SC Upholds Centre's Notification Bringing Into Force Insolvency Of Personal Guarantors To Corporate Debtors

Author: Sarojanand Jha, Founding Partner, Vedanta Legal

In a recent landmark decision, the Supreme Court has upheld the challenge to a Notification dated 15^th November 2019 (“Notification”) issued by the Ministry of Corporate Affairs, which brought into force the provisions of the insolvency of Personal Guarantor to the Corporate Debtor.

The expression “Personal Guarantor” is a common term in a financial transaction, especially in loan borrowing transaction. In simple terms, Personal Guarantor means the person nominated by the Borrower and accepted by the Bank who will execute the Personal Guarantee in favour of the Bank qua the repayment of the loan amount. The liability of the guarantor is co-extensive with that of the principal Borrower.

The IBC provides insolvency of broadly two categories of legal persons firstly, limited liability entities, i.e. Companies/Limited Liability Partnerships (“LLPs”) and secondly, Individuals and Partnership Firms. The IBC further provides that the adjudicating authority, for the purpose of Part III (that deals with insolvency resolution and bankruptcy of individuals and partnership firms), would be the Debt Recovery Tribunal (“DRT”) that was established under the RDBFI Act. The adjudicating authority for corporate insolvency (companies, LLPs and limited liability entities), on the other hand, is the NCLT. The appeal from the NCLT lies to the National Company Law Appellate Tribunal (“NCLAT”), and on the other hand, the appeal from the DRT lies to the Debt Recovery Appellate Tribunal (“DRAT”). A further appeal from both NCLAT and DRAT lies before the Supreme Court.

While the Central Government brought into force the provisions of IBC pertaining to the insolvency resolution process of the Corporate Debtors in 2016, the provisions relating to the insolvency resolution of the Individuals and Partnership Firms were not brought into force initially. Thus, the insolvency process of the “Personal Guarantors to the Corporate Debtors” (which is one of the species of ‘Individuals’) was yet to be brought into force by the Central Government.

On 15^th November 2019, the Central Government issued the aforesaid Notification in the official gazette whereby w.e.f. 1^st December 2019, various provisions of the IBC were brought into force, insofar as they relate to the Personal Guarantors to the Corporate Debtors.

Aggrieved by the aforesaid Notification, various petitions were filed before different High Courts as well as before the Supreme Court. By its detailed Judgment dated 21^st May 2021, the Supreme Court has rejected the challenge to the Notification issued by the Central Government in the case titled Lalit Kumar Jain Vs Union of India & Ors.       

The writ petitioners before the Supreme Court challenged the legality of the Notification essentially on two principal grounds:

Firstly, the Notification was ultra vires the powers of the Central Government under Section 1(3) of the IBC. The petitioners argued that the executive 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 creditors.

Secondly, by applying the IBC to “Personal Guarantors” only takes away the protection afforded by law. The petitioners argued that once a resolution plan under IBC is accepted, the Corporate Debtor is discharged of its liability as the liability of a guarantor is co-extensive with the principal debtor. It was urged, therefore, that the Notification, which has the effect of allowing proceedings before the NCLT, deprives the Personal Guarantors of their valuable substantive rights.

 While negativing the first ground, the Supreme Court held that the Notification is not an instance of legislative exercise or amounting to impermissible and selective application of provisions of the IBC. It held that there is no compulsion in the IBC that it should, at the same time, be made applicable to all individuals (including personal guarantors) or not at all. The Court also relied upon the report of the Working Group of Individual Insolvency (Regarding Strategy and Approach for Implementation of the Provisions of the Insolvency and Bankruptcy Code, 2016), which recognized the dynamics and the interwoven connection between the Corporate Debtor and guarantor, who has extended his personal guarantee.

The Supreme Court also negatived the second principal ground of challenge and held 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.

In view of the above, the Supreme Court upheld the validity of the impugned Notification. The two-key outcome of the decision of the Supreme Court are:

a)         insolvency proceedings may also be initiated against a Personal Guarantor to the Corporate Debtor (who are mostly associated with the Corporate Debtors as the Director/Promotor/Chairman or Managing Directors) before the same forum, i.e. the NCLT before whom the insolvency proceedings in respect of the Corporate Debtor may be initiated/pending.

b)         the approval of a resolution plan for the Corporate Debtor, would not, ipso facto, discharge a Personal Guarantor to the Corporate Debtor, of its liability to discharge the debt of the Corporate Debtor and the creditors would be at liberty to seek discharge of the same from such Personal Guarantor to the Corporate Debtor.