Owing to prolific changes brought in Insolvency and Bankruptcy Code, 2016, economy has faced a lot of ripple effects. Absence of any efficacious forum for enforcement of personal guarantee for corporate debtor hailed as an important economic concern. The present article discusses the ramifications of Lalit Kumar Jain v. Union of India , and the loopholes which need to be plucked for the enforcement of Part-III in its letter and spirit.
: Personal Guarantors, Corporate Guarantors, Co-extensive Liability, Liability of Guarantors.
Since it’s inception IBC has been exposed to various prolific legislative and judicial reforms. The latest and perhaps the most significant development was driven by the notification dated 15th November 2019 . By the impugned notification, the Central Government enacted Part III of the IBC thus, expressly bringing personal guarantors to corporate debtors, within the sweep of the IBC. With this the recovery of debt from the surety will be exposed to a framework which is easier, and time bound for the creditors.
The Article focuses on nuances pertaining to the initiation of Corporate Insolvency Resolution Process (CIRP) against Personal Guarantors to the Corporate Debtors before the enforcement of Part-III. With this enforcement, the legislature intends to iron out the creases present in the current status of guarantors. The author will conclude with the loopholes which need to be plucked for the enforcement of the impugned notification in its true spirit.
CO-EXTENSIVE LIABILITY OF THE GUARANTORS
Guarantees are commonly used in financing transactions. Historically, India is an economy where a large part of companies (listed/unlisted) are run by the owners/promoters . Banks ensure the guarantee of the promoters to secure their skin in the game. The promoters stand in a fiduciary relationship with the company and by virtue of this relationship they owe a duty of loyalty and care towards the company. SC in the case of Lalit Kumar Jain acknowledged the “Intrinsic connection” between personal guarantors and their corporate debtors. The erstwhile insolvency regime did not have any efficacious forum to enforce personal guarantees, it was a prolific step to enable rehabilitation and bankruptcy proceedings against personal guarantors. The present regime will allow the creditors to run recovery proceedings against creditors and guarantors simultaneously before the same Adjudicating Authority of the NCLT having territorial jurisdiction . This move stems from the judgement of Essar Steel , wherein the Supreme Court (‘SC’) gave a nod for the lenders to go after the guarantors for the unsettled portion of the debt under the resolution plan.
Section 126 of the Indian Contract Act, 1872 honours the promise of the surety to pay the agreed portion of the future debt owed by the debtor to the creditor. The presence of three parties in this contract makes it a tripartite agreement and the privity of contract extends to the surety as well. Further, Section 128 creates a co-extensive liability between the surety and debtor. This liability of the surety is immediate . It is open to the creditor to move to the guarantors without exhausting the remedies against the debtor . Court further placed reliance on the case of Kesoram Mills , and held that the liability of the guarantor is invoked the moment the default is committed and a demand notice seeking for the payment of guaranteed amount is sent by the creditors.
GUARANTORS LIABILITY UNDER MORATORIUM PERIOD
SC in the case of State Bank of India v. Ramkrishnan & Anr. cleared the air regarding the applicability of Section 14 to the guarantors. SC reversed the holdings of the Tribunals and held that a CIRP for a guarantor is to be carried out in Part III, which contains a separate provision for moratorium. Section 96 and 101 will hold the ground only when separate insolvency procedure is to be followed for the guarantors. Giving a broad interpretation to Section 14 so as to make it applicable for the guarantors would curtail significant rights of the creditors. Thus, the Court resorted to giving a literal interpretation to Section 14. Even if the guarantors and debtors are a part of the same process, the assets of the guarantors are different from that of the debtors . CIRP might not impact against the assets of the guarantors. This argument is in consonance with the recent notification which prescribes for the initiation of separate proceedings against the corporate debtor and corporate guarantors. Court based its findings on Eradi Committee Report and held that the contractual principles of guarantee must be respected even during the period of moratorium and an alternate interpretation which restricts its meaning might not have been the intention of the IBC.
If there is a stay on actions against the assets of the personal guarantors during a CIRP, such promoters might indulge in filing frivolous applications merely taking advantage of the stay granted by the tribunal and guard their assets. The court was thoughtful about such a circumstance wherein the personal guarantors, who are also the promoters of the corporate undergoing the insolvency proceedings, might frustrate the procedure for the sake of their own interest. However, with the enactment of Part-III of the IBC, the provisions relating to the moratorium are relatively relaxed.
IMPACT OF LALIT KUMAR JAIN V. UNION OF INDIA- THE GOOD, THE BAD, AND THE UGLY.
Recently, the vires of the notification issued by the Central Government was challenged on the procedural front before various High Courts. SC clubbed all the petitions and decided to hear them together as they involved an interpretation of common question of law. The Supreme Court stated that it was clear that the Central Government's technique of bringing certain parts of the IBC into force had a definite purpose: to achieve its objectives in relation to the priorities. The ruling strengthens the IBC's biting power , as creditors of a corporate debtor would now be able to pursue both the corporate debtor and its personal guarantor at the same time. The NCLT would be able to look at the big picture, so to speak, see the nature of the assets available, and help the Committee of Creditors come up with realistic resolution proposals, taking into account the possibility of recovering some of the creditor’s dues through personal guarantors. Based on this reasoning, the SC decided that the challenged notification was neither a legislative act nor an example of improper and selective application of the IBC’s provisions.
In the author’s opinion, the Apex Court stopped short of answering the question which was primary in all the read petitions. The issue at hand was that the application of the IBC to personal guarantors takes away the protection offered by law envisaged under Sections 128, 133 and 140 of the Indian Contract Act, 1872. As an effect of the impugned notification the provisions of the Part-III of the IBC deprives the guarantors of their valuable rights. The Court relying on the judicial precedents held that, approval of resolution plan does not ipso facto discharge a personal guarantor of his/her liability under the contract of guarantee. The release or discharge of a principal borrower from the debt owed by it to its creditors, 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/her liability, which arises out of an independent contract. The form and scope of the personal guarantor’s liability would be largely determined by the conditions of the guarantee itself. The court opined the aforementioned as an answer to the subordinate issue which was raised by some of the lawyers during the course of their arguments. The observation of the court is going to adversely affect the interests of guarantors in particular and credit culture in general.
Another dichotomy which surfaces here is whether the second observation laid down by the Court is of the nature of obiter dictum or ratio decidendi . Whether the same will be binding on all the subordinate courts and tribunals vide Article 141 of the Constitution of India? This error which has crept into the judgement could potentially open the floodgates of litigation. In my opinion, the said portion of the judgement must not be treated as gospel truth by NCLT/NCLAT members and must be reviewed by a larger bench. The Essar Steel Judgement and Vijay Kumar Jain v. Standard Chartered Bank has been wrongly relied upon by the SC in the case at hand. The Essar Steel Judgement expressly lays down that the subrogation rights of the guarantor cannot be taken away by the resolution plan. The Hon’ble NCLAT held that anything recovered from the guarantor by the bankers will, in turn, make the guarantors step in the shoes of the creditors . The opinion of the SC that the approval of resolution plan relating to the corporate debtor does not operate so as to discharge the liability of guarantor is in direct contradiction with the aforementioned NCLAT ruling.
This ambiguity, will negatively impact the status of personal guarantors and in turn will have an immediate impact on the availability of credit. IBC was brought into force, with an objective of creating an alternative credit market . Owing to an overdependence over the public service banks and traditional ways of lending, it was germane to develop the current bond market and establish a secured lending market. Secured in terms of efficient payback in an event of financial distress.
CONCLUSION AND SUGGESTIONS
Enforcement of Part-III does not address the uncertainties currently present but opens the door wide for further interpretation and clarifications by the legislature and tribunals/courts. As per the established principles, the debt payable by corporate guarantors is included within the meaning of financial debt. It is highly likely that the same guiding principles will establish the regime of enforcement of debt payable by the personal guarantors.
In the case of Ferro Alloys Corporation Limited , the tribunal went to give a harmonious and purposeful reading and reasonings of the definitions of the IBC. The IBC did not expressly define the word ‘Corporate Guarantors’. However, to uphold the true essence of the legislation and make provisions watertight to protect against the fraudulent players, the Tribunal read the term ‘Corporate Guarantors’ within the meaning of the ‘Corporate Debtor’. By the combined reading of Section 3(11) and Section 5(8)(i), the liability of the surety would form part of the financial debt as soon as the guarantee is invoked. The Tribunal accepted the admission of application against a surety u/s 7 despite any express mention of the term ‘Corporate Guarantors’ in the IBC.
Now, since the proceedings against the guarantors can be initiated simultaneously by the creditors, this may lead to chaos and confusion. There is a need for a lot of clarity on the procedural front. It is currently unclear whether the Resolution Professional (“ RP ”) of the Corporate Debtor and the RP of Guarantors would work separately or in tandem to ensure that there is no excess siphoning of funds. The bifurcation of proceedings against the guarantors on one side and initiating CIRP against the corporate debtor by different Adjudicating Authorities, on the other, will cause an unimaginable set of inconsistencies and errors. Initiating simultaneous proceedings will also open floodgates for litigation and over burden the NCLT/NCLATs with multiple insolvency proceedings qua the same debt/default.
The Piramal judgement , held the application against the second guarantor is not maintainable. The judgement failed to take into account the necessary implications that the claim of the creditor from the second guarantor is completely infructuous. In Essar Steel it was held that the creditors must file their claim at the time of admission of the application and no claims thereafter shall be entertained. This makes Piramal pronouncement contrary to the pronouncement of the court in the Essar Steel .
In view of many contradictions, SC will need to step in not only to redress the issues which have arisen after the enactment of the notification but also regarding the issues which will surface soon regarding the judicial precedents and their nexus with the present notification.