Extinguishment of Personal Guarantee in Resolution Plan under the IBC

[Karnika Singh Pasayat and Vignaraj Pasayat are advocates practising in the Supreme Court of India and the High Court of Delhi]

The National Company Law Appellate Tribunal (NCLAT), New Delhi Bench, recently rendered a ruling in Puro Naturals JV v. Warana Sahakari Bank (Company Appeal (AT) (Insolvency) Nos.661-663 of 2023 dated November 24, 2023)on whether to approve a resolution plan that Puro Naturals JV had proposed for Shivaji Cane Processors Limited. Important questions about the extinction of security interests and the personal guarantees of financial creditors who objected were raised in this case concerning section 30(2) of the Insolvency and Bankruptcy Code, 2016 (IBC).

On February 18, 2021, Shivaji Cane Processors Limited, a significant participant in the sugar and cane processing industries, went through a corporate insolvency resolution process (CIRP). The committee of creditors (CoC) gave Puro Naturals JV, the approved resolution applicant, a resounding 78.03% majority vote. Nevertheless, with a combined vote share of 21.97%, dissenting creditors Shree Warana Sahakari Bank Limited and Kolhapur Urban Co-operative Bank voted against the resolution plan.

The principal issue before the tribunal was the compliance of a resolution plan with section 30(2) of the IBC and Insolvency and Bankruptcy Board of India (Insolvency Resolution Process for Corporate Persons) Regulations, 2016 (the CIRP Regulations). The plan involved the extinguishment of security interest and guarantees of financial creditors, including those who dissented.

In its definitive ruling, the NCLAT held that section 30(2) of the IBC and the CIRP Regulations are not violated by a resolution plan that allows the extinguishment of security interests and personal guarantees of financial creditors, even those who dissent. The decision emphasized that these resolution plan clauses complied with all relevant legal requirements.

The Supreme Court in Lalit Kumar Jain v. Union of India clarified that resolving a corporate debtor under the IBC does not automatically release its guarantors from liability. Resolution plans, often extinguishing claims against the corporate debtor, explicitly preserve those against promoters and guarantors. Conversely, a recent NCLAT judgment considered whether a resolution plan can provide for the release of personal guarantees when they have not been subject to the insolvency resolution process.

Moreover, in SVA Family Welfare Trust v. Ujaas Energy Limited (Company Appeal (AT) (Insolvency) No. 266 of 2023), the resolution plan for Ujaas Energy by SVA Family proposed INR 74.8 crores to creditors, including INR 23.8 crores to release personal guarantees of the promoters of the corporate debtors. Approved by 78% majority of creditors, it faced objection from Bank of Baroda, which argued it could not provide for the release of personal guarantees. The National Company Law Tribunal (NCLT) upheld the objection of the Bank, rejecting the plan.

The NCLAT overturned the NCLT decision of rejection of the Ujaas Energy resolution plan proposed by SVA Family. The NCLAT held that the CoC acted within its commercial wisdom in approving a plan that entailed the release of personal guarantees. While acknowledging precedents like the Lalit Kumar Jain judgment, which affirmed that corporate debt resolution does not per se discharge the personal guarantors from liabilities, the NCLAT distinguished such cases. It emphasized that these judgments do not preclude resolution plans from stipulating the release of personal guarantees under appropriate circumstances.

The NCLAT further distinguished this case from its earlier ruling in Nitin Chandrakant Naik v. Sanidhya Industries LLP (Company Appeal (AT) (Insolvency) No. 257 of 2020), where the tribunal had determined that the personal guarantor’s assets could not be consumed by a resolution plan without first undergoing the proper legal proceedings. The NCLAT noted that the resolution plan in Ujaas Energy only allowed for the discharge of the personal guarantee that had been given as security for money given to the corporate debtor; it made no mention of the personal guarantor’s assets. The NCLAT concluded by highlighting how the minutes of the CoC meetings made it abundantly evident that the release of personal guarantees had been carefully considered and decided upon by the CoC. The NCLAT saw no basis to doubt the CoC’s commercial wisdom because it had applied its mind in consenting to the release of the personal guarantees in exchange for a specific consideration.

It is true that the CoC has broad discretion in using its commercial judgment; courts and tribunals have generally acknowledged this, especially in the wake of the Supreme Court’s ruling regarding Essar Steel’s insolvency case. Furthermore, section 31 of the IBC stipulates that resolution plans are binding on all parties involved in the corporate debtor, including guarantors, and allows for a broad variety of actions to be performed through them. Nevertheless, the question of whether a resolution plan can eliminate creditors’ ability to pursue legal action against parties other than the corporate debtor remains crucial as raised in the NCLAT’s ruling in Ujaas Energy.

Under the CIRP, creditors lose their individual powers to collect debts and must abide by the majority decisions of the CoC. Even if they disagree, creditors are bound by a resolution plan approved by a 76% majority, even if it means accepting significant losses (like an 70% haircut). As long as they receive at least liquidation value of their claims, dissenting creditors no longer have the right to pursue individual claims against the corporate debtor as per the approved resolution plan.

The Ujaas Energy case throws a curveball because it involves a guarantee, not the corporate debtor’s own debt. Rather, the guarantee is a third-party obligation that was established by a contract of guarantee between a creditor and a third party (often the corporate debtor’s promoters). Certainly, the creditor, being the beneficiary, that receives the guarantee may forego its claims under it, but can the CoC make a decision that eliminates this privilege without the consent of each individual creditor?

It is made clear under IBC that the CIRP pertains solely to the corporate debtor and its assets and, consequently, addresses the rights of creditors with respect to the corporate debtor. In light of this, it is debatable if the CoC’s decisions have the authority to revoke a creditor’s entitlement to a debt owed by the guarantor, not the corporate debtor. In addition, even though the NCLAT’s ruling acknowledges that a resolution plan cannot address the guarantor’s assets, it ignores the possibility that settling a personal guarantor’s debt without taking into account their assets would infringe upon the rights of the creditor under the terms of the larger borrowing arrangement.

More recently in December 2023, the NCLT, Mumbai Bench in Vijendra Kumar Jain, Resolution Professional of the Television Network Limited v. Sab Events & Governance Now Media Ltd referred to the decisions in Puro Naturals andUjaas Energy Limited and observed that reliance by the applicant on the judgment of Lalit Kumar Jain is misplaced on the facts of the present case and it is clear that where CoC has passed a resolution plan with 93.5% votes after deliberating on the plan, and such plan provides for extinguishment of personal guarantee, the adjudicating authority cannot interfere with the commercial wisdom of CoC. The financial creditor cannot push the corporate debtor to liquidation just to protect the personal guarantee from being extinguished. The objects of the IBC as far as possible is “resolution not liquidation”.

At this juncture it is interesting to point out that in Vineet Saraf v. Rural Electrification Corpn. Ltd., wherein under the Insolvency and Bankruptcy (Application to Adjudicating Authority for Insolvency Resolution Process for Personal Guarantors to Corporate Debtors) Rules, 2019, the petitioner, a personal guarantor, contested the respondent’s demand notice on the grounds that it had allocated all of its responsibilities to FACOR Power Ltd. without excluding personal guarantees. According to the petitioner, this assignment made it more difficult to utilize his guarantee. The Delhi High Court stressed the difference between a promise not to sue and an unconditional release, holding that a reserve clause in a deed that frees the principal borrower preserves the creditor’s right to take legal action against the guarantor.

The petitioner challenged the demand notice contending that he is not liable to pay any debt to respondent and the same should be quashed. Rejecting the contentions of petitioner, the Court held that “…the principal debt persists and has never been extinguished. It is, therefore, the case that the assignee can recover the unrecovered part of the debt from FACOR Power, i.e., the principal borrower, and the respondent, in the instant petition, is also attempting to recover the unrecovered part of the debt.”

The petitioner had also contended that as the personal guarantees were not specifically part of resolution plan and assignment agreement, the respondent can only enforce the guarantee provided by the petitioner to the creditor.

The Delhi High Court observed that the contention of the petitioner is not of amending the resolution plan and assignment agreement so as to include the personal guarantee but of the legal consequences of the debt being assigned while retaining the personal guarantee, such that the creditor/ respondent cannot enforce the same. Furthermore, the respondent issued the demand notice as a statutory compliance of section 95 of the IBC so as to enable the petitioner to inform the NCLT that there is a debt recoverable from the petitioner to the lender.      

The Court finally opined: “In a petition praying for a writ of prohibition, where a petitioner is to demonstrate the absence of jurisdiction, the court does not consider it fit, to develop, if at all this is a case for that to take place, an area of private contractual law, and then to use that development in order to establish a want of jurisdiction on the part of the respondent,” while dismissing the aforementioned petition.

The law in State Bank of India v. V. Ramakrishnan, Committee of Creditors v. Satish Kumar Gupta, and Lalit Kumar Jain clearly establishes that the personal/corporate guarantor’s liability remains unabated even after the corporate debtor’s liability is extinguished upon the approval of a resolution plan. The IBC provisions and previous rulings, such as Lalit Kumar Jain, which upheld the notifications for proceedings against the personal guarantor, were examined by the two-judge bench of the Supreme Court, which concluded unequivocally that the guarantor’s liability remains undischarged even after the resolution plan is approved.

Furthermore, in Prashant Sashi Ruia v. State Bank of India, the personal guarantors of Essar Steel filed writ petitions before the Gujarat High Court, requesting the issuance of a writ of prohibition against the Debt Recovery Tribunal (DRT), in response to applications filed by the State Bank of India seeking the recovery of amounts owed in accordance with guarantees. The writ petitions were filed on the grounds that there were no outstanding debts in the financial creditors’ books that would allow them to pursue claims against the guarantors, and that Essar Steel India Limited’s entire debt was assigned to Arcelor Mittal India Private Limited in accordance with the resolution plan approved by the NCLT.

While dismissing the writ petitions, a division bench of the Gujarat High Court cited the ruling of the High Court of Australia in Hutchens v. Deauville Investments Pty Ltd ([1986] HCA 85) and directed the DRT to proceed with the decision on careful consideration. Following the High Court’s instructions, the DRT in Ahmedabad rejected the bank’s application by placing reliance on the Hutchens case. Both the Gujarat High Court and the DRT erred when they neglected to recognize the proper factual matrix in the Hutchens case and the ratio established in it.

It is rather inapt that the High Court of Gujarat, instead of following the ratio of Indian courts on guarantors’ liability not getting extinguished even after the corporate debtor is discharged from the liability on the sanction of a resolution plan, had ordered the DRT to apply the Hutchens judgment by the High Court of Australia.

Conclusion

The NCLAT’s ruling in Ujaas Energy is consistent with the long-standing legal principle that the CoC’s commercial wisdom is immune to judicial review. Although it seems to curtail a financial creditor’s rights to recover under personal guarantee agreements, it strengthens the legitimacy of the CoC’s collective commercial decisions.

There could be a lot of ramifications from this precedent, and it is unclear if and when the Supreme Court will weigh in on this matter. The current position of law emphasizes the significance of consensus within the CoC by essentially limiting a financial creditor’s recovery rights under personal guarantee agreements.

– Karnika Singh Pasayat & Vignaraj Pasayat