The  future of personal gurantors under IBC

author Guneet Mayall

calender May 13, 2024

The Future of Personal Guarantors under IBC

Insolvency and Bankruptcy Code, 2016 (“Code”) was introduced with the aim to revamp the erstwhile insolvency and bankruptcy laws in India to facilitate and foster the resolution process by lenders against the insolvent debtors, in a systematic, effective and timely manner.  The Code intended to reorganize and resolve insolvency along with maximization of assets of such debtors with a focus on emphasizing restructuring and not liquidating it at first instance.  Since then, the legal regime in relation to insolvency has undergone a paradigm shift witnessing new horizons. One of the divisive provisions under the Code pertains to the initiation of insolvency proceedings of personal guarantors. 

Recently, the National Company Law Tribunal (“NCLT”) accepted the revived application of initiating the personal insolvency proceedings by Indiabulls Housing Finance Limited (“IHFL”) against the chairman of Zee Entertainment Enterprises Ltd (“ZEEL”), Mr. Subhash Chandra, in the capacity of being a personal guarantor to the corporate debtor Vivek Infracon Private Limited who defaulted on a payment of INR 170 crore (Indian Rupee One Hundred and Seventy Crores) approximately. 

Who is a personal guarantor and when does the liability of a personal guarantor arise?

A personal guarantor is an individual who has made a promise to assume the responsibility for the debt repayment if the corporate debtor, who is the original borrower fails to fulfil its obligation to a lender/creditor. 

Section 128 of the Indian Contract Act, 1872, which deals with the liability of the surety of a principal debtor states it is co-extensive with that of the principal debtor. The Apex Court while interpreting and examining the term ‘co-extensive liability’ in the case of Industrial Investment Bank of India Ltd. v. Biswanath Jhunjhunwala held that the liability of a surety is not an alternative to the principal debtor and hence the creditor can initiate the proceeding independent of the fact whether proceeding has been first initiated against the principal debtor or not. 

A Similar view was taken by the National Company Law Appellate Tribunal (“NCLAT”) in the case of State Bank of India, Stressed Asset Management Branch Vs. Mahendra Kumar Jajodia, stating that the proceedings against a personal guarantor under the Code can be initiated by a creditor without any pending proceedings against the corporate debtor. Since the Code was still evolving, this judgement of the NCLAT faced criticism and was also challenged before the Supreme Court of India, which reasserted the NCLAT order.  

Development and evolving dynamics related to insolvency proceedings against personal guarantors.

In 2019, the Code was amended, enabling the creditors to file insolvency proceedings against personal guarantors. After various petitions filed in the Supreme Court against the amendment stating it to be illegitimate, it was held in Lalit Kumar Jain v. Union of India held that the guarantor will be released from its responsibilities and liabilities only upon two conditions: 

  • Firstly, if the language of the guaranteed contract states otherwise and, 
  • Secondly, as a result of a voluntary action by the corporate debtor.

The petition was dismissed, and the apex court declared the amendment to be legitimate.

Subsequently, the validity of the amendment was alleged to be unconstitutional and was challenged several times before the Supreme Court, however in November 2023, the apex court upheld the validity of the provisions stating it irrefutably constitutional putting an end to the widespread chaos and allegations.

Insolvency Resolution Process (“IRP”) against the personal guarantors under the Code

It is abundantly clear from the above that currently there is no such condition precedent that the creditor shall first initiate the Corporate Insolvency Resolution Process (“CIRP”) proceedings of a corporate debtor before initiating the Insolvency Resolution Process (“IRP”) of its personal guarantors.

Section 95 of the Code states that a creditor either on its own or through the Resolution Professional (“RP”), file an application before the NCLT for initiating the IRP of a personal guarantor. Once the said application under Section 95 of the Code is filed with the NCLT, an interim moratorium under Section 96 of the Code is imposed upon the personal guarantor. The NCLT on the basis of the merit may admit or reject the said application as per the provisions of Section 100 of the Code. In case of admission of the said application by the NCLT, a moratorium under Section 101 of the Code is imposed, pursuant to which the personal guarantor is barred from transferring, alienating, encumbering or disposing of any of his assets or his legal rights or beneficial interest therein. Further, no legal proceedings can continue or be initiated against the personal guarantor in respect of any debt during the moratorium period imposed as per Section 101 of the Code.

Impact of the current legal landscape

The current legal landscape may have various impacts on the stakeholders which may include the following:On the Creditors

On the Creditors

The creditor’s confidence is likely to get advanced, providing them with a more financially secure position, as the initiation of IRP against a personal guarantor irrespective of a CIRP is initiated against the corporate debtor and will act as an additional tool in the hands of the creditors. 

On the Personal Guarantors

In the current scenario, the personal guarantors may act with more caution considering the exposure to the higher risk due to the initiation of IRP against them on the occasion of default by the corporate debtor, pursuant to which even their personal assets may be delineated, and their creditworthiness may be affected. This seems to dilute the concept of ‘corporate being separate from the owners and, limited liability of owners’, to some extent.

On Corporate Debtors

On one hand, the credit environment being supportive towards creditors to initiate the IRP against personal guarantors will provoke them to have more personal guarantees in place while offering credit to the corporates, while, on the other hand, the founders will be more conservative and calculative to offer such personal guarantees. This may lead to a situation of cash crunch or inadequacy of funds to the corporates.

Conclusion

The Code which was established with an aim to strengthen the economy of India, choosing restructuring over the insolvency of the corporate debtor affirming the liquidation to be the measures of last resort. The legal landscape in the hour is definitely a pro for creditors however it may be a con for the individuals and founders offering guarantees to their companies.  It will be interesting to see how the evolving landscape in relation to personal guarantees under the Code will navigate the economy of the country.

Blog Insolvency And Bankruptcy

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