A personal guarantor is an individual who provides surety under contract of guarantee to secure the obligations of a borrower. Personal guarantors play a pivotal role in securing loans for businesses and facilitating economic activities. The liability pertaining to the personal guarantors under Insolvency Bankruptcy Code, 2016 (hereinafter referred to as the “IBC”) has evolved significantly with the legal framework extending its reach to bring the personal guarantors at a similar pedestal as the corporate debtors. This significant shift has brought in an additional layer of protection to the creditors while severely limiting the rights available to the personal guarantors. Through this article, we delve into the transformative journey of liability of the personal guarantors along with exploring the key changes and case laws that have been instrumental in framing the current position of the insolvency laws for personal guarantors.
Tracing The Inclusion Of Personal Guarantors Under Ibc
The insolvency process of personal guarantors changed tremendously after the introduction of IBC. To recover their dues from the personal guarantor in case of a default by the corporate debtor before the introduction of IBC, the creditors had the following options:
- Approaching civil courts under the now repealed Provincial Insolvency Act,1920;
- Approaching the civil courts and filing a civil suit under the Indian Contract Act,1872;
- Approaching the Debt Recovery Tribunal (‘DRT’) under Securitization and Reconstruction of Financial Assets and Enforcement of Securities Act, 2002 (‘SARFAESI’).
IBC was enacted in 2016, however, not all the provisions of IBC were enforced at the time of enactment. Parliament gave Central Government the power to bring different provisions of IBC into force at different dates. The provisions relating to insolvency resolution and bankruptcy of personal guarantors which are covered under Part III of IBC were enforced when the Central Government notified the Insolvency and Bankruptcy (Application to Adjudicatory Authority for Insolvency Resolution Process for Personal Guarantee to Corporate Debtors) Rules, 2019. (Rules).
The Rules brought the personal guarantors under IBC which exposed them to higher level of risk of losing their personal assets in case of insolvency proceedings. If Corporate Insolvency Resolution Process (‘CIRP’) has been initiated against the corporate debtor before the Hon’ble National Company Law Tribunal (‘NCLT’) then any proceeding initiated for recovery of money against the personal guarantor would be transferred to that respective Hon’ble NCLT wherein the proceedings against the Debtor are ongoing. CIRP is initiated against a personal guarantor by filing an application either under Section 94 or 95 of IBC. Unlike commencement of interim moratorium under Section 14 of IBC wherein moratorium period starts after the application has been duly admitted by the Adjudicating Authority i.e., NCLT, in case of an application under Section 94 or 95 of IBC all the outstanding debts are placed under moratorium as soon as the application is filed.
Legal Precedents On Personal Guarantor Liability
Lalit Kumar Jain Vs Union of India & Ors. [i]
Hon’ble Supreme Court of India held that the personal guarantors had an innate connection with the corporate debtors and that the liability of the personal guarantors did not stand discharged even after the resolution plan was approved. It was held that an Insolvency Resolution Process can be initiated against the personal guarantors by the creditors if they have agreed to excessive cuts in the CIRP, however, the Hon’ble Court clarified that the creditors cannot recover amount in excess to the claim amount.
State Bank of India Vs Mahendra Kumar Jajodia [ii]
Hon’ble NCLAT held that the NCLT is the correct adjudicating authority for initiation of insolvency proceedings in case of personal guarantors. It was further held that even if there is no CIRP initiated against the corporate debtor before the NCLT even then Insolvency Resolution Process (IRP) could be initiated against the personal guarantor before the adjudicating authority having territorial jurisdiction. Hon’ble NCLAT’s order was challenged before the Hon’ble Supreme Court which held that the judgment did not warrant any interference.
State Bank of India Vs. V.Ramakrishnan [iii]
Hon’ble Supreme Court held that the liability of Personal Guarantor under a contract of guarantee is not ipso facto discharged upon the approval of a resolution plan. It was further held that the liability of the personal guarantor arises from a contract which is independent, and the extent of the liability depends on the terms of the contract. The Hon’ble Court ruled that possession of the guarantor’s assets could be obtained under SARFAESI Act even if the CIRP had been initiated against the corporate debtor. It was held that the moratorium under IBC acts as no shield for the guarantor and extends only to the corporate debtor.
State Bank of India Vs. Athena Energy Ventures Private Limited [iv]
Hon’ble NCLAT relying on SBI Vs. Ramakrishnan judgment held that a creditor had the right to file a claim against both the corporate debtor and the guarantor simultaneously. It was held that under the contract of guarantee, upon receiving the entire amount only the question pertaining to no further adjustment would arise. It was further held that keeping in view Section 60(2) and (3) there was no bar under IBC on the creditor simultaneously proceedings against the corporate debtors and guarantors.
Proceedings Pending Before Hon’ble Supreme Court Of India
Number of writ petitions challenging the constitutional validity of chapter III of IBC have been filed before the Hon’ble Supreme Court of India, one of the writ petitions is titled as “Anil Dhirajlal Ambani Vs. Union of India” [v] wherein the Constitutional validity of Section 95 (Application by creditor to initiate insolvency resolution process), 96 (Interim-moratorium), 97 (Appointment of resolution professional), 99 (Submission of report by resolution professional), 100 (Admission or rejection of application) of IBC has been challenged. It has been argued that these provisions are violative of fundamental rights and arbitrary as no chance for being heard is given to the personal guarantors as the interim moratorium is initiated as soon as an application under Section 95 of IBC is filed. Furthermore, the Resolution Professional’s report under Section 99 is not provided to the personal guarantor due to which the reasoning as adopted by the Adjudicating Authority behind admitting the application is never known to the personal guarantor.
Hon’ble Supreme Court is yet to decide these writ petitions on the validity of chapter III of IBC. The decision in these writ petitions will provide final clarity as to the constitutionality of chapter III of IBC and the fate of the liability of personal guarantors.
The incorporation of personal guarantors under IBC has exposed them to increased risk and a greater degree of liability. While it has strengthened creditor protection, it has raised significant legal questions pertaining to the rights of the personal guarantors. That is why the need of the hour is for the personal guarantors to be wary of the risk involved in entering a contract of guarantee qua the corporate debtor. With the due evolvement of IBC, balancing creditor protection with the rights of personal guarantors is a tremendous challenge. Legal framework pertaining to the personal guarantors is being constantly interpreted with the help of judicial precedents. Hopefully the framework governing the liability of the personal guarantors would take proper shape in the coming years with significant case laws ensuring that justice and equity prevail.
[i] 2021 SCC OnLine SC 396
[ii] Company Appeal (AT) Insolvency No. 60 of 2022
[iii] (2018) 17 SCC 394
[iv] Company Appeal (AT) (Ins) No.633 of 2020.
[v] WP(C) 519/2022