Supreme Court Clarifies the Extent of Liability of Personal Guarantors under the IBC

[Tanisha Gautam is a 4^th year B.A. LL.B. (Hons.) student at the Institute of Law, Nirma University, Ahmedabad]

The impact of a personal guarantee in relation to a corporate debtor undergoing insolvency proceedings under the Insolvency and Bankruptcy Code, 2016 (the “Code”) has raised interesting legal issues. A personal guarantee refers to a promise made by an individual (the guarantor) to assume responsibility for the repayment of a debt in the event that the borrower (corporate debtor) fails to fulfil its obligation to a creditor. The recent pronouncement of the Supreme Court in Surendra B. Jiwrajika v. Omkara Assets Reconstruction Private Limited (9 November 2023) has settled the ambiguity surrounding the liability of personal guarantors under the Code. Nevertheless, certain issues remain unaddressed.

Following the Insolvency and Bankruptcy Code (Second Amendment) Act, 2018 and the subsequent Notification No. S.O. 4126 dated 15 November 2019, personal guarantors are directly subjected to insolvency proceedings without the requirement of creditors primarily initiating the insolvency proceedings against the corporate debtor. The Supreme Court recently clarified the constitutionality of these provisions under the Code along with the extent of liability attributable to the personal guarantors under the legislation.

The judgement is critical since it grants higher leverage to the creditors of the corporate debtor to retrieve the outstanding amount that was not collected throughout the corporate insolvency resolution process (“CIRP”) of the corporate debtor by virtue of the personal guarantor’s insolvency resolution process (“PGIRP”). This creates a “dual safety-net” for the creditors to claim their dues from not just a single entity. The result of the recently pronounced judgment in Omkara Assets strengthens the already high bargaining power of the creditors, leaving the personal guarantors with limited scope of protection under the Code.

Liability of Personal Guarantors: Applicability Of Co-Extensiveness & Ipso Facto Discharge

The liability of personal guarantors is co-extensive with that of the corporate debtor, as expressly provided under section 128 of the Indian Contract Act, 1872 (“ICA”). A personal guarantor’s liability is established through an independent contract, and the contractual terms dictate the nature and magnitude of said liability. Hence, the creditors may initiate legal proceedings against both the corporate debtor and its personal guarantor simultaneously, or they may decide to proceed in any other preferred sequence. Proceedings against the personal guarantor may be either to recover the entire amount, or the remaining amount.

A conclusion can be drawn that, once the resolution plan is accepted by the committee of creditors (“CoC”), the liability of the corporate debtor comes to an end, thereby ultimately discharging the personal guarantor of its liability as well. This rationale, as analogised from the provisions of the ICA, does not hold valid owing to the various rulings of the High Courts and the Supreme Court. Liability of the personal guarantor continues even if the corporate debtor is discharged from its liability.

The case of Maharashtra State Electricity Board Bombay v. Official Liquidator ruled on the applicability of section 134 of the ICA and determined that the guarantor can be sued since the debtor was released from liability due to an involuntary process of operation of law, i.e., insolvency, and not due to any action or inaction on the part of the creditor. Here, the “Court examined that a Guarantor’s duty under an unambiguous promise persists since there is no dismissal under Section 134, ICA”. Therefore, personal guarantors are not automatically released from their obligation even if the corporate debtor’s liability is discharged by an operation of law in liquidation proceedings.

It is an established legal principle that when a resolution plan for a corporate debtor is approved, all liabilities, claims, dues, and any waivers, reliefs, or exemptions for past periods are extinguished. However, this discharge is restricted to the corporate debtor itself and does not release the directors of the company, who may have acted as personal guarantors, from their obligation to make payments to the creditors as stipulated in the terms of the contract they have entered into.

The Supreme Court in State Bank Of India v. V. Ramakrishnan held that the approval of a resolution plan under section 31(1) of the Code does not automatically result in the discharge of the guarantor. Instead, it may allow the creditors to continue their efforts to recover any remaining gap or shortfall in the amount owed to them from the corporate debtor by pursuing the guarantor.

In the Committee of Creditors of Essar Steel India Limited v. Satish Kumar Gupta, the Supreme Court based its decision on section 31(1) of the Code, holding that once a resolution plan is approved and authorized, it is binding on the corporate debtor and all other parties, including guarantors. However, in the present case, the resolution plan clearly provides that the creditor’s rights to enforce guarantees, whether corporate or personal, would continue after approval. Aside from section 31(1), the Supreme Court’s reasoning in this case was based on the particular terms of the settlement plan.

As a result of the Code being vague and silent, the position whether the creditors have the right to enforce guarantees after a resolution plan has been approved remained obscure. In the absence of any clarity, guarantor’s duty towards creditors may be assessed on an individual facts of the matters before the courts.

Changing Dynamics: Supreme Court Clarifying the Liability of Personal Guarantors in Lalit Kumar

Giving finality to the unsettled position, the Supreme Court, in Lalit Kumar Jain v. Union of India held that the release of the guarantor from its responsibilities is contingent upon two conditions: firstly, unless the language of the contract states otherwise and, secondly, if it is the result of a voluntary action by the corporate debtor, such as a release, discharge, composition, or modification of the guarantee agreement. The Supreme Court therein defined the lines of liability of the personal guarantors under the Code, and, while dismissing the petitions, declared the Notification of 2019 to be legally sound and legitimate.

“It is therefore, clear 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… However, this court has indicated, time and again, that an involuntary act of the principal debtor leading to loss of security, would not absolve a guarantor of its liability”.

Constitutionality of the Provisions of the Code: Omkara Assets to the Rescue of Creditors?

After Lalit Kumar, various petitions were filed challenging the constitutional validity of the provisions of the Code concerning the liability of personal guarantors on the grounds that the room for personal guarantors to be targeted under the insolvency proceedings is extreme and inordinate.

Firstly, personal guarantors are subjected to direct insolvency proceedings; and secondly, they are not given due opportunity to raise contentions upon the filing of insolvency petitions by creditors before the resolution professional. The Supreme Court dismissed the petitions and concluded that the role of a resolution professional is merely of a facilitator and not an adjudicator. While addressing the issue, the Court made it clear that the resolution professional is only hired by the adjudicatory authority based on a suggestion by the Insolvency and Bankruptcy Board of India. The sole objective of the resolution professional is to assist in the facilitative process of report preparation in accordance with section 99 of the Code.

The Court ruled that the current legislative framework does not allow for an extra adjudicatory stage, and adding such a stage would mean “rewriting the terms of the statute”. It also made clear that there are strict deadlines for both appointing an resolution professional and for turning in a report. Adding an adjudicatory stage would not only slow down the process but also make it more complicated. Additionally, the Court concluded that sections 95 to 100 of the Code cannot be judged unconstitutional solely on the absence of provisions allowing personal guarantors an opportunity to present their case prior to creditors filing insolvency petitions.

The recent ruling represents a significant turning point, as it provides reassurance regarding the presence of sufficient safeguards for the effective performance of resolution professionals throughout the insolvency procedure. However, the protection given to the personal guarantors under the Code still remains negligible.

Unaddressed ISSUES: Need for the Court’s Assessment

The Code introduces a paradox, promising enhanced recoveries for creditors but imposing notable challenges on those standing as guarantors. One pressing issue is the potential for “multiple and concurrent insolvency proceedings”. The co-extensive liability of debtors and guarantors allows the creditors to initiate simultaneous insolvency actions against both parties. This raises concerns about jurisdictional conflicts and operational challenges for National Company Law Tribunals (“NCLTs”). The example of a guarantor providing guarantees for companies in different locations, coupled with the initiation of CIRP in different cities, further underscores the complexity. Section 60(2) of the Code mandates filing insolvency petitions against guarantors where CIRP for the borrower is underway, creating uncertainties regarding precedence and the formulation of repayment plans across multiple proceedings.

Another issue emerges in the form of “creditor’s double-dipping”, a practice allowing creditors to initiate simultaneous CIRP against both the principal debtor and the guarantor. While the National Company Law Appellate Tribunal (“NCLAT”) expressed concerns about double-dipping, the co-extensive liability of personal guarantors and borrowers, section 60(2) of the Code permits concurrent proceedings against both parties. This potential for double-dipping by creditors raises questions about the fairness of the insolvency resolution process for personal guarantors. This further calls for the question of “res-subjudice”. How is the Code permitting concurrent proceedings, when a proceeding on the same matter, same issue, same parties already is submitted before the tribunal?

Lastly, the extinguishment of a guarantor’s right of subrogation under the Code stands out as a significant issue which the courts have failed to address so far. Traditionally, guarantors possess the right to step into the shoes of the creditor, recovering monies paid on behalf of the principal debtor. However, the Code denies guarantors this right, emphasizing the “pro-creditor” nature of the insolvency regime. Denial of right of subrogation will only hinder the personal guarantors from extending guarantees owing to the extremist nature of the Code towards personal guarantors.

Conclusion

Incorporation of the treatment of personal guarantors into the Code carries remarkable ramifications for individuals who have provided personal guarantees. Personal guarantors are susceptible to the possibility of insolvency procedures, which might result in the potential forfeiture of their personal assets, loss of commercial value of business, and creditworthiness.

The recent affirmation of the provisions of Code concerning personal guarantors is likely to elevate creditor confidence. This could lead to a more assertive approach by creditors in initiating insolvency proceedings against guarantors, fostering a sense of financial security. Additionally, the judgment may prompt caution among promoters and individuals offering personal guarantees, potentially leading them to be more circumspect due to the highlighted risks, even for solvent companies. In this pro-creditor environment, personal guarantors face challenges that necessitate a careful evaluation of their financial engagements, highlighting the need for legislative and procedural clarity to ensure a fair and efficient insolvency resolution process.     

– Tanisha Gautam