In the wake of enactment of Notification No. S.O. 4126(E) in November 2019, which brought into effect the Part III of Insolvency and Bankruptcy Code, 2016 (IBC) only against personal guarantors, multiple petitions were filed before various high courts of the country challenging the constitutional validity of this selective application. These petitions were later transferred to the Supreme Court through a Transfer Petition filed by the Insolvency and Bankruptcy Board of India (IBBI) so as to avoid conflicting decisions and in the recent landmark decision of Lalit Kumar Jain v. Union of India & Ors, a division Bench comprising of Justice Nageswara Rao and Justice Ravindra Bhat authoritatively settled the matter by unanimously upholding the constitutional validity of Part III vis-à-vis Personal Guarantors. This article discusses the findings of the Apex Court regarding the major contentions raised by Petitioners and analyses its implications on the debt recovery mechanism under IBC.
Section 1(3) IBC – the excessive delegation conundrum
While the IBC was notified way back in 2016, not all of its provisions were brought into effect immediately.[1] Section 1(3) of IBC empowers the Central Government to provide different dates for the commencement of different provisions of the Code through notification in the Official Gazette. However, nowhere does it authorise the commencement of the provisions only with respect to a certain class of individuals. Therefore, the primary contention raised by the Petitioners was that the impugned notification was excessive delegation of powers, since the Central Government had selectively made the Part III applicable only to the Personal Guarantors.
Another, absurdity which arose was that Part III of IBC only contemplated its applicability to “Individuals and Partnership Firms” and any reference to “Personal Guarantors” was absent. In fact, the definition of Personal Guarantors contained under section 5(22) was only meant to be applicable to Part II through the literal interpretation of the phrase, “in this Part, unless the context otherwise requires”. In this regard, it was argued that the Central Government had clearly travelled beyond the powers delegated to it by the Code. However, the Supreme Court rejected this argument and held that the notification was indeed a valid exercise of powers and that the said enactment is not ultra vires the scope of section 1(3).
A constitutional – legal argument
Another ground of attack was that there existed no intelligible differentia or rational basis for the selective applicability of Part III only in respect of “Personal Guarantors” as opposed to “Individuals” or “Partnership Firms”. Section 5(22) defines a Personal Guarantor as “an individual who is the surety in a contract of guarantee to a corporate debtor”. A bare reading of this provision entails that Personal Guarantors are a special subset of “Individuals” who have undertaken the responsibility of being a Surety. This means that there is, in fact, a reasonable and valid classification between the two categories and the Supreme Court rightly observed that it was the Parliamentary intention to treat these categories differently. Moreover, there is no compulsion under the IBC that it should be made applicable to all the individuals at the same time.
Co-extensive nature of personal guarantee
One of the contentions raised was that once the resolution plan is approved, the debt is said to be extinguished and hence the Personal Guarantor will no longer be liable. However, it is a settled principle of law that the liability of Surety is co-extensive with that of the Principal Debtor[2] and in the case of State Bank of India v. Indexport Registered, the Supreme Court had held that the decree-holder bank has the option of executing the decree against the Guarantor even before proceeding against the Principal Borrower. An implication of this principle would be that the liabilities of Corporate Debtor and Personal Guarantor are also joint and several.[3]
In SBI v. V. Ramakrishnan, the Supreme Court observed that it is clear from the wordings of section 31(1) of IBC that the approval of resolution plan does not discharge the Personal Guarantors, since the approved resolution plan may also contain provisions for payments to be made by Personal Guarantors. This is supported by the ruling in Maharashtra State Electricity Board v. Official Liquidator, wherein it was held that a discharge secured by Principal Debtor through the operation of law in an insolvency or bankruptcy proceeding does not absolve the Surety of his liability. Following this reasoning, the Supreme Court observed that the approval of resolution plan does not ipso facto negate the liability of Personal Guarantor. This liability arises from an independent contract and the very object of IBC is not to allow the Personal Guarantors to escape from such independent and co-extensive liability.[4]
Consequential parallel proceedings
Another issue which arose was that if the Notification was to be given effect and the Corporate Insolvency Resolution Process (CIRP) of Personal Guarantors was also to be allowed alongside the CIRP of Corporate Debtor, then this would lead to duplicity of proceedings. This question was addressed by the National Company Law Appellate Tribunal (NCLAT) in the case of Dr. Vishnu Kumar Agarwal v. Piramal Enterprises Ltd., where it was observed that under IBC there is no bar against filing of two simultaneous proceedings – one against Principal Borrower, another against Corporate Guarantor. But at the same time it cautioned against the initiation of multiple proceedings by the same Financial Creditor for a common set of claims.
As per the scheme of IBC, the Adjudicating Authority (AA) for the insolvency resolution and liquidation of Corporate Persons is the National Company Law Tribunal (NCLT), while the AA for individuals would be the Debt Recovery Tribunal (DRT). Section 60 specifically mentions that when a CIRP of a Corporate Debtor is already pending before a particular bench of NCLT, then an application for insolvency resolution of a Personal Guarantor should be filed before that bench itself[5] or should be transferred before it from any other forum[6] and the NCLT will be conferred with all the powers of DRT under Part III for this purpose.[7] This shows that although IBC allows for the parallel proceedings to be instituted against Corporate Debtor and Personal Guarantor, these two matters will be adjudged simultaneously by the same bench, which would also act as a safeguard against the imposition of excessive liability upon Personal Guarantor for the default of Corporate Debtor. Based on this reasoning, the Supreme Court concurred that the NCLT will be able to consider the whole picture since the adjudicating forums will be common.
No question of preclusion by moratorium
Upon the commencement of CIRP, a moratorium is imposed, wherein no judicial proceedings can be instituted or continued regarding the recovery, enforcement of security interest, sale or transfer of assets or termination of essential contracts. This is done to ensure that the assets of the Corporate Debtor remain intact and CIRP can be carried out in an unhindered manner.[8] Therefore, one argument could be that since the moratorium has already commenced, the assets of the Personal Guarantor cannot be attached. However, this question has been conclusively determined by the Supreme Court in the case of SBI v. V. Ramakrishnan, where it was categorically held that the “moratorium” envisaged under section 14 does not extend to Personal Guarantors. This view was confirmed by the 2018 amendment that inserted sub-section 3(b) which states that the moratorium will not be applicable to a “Surety in a contract of guarantee to a Corporate Debtor”, hence clarifying that the Personal Guarantors will still be liable, despite the commencement of moratorium.
Conclusion
The landmark proclamation of constitutional validity of Part III by the Supreme Court has dual implications. On the one hand, it would expedite the debt recovery process for Banks, as now they would have the option of proceeding against the Personal Guarantors. Moreover, it would also ensure greater accountability on part of the Personal Guarantors in lieu of the guarantees furnished by them. However, from the point of view of Personal Guarantors, the picture appears to be very bleak, since even they can be subjected to insolvency resolution for the default of Corporate Debtor. That being said, since the permissibility of parallel proceedings has now been upheld, the availability of a common adjudicating forum by virtue of sections 60(2) and 60(3) will now aid to ensure that a holistic picture is being considered by NCLT and the interests of all stakeholders are being balanced. Yet, despite this affirmative judicial endorsement by the Supreme Court in Lalit Kumar Jain v. Union of India & Ors, it remains to be seen how effective the enforcement of Part III provisions against Personal Guarantors will prove in the long run.
[Manasi Desai is a 4th year B.A.LL.B. (Hons.) student at Symbiosis Law School, Pune]
[1] Commentaries, Insolvency and Bankruptcy Code, 2016, TAXMANN (https://www.taxmann.com/research/search?searchData=Presently%20code%20not%20made%20applicable%20to%20partnership%20firms%20and%20individuals).
[2] Bank of Bihar v. Damodar Prasad, AIR 1969 SC 297; Maharashtra State Electricity Board v. Official Liquidator, AIR 1982 SC 1497; State Bank of India v. Indexport Registered, (1992) 3 SCC 159; Ram Kishun v. State of UP, (2012) 11 SCC 511.
[3] Urgo Capital Limited v. Bangalore Dehydration and Drying Equipment Co. Pvt. Ltd., [2020] 115 taxmann.com 362 (NCL-AT).
[4] State Bank of India v. V. Ramakrishnan, (2018) 17 SCC 394.
[5] The Insolvency and Bankruptcy Code, 2016, No. 31, Acts of Parliament (2016), § 60(2).
[6] The Insolvency and Bankruptcy Code, 2016, No. 31, Acts of Parliament (2016), § 60(3).
[7] The Insolvency and Bankruptcy Code, 2016, No. 31, Acts of Parliament (2016), § 60(4).
[8] Swiss Ribbons Pvt. Ltd. v. Union of India, (2019) 4 SCC 17.
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