Personal Guarantor Under Insolvency and Bankruptcy Code 2016 | DMA Advocates

Personal Guarantor Under Insolvency and Bankruptcy Code 2016

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Introduction:

The Insolvency and Bankruptcy Code, 2016 (“Code”) is one of the most significant legislative developments in recent years, resulting in a flurry of litigation, multiple legal interpretations, and regular modifications to deal with non-performing assets held by various Indian financial institutions.

Originally, banks requiring personal guarantees from Promoters to secure their ‘skin in the game’ would always demand them and ensure that the same is provided to them. The lack of an efficient forum to enforce the personal guarantees that go hand in hand with the insolvency of the company for which the personal guarantees were issued has come back to bite now that there is over-leverage.

The law doesn’t envisage that the Insolvency resolution of the personal guarantor should follow only when the process of corporate insolvency resolution of the corporate debtor has come to an end. The purpose of initiating Insolvency and Bankruptcy proceedings against the Personal Guarantor is not only sensible but fair in the generality of cases to synchronize the two proceedings. That is not to say that when the proceedings against the Corporate debtor could be fruitfully decided the Personal Guarantor should also be proceeded against. 

Lalit Kumar Jain v. Union of India

SUPREME COURT OF INDIA

T.C.(C) No. 245/2020 dated 21.05.2021

Quorum: Hon’ble Justice L Nageswara Rao and Hon’ble Justice Ravindra Bhat

FACTS:

The constitutional validity of Insolvency and Bankruptcy (Application to Adjudicating Authority for Insolvency Resolution Process for Personal Guarantors to Corporate Debtors) Rules, 2019 (hereinafter referred to as ‘impugned notification’) was addressed in this case by the Supreme Court. The impugned notification was issued by the Central Government on 15.11.2019. The Supreme Court assessed petitions which were filed under Article 32 and petitions which were transferred from various High Courts under Article 139 of the Constitution.

Provisions Enforced: Section 2(e), Section 78, Section 79, Section 94-187; Section 239 (2) (g), (h), (i), Section 239(2)(m) to (zc); Section 239 (2)(zn) to (zs) and Section 249 of the IBC.

Following this, notices were issued to the petitioners to initiate insolvency proceeding as per Part III of the Insolvency and Bankruptcy Code of 2016 (hereinafter referred to as the ‘Code’).

 

ISSUES:

 

  1. Whether the Central Government can notify parts of the provisions or essentially limit its application to certain categories of people?
  2. Whether the Central Government has the power to impose conditions through notifications?
  • Whether the issuance of the impugned notification by the Central Government was ultra vires?

ARGUMENTS (Petitioners):

  1. Excessive Delegation:

The Central Government has no power to prescribe or impose conditions by way of the notification, and such enforcement was ultra vires to the powers granted to the Central Government. It was submitted by the petitioners that as per Section 1(3) of the Code, the Central Government cannot notify parts of the provisions or essentially limit its application to certain categories of people. The issuance of the impugned notification by the Central Government was, therefore, ultra vires to Section 1(3) of the Code. There exists no demarcation between an individual and a personal guarantor of the corporate debtor as per Part III of the Code and the enforcement of the impugned legislation is outside the scope of powers prescribed under Section 1(3) of the Code.

  1. Provisions are not severable:

The provisions which were brought into effect were not severable as they dealt with individuals and partnership firms and did not solely apply to personal guarantors of corporate debtors. The Central Government has classified individuals wherein insolvency personal guarantors of corporate debtors are considered along with insolvency of corporate debtors. This power is vested with the legislative and not the executive.

  1. Non-Application of Mind:

Firstly, the enforcement of Section 2(e) of the Code attracted non-application of mind. Section2(e) had come into force with retrospective effect from 23.11.2017, and the same was noted by the Supreme Court in the case of State Bank of India v. V. Ramakrishanan.

Secondly, the Central Government had failed to enforce Section 243 which would repeal Presidency Towns Insolvency Act, 1909 and Provincial Insolvency Act, 1920. The aforementioned Acts deal with the insolvency proceedings of personal guarantors of corporate debtors. Without Section 243 not being enforced, there would exist two self-contradictory legal routes to initiate solvency proceedings against the personal guarantors of corporate debtors.

  1. Ultra vires:

The impugned notification enforced provisions under Part III of the Code is specific to personal guarantors of corporate debtors. However, Part III governs the Insolvency and resolution procedure for individuals and partnership firms. It was contended that personal guarantors are to be excluded from the definition of individuals. This is supported by a joint reading of Section 2(e), 2(g) and Part III of the Code.

Furthermore, Section 95 of the Code states that a creditor can invoke insolvency resolution process against an individual only with respect to a partnership firm.

The enforcement of provisions through the impugned notification where Part III is brought into force only with respect to personal guarantors of corporate debtors results in it being ultra vires to the Objects and Reasons of the Code. The object of the code here is to focus on the revival of the company and to save it from liquidation. The Code here operates as beneficial legislation. 

  1. Enforcement of the

    provisions are arbitrary and discriminatory in nature:

This was argued on two grounds:

  • That there is no intelligible differentia as to why personal guarantors of corporate debtors have been singled out as the Code and Part III of the Code does not specifically cater to personal guarantors of corporate debtors;
  • The impugned notification does not demarcate between operational and financial creditor. It is to be noted that there exist two sets of procedure for operational and financial creditors.

ARGUMENTS (Respondents):

  1. The 2018 Amendment: Section 2(e) and Section 60 were amended to include the Insolvency or bankruptcy of a corporate/personal guarantor to a corporate debtor. NCLT would be deemed as the adjudicating authority.
  2. There is no excessive legislation is this case as the executive has the power to enact provisions of a statute for a particular purpose at any given period of time. Furthermore, Section 1(3) of the Code empowers the Central Government to enforce provisions in order to meet the object of the Code. The impugned notification was published keeping in mind the recommendations put forth by the Bankruptcy Law Reforms Committee. It was recommended that insolvency proceedings were applicable to personal guarantors of the corporate debtor and there should exist a synchronous resolution process.
  3. The term ‘personal guarantor’ was defined under Section 5(220) of the Code and that NCLT would be considered as the adjudicating authority as per Section 60(2) of the Code. Furthermore, the NCLT is vested with all powers similar to that of the DRT as per Section 60(4) of the Code. Lastly, that as per Section 179, the DRT would be considered as the adjudicating authority for insolvency resolution and this is subject to Section 60 of the Code. The Counsel for Respondents relied on the case of Embassy Property Developments (P) Ltd. v State of Karnataka
  4. Section 2 is not to be considered as a definition clause by as a tool that provides a phased and limited interpretation of the Code. Additionally, Part II of the code applied to all categories of corporate entities who are debtors. Part III was enforced to establish a suitable mechanism for personal guarantors who constituted a class of individuals.
  5. The liability of the guarantor was co-extensive, joint and several with that of the principal borrower unless the contrary is provided under the contract. This has been enumerated under Section 128 of the Indian Contract Act of 1872. Additionally, the guarantor’s obligations are not absolved under Sections 133-136 of the Indian Contract Act of 1872. The rights of the creditor and guarantor will continue to exist in case of bankruptcy or liquidation.
  6. Part III applies to individuals and partnership firms in a composite manner. The power of the vested by the Central Government under Section 1(3) should not be characterized as a conditional legislation. As per Section 1(3) the Central Government can determine the date on which the Code will come into force and it can also appoint different dates for different provisions of the Code. Literal rule of construction is not to be applied while reading Section 1(3) of the Code and the aforementioned section is not to be construed in isolation.
  7. The scheme and the structure of the Code considers ‘parliamentary hybridization and legislation fusion’ wherein the NCLT is empowered deal with insolvency proceedings of personal guarantors of corporate debtors.

ANALYSIS:

  1. The Supreme Court analyzed all the notifications proposed by the Central Government. The Court went ahead and looked into every notification that was released and the subsequent provisions that it gave effect to. It highlighted that the Central Government sought to fulfil the object of the Code while passing notifications. The Court noted that the Insolvency and Bankruptcy Board of India was set up to examine relevant issues and evolving standards of rules and regulations.
  2. The Supreme Court on Part III of the Code and NCLT’s role:

Prior to 2018 amendment, it was noted that all individuals i.e, personal guarantor to corporate debtors, partners of firms, partnership firm and other partners fell under the Section 2(e) of the Code. Section 60 stated that the adjudicating authority with respect to personal guarantors was NCLT.

Post 2018 amendment: Section 2(e) was further categorized into Section 2(f) and 2(g). Section 60 was altered wherein insolvency and bankruptcy proceedings w.r.t. liquidation and bankruptcy process were divided into three categories corporate debtors, corporate guarantors of corporate debtors and personal guarantors to corporate debtors wherein NCLT was considered the adjudicating body.

Manner of interpretation: It was noted that although the term ‘personal guarantor’ was not defined, it fell under the definition of ‘individual’ under the Code. The Supreme Court while interpreting Section 60 (2) applied the principle behind the maxim ‘reddendo singular singulis’ in the case of Rajendra K. Bhutta v. Maharashtra Housing and Area Development Authority. Section 60(2) applies three categories when it comes to insolvency resolution, bankruptcy or liquidation. It being corporate debtors, corporate and personal guarantors to corporate debtors.

The Supreme Court also assessed Sections 234 and 235 of the Code. As per the aforementioned Sections the overseas assets of a corporate debtor or its personal guarantor are to be dealt with in the same manner as insolvency proceedings.

The Court analysed Sections 79 and 94-187 where the former is a definitional Section and the latter lays down the initiation of resolution process before the adjudicating authority.

It was observed that the intent of the impugned legislation was to allow for pending proceedings to be adjudicated as per the Code. Although Section 243 had not been enforced (where it would repeal personal insolvency laws), Section 60(2) provided for resolution process or bankruptcy of a personal guarantor which would be filed under the NCLT. Therefore, the adjudicating authority would be the NCLT for personal guarantors, if there is a parallel resolution or liquidation process is pending. Furthermore, under Section 60(3) the aforementioned rule would be applicable.

  1. On the Central Government not notifying Section 243:

The Court discussed the case of SBI. V. Ramakrishnan and noted that the rationale behind not notifying Section 243 would be that the non-obstante clause under Section 238 gives the Code an overriding effect over other prevailing enactments. Section 243 has not been enforced, the proceedings pending under the PIA and PTIAct will continue. In addition to the same, the impugned notification was a consequence of the non-obstante clause given under Section 238. Thus, if a proceeding were to be instituted against a personal guarantor, it would be done under the Code.

 

  1. On Section 1(3) of the Code:

It was held that the court had no occasion to consider what could be the effective exercise of power under Section 1(3). The 2018 amendment inserted Sections 2(e) and 60(2) for the purpose of strengthening the corporate insolvency process. During this period of time the Code was not made applicable to individuals which included personal guarantors.

The arguments pertaining to insolvency process, application of moratorium and other provisions are incongruous in nature and were declared unsubstantial in nature.

 

  1. On the intent of the Central Government:

It was noted that the intent of the Parliament was to treat personal guarantors as a different species of individuals wherein the they shared a common adjudicating authority with the corporate debtor. Part II of the Code is applicable to corporate persons and Part III is applicable to that of individuals and it was noted that there is no inconsistency.

[1]State Bank of India v Anil Dhirajlal Ambani, IA No. 1009/2020 in CP(IB)/916/(MB)/2020 & IA No. 1010/2020 in CP(IB)/917/(MB)/2020

[2] State Bank of India v. V. Ramakrishanan, (2018) 17 SCC 394.

[3] Embassy Property Developments (P) Ltd. v State of Karnataka, (2020) 13 SCC 308.

[4] Para 52 of the judgement.

[5] A rule of interpretation meaning ‘to each to each’ usually applied in matters relating to property. When a sentence has multiple antecedents and consequents, they are to be read distributively. Each phrase or expression is to be referred to its appropriate object.  (Black’s Interpretation of Laws – kindly refer to para 87 of the judgement).

[6] Rajendra K. Bhutta v. Maharashtra Housing and Area, (2020) 13 SCC 208.

[7] When a resolution process has been initiated against an individual ‘A’ before the DRT a where ‘A’ has sought personal guarantee from company ‘B’, and if a resolution process has been initiated against company ‘B’ at NCLT the proceedings against ‘A’ will transfer from DRT to NCLT. (kindly refer to para 95 Of the judgement).

[8] SBI. V. Ramakrishnan (2018) 17 SCC 394.

[9] Provincial Insolvency Act of 1920.

[10] Presidency Towns Insolvency Act of 1909.

Held

1. The Central Government by publishing the notification has not selectively applied the provisions of the Code. It not a compulsion that the Code is to be made applicable to all individuals. The impugned notification through Section 1(3) of the Code enforces provisions that particularly deal with the personal guarantors of corporate debtor, and this forms a mere sub-category of persons to whom the Code is extended. The impugned notification was issued within the power of the Parliament, with valid exercise of power.
2. Liability of the corporate debtor: The Court held that involuntary act of the principal debtor leading to loss of security, would not absolve a guarantor of its liability. The approval of a resolution plan is a contract of guarantee. The release or discharge of a principal borrower is done via the operation of law and it arises from an independent contract.
3. The impugned notification was held constitutional and petitions were dismissed.

References:

  1.  https://www.barandbench.com/news/litigation/supreme-court-upholds-provisions-insolvency-and-bankruptcy-code-insolvency-personal-guarantors.
  2. https://www.scconline.com/blog/post/tag/excessive-delegation-of-powers/
  3.  State Bank of India v. V. Ramakrishanan, (2018) 17 SCC 394.
  4. Embassy Property Developments (P) Ltd. v State of Karnataka, (2020) 13 SCC 308.
  5. Rajendra K. Bhutta v. Maharashtra Housing and Area, (2020) 13 SCC 208.
  6. SBI. V. Ramakrishnan (2018) 17 SCC 394.
  7. Provincial Insolvency Act of 1920.
  8. Presidency Towns Insolvency Act of 1909.

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