Insolvency Resolution Process of Personal Guarantors in India

Part-1 : Lalit Kumar Jain v. Union of India, Transferred Case (Civil) No. 245/2020, Supreme Court of India, decided on 21st May, 2021


INTRODUCTION:


The Supreme Court of India on 21st May, 2021 delivered the judgment in the petitions challenging the notification dated 15th November, 2019, of the Government of India which enforced certain provisions of the Insolvency and Bankruptcy Code, 2016 relating to insolvency of Personal Guarantors. The petitions were previously pending before various High Courts, but after the Insolvency and Bankruptcy Board of India (IBBI) had sought the transfer of the petitions from High Courts to the Supreme Courts, the latter transferred the petitions to itself by its order dated 29th October, 2020. The court had stated that in its order that since IBC was at a nascent stage, therefore, it would be better for the Court to take up the interpretation of provisions of the Code, so as to avoid any confusion, and to authoritatively settle the law.


ISSUES:


Issue No. 1:


The Petition challenged the validity of a notification dated 15th November, 2019 issued by the Central Government (“the impugned notification”). The operative portion of the notification read as:


“NOTIFICATION:

New Delhi. the 15th November, 2019

S.O. 4126(E).- ln exercise of the powers conferred by sub-section (3) of section I of the Insolvency and Bankruptcy Code. 2016 (31 of 2016). the Central Government hereby appoints the 1st day of December,2019 as the date on which the following provisions of the said Code only in so far as they relate to personal guarantors to corporate debtors. shall come into force:

(1) clause (e) of section 2;

(2) section 78 (except with regard to fresh start process) and section 79;

(3) sections 94 to 187 (both inclusive);

(4) clause (g) to clause (i) of sub-section (2) of section 239;

(5) clause (m) to clause (zc) of sub-section (2) of section 239;

(6) clause (zn) to clause (zs) of' sub-section (2) of section 240; and

(7) Section 249”


It was contended by the petitioners that the executive government could not have selectively brought into force the Code, and applied some of its provisions to one sub-category of individuals, i.e., personal guarantors to corporate creditors. All the petitioners in unison argued that the impugned notification, in seeking to achieve that end, is ultra vires. This argument was premised on the nature and content of Section 1(3), which the petitioners characterize to be conditional legislation. Unlike delegated legislation, they said, conditional legislation is a limited power which can be exercised once, in respect of the subject matter or class of subject matters. As long as different dates are designated for bringing into force the enactment, or in relation to different areas, the executive acts within its powers. However, when it selectively does so, and segregates the subject matter of coverage of the enactment, it indulges in impermissible legislation. Reliance was placed on several judgments of the Apex Court, with respect to the limits of such power- notably the decisions of the Privy Council in Burah, of the Federal Court in State of Bombay v. Narothamdas Jethabai1951 2 SCR51; In Re Delhi Laws Act, 1912, Jatindranath Gupta v. Province of Bihar (1949-50) 11 FCR 595, Hamdard Dawakhana v. Union of India 1960 (2) SCR 671, State of TN v. Sabanayagam (1998) 1 SCC 318 and Vasu Dev Singh v. Union of India (2006) 12 SCC 753.


Therefore, the issue before the Apex Court was whether the Central Government had the power to issue the impugned notification and bring Part III in force only with respect to personal guarantors to corporate debtors. And if yes, whether the impugned notification wa ultra vires the objects and purpose of the Code.


Issue No. 2:


The other question before the Supreme Court, was that the impugned notification, by applying the Code to personal guarantors only, takes away the protection afforded by law. Reference was made to Sections 128, 133 and 140 of the Contract Act; the petitioners submitted that once a resolution plan is accepted, the corporate debtor is discharged of liability. As a consequence, the guarantor whose liability is co-extensive with the principal debtor, i.e. the corporate debtor, too is discharged of all liabilities. It was urged therefore, that the impugned notification which has the effect of allowing proceedings before the NCLT by applying provisions of Part III of the Code, deprives the guarantors of their valuable substantive rights.


Therefore, the issue before the Apex Court was whether the approval of a resolution plan discharge a personal guarantor (of a corporate debtor) of her or his liabilities under the contract of guarantee.


OBSERVATIONS/FINDINGS OF THE SUPREME COURT:


With respect to Issue No. 1:


Whether the Central Government had the power to issue the impugned notification and bring Part III in force only with respect to personal guarantors to corporate debtors? if yes, whether the impugned notification is ultra vires the objects and purpose of the Code?


The Supreme Court observed that the impugned notification operationalizes the Code so far as it relates to personal guarantors to corporate debtors:


(1) Section 79 pertains to the definitional section for the purposes of insolvency resolution and bankruptcy for individuals before the Adjudicating Authority.

(2) Section 94 to 187 outline the entire structure regarding initiation of the resolution process for individuals before the Adjudicating Authority.


The impugned notification authorises the Central Government and the Board to frame rules and regulations on how to allow the pending actions against a personal guarantor to a corporate debtor before the Adjudicating Authority. The intent of the notification, facially, is to allow for pending proceedings to be adjudicated in terms of the Code. Section 243, which provides for the repeal of the personal insolvency laws has not as yet been notified. Section 60(2) prescribes that in the event of an ongoing resolution process or liquidation process against a corporate debtor, an application for resolution process or bankruptcy of the personal guarantor to the corporate debtor shall be filed with the concerned NCLT seized of the resolution process or liquidation. Therefore, the Adjudicating Authority for personal guarantors will be the NCLT, if a parallel resolution process or liquidation process is pending in respect of a corporate debtor for whom the guarantee is given. The same logic prevails, under Section 60(3), when any insolvency or bankruptcy proceeding pending against the personal guarantor in a court or tribunal and a resolution process or liquidation is initiated against the corporate debtor. Thus if A, an individual is the subject of a resolution process before the DRT and he has furnished a personal guarantee for a debt owed by a company B, in the event a resolution process is initiated against B in an NCLT, the provision results in transferring the proceedings going on against A in the DRT to NCLT.


The Supreme Court further opined that there was sufficient legislative guidance for the Central Government, before the amendment of 2018 was made effective, to distinguish and classify personal guarantors separately from other individuals. The court was clearly cognizant of the fact that the amendment, in so far as it inserted Section 2(e) and altered Section 60(2), was aimed at strengthening the corporate insolvency process. At the same time, since the Code was not made applicable to individuals (including personal guarantors), the court had no occasion to consider what would be the effect of exercise of power under Section 1(3) of the Code, bringing into force such provisions in relation to personal guarantors.


The Court further opined that the argument that the insolvency processes, application of moratorium and other provisions are incongruous, and so on, are insubstantial. The insolvency process in relation to corporate persons (a compendious term covering all juristic entities which have been described in Sections 2 [a] to [d] of the Code) is entirely different from those relating to individuals; the former is covered in the provisions of Part II and the latter, by Part III. Section 179, which defines what the Adjudicating authority is for individuals is “subject to” Section 60. Section 60(2) is without prejudice to Section 60(1) and notwithstanding anything to the contrary contained in the Code, thus giving overriding effect to Section 60(2) as far as it provides that the application relating to insolvency resolution, liquidation or bankruptcy of personal guarantors of such corporate debtors shall be filed before the NCLT where proceedings relating to corporate debtors are pending. Furthermore, Section 60(3) provides for transfer of proceedings relating to personal guarantors to that NCLT which is dealing with the proceedings against corporate debtors. After providing for a common adjudicating forum, Section 60(4) vests the NCLT "with all the powers of the DRT as contemplated under Part III of this Code for the purpose of sub-section (2)". Section 60 (4) thus (a) vests all the powers of DRT with NCLT and (b) also vests NCLT with powers under Part III. Parliament therefore merged the provisions of Part III with the process undertaken against the corporate debtors under Part II, for the purpose of Section 60(2), i.e., proceedings against personal guarantors along with corporate debtors. Section 179 is the corresponding provision in Part III. It is "subject to the provisions of Section 60". Section 60 (4) clearly incorporates the provisions of Part III in relation to proceedings before the NCLT against personal guarantors.


The court was of the view that Parliamentary intent was to treat personal guarantors differently from other categories of individuals. The intimate connection between such individuals and corporate entities to whom they stood guarantee, as well as the possibility of two separate processes being carried on in different forums, with its attendant uncertain outcomes, led to carving out personal guarantors as a separate species of individuals, for whom the Adjudicating authority was common with the corporate debtor to whom they had stood guarantee. The fact that the process of insolvency in Part III is to be applied to individuals, whereas the process in relation to corporate debtors, set out in Part II is to be applied to such corporate persons, does not lead to incongruity. On the other hand, there appear to be sound reasons why the forum for adjudicating insolvency processes – the provisions of which are disparate- is to be common, i.e through the NCLT. As was emphasized during the hearing, the NCLT would be able to consider the whole picture, as it were, about the nature of the assets available, either during the corporate debtor’s insolvency process, or even later; this would facilitate the CoC in framing realistic plans, keeping in mind the prospect of realizing some part of the creditors’ dues from personal guarantors.


It was therefore held by the Supreme Court that the impugned notification was not an instance of legislative exercise, or amounting to impermissible and selective application of provisions of the Code. It held that the impugned notification was issued within the power granted by Parliament, and in valid exercise of it. The exercise of power in issuing the impugned notification under Section 1(3) is therefore, not ultra vires; the notification is valid.


With respect to Issue No. 2:


Whether the approval of a resolution plan discharge a personal guarantor (of a corporate debtor) of her or his liabilities under the contract of guarantee?


With respect to this issue, the Supreme Court was of the view that 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. As to the nature and extent of the liability, much would depend on the terms of the guarantee itself. The Court observed that an involuntary act of the principal debtor leading to loss of security, would not absolve a guarantor of its liability. The bench relied on the judgment of Maharashtra State Electricity Board v. Official Liquidator, High Court, Ernakulum & Anr 1982 (3) SCC 358 which held that the liability of the guarantor (in a case where liability of the principal debtor was discharged under the insolvency law or the company law), was considered. It was held that in view of the unequivocal guarantee, such liability of the guarantor continues and the creditor can realize the same from the guarantor in view of the language of Section 128 of the Contract Act as there is no discharge under Section 134 of that Act.


It was therefore held by the Supreme Court that approval of a resolution plan does not ipso facto discharge a personal guarantor (of a corporate debtor) of her or his 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 his or her liability, which arises out of an independent contract.


DECISION:


1. It was held that the impugned notification was legal and valid.

2. It was also held that approval of a resolution plan relating to a corporate debtor does not operate so as to discharge the liabilities of personal guarantors (to corporate debtors).


This post was authored by Kushank Sindhu, Partner and Anmol Singh, Trainee Advocate.

The authors may be contacted at Kushank.s@sigmachambers.in


DISCLAIMER. THIS CONTENT HAS BEEN PREPARED FOR INFORMATIONAL PURPOSES ALONE AND IS NOT A SUBSTITUTE FOR LEGAL ADVICE. PLEASE OBTAIN LEGAL ADVICE PRIOR TO ACTING ON OR RELYING ON THE CONTENTS OF THIS PAGE.


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