Limiting the Application of Moratorium to Personal Guarantors

[Karan Sangani is a 4th year B.A., LL.B. (Hons.) student at NALSAR University of Law in Hyderabad]

One of the contentious issues under the Insolvency and Bankruptcy Code 2016 (“the Code”)relates to the applicability of the moratorium to the personal guarantors of the corporate debtors under section 14 of the Code. This was resolved by the Supreme Court recently in State Bank of India v. V Ramakrishnan. The Supreme Court reversed the decision of the National Company Law Appellate Tribunal (“the NCLAT”) and held that moratorium under the section 14 of the Code does not extend to personal guarantees.

Moratorium under section 14 of the Code

The Oxford dictionary defines “moratorium” as “a legal authorization to debtors to postpone payment”. The moratorium under section 14 of the Code refers to a period wherein no judicial proceedings for recovery, enforcement of security interest, sale or transfer of assets, or termination of essential contracts can be instituted or continued against the corporate debtor. The moratorium under the Code comes into operation upon the insolvency commencement date and stays in effect till the end of the corporate insolvency resolution process (“CIRP”) period.

Views of the NCLT, NCLAT and High Courts

While the language of section 14 of the Code explicitly mentions that the moratorium applies only with respect to corporate debtor, there was an ambiguity with respect to applicability of the moratorium to personal guarantors due to the binding nature of the resolution plan upon the guarantors under section 31(1) of the Code. The issue, which has been discussed extensively in a number of cases, had only confounded the application of the law.

Initially the NCLAT, in Alpha & Omega Diagnostics (India) Ltd. v. Asset Reconstruction Company of India Ltd., upheld the strict interpretation of section 14 adopted by the National Company Law Tribunal (“the NCLT”), Mumbai Bench, which limited the benefit of moratorium to corporate debtor—asthe term “its” under section 14(1)(c) of the Code refers only to the property of the corporate debtor undergoing a CIRP. The same principle was subsequently applied by the NCLAT in Schweitzer Systemek India Pvt. Ltd. v. Phoenix ARC Pvt. Ltd. and the NCLT, Ahmedabad Bench in IDBI Bank Ltd. v. BCC Estate Pvt. Ltd.

However, the same principle was rejected by the Allahabad High Court in Sanjeev Shriya v. State Bank of India on a combined reading sections 14, 31(1) and 33 of the Code by holding that the proceedings against the guarantor cannot be continued in the absence of determination and crystallisation of liability against the principal debtor or guarantor under section 31(1) of the Code (which provides for the finalisation of CIRP) or under section 33 of the Code (which provides for the order of liquidation of corporate debtor). The Court further placed reliance upon the unnotified section 60 of the Code, which provides that the adjudicating authority in relation to insolvency resolution and liquidation for personal guarantors shall be the NCLT.

The Bombay High Court in Sicom Investments and Finance Limited v. Rajesh Kumar Drolia and Ors disagreed with the opinion of the Allahabad High Court and observed that the reliance placed on section 60 of the Code to extend the applicability of moratorium to the guarantors of corporate debtors under section 14 of the Code was wholly misplaced. The Court further rejected the notion that the failure to provide the extension of moratorium to personal guarantors would result in multiplicity of proceedings, by highlighting the fundamental distinction between proceedings against the corporate debtor under the Code and court proceedings against the guarantors. The Court noted that a proceeding under the Code is a proceeding for insolvency resolution or liquidation and/or bankruptcy, whereas a suit filed against the guarantor is a proceeding for recovery of money.

Decision of the Supreme Court

In the instant case, the corporate debtor initiated the insolvency resolution process and invoked the moratorium under section 14 of the Code. The respondent, who was the managing director of the corporate debtor as well as the personal guarantor in respect of credit facilities extended by the appellant bank, sought to invoke the moratorium under section 14 of the Code against the proceedings initiated against him by the bank under the Securitisation and Reconstruction of Financial Assets and Enforcement of Securities Interest Act, 2002. The plea was allowed by the NCLT, Chennai Bench on the ground that as the resolution plan arrived thereunder would be binding upon the personal guarantor and, as the guarantor stands in the shoes of the creditor after the initiation of proceedings against the creditor, section 14 of the Code would extend to personal guarantor as well. On appeal, the NCLAT endorsed this particular view.

The Supreme Court had to consider two conflicting streams of precedent. While reversing the decision of the NCLAT, the Supreme Court relied upon section 14(3) of the Code—introduced by way of the Insolvency and Bankruptcy Code (Amendment) Ordinance, 2018 (“the Amendment”)—which states that the application of moratorium would not extend to a surety in a contract of guarantee for corporate debtor. The Court noted that the Amendment being a clarificatory statute would have retrospective effect.

The Supreme Court endorsed the decision of the Bombay High Court by providing a strict interpretation to section 14 of the Act and rejecting the reliance placed by the bank on sections 31 and 60 of the Code. The Court further delved into the question of legislative intent and noted that section 14 of the Code was enacted with the aim that the proceedings against the guarantor should not be stayed while the corporate debtor is undergoing an insolvency proceeding, as the previous enactments such as section 22 of the Sick Industrial Companies (Special Provisions) Act, 1985 had resulted in huge outstanding debts to banks and financial institutions. The Court, for the purpose of interpretation, contrasted the language of the unnotified sections 96 and 101—which provide for interim-moratorium and moratorium with respect to individuals and partnership firms—with section 14 of the Code. The Court observed that, being wider in scope, section 101 would apply to personal guarantors as such moratorium is in “relation to the debt” as opposed to the “debtor” and would attach to the personal guarantor only if Part III (Insolvency Resolution and Bankruptcy for Individuals and Partnership Firms) proceedings are initiated against the personal guarantor.    

Conclusion

The ambiguity with respect to the applicability of the moratorium to personal guarantors under section 14 of the Code had resulted in an adverse impact on the use of personal guarantees as an acceptable form of securing debt by the creditors. By limiting the application of section 14, the Supreme Court has not only given full effect to the intent of the legislature but also provided an interpretation, which is in consonance with contractual principle of guarantee that the liability of the surety is independent and co-extensive with that of the principal debtor.

– Karan Sangani

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1 comment

  • Does the act of limitation for the surety still hold once the principal debtor (the company) is sent a recovery notice under section 29?

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