Recently the Supreme Court (“SC”) in the matter of Lalit Kumar Jainv. Union of India and Ors, while upholding the legality and validity of provisions relating to the Personal Guarantors to Corporate Debtors (“CD“) under the Insolvency and Bankruptcy Code, 2016 (“IB Code“), inter-alia held that that approval of a resolution plan does not ipso facto discharge a personal guarantor (of a corporate debtor) of its liability under the contract of Guarantee. Further, the Court reiterated that “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“.
Ministry of Corporate Affairs vide its Notification dated 15th November 2019, notified that the Central Government in the exercise of the power conferred under Section 1(3) of the IB Code appointed 1st December 2019 as the date on which the provisions relating to the Personal Guarantors to CD under IB Code came into force (“Notification“). Pursuant to the Notification various petitions were filed before the Adjudicating Authority under the IB Code for initiating insolvency resolution process of Personal Guarantors to CD. Personal Guarantors filed various writ petitions before High Courts across the country under Article 226 of the Constitution of India (“COI”), challenging the constitutional validity of the Notification under the Insolvency and Bankruptcy Board of India (Application to Adjudicating Authority for Insolvency Resolution Process for Personal Guarantors to Corporate Debtors) Regulations, 2019 (“Regulation”) and rules contained therein, in relation thereto on the ground that inter alia the Notification is ultra vires the Code and Article 14 of the COI. The famous writ petitions being Lalit Kumar Jain v. Union of India & Ors. and the writ petition filed by Anil Ambani before Delhi High Court (“DHC”), which stayed the proceedings against the personal guarantors qua the Petitioners under the respective writ petitions. Pertinently, State Bank of India vide a Special Leave Petition No. 10494 of 2020 before the SC, challenging the order passed by the DHC in the writ petition filed by Mr Ambani. The SC dismissed the Special Leave Petition and observed that since the order is interlocutory in nature, it does not warrant any interference.
In the interim, the Insolvency and Bankruptcy Board of India (“IBBI”) filed petitions before the SC seeking transfer of all Petitions filed before various High Courts, challenging the validity of the Notification. In the said transfer petitions, the SC passed an order dated 29th October 2020, allowing transfer of all petitions challenging the validity of the Notification, Regulation and/or Rules to the SC. The SC also observed that the High Courts shall not entertain petitions touching the same subject and the interim orders passed by the High Courts, if any, in such petitions shall continue until further orders. Additionally, several Personal Guarantors approached the SC by filing petitions challenging the constitutional validity of the Notification and provisions of the IB Code relating to Personal Guarantors. They were tagged along with the captioned transfer petition.
Grounds for Challenge / Contentions raised by the Personal Guarantors
- The power conferred upon the Central Government under Section 1(3) of the IB Code could only be regard to the time when different provisions of the Code could have been made effective and does not permit Central Government to limit the application of the parts of IB Code to certain categories of persons without making an intelligible differentia so as to single out the Personal Guarantors.
- The Central Government has no authority – legislative or statutory – to impose conditions on the enforcement of the IB Code as a corollary, that the enforcement of Sections 78, 79, 94-187 etc. in terms of the Notification of the IB Code only in relation to Personal Guarantors is ultra vires the powers granted to the Central Government.
- The provisions of Part III of the IB Code, which are partly brought into effect by the Notification, provide a single procedure for the insolvency resolution process of a Personal Guarantor, irrespective of whether the creditor is a Financial Creditor or an operational creditor. Treating Financial Creditors and operational creditors on an equal footing in Part III of the IB Code is in contrast to Part II of the IB Code, which provides different sets of procedures for different classes of creditors. In support of this submission, the Petitioners relied upon Swiss Ribbons (P.) Ltd. v. Union of India, where this Court upheld the difference in procedure for operational creditors and Financial Creditors on the basis that there are fundamental differences in the nature of loan agreements with Financial Creditors and contracts with operational creditors for supplying goods and services.
- That the act of clubbing Financial Creditors and operational creditors concerning the procedure for insolvency resolution of Personal Guarantors to CDs amounts to treating unequals equally and amounts to collapsing the classification that is carefully created by the Parliament in Part II of the IB Code.
- That the liability of a guarantor is co-extensive with that of the principal debtor (Section 128 of Indian Contract Act, 1872) and that an approved resolution plan in respect of a CD amounts to the extinction of all outstanding claims against that CS; consequently, the liability of the guarantor, being co-extensive with that of the CD, would also extinguish. Reliance was placed on Committee of Creditors of Essar Steel India Ltd. v. Satish Kumar Gupta, in which its was ruled that “Section 31 (1) of the Code makes it clear that once a resolution plan is approved by the Committee of Creditors, it shall be binding on all stakeholders … This is for the reason that this provision ensures that the successful resolution applicant starts running the business of the corporate debtor on a fresh slate … All claims must be submitted to and decided by the resolution professional so that a prospective resolution applicant knows exactly what has to be paid in order that it may then take over and run the business of the corporate debtor. This the successful resolution applicant does on a fresh slate “.
Contentions by the Central Government
- The 2018 Amendment to IB Code substituted the pre-amended definition to Section 2 (e) by introducing three different classes of debtors: (i) Personal Guarantor to the CD – Section 2 (e), (ii) Partnership Firms and Proprietorship Firms – Section 2 (f) and Individuals – Section 2 (g) to cover three different sets of entities and deal with them differently.
- The intention was to clearly distinguish Personal Guarantors to the CD from other individuals. Partial amendment to Section 60 (2) was made to trigger the insolvency of corporate guarantors and Personal Guarantors to the CD when the insolvency proceedings for the CD was initiated and subject the Personal Guarantor to the CD, facing insolvency to achieve a unified adjudication through the same forum.
- Personal Guarantors were dealt separately from other individuals. The separation achieved through the 2018 Amendment was not realised. The insolvency resolution process of the CD would have to be dealt separately and independently of its promoters and directors who had furnished their guarantees to secure the debt of the CD. Such a situation would lead to a peculiar problem of the resolution applicant facing huge liability, whereas the personal guarantors would be out of the resolution process and would have to be proceeded against separately.
- The procedure to be adopted by the Adjudicating Authority and the rules of insolvency (in relation to personal guarantors, under Part III of the Code) might be different from that relating to the CD. Unifying both processes under one forum enables the Adjudicating Authority to have a clear vision of the extent of debt of the CD, its available assets and resources, and the assets and resources of the personal guarantor.
Court’s analysis and verdict
Considering the submissions made by the Personal Guarantors and the Central Government, the SC dismissed the entire bunch of Petitions that challenged the constitutional validity of the Notification and provisions relating to the Personal Guarantor’s, observing-
- The Notification is legal and valid, and approval of a resolution plan relating to a CD does not operate as a discharge of the liabilities of Personal Guarantors of the CD.
- As regards, various notifications including the Notification which came into effect from time to time under the IB Code, SC observed that the Central Government followed a stage-by-stage process of bringing into force the provisions of the IB Code, regard being had to the similarities or dissimilarities of the subject matter and those covered by the IB Code.
- Section 60(2) alludes to insolvency resolution or bankruptcy, or liquidation of three categories of persons, i.e. CDs, corporate guarantors (to CDs) and personal guarantors (to CDs). They apply distributively, i.e. that insolvency resolution or liquidation processes apply to CDs and their corporate guarantors. In contrast, insolvency resolution and bankruptcy processes apply to personal guarantors (to CDs) who cannot be subjected to liquidation.
- The SC also observed that “the non-obstante provision under Section 238 gives the Code overriding effect over other prevailing enactments. This is perhaps the rationale for not notifying Section 243 as far as personal guarantors to corporate persons are concerned. Section 243(2) saves pending proceedings under the Acts repealed (PIA and PTI Act) to be undertaken in accordance with those enactments“. The Notification, as a consequence of the non-obstante clause in Section 238, has the result that if any proceeding were to be initiated against personal guarantors, it would be under the IB Code.
- The Impugned Notification is not an instance of improper legislative exercise or amounting to impermissible and selective application of provisions of the IB Code. There is no compulsion in the IB Code that it should, at the same time, be made applicable to all individuals, (including personal guarantors) or not at all.
- Any recourse under Section 133 of the Contract Act, 1872 to discharge surety’s liability on account of variance in terms of the contract, without their consent, stands negated. Language of Section 31 of the IB Code makes it clear that the approved plan is binding on the guarantor in order to avoid any attempt to escape liability under the provisions of the Contract Act, 1972.
- The sanction of a resolution plan and finality imparted to it by Section 31 does not per se operate as a discharge of the guarantor’s liability. However, an involuntary act of the principal debtor leading to loss of security would not absolve a guarantor of its liability.
- Approval of a resolution plan does not ipso facto discharge a Personal Guarantor of a CD of their liabilities under the contract of Guarantee. 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 their liability, which arises out of an independent contract.
The verdict is a boost for lenders. It allows them to seek recovery of dues from Personal Guarantors of loans even while bankruptcy processes against the principal borrower Company / CD are pending. It further empowers the very principles of Guarantee as envisaged under the Indian Contract Act. It opens a way for banks and financial institutions to go behind the Personal Guarantors of the CD to recover its debt simultaneously with the proceeding against the CD, which would enable them to recover sums in addition to the amounts received under the resolution plan, who many at times suffer haircuts under the resolution plan despite having secured claims. In the light of this judgment, proceedings against Personal Guarantors can be filed and proceeded with, which were earlier sine dine adjourned by the Adjudicating Authority due to the interim protections obtained by respective Personal Guarantors. The Personal Guarantors will now require adequate legal advice to analyse and ascertain the nature and extent of the liability, which would much depend on the terms of independent contracts / guarantee documents for actions initiated and/or to be initiated by the Financial Creditors for initiating insolvency actions against them.