ASSESSING THE MAINTAINABILITY OF CIRP OF PERSONAL GUARANTORS: LEGAL FRAMEWORK AND CONSEQUENCES
Updated: Feb 15
This post, the Winning Entry of the RFMLR-IBBI Blog Series Competition, 2021, is authored by Priankita Das, fourth-year student of B.A. LL.B. (Hons.) at Dr. Ram Manohar Lohiya National Law University, Lucknow.
Post the notification of certain provisions under Part III of the Insolvency and Bankruptcy Code, 2016 (“IBC”) by the Ministry of Corporate Affairs in November 2019, several issues have come to light vis-à-vis the insolvency resolution process of personal guarantors to corporate debtors. One of the biggest trials that the Part III of the IBC had to undergo was the challenge to its constitutionality, which was ultimately upheld in Lalit Kumar Jain v. Union of India by the Hon’ble Supreme Court. Notwithstanding this, there remains ambiguity in the insolvency and bankruptcy proceedings of personal guarantors under Part III of the IBC.
The debate pertaining to the simultaneous initiation of the corporate insolvency resolution process (“CIRP”) of corporate debtors and their personal guarantors has temporarily been laid to rest by the National Company Law Appellate Tribunal (“NCLAT”) in State Bank of India v. Athena Energy Ventures Private Limited (“Athena”), wherein it was stated that creditors are entitled to proceed against both the corporate debtors and their personal guarantors simultaneously for the same set of debt. The NCLAT had placed reliance on the observations of the Insolvency Law Committee in its Report of February 2020 that concluded that restriction of a creditor from initiating a simultaneous CIRP would cause prejudice to the right of the creditor provided under the contract of guarantee, i.e., to proceed against both the principal borrower and the surety at the same time. This view was also previously dictated by the NCLAT in Edelweiss Asset Reconstruction Company Ltd. v. Sachet Infrastructure Pvt. Ltd.
While the discussion revolving around simultaneous proceedings has taken a backseat at the moment, another issue has recently emerged vis-à-vis personal guarantors – Whether a CIRP can be initiated against personal guarantors in the absence of an ongoing CIRP against the corporate debtor? This article, while taking note of the statutory set-up and judicial precedents pertaining to the issue, analyses the implications of both barring and allowing such initiations.
2. STATUTORY SET-UP
To analyze the issue against the backdrop of statutes, two Acts shall be investigated: the Indian Contract Act, 1872 (hereinafter “ICA”), and the IBC, including the Rules and Regulations issued thereunder.
2.1 Indian Contract Act, 1872
It is a well-established fact that under Section 128 of the ICA, the liability of a surety is co-extensive with that of a principal borrower, which in essence means that a creditor can proceed against the guarantor without first exhausting its remedy against the principal borrower. This position has also been taken by the Reserve Bank of India in its Master Circular on Wilful Defaulters.
This would have sufficed as an adequate statutory back-up to permit creditors to proceed against personal guarantors in the absence of an ongoing CIRP of the corporate debtor; however, Section 238 of the IBC dictates that the provisions of the IBC shall override any other law that is inconsistent with its provisions. Therefore, a need arises to examine the provisions contained in the IBC, and its Rules and Regulations.
2.2 IBC, 2016, and the Rules and Regulations thereunder
Neither the 2019 Rules nor the Regulations expressly provide for or bar the initiation of the CIRP of a personal guarantor in absence of an ongoing CIRP of the corporate debtor. Contrarily, under the IBC, Section 60 envisages that the National Company Law Tribunal (“NCLT”) will have jurisdiction over the CIRP of personal guarantors, and the application for the CIRP would be filed before the NCLT where the corporate debtor is undergoing its own CIRP. Under Clause 3 of the provision, it is stated that any pending CIRP of the personal guarantor shall be transferred to the NCLT dealing with the corporate debtor’s CIRP.
3. DUAL JURISDICTION OVER PERSONAL GUARANTORS
It is pertinent to note that an application for the CIRP of a personal guarantor, in its capacity of an individual under Part III of the IBC, and in the absence of an ongoing CIRP of the corporate debtor, shall be filed under Section 95 before the Debt Recovery Tribunal (“DRT”), which is the Adjudicating Authority for Part III as per Section 79(1). However, such applications against personal guarantors have been rejected by the NCLT in Insta Capital Pvt. Ltd. v. Ketan Vinod Kumar Shah (“Insta Capital”) and Altico Capital India Ltd. v. Rajesh Patel (“Altico Capital”) on the ground of the absence of an ongoing CIRP of the corporate debtor.
According to Section 60(3) of the IBC, the CIRP of the personal guarantor shall be transferred to the NCLT where the corporate debtor is undergoing its own CIRP, which is vested with all the powers of the DRT under Section 60(4). If the CIRP of the corporate debtor is already pending, then the application initiating the personal guarantors’ insolvency shall be filed before the NCLT presiding over the CIRP of the corporate debtor by virtue of Section 60(2). However, it is to be noted that the application shall still be filed under Section 95, as Section 7 only allows for applications to be filed against the corporate debtor.
Thus, the jurisdiction over the CIRP of personal guarantors is vested with two fora, i.e., the NCLT and DRT, albeit in different situations, i.e., in the capacity of an individual and in the capacity of a personal guarantor. The situation is dependent upon the pending nature of the CIRP of the corporate debtor.
4. MULTIPLE INTERPRETATIONS OF SECTION 60(2) OF THE IBC
The above discussion vis-à-vis the dual jurisdiction was undertaken by the NCLT (Mumbai Bench) in its orders in Insta Capital and Altico Capital, wherein it had dismissed the applications filed under Section 95 of the IBC by the financial creditor for the initiation of the CIRP of the personal guarantor, due to the lack of an ongoing CIRP of the corporate debtor. However, differing interpretations of Section 60(2) of the IBC have come to light which allow and bar such initiation.
4.1 A Bar on the Initiation of Personal Guarantors’ CIRP
In the Insta Capital judgment, the NCLT opined that Section 60(2) of the IBC contains a non-obstante clause that specifies that “only where a CIRP process or liquidation process of a Corporate Debtor is pending before NCLT, an application initiating Insolvency Resolution Process against the Personal Guarantor, of such Corporate Debtor shall be filed before such NCLT.” Further, it noted the difference between the filing of applications for CIRP for corporate guarantors and personal guarantors under Sections 7 and 95 respectively and emphasized the unfeasibility of placing the two separate entities on the same pedestal. Thus, in the NCLT’s opinion, an application for the CIRP of a personal guarantor cannot be filed unless there is an ongoing CIRP against the corporate debtor.
4.2 Not a Bar on the Initiation of Personal Guarantors’ CIRP
In PNB Housing Finance Ltd. v. Mr. Mohit Arora, the NCLT (Delhi Bench) opined that in cases where the application itself is pending for the initiation of the corporate debtor, the application for the initiation of the personal guarantor’s CIRP can be filed under Section 95. The ‘initiation’ of the corporate debtor’s CIRP is not a pre-requisite for the maintainability of the Section 95 application.
Going forward on the same wavelength, the NCLAT recently in State Bank of India, Stressed Asset Management Branch v. Mahendra Kumar Jajodia (“Mahendra Jajodia”) clarified the position and held that Section 60(2) does not, in any way, prohibit the filing of proceedings against personal guarantors even if no proceedings are pending before the NCLT. It laid emphasis on the use of terms ‘a NCLT’ and ‘such NCLT’ in Section 60(2) and opined that the only purpose of this provision is to ensure that the proceedings are ongoing before the same NCLT. It does not act as a bar on the initiation of the CIRP of personal guarantors in the absence of an ongoing CIRP of the corporate debtor. Given that the ruling has come from the appellate tribunal and is more recent in nature, it is the presiding rule of law and thus, the CIRP of personal guarantors can be initiated independently.
To prevent any further differing interpretations of the same provision, it is suggested that a proviso must be inserted under Section 60(2) of the IBC to clarify what the intent of the Legislature had been while drafting this provision. This would, in turn reduce the multiplicity of interpretations of the same.
5. POSITION WITH RESPECT TO CORPORATE GUARANTORS
In its 1992 judgment, the Hon’ble Supreme Court in State Bank of India v. Indexport Registered held that by virtue of Section 128 of the ICA, a decree can be executed first against the guarantor without proceeding against the principal borrower. In a more recent case, and in the context of corporate guarantors, the NCLAT in Ferro Alloys Corporation Ltd. v. Rural Electrification Corporation Ltd. held that initiation of the CIRP of the corporate debtor is not mandatory before proceeding against its corporate guarantors under Section 7 of the IBC. Further, in BRS Ventures Investments Ltd. v. SREI Infrastructure Ltd., the NCLAT held an application under Section 7 to be maintainable against the corporate debtor for the same debt and default for an ongoing CIRP of the corporate guarantor in light of the judgment pronounced in Athena. Thus, the position seems to be clear in respect of corporate guarantors – the CIRP of the corporate guarantor can be initiated in the absence of an ongoing CIRP of the corporate debtor.
With respect to personal guarantors, the Courts have clarified their stance vis-à-vis the initiation of simultaneous proceedings against personal guarantors and corporate debtors through cases such as ICICI Bank Ltd. v. CA Ritu Rastogi, Kiran Gupta v. State Bank of India, and Committee of Creditors of Essar Steel v. Satish Kumar Gupta, wherein they have emphasized upon the co-extensive liability of guarantors and debtors as elaborated upon in Bank of Bihar Ltd. v. Damodar Prasad, and how the purpose of a guarantee is defeated if the creditor is asked to postpone its remedy against the surety, which was also the position taken by the Hon’ble Supreme Court in Laxmi Pat Surana v. Union Bank of India.
Despite the recent clarity provided in the Mahendra Jajodia case which reduced the murky nature of the courts’ stance on the initiation of CIRP of personal guarantors, it is pertinent to note that the co-extensive liability shall be affected by both barring and allowing such initiation. This consequence, along with the effect of the moratorium imposed by Sections 96 and 101 of the IBC that are applicable to personal guarantors but not to corporate guarantors, is discussed in the following section.
6. CONSEQUENCES OF INITIATION OF CIRP OF PERSONAL GUARANTORS
The consequences of both barring and allowing for the initiation of CIRP of personal guarantors in the absence of an ongoing CIRP of the corporate debtor are presented, namely – the reduction of the independent and co-extensive liability of personal guarantors, and the effect of the moratorium imposed under Sections 96 and 101.
6.1 Independent and Co-Extensive Liability of Personal Guarantors
As previously discussed, under Section 128 of the ICA, the liability of a surety is co-extensive with that of a principal borrower. The creditor retains the right to proceed against both the surety and the principal borrower independently of each other. However, if the decision in Insta Capital were to be followed, it would essentially mean that the creditors do not have the right to proceed against the surety, without first exhausting its remedy against the corporate debtor, as was their right before.
Albeit the fact that creditors are permitted to proceed against the personal guarantors and corporate debtors simultaneously, this nevertheless stands as a reduction of the independent liability of the surety and principal borrower.
6.2 Effect of Moratorium under Sections 96 and 101 of the IBC
Section 96 of the IBC imposes an expansive restriction on the creditor for initiating any legal proceeding in respect of any debt. Similarly, when a moratorium under Section 101 commences, the restriction persists over the creditor till the end of the proceeding. The Hon’ble Supreme Court in P. Mohanraj v. M/s. Shah Brothers Ispat Pvt. Ltd. also held that any legal proceeding, even indirectly relatable to the recovery of any debt, would be covered under the ambit of the moratorium under Section 14 of the IBC. Since Sections 96 and 101 also make use of the words ‘any’ legal proceeding and ‘any’ debt, it can be inferred that such an expansive interpretation can also be accorded to these provisions, as has been given to Section 14.
In essence, this would mean that if the initiation of the CIRP of personal guarantors were to be allowed in the absence of an ongoing CIRP of the corporate debtors, the creditor, barred by the moratorium, would be unable to initiate a CIRP against the corporate debtor. In this aspect, the creditors would lose their right to initiation of simultaneous proceedings against the corporate debtor and the personal guarantor, which would be detrimental to the recovery of their due amounts.
It is suggested that in order to prevent the diminishment of the co-extensive liability of the personal guarantor and be in compliance with the Mahendra Jajodia ruling of the NCLAT, an exception must be made for proceedings against the corporate debtor from the moratorium under Sections 96 and 101 of the IBC. This would ensure that the creditors retain their right to proceed against both creditors and personal guarantors independently and/or simultaneously, while preserving the co-extensive liability as well.
After a detailed examination, it can be concluded that the initiation of the CIRP of personal guarantors is not dependent upon the pending nature of the CIRP of the corporate debtor. Notwithstanding this, certain links, such as simultaneous initiation and same forum for proceedings, can be built into the regulatory processes for the corporate debtor and personal guarantors’ proceedings to make the process unambiguous, efficient, and free of uncertainty; as has been recommended in the Report of the Working Group on Individual Insolvency.
Admittingly, the provisions of the IBC and the subsequent judicial pronouncements based thereon seem to be averse for guarantors. However, given the objective of the IBC, i.e., the revival of corporate entities, the decisions seem to be on the same wavelength on the issue at hand. Keeping in mind the objective, certain authors such as Ketan Gaur and Anirudh Krishnaa have suggested ways in which the position could be altered to be less averse to guarantors, while concurrently maintaining the objective of the IBC. To this extent, it has been recommended that where the CIRP is simultaneously initiated against the corporate debtor and its personal guarantor, the NCLT could first conclude the CIRP of the personal guarantor, who could then admit its claim in the CIRP of the corporate debtor in the capacity of a creditor, in furtherance of its right of subrogation. However, the Courts have taken a different approach in Lalit Kumar Jain v. Union of India and Lalit Mishra v. Sharon Bio Medicine Ltd., wherein the guarantor’s right of subrogation was said to be nullified after the invocation of the guarantee by a creditor. Thus, it remains to be seen how the Courts approach the IBC with a view to make it less averse to guarantors.