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Personal Guarantors to Corporate Debtors under IBC - Key issues

Published: Nov 13, 2020

By Puneet Agrawal and Gaurav Gupta

Insolvency Resolution Process of Personal Guarantors has gained importance in recent times with enforcement of provisions pertaining to Personal Guarantors under IBC w.e.f 01.12.2019. In the present Article, an attempt is made to discuss the key issues that arise pertaining to Insolvency Resolution process of Personal Guarantors.

We shall cover the following issues:

1. What is the impact of admission of Corporate Insolvency Resolution Process of the Corporate Debtor on proceedings against the Corporate Debtor?
2. In which forum the proceedings will lie for insolvency proceedings?
3. Insolvency would be under the IBC or under the Old Acts?
4. Once Resolution Plan is approved under Section 31 of the IBC, can the liability still be recovered from the personal guarantor?
5. If instead of Resolution Plan being approved under Section 31, the insolvency application results into liquidation, and whether liability can be recovered from surety?
6. Vires of the provisions pertaining to Personal Guarantor under IBC
7. After approval under Section 31 of IBC, whether personal guarantor can take money from Corporate Debtor?

Background

Section 5(22) of the Code defines "personal guarantor" to mean an individual who is the surety in a contract of guarantee to a corporate debtor.

Contracts of guarantee covered under Chapter VIII of the Contract Act, 1872 – " Contract of guarantee is a contract to perform the promise, or discharge the liability, of a third person in case of his default." [S. 126]

The rights and obligations of the guarantor (surety) are determined by the detailed provisions contained in the said chapter VIII of the Contract Act .

Guarantor's liability under Contract Act

Guarantor's liability arises because of the contract of guarantee . Under Section 128 of the Contract Act, liability of surety is co-terminus with that of the principal debtor.

The Guarantor's liability is so onerous, that if there is dispute between Principal Debtor and creditor, then also surety will have to pay the debts.

In the case of Ram Krishan v. State of UP AIR 2012 SC 2288 , it was held that creditor has a right to obtain a decree against the surety and the principal debtor. Surety has no right to restrain execution of the decree against him until the creditor has exhausted his remedy against the principal debtor for the reason that it is the business of the surety/ guarantor to see whether the principal debtor has paid or not.

Notification dated 15.11.2019

By virtue of the Notification dated 15.11.2019, the following provisions of the IBC pertaining to personal guarantors to Corporate Debtors were notified [w.e.f. 1.12.2019]:

Part-III of the IBC

Part III of the Code makes provisions for insolvency resolution and bankruptcy of individuals and partnership firms.

For this purpose, it classifies individuals into three categories:

• Personal guarantors to Corporate Debtors
• Partnership firms and proprietorship firms, and
• Other individuals

As on date, only the provisions qua the Personal Guarantors to Corporate Debtors have been notified.

Issue I: What is the impact of admission of Corporate Insolvency Resolution Process of the Corporate Debtor on proceedings against the Corporate Debtor?

To take an example, ABC Ltd. owed a sum of Rs. 100 crore to a leading Bank, Bank Corp. Mr. A had extended personal guarantee of the said debt in favour of Bank Corp.

ABC Ltd. filed an application under Section 10 before the NCLT, and the Application was subsequently admitted. Consequently, moratorium under Section 14 was put in place by virtue of order of NCLT. Question arises whether Bank Corp can sue Mr. A, the personal Guarantor.

The above issue has been addressed by the judgment of Hon'ble Supreme Court in the case of State Bank of India v. V. Ramakrishnan, - 2018-TIOLCORP-03-SC-IBC dated 14.08.2018 (SC). It was the plea of the Guarantor that Section 14 of the Code would apply to personal Guarantor as well, hence proceedings against personal guarantor and his property would have to be stayed.

NCLT allowed the I.A. and stayed the proceedings against Guarantor in view of moratorium. Reliance was also placed on Section 31 of the Code whereby a Resolution plan once made would bind the personal guarantor as well.

On Appeal, the NCLAT dismissed the Appeal and upheld NCLT order. The State Bank of India filed Civil Appeal before the Supreme Court.

However, the Supreme Court reversed the decisions of NCLT and NCLAT and held that the proceedings can go on against the personal guarantor despite moratorium in favour of the Corporate Debtor.

Supreme Court considered and expressed its approval with the Insolvency Law Committee Report dated 26.03.2018, wherein it was stated as under:

• It was recommended to insert by way of an explanation that all assets of guarantors to the corporate debtor shall be outside the scope of moratorium imposed under the Code.
• The general principle of guarantee contracts is that the liability of the principal debtor and the surety is co-extensive and its joint and several.
• It was noted that this characteristic of such contracts, i.e. of having remedy against both the surety and the corporate debtor, without the obligation to exhaust the remedy against one of the parties before proceeding against the other, is utmost important for the creditor and is hallmark of a guarantee contract.
• The availability of such remedy is in most cases the basis on which the loan may have been extended.

Court's observations

On Section 31 of the Code, the Court observed that this section only states that once a Resolution plan, as approved by COC, takes effect, it shall be binding on the corporate debtor as well as the guarantor. This is for the reason that otherwise, under Section 133 of the Contract Act, any change made to the debt owed by the corporate debtor, without the surety's consent, would relieve the guarantor from payment. It was further observed that Section 31(1) makes it clear that guarantor cannot escape payment as the Resolution plan, which has been approved, may well include provisions as to payments to be made by such guarantor.

Further, Sections 96 and 101, when contrasted with Section 14, would show that Section 14 cannot possibly apply to a personal guarantor.

Part III contemplates a separate moratorium, applicable separately in the case of personal guarantors against whom IRP may be initiated under Part III.

The object of the Code is not to allow such guarantors to escape from an independent and coextensive liability to pay off the entire outstanding debt, which is why Section 14 is not applied to them.

Section 22 of SICA provided that creditors could not proceed against guarantors as well after the Company had been declared sick under the Act, without permission from Board for Industrial and Financial Reconstruction.

Parliament, when it enacted Section 14, specifically did not provide for any moratorium along the lines of Section 22 of the Sick Industrial Companies (Special Provision) Act, 1985 ("SICA") in Section 14 of the Code.

Issue II: In which forum the proceedings will lie for insolvency proceedings?

In our example, where ABC Ltd. has defaulted on payment of debt to Bank Corp and Bank Corp is proceeding against the Personal Guarantor, Mr. A, question arises who shall be the Adjudicating Authority?

In case where CIRP against Corporate Debtor is pending, then Section 60 of the Code is applicable qua the personal guarantors.

As per Section 60(1):

• The Adjudicating Authority,
• in relation to insolvency resolution and liquidation for
• corporate persons including corporate debtors and personal guarantors thereof
• shall be the National Company Law Tribunal having territorial jurisdiction over the place where the registered office of the corporate person is located.

Section 60(2) provides that:

• Without prejudice to sub-section (1) and Notwithstanding anything to the contrary contained in the Code,
• where a corporate insolvency resolution process or liquidation proceeding of a corporate debtor
• is pending before a National Company Law Tribunal ,
• 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 such National Company Law Tribunal

The non obstante clause provided in sub-section (2) of Section 60 of the Code thus prevails over anything to the contrary contained in the Code.

Further, in terms of Section 60(3) of the Code,

•  An insolvency resolution process or liquidation or bankruptcy proceeding of a corporate guarantor or personal guarantor , as the case maybe, of the corporate debtor pending in any court or tribunal shall stand transferred to the Adjudicating Authority dealing with insolvency resolution process or liquidation proceeding of such corporate debtor

Section 179 of the Code provides that subject to provisions of Section 60 , the Adjudicating Authority, in relation to insolvency matters and individuals and firms shall be the DRT.

In view of Section 60 of the Code,

• where CIRP of a corporate debtor is pending before NCLT, an application relating to insolvency resolution or liquidation or bankruptcy of a corporate guarantor or a personal guarantor shall be filed before the NCLT and not the DRT.

Further, as and when the insolvency proceedings of the Corporate Debtor is filed in NCLT, the insolvency or bankruptcy proceedings of a personal guarantor shall be transferred to the NCLT.

Issue III: Insolvency would be under the IBC or under the Old Acts?

As per our example, ABC Ltd. went into CIRP and the proceedings against the Personal Guarantor were being initiated. Question arises which law will govern the Personal Guarantor?

Supreme Court in the case of V. Ramakrishnan (supra) has specifically clarified that till the time the provisions of Personal Guarantors were enforced by way of Notification, the Personal Guarantors shall be covered under old laws, i.e. Presidency-Towns Insolvency Act, 1909 or the Provincial Insolvency Act, 1920.

There shall be two periods that arise by virtue of Notification notifying provisions w.e.f. 01.12.2019:

• One pre-Notification: where proceedings shall be carried out before the NCLT in accordance with the Presidency-Towns Insolvency Act, 1909 or the Provincial Insolvency Act, 1920
• Another post- Notification: where provisions of IBC pertaining to personal guarantors shall be applicable

In the present case, in view of the fact that Section 243 of the Code has not yet been brought into force, Section 238 will apply. It provides that the provisions of this Code shall have effect, notwithstanding anything inconsistent therewith contained in any other law for the time being in force. Hence, the provisions of IBC shall prevail over the Presidency Towns Insolvency or the Provincial Insolvency laws.

Section 243 has not yet been enforced because since presently only provisions qua personal guarantors have been enforced and provisions qua other individuals and partnership firms/ sole proprietorship are yet to be enforced.

Issue IV: Once Resolution Plan is approved under Section 31 of the IBC, can the liability still be recovered from the personal guarantor?

An important question arises qua the liability of Personal Guarantors, namely, in case Resolution plan is approved by NCLT under Section 31, then whether balance liability can still be recovered from the personal Guarantor?

As per our example, where ABC Ltd. had owed a sum of Rs. 100 crore to Bank Corp. Mr. A had extended personal guarantee of the said debt in favour of Bank Corp.

Now, in insolvency resolution process of ABC Ltd., Resolution Plan has been approved by Committee of Creditors and subsequently approved by NCLT, under Section 31. Section 31 says that once Resolution Plan accepted, it shall be binding on debtor, creditor and the guarantor.

Out of Rs. 100 crore liability owed to Bank Corp, the Resolution Plan says that Bank Corp will get Rs. 70 crore.

Calcutta High Court decision

Calcutta High Court in the case of Gouri Shankar Jain v. Punjab National Bank 2019 SC OnLine Cal 7288 (SB) , framed the question whether balance Rs. 30 crore dues can be recovered from Personal Guarantor, i.e. Mr. A?

The High Court relied on Supreme Court's decision in the case of Maharashtra State Electricity Board v. Official Liquidator (1982) 3 SCC 358 and held that approval of Resolution Plan does not impair the right of financial creditor to recover the balance amount from the guarantor of the Corporate Debtor. While holding so, the High Court did not consider the applicability of Section 31 of the Code.

It is respectfully submitted that insolvency process under IBC is operation of law. Further, as per the facts of the case in Maharashtra State Electricity Board (supra), there was actual liquidation. It was then held that the fact that the Principal Debtor has gone into liquidation would not have any effect on the liability of the guarantor.

Here, in the present facts, there is a vital difference, namely, that the terminal point is the acceptance of resolution plan and not liquidation. Further, Section 31 of IBC states that the resolution plan is binding on the creditor, debtor and the guarantor. Thus, in view of the authors, Section 31 of IBC would bring about a change in the creditor's right to recover from the guarantor. With respect, it is submitted that Section 31 of IBC was not submitted by the counsels in course of arguments, which if presented, may have changed the decision of the Hon'ble Court.

Punjab and Haryana High Court decision

In the case of Kundanmal Dabriwala v. Haryana Financial Corporation, MANU/PH/3320/2011 , the Hon'ble Punjab and Haryana High Court, held that scheme sanctioned by Court under Sections 391 and 394 of the Companies Act, 1956 was binding on the creditors whether such creditors assented to it or not. The Court therein took note of Section 135 of the Contract Act, and held that, a contract between the creditor and the principal debtor by which the creditor compounds with the principal debtor, discharges the surety.

The decision of Calcutta High Court in Gouri Shankar (supra) has distinguished the decision of Punjab and Haryana High Court in the case of Kundanmal Dabriwala (supra), saying that it requires reconsideration. However, the distinction between a liquidation and settlement of claim under Section 391 of erstwhile Companies Act, 1956, or under Section 31 of the IBC was not presented for been examined by the Hon'ble Calcutta High Court.

Clean Slate Theory

Further, reliance is placed on the decision of Hon'ble Rajasthan High Court in the case of Ultra Tech Nathdwara Cement v. Union of India, -2020-TIOL-760-HC-RAJ-GST. The Hon'ble Court held as under:

The purpose of the statute is very clear that it intends to revive the dying industry by providing an opportunity to a resolution applicant to take over the same and begin the operation on a clean slate.

Similarly, in the case of Committee of Creditors of Essar Steel India Limited vs. Satish Kumar Gupta and Ors. - 2019-TIOLCORP-18-SC-IBC-LB, Hon'ble Supreme Court while discussing Section 31, observed as under:

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 as it were.

Thus, in view of the above, once Resolution plan is accepted, then the Corporate Debtor's business begins on a fresh slate. This, in the view of the Authors should also absolve the Personal Guarantors, whose liability is only co-terminus with that of the Principal Debtor and no more.

Section 128 of the Contract Act

Further, reference is invited to Section 128 of the Contract Act. As per the said provision, liability of guarantor is co-terminus with liability of Principal Debtor. When, as per our example, the Liability of Principal Debtor is reduced to Rs. 70 crore from Rs. 100 crore, to say that the Guarantor's liability will remain Rs. 100 crore, may not be reflective of the correct legal position.

Issue V: If instead of Resolution Plan being approved under Section 31, the insolvency application results into liquidation, and whether liability can be recovered from surety?

Other question that has to be considered is if the insolvency application of ABC Ltd. results into liquidation, whether liability can still be recovered from the surety?

Here, a s discussed above , the principle laid down by Hon'ble Supreme Court in the case of Maharashtra State Electricity Board v. Official Liquidator (1982) 3 SCC 358 shall apply. The liability can thus be recovered from the personal guarantor.

Issue VI: Vires of the provisions pertaining to Personal Guarantor under IBC

The Writ Petitions that were filed before several HC by the Personal Guarantors had challenged Notification dated 15.11.2019 and the Insolvency and Bankruptcy (Application to Adjudicating Authority for Insolvency Resolution Process of Personal Guarantors to Corporate Debtors) Rules, 2019.

The Writ Petitioners also sought a declaration that Section 95, 96, 99, 100, 101 of the IBC are unconstitutional insofar as they apply to personal guarantors of Corporate Debtors.

Anil Ambani case

In the case of State Bank of India v. Anil Ambani, in NCLT, - 2020-TIOLCORP-11-NCLT dated 20.08.2020, proceedings were initiated against the Respondent, i.e. Personal Guarantor before NCLT. The Tribunal by order dated 20.08.2020 appointed Resolution Professional.

One of the key challenge raised by the Respondent was that in view of pendency of Resolution plans in cases of the Corporate Debtor, the Petition should not be proceeded with. In this regard, it is settled principle under Contract Act, that even if the proceedings are pending between Principal Debtor and the Creditor, then also the Guarantor can be proceeded against.

The Tribunal relied on Gouri Shankar Jain (supra) and held that the principle laid down therein applies on all fours to the case at hand. It was further observed that the law doesn't envisage that the insolvency resolution of personal guarantor should follow only when the CIRP of Corporate Debtor has come to an end in view of Section 60(2) read with Section 95 and 97(3) of the Code.

The Respondent filed writ petition against the said order before Hon'ble Delhi High Court in the case of Anil Dhirajlal Ambani v. SBI W.P. (C) 5712/2020. The Court was pleased to stay the proceedings under Part-III.

Several other petitions also came to be filed in the High Courts.

Transfer Petition

Thereafter, the matters were transferred to Supreme Court by virtue of order in the case of IBBI v. Lalit Kumar Jain and Ors. - 2020-TIOLCORP-10-SC-IBC-LB. The Hon'ble Court observed that considering importance of issues raised which need finality of judicial determination at the earliest, it is just and proper that the writ petitions are transferred from High Court to Supreme Court.

Further, it has been directed that no High Court shall entertain any petition wherein challenge is made to Notification dated 15.11.2019 and provisions pertaining to Personal Guarantors.

As on date the matter is pending before Hon'ble Supreme Court.

Issue VII: After approval u/s 31, whether personal guarantor can take money from Corporate Debtor?

The final question that needs to be addressed is:

As an example, the Resolution plan makes provision for payment of Rs. 70 crore to Bank Corp. Out of Rs. 70 crore, Rs. 40 crore is recovered from Corporate Debtor whereas balance Rs. 30 crore is paid by Mr. A, the Personal Guarantor. Question arises, whether Mr. A upon payment of Rs. 30 crore can recover from the Corporate Debtor?

The said question is a pure question of Contract Law and is answered by Section 140 of the Contract Act.

Section 140 provides for rights of surety on payment or performance.

• Where a guarantee debt has become due,
• or default of the principal debtor to perform a guaranteed duty has taken place,
• the surety,
• upon payment or performance of all that he is liable for,
• is invested with all the rights which the creditor had against the Principal Debtor.

Once liability is paid, then the Personal Guarantor steps into the shoes of Creditor and is invested will all the rights which the Creditor had against the Principal Debtor.

[Puneet Agrawal, Partner and Gaurav Gupta, Manager, ALA Legal, Advocates and Solicitors - The views expressed are strictly personal.]