a product of conditional legislation and delegated legislation. The Court analysed several precedents and concluded that the executive pillar has the power to decide on the following matters-
- To determine when the provision has to come into force.
- To make some incidental modifications while maintaining the essence and keeping the substance of the legislation intact.
The Court noted that the provision of the Code was brought and implemented in stages. It was a deliberate decision made by the executive to administer such a provision effectively. Initially, it established a regulatory body for the proper functioning of the Code, followed by the commencement of the Code for companies registered under the Companies Act, 2013 or other special legislation and limited liability partnerships. After that, it operationalised the provisions for personal guarantors to corporate debtors, partners of firms and other individuals.
As a result, the Supreme Court determined that the executive was well within its rights to apply some of its provisions to a specific group of people. It also concluded that the sole purpose of taking those deliberate steps was to achieve the IBC’s objectives in terms of priorities.
- Whether or not the contested Notification removes the personal guarantor’s legal protection under the contract of guarantee (w.r.t. Sections 128, 133, and 140 of the Contract Act)?
In determining whether or not the Notification removes the personal guarantor’s legal protection under the contract of guarantee, the Court considered section 133 of the Contract Act, 1872 –“Any variance, made without the surety’s consent, in the terms of the contract between the principal 1[debtor] and the creditor, discharges the surety as to transactions subsequent to the variance. -Any variance, made without the surety’s consent, in terms of the contract between the principal 1[debtor] and the creditor, discharges the surety as to transactions subsequent to the variance.”It provides that in times when the terms of the contract vary between the debtor and the creditor and the surety is unaware about it, the liability of the surety stands discharged.
However, the Court said that a particular amount of debt, be it all or a portion of it, extinguishes as soon as the resolution plan is sanctioned or when the resolution process ends. But it will not give the same immunity to the personal guarantor. The creditor may proceed against the personal guarantor for recovery.
The Court relied upon the judgment of State Bank of India (SBI) v. V. Ramakrishnan, wherein Justice R. Nariman held that the approval of a resolution plan would not ipso facto discharge a personal guarantor of their liabilities under the contract of guarantee. He also noted the fact that the liability of a surety arises out of an independent contract and, therefore, extinguishment of corporate debt through insolvency and liquidation proceedings or by operation of law cannot discharge its liabilities.
Thus, applying the above laid down principles, in the present case, the SC ruled that the impugned Notification is legal and not ultra vires the Code.
The current decision will reverberate throughout the business community. It is a major setback for prominent industrialists like Anil Ambani, Sanjay Singhal, Venugopal Dhoot and Atul Punj, who had received crores of rupees as advanced for their firms. The judgement is significant because it now gives lenders the much-needed green signal to invoke personal guarantees of promoters to recover the dues. Thus, it is clear that the following judgment strengthens the IBC’s power because banks and financial institutions have the option of proceeding against both the corporate debtor and its guarantor at the same time.