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Personal Guarantors to Corporate Debtors - New Regime Unfolding New Issues

[Dhiraj Yadav and Barkha Dwivedi are students at Ram Manohar Lohia National Law University.]

 

The Indian Parliament enacted the Insolvency and Bankruptcy Code (IBC) in 2016. The objective was to create a comprehensive and efficacious framework for reorganization and resolution of defaulting firms. The IBC deals with the insolvency and bankruptcy process of both corporates and individuals and provides a separate framework for both of them. The legislature intended phased implementation of the IBC and, therefore, inserted Section 1(3) to empower the Central Government to implement different provisions of the IBC on different dates. Pursuant to this, the Central Government notified only the parts (Part I and II) pertaining to corporate insolvency when the IBC came into being, i.e., 1 December 2016. The same was to be followed by the regime for the insolvency resolution and bankruptcy of individuals and partnership firms.

 

Considering the growth of individual credit market and weak recovery process, the Union Government, vide notification dated 15 November 2019, notified certain provisions of Part III of the IBC, extending its applicability to the personal guarantors of the corporate debtor. It is pertinent to note that Part III covers ‘fresh start process’, ‘insolvency resolution process’ and ‘bankruptcy’. However, provisions pertaining to ‘fresh start’ have not been notified yet. The same is expected to be notified in the next phase, which may be another four to six months away, as stated by the Corporate Affairs Secretary.

 

It is well known that the IBC was drafted in a very short span of time and is still in its infancy. Therefore, implementing the notified provisions will not be a cake walk as there subsist plenty of grey areas and unresolved issues in the law. The article aims at bringing to light the challenges that will afloat due to the new regime.

 

Liability arising upon the approval of a resolution plan

 

Firstly, the position with regard to the liability of a personal guarantor upon the approval of a resolution plan of the corporate debtor is still obscure. As per the IBC, once the resolution plan is approved by the committee of creditors and adjudicating authority, the corporate insolvency resolution process (CIRP) comes to an end. However, complexity arises when a creditor exercises his right to proceed against the guarantor for the satisfaction of the outstanding debt after the partial satisfaction of the amount by the resolution plan. There is no specific provision in the IBC that precludes the creditor from proceeding against the guarantor for the remaining amount of debt. However, a cursory reading of Section 31(1) of the IBC suggests that liability of a personal guarantor stands extinguished upon the approval of a resolution plan since it is binding on the guarantors. It is contended that when a resolution plan is approved, the principle debt becomes zero and subsequently, as per Section 128 of the Indian Contract Act, 1872 (ICA), the guarantor stands discharged of its liability.

 

To the contrary, it is asserted that as per Section 134 of the ICA, a guarantor is discharged of its liability, if the creditor on its own instance discharges the principal debtor. However, this discharge of guarantor’s liability ought to be a voluntary act of the creditor and not the result of the operation of law. The approval of the resolution plan by the tribunal and subsequent discharge thereof is due to statutory provisions, and is, therefore, an operation of law.  Hence, the liability of the personal guarantor does not stand extinguished. Adding to it, the Apex Court, while adjudicating upon the matter of State Bank of India v V. Ramakrishnan, observed that a personal guarantor is not discharged of its liability upon the approval of a resolution plan. However, it failed to answer as to what extent can the creditor claim his debt from a personal guarantor after taking a haircut under the resolution plan.

 

The Apex Court, while adjudicating upon the case of Committee of Creditors of Essar Steel India Pvt. Ltd v Satish Kumar Gupta, again got the opportunity to deal with this issue as the financial creditors of Essar Steels proceeded against the personal guarantor to recover the outstanding debt. However, instead of delving into the issue, the court preferred not to touch upon it. It is unclear as to why the Supreme Court averted the issue even though the plan created an oddity by permitting the financial creditors to invoke guarantees but restricting the guarantors from exercising their subrogation rights.

 

Issues pertaining to subrogation rights

 

There prevails another conundrum concerning the right of subrogation of the personal guarantor under the IBC.  Subrogation right is expounded under Section 140 of the IBC. Succinctly, it is the right of the guarantor to recover from the principal debtor, the amount paid on his behalf to the creditor. While submitting the resolution plan for the corporate debtor, every prudent applicant seeks extinguishment of all the liabilities, including those arising out of the right of subrogation. This prevents the personal guarantor from claiming the amount, if any, that he paid on behalf of the corporate debtor.

 

The issue was dealt by the National Company Law Appellate Tribunal in the case of Lalit Mishra and Others v Sharon Bio Medicine Limited, wherein it was observed that a guarantor cannot enjoy subrogation rights under the IBC as the proceedings thereunder are not recovery proceedings. The aim of the IBC is to revive the company and not to make certain that credit is available to all stakeholders. Moreover, it should also be considered that allowing the exercise of subrogation right will mean that the debt remains as it is and this will act as an obstruction in the revival of the corporate debtor.

 

The stand of the NCLAT is arguably detrimental to the interest of the personal guarantors. Not providing the right of subrogation, which is not merely a statutory right but also an extension of the principle of natural justice, would be prejudicial to the guarantor and would result in unanticipated and unmerited loss. Nevertheless, it is still a matter of contention whether two parties (corporate guarantor and the resolution applicant) should be permitted to take away the rights of a third party (personal guarantor) who is not even a party to the contract. The issue appears to be far from being settled and, therefore, the stand of the Apex Court is eagerly awaited.

 

Issues revolving around the manner of proceedings

 

After the implementation of Part III, there may be multiplicity of insolvency proceedings for the same amount of debt. Therefore, a harmonious reading of provisions is imperative. The IBC explicitly mentions under Section 60 that proceedings relating to insolvency resolution or bankruptcy of a personal guarantor shall be carried out before the same NCLT where a corporate insolvency resolution process or liquidation proceeding of the corporate debtor is pending. It has also been specified in the IBC that the proceedings shall lie before the NCLT having the territorial jurisdiction where the registered office of the corporate person is located. However, in a situation where the personal guarantor has undertaken a guarantee for more than one entity, and such entities simultaneously undergo the CIRP in different NCLTs, it is to be seen as to how the appropriate NCLT would be determined.

 

Besides this, the manner of proceedings has not been made clear in that whether the proceedings against the corporate debtor and the personal guarantor can be consolidated, or whether they are to take place independent of each other. It is also to be seen whether the adjudicating authority can appoint a common resolution professional for both proceedings.

 

Conclusion

 

Bringing personal guarantors within the purview of the IBC is indeed a welcome step as the same will increase the efficiency of the resolution process. However, it is apparent that the legislature has yet again failed to take into consideration the practical intricacies of the insolvency process. Courts and tribunals should be on their toes in order to ensure effective functioning of the regime. However, in the process of making the recovery mechanism smoother and creating parallel remedy for the creditors, it should not be overlooked that a personal guarantor and a corporate guarantor cannot be treated similarly. The IBC itself adopts a more humane approach and prescribes a less stringent resolution process for individuals. It is to be seen as to whether the tribunal will entail this approach in mind while setting the precedent for the yet infant insolvency resolution process.

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