Insolvency and Personal Guarantors: Lalit Kumar v. Union of India

[Priyanka Pillai is an associate at IC Universal Legal, Mumbai]

The protracted saga of the treatment of personal guarantors under the Insolvency and Bankruptcy Code, 2016 (the “Code”) seems to have been finally put to rest by the Supreme Court by way of its judgment in Lalit Kumar Jain v. Union of India. The inception of this tale was the notification issued by the Ministry of Corporate Affairs on November 15, 2019 (“Impugned Notification”) which brought into force Part III of the Code, which dealt with insolvency of individuals only so far as it relates to personal guarantors to corporate debtors. As it targeted the promoters of the biggest Indian companies undergoing insolvencies, the Impugned Notification led to a string of challenges as to its constitutionality before various High Courts. Finally on October 29, 2020, the Supreme Court stayed the High Courts from admitting or hearing any and all writ petitions challenging the Impugned Notification and transferred to itself all the matters pending before various High Courts.

The major ground of challenge against the Impugned Notification was that the Central Government did not have the power to bring into force select parts of the Code and in turn create a sub-category of individuals being personal guarantors. This contention was premised on the claim that the power under section 1(3) of the Code to bring provisions into force was only a function of conditional legislation, whereas the action undertaken through the Impugned Notification was inherently legislative in nature. The Court analysed a number of precedents to determine the scope of delegated legislation and conditional legislation. It finally held that where the power granted to the executive wing was limited to determine when a particular provision must be brought into force and allowed making of peripheral modifications to effectively the administer such law in a particular circumstance while keeping intact the inbuilt policy, essence and substance of the legislation itself, it was acting well within its powers.

The provisions of the Code were brought into force in a phased manner from the very start of its implementation under section 1(3) of the Code, which empowered the Central Government to decide when a particular provision would be made effective. As at the beginning, it was important to set up the foundational pillars such as the regulatory body and related professional agencies required for the functioning of the Code. Thereafter, the provisions pertaining to the operationalizing the Code with respect to entities such as companies incorporated under the Companies Act, 2013 or other special legislation, and limited liability partnerships, were brought into force. The phased implementation of the Code was a deliberate decision designed to fulfill the objectives underlying the Code while having regard to its priorities.

Section 2 of the Code lays down the list of entities that the Code extends to and the erstwhile un-amended section 2 of the Code did not differentiate between the sub-categories of individuals.  Personal guarantors to corporate debtors, partners of firms and other individuals were all grouped together under the erstwhile un-amended section 2(e). However, the erstwhile section 60 of the Code contemplated that the adjudicatory authority for personal guarantors was to be National Company Law Tribunal (“NCLT”) whereas for all other individuals the adjudicatory authority was contemplated to be the Debt Recovery Tribunal under Part III of the Code.

Therefore, there existed a clear inconsistency in the Code with regard to the treatment of personal guarantors vis-à-vis other individuals, and the inconsistency was sought to be remedied through the Insolvency and Bankruptcy Code (Amendment) Act, 2018 (“2018 Amendment”). The 2018 Amendment modified section 2(e) and sub-categorised individuals into three categories: (i) personal guarantors (ii) partnership firms and proprietorship firms and (iii) other individuals. This was a calculated move following the recommendations of the Report of the Working Group on Individual Insolvency, emphasizing the intrinsic relationship between personal guarantors and corporate debtors and how the insolvency resolution process of the corporate debtors would be in a way incomplete without bringing the personal guarantors under the scope of the same. The 2018 Amendment also altered section 60 in that 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 of corporate debtors were to be considered by the same forum, i.e. NCLT.

Therefore, the Court held that the 2018 Amendment, as far as it inserted section 2(e) and altered section 60(2), sought to streamline the resolution process. It sought to bring together all the stakeholders under the same forum, and aid the creditors to consider the holistic picture as to the nature of the assets available, either during the corporate debtor’s insolvency process, or even later; and to facilitate the creditors in framing realistic plans, keeping in mind the prospect of realizing some part of the creditors’ dues from personal guarantors and corporate guarantors.

The Court, therefore, held that the Impugned Notification is not an instance of legislative exercise or amounting to impermissible and selective application of provisions of the Code. It took into account the phased implementation of the Code since its inception and that the intent of the legislature was never that the Code should be made applicable to all individuals, (including personal guarantors) all at once. Conversely, there is sufficient indication in the Code by sections 2(e), 5(22), 60 and 179 indicating that personal guarantors, though forming part of the larger group of individuals, were to be, in view of their intrinsic connection with corporate debtors, dealt with differently through the same adjudicatory process and by the same forum (though not insolvency provisions) as such corporate debtors.

The secondary issue addressed in the judgement was the juxtaposition of the treatment of personal guarantors under the Code against the rights of guarantors under the Indian Contract Act, 1872 (“Contract Act”). The successful end of a resolution process for a corporate debtor is synonymous with a successful resolution plan extinguishing the whole or part of the debt. Although the claims as against the corporate debtor stands extinguished, the same treatment is not rendered to the personal guarantor, as all avenues are open for the creditor to proceed against the personal guarantor.

Section 133 of the Contract Act lays down that a surety would stand discharged of the liability under a contract of guarantee if the terms of the contract are varied without the acquiescence of the said surety. The Court however relied on its pronouncement in SBI v. V. Ramakrishnan, where it observed that the language of section 31 of the Code clearly made the approved plan binding on the guarantor. The Court rightly held that approval of a resolution plan would not not ipso facto discharge a personal guarantor of their liabilities under the contract of guarantee. As extinguishment of debt of the corporate debtor under the Code was a result of an involuntary process, i.e. by operation of law, or due to liquidation or insolvency proceeding, the same could not absolve the surety of their liability, which arises out of an independent contract.

Finally, the Supreme Court has ruled that the Impugned Notification is legal and not ultra vires the Code. The writ petitions, transferred cases and transfer petitions were therefore, dismissed.

Priyanka Pillai

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