Personal Guarantors to Corporate Debtors can now be made liable under IBC
The Supreme Court in the case of Lalit Kumar Jain v. Union of India has upheld the constitutionality of the Notification dated 15.11.2019 which was issued by the Ministry of Corporate Affairs. Through this Notification, the central government has exercised its power conferred by section 1(3) of the Insolvency and Bankruptcy Code, 2016, and has appointed a date on which some provisions of the Code only in so far related to personal guarantors to the corporate debtor shall come into force.
Basically, personal guarantors to corporate debtors mean those individuals who have signed personal guarantees on corporate loans. According to Section 5(22) “personal guarantor” means an individual who is the surety in a contract of guarantee to a corporate debtor. Consequently, through this decision, the Supreme Court has now permitted that the personal guarantors are accountable and liable for the unpaid dues and the provisions of IBC will be made applicable to them.
It is understood that the provisions of IBC have come into force at different dates through different Notifications according to the need, and in a phased manner. The same enabling power was delegated to the Central government by the Parliament through Section 1(3) of the IBC so that the central government can play an active role in operationalizing the Code. Even this Notification was issued by the Central government that tends to bring certain provisions of the Code into function. However, some personal guarantors who had furnished personal guarantees to banks and financial institutions were felt affected by this Notification and had approached different High Court challenging the vires of the Notification.
Petitioners knocking the door of the Courts
The main argument of the petitioners is that the Notification is ultra vires as this Notification is an exercise of excessive delegation. The petitioners argue that the power conferred by the Parliament under section 1(3) of IBC just provides enabling power to the Central Government and such nature of power is an instance of conditional legislation as the legislature has already enacted the law and the only function assigned to the executive is to bring the law into operation as per their rationale reasoning. Thus, their argument stands on the point that when no element of the legislation was left open to the government to legislate, the impugned Notification in substance modifies the text of the actual sections of Part III by creating a distinction between an individual and a personal guarantor to a corporate debtor and thus, effects a classification of individuals. The petitioners termed this act of exercising power as something which is completely outside the scope and power conferred under Section 1(3) of the Code and thereby, the impugned Notification is ex-facie in violation of the principles of delegation.
Further, another important argument that the petitioners submitted was that the liability of the guarantor is co-extensive with that of the principal debtor and it is the settled law that once the proceedings are concluded against the debtors, consequently, the liability of the guarantor which is co-extensive to that of the debtor also extinguishes. Therefore, this Notification allows creditors to unjustly enrich themselves by claiming in the insolvency process of the guarantor without accounting for the amount realized by them in the CIRP of the corporate debtor.
Counter-arguments of the Respondents
Union of India however, countered all the arguments and held that the Notification is not a result of excessive delegation but is in the spirit of the 2018 amendment to the Code. It was argued that the 2018 amendment substituted the definition in section 2(e) and therefore, introduced three different classes of debtors, which are personal guarantors to corporate debtors, partnership firms & proprietorship firms, and individuals with a view to deal with personal guarantors differently from the other two entities.
The 2018 amendment further amended Section 60 of the Code that deals with Adjudicating Authority. By virtue of sub-section (2) of Section 60, when a CIRP or liquidation proceeding of a corporate debtor is pending before an NCLT, an application relating to the insolvency resolution or liquidation or bankruptcy of a corporate guarantor as well as personal guarantor of the corporate debtor shall be filed before such NCLT only. Thus, the objective was to allow the creditor to trigger insolvency proceedings even against the personal guarantor to a corporate debtor facing insolvency just like the corporate guarantor and to unify both the process under one forum thereby enabling the adjudicating authority to have a clear vision of the extent of the debt of the corporate debtors and its available assets and resources.
Union of India further argued that the impugned Notification is well-under the power of parliament given as per Section 1(3) of the IBC and, therefore, the flexibility enjoyed by the Central government to implement provisions of the Code to meet objectives is not excessive delegation but a mere use of power enabled to the government. The Solicitor General argued that personal guarantors and corporate guarantors formed part of the same class in as much as they were guarantors to corporate debtors, yet the personal guarantors being individual were not included in part-III for functional and operational purposes. Hence, as a result, a conscious decision was taken through the impugned Notification to enforce Part-III and operationalize the mechanism suitably for a class of individuals’ i.e. personal guarantors. The objective was to remove any anomaly related to personal guarantors being outside the scope of the code. Therefore, the central government acted within its right to confine the enforcement of the provisions of the Code to a class of individuals i.e. to personal guarantors without altering the identity and structure of the Code.
While countering the argument related to the co-extensive nature of guarantor and debtor, the respondent submitted that the word co-extensive can only relate to the quantum of the principal debt. It was argued that the continuation of a financial creditor’s claim against a guarantor would not lead to double recovery of a claim as the financial creditor would be able to recover only the balance debt which remains outstanding and unrecovered from the principal borrower. Through arguments, Solicitor General also relied on the principle of ‘double dip’ that deals with the notion of dual nature of recovery by a creditor for the same debt from two entities. It means that in case a portion of the debt is recovered from one of the entities, the other entity would be liable for the unsatisfied amount of the claim. Thus, the impugned Notification is in no way violating the spirit and core of either Code or the Constitution.
The decision of the Supreme Court
i. The Hon’ble Court was of the opinion that even before the 2018 Amendment Act related to IBC came into force, there was sufficient legislative guidance available for the Central government through Section 5(22), 60, 234 and 235 of the IBC to differentiate the identity of personal guarantors from other individuals. However, the Court held that before the amendment to Section 2(e) which was introduced in the year 2018, all the individuals were covered under one description as per this Section. Therefore, the Central government felt it difficult to enforce Part III of the IBC in respect to only personal guarantors. Hence, the central government brought an amendment in year 2018 to this Section and classified individuals into three different categories. The intent of the Parliament was clearly lucid that it wanted to treat personal guarantors separately from other individuals and the amendment provided sufficient statutory backing for the current move of Central Government to bring personal guarantors to corporate debtors within the scope of IBC via Impugned Notification.
ii. Seemingly, the Court was also of the opinion that 2018 amendment to Section 60 of the IBC substantiates the legislative intent of the Parliament as this amendment has ensured that there should a same forum i.e. NCLT for the insolvency and bankruptcy processes relating to liquidation and bankruptcy in respect of three categories, i.e. corporate debtors, corporate guarantors of corporate debtors and personal guarantors to corporate debtors. Therefore, through this amendment, all those matters which have the potential to impact in dealing with corporate debtor were designated to one common forum. Eventually, the personal guarantor to corporate debtor is one of those matters that can impact the corporate debtor and hence it was a necessity to even consider them while dealing with the matters of corporate debtors under IBC.
iii. The Court was of the view that the Parliament intendedto treat personal guarantors differently from other categories of individuals with a view to rule out the possibility of having two separate process being carried out in two different forums that may result in ambiguous situations and uncertainty in the outcome. The Parliament decided to carve out personal guarantors as a separate species of individuals so that even they can be dealt under same law i.e. IBC so that the NCLT forum can calculate the assets and liabilities of Corporate debtor myopically.
iv. While dealing with the issue related to overlapping of Legislations and repealing of the same, the Hon’ble Court referred to the judgment of SBI v. Ramakrishnan where it was observed that the proceedings hitherto personal guarantors is outside the purview of IBC as well as NCLT because the provisions under IBC law (Section 243) is yet not notified. Therefore,the proceedings related to personal guarantors were covered as per Presidency Towns Insolvency Act, 1909 and Provincial Insolvency Act 1920. However, the court finally upheld that Section 238 of the Code i.e a non-obstante clause has overriding effect over prevailing enactments. Seemingly, the current notification has overriding effect on other enactments as per the consequences of Section 238 and hence, IBC is now made applicable on all proceedings related to personal guarantors.
v. Coming to the point of co-extensive liability, the Supreme Court held that an involuntary act of the principal debtor leading to loss of security would not absolve a guarantor of its liability. The liability of the guarantor continues and the creditor can realize the same from the guarantor in view of Section 128 of the Contract Act as there is no discharge under Section 134 of the same Act. Therefore, approval of a resolution plan under Section 31 of IBC does not ipso facto discharge a personal guarantor of the corporate debtor of its liabilities under the contract of guarantee. The Court made a reference to the case of Re: Maharashtra State Electricity Board Bombay v. Official Liquidator, High Court, Ernakulum, wherein it was held that “in view of the unequivocal guarantee, such liability of the guarantor continues and the creditor can realise 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 said Act.” Henceforth, the Court concluded that the impugned Notification is legal and valid.
vi. In regard to the above-mentioned observations, the Hon’ble Supreme Court came to a conclusion that the Impugned Notification is not an instance of excessive delegation as the government has not entered into the domain of exercising law-making powers. The Court was convinced with the argument of the government that there is no requirement of the Code to enact any provision at same time for all types of individuals. So, the action of government does not result in any practice of discrimination as there is sufficient guidance in making Part-III applicable only for Personal guarantors and not for all the individuals because of the unique relationship between personal guarantors and corporate debtors.
vii. The Court finally held that as the provisions of this Code have been brought in force in a phased manner by the Central Government through its enabling power under Section 1(3) as and when required as per the need, the current Notification which is made applicable only on one category of individuals i.e. personal guarantors to corporate debtors is in no way violation to the IBC law and thus stands within the spirit of Constitution. Hence, keeping in mind the observations made by the Court, it was held that the Notification is intra vires and is constitutionality valid.
This decision will surely be a relief to the creditors as they can now initiate proceedings against the personal guarantors as well who mostly are promoters, directors, etc. On the other hand, the personal guarantors would not be happy with the decision as now those assets which they have guaranteed personally for the loan of the corporate debtor are now at risk of being included in the proceedings. However, this judgment will ease the work of NCLT to see the broader picture in relation to the assets and liabilities of the corporate debtor. This judgment has the potential to serve the substance of the Code for which it was introduced and brought into force.