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PERSONAL GUARANTOR UNDER THE CORPORATE INSOLVENCY RESOLUTION PROCESS.

Introduction


It is well-known fact that the Insolvency and Bankruptcy Code, 2016[i] has spurred furious litigation by the corporates and multiple interpretations in the last few years. India, as a country, has a large percentage of the population involved in entrepreneurship, and a large percentage of these companies, be it listed or unlisted, are run by promoters. Normally banks require a personal guarantee to be given by the Promoters when loans are given out. However, when the company faced insolvency or bankruptcy issue, the banks faced the problem of bringing the personal guarantor into the picture. The absence of a proper forum to enforce this personal guarantee in interlinked with the insolvency of the company for which the guarantee exists. This problem led the legislators and government to come up with a provision relating to personal guarantees.


In the landmark judgment of Lalit Kumar Jain v. Union of India[ii] a two-judge bench of Justice L. Nageswara Rao and Justice R. Ravindra Bhat on May 21, 2021, upheld the validity of the notification passed by the government regarding insolvency proceedings against the personal guarantors of corporate debtors provided that the insolvency or bankruptcy proceedings of the corporate debtor is pending before the National Company Law Tribunal. Such a judgment will ring loud and clear in the business community. The provisions under Part III of the Code relating to personal guarantors came into effect through a government notification on December 1, 2019, allowing the creditors to move against the personal guarantors of the stressed corporate debtor under the Insolvency and Bankruptcy Code, 2016. Along with this “The Insolvency and Bankruptcy (Application to Adjudicating Authority for Insolvency Resolution Process for Personal Guarantors to Corporate Debtors) Rules, 2019” and the “Insolvency and Bankruptcy Board of India (Insolvency Resolution Process for Personal Guarantors to Corporate Debtors) Regulations, 2019” also came into effect through separate notifications. These rules and regulations further explained the framework for creditors to bring the personal guarantors of corporate debtors into the picture. The Attorney General of India asserted that by including the personal guarantors within the purview of insolvency or bankruptcy proceedings the possibility of both the parties arranging for payment is higher. This would in turn lead to maximization of assets, thus fulfilling one of the main purposes of the Code.


Lalit Kumar Jain v. Union of India- A Resolved Conundrum


In the present case, the main argument by the petitioners was that the notification dated November 19, 2019, is ultra vires. The petitioners, being incapacity of directors, promoters, had furnished a personal guarantee to financial institutions and banks and presently they are facing insolvency proceedings which are at different stages. The main point of attack by the petitioners was that a some of the provisions of the code cannot be selectively brought into force only for a sub-category of individual, that is, personal guarantor to the corporate debtor.


The main contentions raised by the petitioners which the court has dealt with are:


· The Government has exercised excess powers than given to it under Section 1(3) of the IBC.


It was contended that when the legislature enacted the law of Insolvency and Bankruptcy Code in 2016 the only role of the executive was to bring the law into operation and not to legislate on it. It was argued that the government having the power by a ‘conditional legislation’ as this cannot legislate in any manner. However, it was noticed by the court that the interpretation of Section 1(3) of the Code has to be done with the utmost flexibility to meet the actual objectives of the IBC. Hence the notification was held to be in support of the spirit of the IBC.


· Co-extensive nature of the liability of the personal guarantor is disregarded


Among the numerous petitions filed in different High Courts, a common misunderstanding among the petitioners was their belief that on approval of a resolution plan of a corporate debtor, the liability of the personal guarantor would also be extinguished. It was argued that since the approval of the plan amounts to clearing off all outstanding claims against the debtor, then the liability of the guarantor which is co-extensive shall also be cleared off.


However, the Apex Court cleared the misunderstanding relying on a catena of judgments.[iii] When a principal borrower is released from the debt by insolvency proceedings does not discharge the guarantor of his liability as it arises out of an independent contractor. The court substantiated the point by adding that the concept of a guarantee is derived from Section 126 of the Indian Contract Act, 1872. According to this section, if the debtor completely fails to repay the debt to the concerned creditor then the next burden falls on the guarantor and hence the creditor holds the right to initiate insolvency proceedings against the personal guarantor.[iv]


· National Company Law Tribunal should not be the adjudicating authority in case of Personal Guarantors


The entire purpose of the Notification is to enable the outstanding cases of insolvency or bankruptcy to be solved by the Code. When the resolution or liquidation process against a corporate debtor is pending then Section 60(2) provides that an application for the resolution process of the personal guarantor of the corporate debtor has to be submitted with the NCLT. It was noted by the court that even in the unamended IBC, the adjudicating authority for insolvency and liquidation of corporates, including personal guarantors, was the National Company Law Tribunal. [v]The court even stated that there are valid reasons for the adjudicating authority to be NCLT in the case of personal guarantors and corporate debtors. The main reason is that it will enable the NCLT to understand the bigger picture and this would, in turn, help the Committee of Creditors in coming up with effective resolution plans.


· The distribution under Section 60 of the Code does not apply to Personal Guarantors


To the above-mentioned contention by the petitioners, it was argued by the Respondents that after the amendment in Section 60 of IBC in 2018, the line “corporate guarantor or personal guarantor” as the case may be has been added to the Section. This amendment means that the personal guarantor can be a part of the insolvency proceedings which can be decided by the NCLT. It was further stated by the court that without this amendment the personal guarantors would remain outside the machinery of the IBC and that is not the intention of the Code.


Personal Guarantor’s Role in Insolvency Proceedings in the U.K.


The main legislation dealing with insolvency matters in England and Wales is the Insolvency Act 1986 and the Insolvency (England and Wales) Rules 2016. A common practice in the UK is that the director of the company is requested by the banks to provide personal guarantees for the amount lent to the company itself which is known as the director’s guarantee. If the company becomes insolvent then the director can be held personally liable for the repayment. If and when the creditor recovers money from the personal guarantor on default of the debtor then the debtor would remain liable to the guarantor for the said sum. The Director’s liability is huge in such cases of personal guarantee as he can be made to pay the entire debt of the company and if he does not hold enough assets to repay the debt, he may be declared bankrupt. Even if there are several directors giving personal guarantees, the creditor has the liberty to claim the whole amount from one guarantor. The regime in the UK in terms of a personal guarantee is creditor friendly. In the case of National Westminster Bank v. Alfano[vi], the validity of such a personal guarantee was debated and it was held that is valid and unconditional.


Conclusion


It would not be wrong to assert that the judgment in Lalit Kumar Jain v Union of India has brought a sigh of relief to the creditors, be it banks, financial institutions, or any other. However, this judgment has also become a cause of worry for many individuals who were promoters of debt-ridden companies. It is evident that this judgment adds to the powers of the IBC and the creditors who can now go against both the corporate debtor and the personal guarantor. Thus, it is in furtherance of the objective and the actual spirit of the Insolvency and Bankruptcy Code.

References


[i] Insolvency and Bankruptcy Code, 2016, No. 31, Acts of Parliament, 2016 (India)

[ii] Lalit Kumar Jain v. Union of India and Ors. (Civil) No. 245/2020

[iii] Industrial Finance Corpn. of India Ltd. v. Cannanore Spg. & Wvg. Mills Ltd., 2002 5 SCC 54; Punjab National Bank v. the State of U.P., 2002 5 SCC 80.

[iv]Indian Contract Act, No. 9, Acts of Parliament, (1872) (British India)

[v] Vasanth Rajasekaran and Harshvardhan Korada, Personal Guarantors to Corporate Debtors Liable under the IBC, 2016: Supreme Court of India, Mondaq (2021)

[vi] (2012) EWHC 1020 QB



Navin Kumar Jaggi

Mona Das

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