India - Insolvency Proceedings Against Personal Guarantors Under The Insolvency And Bankruptcy Code, 2016- A Missed Opportunity?

Legal News & Analysis - Asia Pacific - India - Insolvency & Restructuring - Dispute Resolution

29 April 2020
 

1. Introduction
 

After a lapse of almost 3 (three) years, Ministry of Corporate Affairs (the “MCA”) finally issued a notification dated November 15, 2019 (the “Notification”) that renders insolvency and bankruptcy proceedings against personal guarantors to be governed by the Insolvency and Bankruptcy Code, 2016 (the “Code”). The said notification stipulated December 01, 2019 as the date for the provisions to come into force (the “Commencement Date”).1

 

To ensure that the said proceedings are filed and adjudicated upon in a smooth manner, the Insolvency and Bankruptcy (Application to Adjudicating Authority for Insolvency Resolution Process for Personal Guarantors to Corporate Debtors) Rules, 2019 (the “Rules”) and the Insolvency and Bankruptcy (Application to Adjudicating Authority for Bankruptcy Process for Personal Guarantors to Corporate Debtors) Regulations, 2019 (the “Regulations”) have also come into force with effect from the Commencement Date.2 While the Rules lay down the procedure for initiating Insolvency Resolution Process (“IRP”) against personal guarantors, the Regulations explain the details of the procedure to be followed for the IRP.

 

The Notification brought a wave of joy amongst the creditors as the expectation rested on greater accountability of the personal guarantors with maximisation of value to the creditors. However, in this article we inter alia discuss how in light of the judgment titled ‘Vishnu Kumar v. Piramal Enterprises’ 3 (“Piramal Enterprise Case”) passed by the Hon’ble National Company Law Appellate Tribunal (“NCLAT”) and other procedural shortcomings, it might perhaps still be a distant dream to reach the pockets of personal guarantors in a manner akin to the intent of the legislature.

 

2. GUIDING PRINCIPLE FOR PERSONAL GUARANTORS

 

It shall be useful to first briefly reflect upon the guiding principles behind a contract of guarantee as mentioned in the Indian Contact Act, 1872 (the “ICA”) under Section 126. A contract of guarantee is a tripartite contract between a surety, the principal debtor and the creditor. The idea of a guarantee is to have a second pocket to pay if the first should be empty.4 An important feature of the contract of guarantee is the co-extensive nature of the liability of the guarantor with that of the principal debtor, unless specified otherwise in the contract.5

 

Thus, the guarantor’s liability to make good the payments on behalf of the principal debtor arises as soon as the principal debtor fails to fulfil its obligations under the contract. Therefore, the very object of taking a personal guarantee from an independent third party is to ensure that the creditor is not asked to sit on his rights against the guarantor till the time his remedies against the principal debtor are not exhausted.6

 

Basis the aforementioned principles of the ICA, a personal guarantor under the Code is defined under Section 5(22) as an individual who is the surety in a contract of guarantee to the corporate debtor.

 

3. INSOLVENCY REGIME GOVERNING PERSONAL GUARANTORS PRIOR TO NOTIFICATION OF PART III OF THE CODE, RULES AND REGULATIONS

 

Prior to the enactment of the Code, the Presidency Towns Insolvency Act, 1909 (“Presidency Towns Act”) (for individuals in the erstwhile presidency towns of Chennai, Kolkata and Mumbai) and the Provincial Insolvency Act, 1920 (“Provincial Insolvency Act”) (for individuals in areas other than the erstwhile presidency towns) governed insolvency and bankruptcy of all individuals, which included personal guarantors. Since the laws were old and archaic, there were multiple shortcomings with the implementation and efficacy of the said individual insolvency laws including but not limited to lack of provisions to appoint a professional like resolution professional to conduct the insolvency process; delayed proceedings due to absence of strict timelines, etc. One of the key features of the said acts was that the process involved therein was debtor centric with minimal role of secured/ unsecured creditors.

 

The Code was passed with the aim of replacing the aforementioned legislations and providing a consolidated statute for insolvency of individuals and corporate persons.7 However, since the Notification is only concerned with personal guarantors, jurisdiction to entertain insolvency and bankruptcy proceedings against partnership firms and individuals other than personal guarantors continues to be governed under the Presidency Towns Act and the Provincial Insolvency Act.

 

4. INITIATION OF INSOLVENCY PROCEEDINGS AGAINST PERSONAL GUARANTORS UNDER THE CODE: INTENT AND PROCEDURE

 

As discussed in the previous section, prior to Notification with respect to Section 60 of the Code, jurisdiction for insolvency and bankruptcy proceedings against personal guarantors vested with the Debt Recovery Tribunal (“DRT”). More often than not, proceedings against corporate debtors for the same default were either pending or eventually came to be pending before an NCLT, even prior to the proceeding against a personal guarantor could be concluded. This had a counterproductive effect and resulted in delayed proceedings and inconsistencies in determining the amount to be recovered from the guarantors. To overcome this shortcoming, Section 60(2) and 60(3) were introduced in the Code, which provide for insolvency proceedings against the personal guarantors and corporate debtors to be handled by the same forum.

 

Therefore, in the present scenario, National Company Law Tribunals (“NCLT”) remains as the forum having competent jurisdiction over proceedings against personal guarantors falling within the ambit of Section 60(2) and 60(3) of the Code, which includes cases in which proceedings against a corporate debtor are either already pending or have come to be filed during pending pendency of proceeding against personal guarantor. In all other cases of individuals and firms including personal guarantors, the forum having jurisdiction shall be the DRT. In other words, both NCLT and DRT have jurisdiction over proceedings against personal guarantors but in different scenarios under the Code.

 

The intent of these provisions of the Code is manifestly to allow for the creditor to initiate and maintain proceedings against both the corporate debtor and the guarantor simultaneously and before the same forum. Needless to say, there are several benefits of a scenario where one forum is dealing with proceedings having the same genesis. At the outset, the provision eliminates the hardship that a creditor would otherwise undergo in approaching two different forums under different legislations for recovery of the same amount arising out of the same transaction. Approaching two different forums could also invariably lead to the possibility of two separate findings, which could adversely impact the rights of the stakeholders involved.

 

Such a consolidation of proceedings also undoubtedly protects the interests of the debtors/ guarantors by ensuring that there is no overlapping in the claim amounts granted to the creditors. In view of the aforesaid, it also becomes clear that, the Code does not place a bar upon the creditors to proceed against the personal guarantor prior to exhausting their remedies against the corporate debtors. On the contrary, it provides for parallel proceedings before the same forum.

 

Prior to initiating proceedings against a personal guarantor, the creditor is required to issue a demand notice in accordance with Section 95(4)(b) of the Code calling upon the guarantor to pay up the defaulted unpaid debt within a period of 14 (fourteen) days. Needless to state, if the debt is not paid during the said time, or is not disputed, an IRP can be triggered by the creditor on the basis of such demand notice. An application for initiation of IRP against a personal guarantor has to be preferred under Section 95 of the Code in Form C of the Rules.8 Since proceedings against the personal guarantor and corporate debtor are related to each other (the debt pursuant to the guarantee being common for both of them), the Rules also provide for service of the application to the personal guarantor as well as the corporate debtor.9

 

The Working Group (“Working Group”) constituted under the chairmanship of Mr. P.K. Malhotra, had opined that the reason for ensuring that the corporate debtor is also made aware of the proceedings initiated against a personal guarantor is that along with having a common forum for proceedings against personal guarantors and corporate debtors, it would also be necessary to introduce other measures to coordinate parallel proceedings of the corporate debtor and its personal guarantor.

 

5. INSOLVENCY PROCEEDINGS AGAINST THE PERSONAL GUARANTOR UNDER A CODE: A MISSED OPPORTUNITY?
 

The NCLAT in the Piramal Enterprises judgement dated January 08, 2019 rightly recognised that counterindemnity obligation in respect of a guarantee comes within the ambit of 'financial debt' defined under the Code. However, what the said judgment failed to appreciate is that the co-extensive nature of a contract of guarantee cannot be undermined in a scenario where proceedings against the corporate debtor are already admitted and pending before a tribunal under the Code. 

 

In the said case, the appellant had appealed against orders passed by NCLT, New Delhi wherein corporate insolvency resolution process was initiated by the tribunal against 2 (two) separate corporate guarantors. The issue that remained before NCLAT for adjudication was whether or not two separate proceedings can be initiated for the same default under Section 7 of the Code. 
 

Though the dispute before it did not directly relate to two parallel proceedings against corporate debtor and personal guarantor, NCLAT held that even though there is no bar under the Code against filing two applications simultaneously under Section 7 of the Code against the 'Principal Borrower' as well as the 'Corporate Guarantor(s)' or against both the “Guarantors'; once an application under Section 7 filed has been by the 'Financial Creditor' for a particular set of claim and the same is admitted against one of the 'Corporate Debtor' ('Principal Borrower' or 'Corporate Guarantor(s)'), a second application by the same 'Financial Creditor' for the same set of claim and default cannot be admitted against the other 'Corporate Debtor' (the 'Corporate Guarantor(s)' or the 'Principal Borrower')”. 

 

Prior to the said judgment, on a separate issue, the Supreme Court in ‘State Bank of India v. Ramakrishna’ 10 (“Ramakrishna Case”) decided on August 14, 2018, held an opinion contrary to the intent relayed by the NCLAT in the aforementioned judgment. In the Ramakrishna Case, the Supreme Court was of the view that “the assets of the surety are separate from those of the corporate debtor, and proceedings against the corporate debtor may not be seriously impacted by the actions against assets of third parties like sureties. Further, it was observed that “…Enforcement of guarantee may not have a significant impact on the debt of the corporate debtor as the right of the creditor against the principal debtor is merely shifted to the surety, to the extent of payment by the surety. Thus, contractual principles of guarantee require being respected even when a moratorium against a corporate debtor under Section 14 of the Code is in effect.” The judgment was also mindful of the fact that had the intention of the legislature been to include proceedings under personal guarantors under Section 14 of the Code, a provision for a separate moratorium under Section 96 would not have existed.

 

However, neither the aforementioned view was considered by the NCLAT in Piramal Enterprise Case, nor Sections 60, 95, 96, 99 and 100 of the Code along with the intention of the legislature which is subsumed in the language of the said provisions was paid any heed to. 

 

The Piramal Enterprise Case also fails to take into consideration an important facet of limitation that continues to run against the other guarantor, in the event proceedings against them are not admitted by the relevant fora. It is plausible that in the proceedings against the first corporate guarantor the creditor is unable to realise the complete debt payable and the limitation to proceed against the other debtor expires. In the meantime, such a practice that forces the creditor to wait around before initiating proceedings against other debtors, shall also give enough time to the corporate debtors, personal and/or corporate guarantors to alienate their assets and wriggle out of their obligations towards the creditors. Consequently, the creditor would be deemed remediless for the unpaid amount of default. Despite the half-baked view, the Piramal  Enterprise Case is now being followed by various NCLTs across the country11 to state that duplicity of proceedings by creditors for the same amount of claim and default are not admissible, despite the clear language of the Code permitting the same.

 

It is crucial to highlight that even though the Piramal Enterprise Case and others are not specifically barring proceedings against personal guarantors, the intent of these is likely to cause a ripple effect in implementation of provisions against personal guarantors.

 

The said judgment disregards the aim and object of the Code, which has been enacted to consolidate laws relating to re-organisation and insolvency resolution of corporate persons, partnership firms and individuals in a time-bound manner for maximisation of value of assets of such persons. Most importantly, the Code aims to balance the interest of all the stakeholders effectively. 

 

In view of the aforementioned, it is critical that simultaneous proceedings against the personal guarantors be deemed admissible by tribunals to not only honour the intent of the legislature but also to safeguard the interests of the stakeholders involved which is one of the major objectives behind enactment of the Code. 

 

6. CONCLUSION

 

As discussed, the Piramal Enterprise Case by the NCLAT may cause impediments in the enforcement of the provisions of Chapter III of the Code notified by the MCA with effect from 01 December 2019.

 

Contrary to the view highlighted in Piramal Enterprise Case, it is imperative that the tribunals across the country adopt a holistic approach while dealing with maintainability of proceedings against personal guarantors by giving considerable weightage to the purpose behind executing the tripartite contract, principles of the ICA and the statement of objects and reasons behind enacting the Code. Contemporaneously, there is a need for the Piramal Enterprise Case to be set aside in order to break the trend of flawed interpretation of the intent of the legislature and provisions of the Code.

 

Further, it is also relevant for the Central Government to consider and appreciate the practical difficulties that a tribunal handling such proceedings may face and provide for them in the Rules and Regulations. For instance, the timeline for the repayment plan against the personal guarantor envisaged under Section 105 of the Code may be redundant if the insolvency resolution process against corporate debtor is not completed in a timely manner under Section 12 of the Code. Therefore, it is also the need of the hour to minimise disparity between provisions governing these two separate proceedings.

 

In addition to the aforementioned, the provisions for initiating proceedings against personal guarantors appear to be a skeleton structure which shall need apt interpretation of the judiciary to fill in the loopholes created, including enlistment of measures that a tribunal may take in case of non-cooperation by a personal guarantor.12 Since the Piramal Enterprise Case is already under challenge before the Supreme Court, it may also be useful if the Supreme Court in its decision also comes with up a comprehensive set of guidelines to be followed in such proceedings that leaves little or no room for the personal guarantors to evade their obligations by using the defense of pendency of proceedings against the corporate debtor.
 

herbert smith Freehills

For further information, please contact:

 

Mohit Chadha, Induslaw 

mohit.chadha@induslaw.com