Authors: Swarnendu Chatterjee, Managing Associate, L&L Partners and Advocate on Record, Supreme Court of India
Yashika Bhardwaj, 3rd Year student, Amity Law School, Noida
In the backdrop of notification issued by Ministry of Corporate Affairs dated November 15, 2019 which implemented Part III of the Insolvency and Bankruptcy Code the blog deals with two issues that were taken up by the Hon’ble Supreme Court in the case of Lalit Kumar Jain v. Union of India. The court while recognising the objective behind the notifying the provisions behind the Insolvency and Bankruptcy Code, primarily dealt with two questions; firstly, whether the notification was constitutionally valid and secondly, whether the notification takes away the protection of the personal guarantor accorded by law under the contract of guarantee.
Keywords- Personal Guarantors, Insolvency and Bankruptcy Code, Ministry of Corporate Affairs.
The Supreme Court’s decision in Lalit Kumar Jain v. Union of India appears to have put an end to the long-running drama of how personal guarantors are treated under the Insolvency and Bankruptcy Code, 2016 (the “Code”). The beginning of this narrative was the Ministry of Corporate Affairs’ notification on November 15, 2019 (“Impugned Notification”), which implemented provisions of Part III of the Code, that hammered out a deal for individuals solely in the context of personal guarantors to corporate debtors. As a consequence of this, banks were authorised to file bankruptcy procedures against the personal guarantor of corporate debtors. The objective was to hold promoters, directors, or, in some circumstances, the controlling chairman personally liable for loans taken out on their personal guarantee by their company. The Impugned Notification sparked a series of objections to its constitutionality before several High Courts since it targeted the promoters of the country’s largest insolvent businesses. Finally, on October 29, 2020, the Supreme Court stayed High Courts from admitting or hearing any writ petitions challenging the Impugned Notification and transferred all outstanding proceedings to itself.
The main argument against the Impugned Notification was that the Central Government lacked the authority to enforce certain sections of the Code, therefore creating a sub-category of persons outlined as personal guarantors. This argument was based on the premise that the ability to put provisions into force under section 1(3) of the Code was merely a function of conditional legislation, but the action done through the Impugned Notification was essentially legislative. To establish the extent of delegated and conditional legislation, the Court looked at a variety of cases.
It was finally decided that the executive branch was functioning well within its powers when the power bestowed to it was limited to determining when a particular provision must come into force and allowing peripheral amendments and modifications to adequately administer such law in a particular circumstance while maintaining the spirit of the legislation itself. Section 1(3) of the Code, which permitted the Central Government to decide when a particular provision would become effective, allowed the provisions of the Code to be implemented in stages from the beginning.
It was critical to establish the basic pillars for the Code’s operation, such as the regulatory body and related professional agencies, right from the start. Following that, the provisions relating to the Code’s operationalization with respect to entities such as corporations established under the Companies Act, 2013 or other special laws became effective. The Code’s gradual implementation was a conscious choice made to ensure that the Code’s objectives were met while keeping its priorities in mind. Section 2 of the Code establishes the list of entities to whom the Code applies, and the previously unamended section 2 of the Code made no distinction between particular sub-categories. Under the previously unamended section 2, personal guarantors to corporate creditors, partners of businesses, and other people were all bundled together (e). However, under the former section 60 of the Code, the adjudicatory authority for personal guarantors was to be the National Company Law Tribunal (“NCLT”), whilst the Debt Recovery Tribunal was to be the adjudicatory authority for all other people under Part III of the Code. As a result, there was an obvious discrepancy in the Code regarding the treatment of personal guarantors in comparison to other people, which was intended to be addressed by the Insolvency and Bankruptcy Code (Amendment) Act, 2018 (“2018 Amendment”).
Individuals were divided into three subcategories by the virtue of amendment in Section 2 (e) i.e., personal guarantors, partnership firms, proprietorship firms, and other individuals. This was a strategic move in line with the recommendations of the Working Group on Individual Insolvency that highlighted the inextricable link between personal guarantors and corporate debtors, and how the insolvency resolution process for corporate debtors would be incomplete without including personal guarantors.
As part of the 2018 Amendment, insolvency and bankruptcy processes pertaining to liquidation and bankruptcy in three categories, namely corporate debtors, corporate guarantors of corporate debtors, and personal guarantors of corporate debtors, were to be handled by the same tribunal, namely the NCLT. As a result, the Court determined that the 2018 Amendment aimed to simplify the resolution process by inserting section 2(e) and changing section 60(2).
As a result, the Court determined that the Impugned Notification does not constitute an improper and selective application of Code provisions. It took into consideration the Code’s gradual adoption from its origin, as well as the fact that the legislature’s objective was never for the Code to be applied uniformly to all persons at once.
In contrast, there is adequate acknowledgement in the Code by sections 2(e), 5(22), 60, and 179 that personal guarantors, despite being part of a larger group of individuals, were to be dealt with differently in light of their intrinsic connection with corporate debtors, through the same forum as to such corporate debtors.
Another issue dealt within the judgement was the parallelism between the treatment of personal guarantors under the Code and the rights of guarantors under the Indian Contract Act.
A successful resolution procedure for a corporate debtor is identical with a successful resolution plan that extinguishes all or a portion of the debt. Whereas the claims against the corporate debtor are extinguished, the same consideration is not given to the personal guarantor, as the creditor has all avenues to continue against the personal guarantor.
Section 133 of the Contract Act states that a surety is released from obligation under a contract of guarantee if the terms of the contract are changed without the surety’s consent.
Nevertheless, the Court relied on its decision in SBI v. V. Ramakrishnan& Anr., in which it stated that the text of Section 31 of the Code made the authorised plan obligatory on the guarantor. The Court correctly ruled that acceptance of a resolution plan does not ipso facto release a personal guarantor from their obligations under the guarantee contract; because the Code’s extinguishment of the corporate debtor’s obligation was the consequence of an involuntary procedure, i.e., by operation of law or owing to liquidation or insolvency action, it could not discharge the surety of their duty arising from an independent contract. The Hon’ble Court dismissed all the transferred cases and petitions as it ruled that the contested notification is legitimate and does not violate the Code.