India: Supreme Court Of India Upholds The Law For Insolvency And Bankruptcy Of Personal Guarantors To Corporate Debtors

(Approval of resolution plan in relation to a corporate debtor does not discharge liabilities of the personal guarantor - Supreme Court in Lalit Kumar Jain vs Union of India & Ors.)

A. Background

On 21.05.2021, the Hon'ble Supreme Court of India, pronounced its judgment in Lalit Kumar Jain vs. Union of India & Ors.¹ on the vires and validity of a Notification² dated 15.11.2019 (hereinafter "impugned notification") issued by the Government of India (hereinafter "Central Government"). The impugned notification brought into effect, selective provisions of Part III of the Insolvency and Bankruptcy Code, 2016 (hereinafter "IBC/ Code"). The net effect of the impugned notification was creation of a scheme for initiating insolvency resolution process under Part-III of the Code only for personal guarantors to corporate debtors (hereinafter "personal guarantors").

B. Challenge

Soon after the issuance of the impugned notification, insolvency proceedings were initiated against several personal guarantors, who had furnished personal guarantees to banks and financial institutions towards loan granted to their related companies. As such, Writ Petitions were filed under Article 32 of the Constitution of India, and before various High Courts across the country. All such cases were transferred to the Hon'ble Supreme Court under Article 139A, as they involved interpretation of common questions of law, in relation to provisions of the Code.

Additionally, vide the impugned notification, Central Government also notified Insolvency and Bankruptcy (Application to Adjudicating Authority for Insolvency Resolution Process for Personal Guarantors to Corporate Debtors) Rules, 2019 and Insolvency and Insolvency and Bankruptcy Board of India (Insolvency Resolution Process For Personal Guarantors To Corporate Debtors) Regulations, 2019. However, the challenge before the Supreme Court of India, only pertained to the impugned notification.

C. Substantive Grounds for challenge and Supreme Court's decision on the same

1. Section 1(3) of the Code, is an instance of conditional legislation

Petitioners unanimously raised the ground of Section 1(3) being an instance of conditional legislation, applicable to situations where the law having been enacted by the legislature, the executive was entrusted with the task of notifying the law, at such time, as it may decide. Petitioners contended that the impugned notification, whereby the Central Government selectively brought provisions of Part- III of the Code in operation, solely for personal guarantors and not for all individuals, in exercise of powers of delegated legislation, is impermissible in view of the principles of conditional legislation. Petitioners relied on Privy Council's judgment in Burah ³ and judgments of the Hon'ble Supreme Court in In Re Delhi Laws Act, 1912⁴, Hamdard Dawakhana⁵, Vasu Dev Singh⁶ and several other judgments.

Decision: The Court dealt with each of these judgments in detail, and inter alia observed that these judgments dealt with instances where the executive exercised carte blanche powers, in terms of extending, modifying and/ or repeal of the enactments. After considering the judgments in detail, the Supreme Court held that the impugned notification was not an instance of legislative exercise and did not amount to impermissible application of provisions of Code. The Court referred to the pattern adopted by the Central Government to gradually implement the law, which is a permissible exercise of powers under the Code⁷. Reference was made to inception of the Code and how each subsequent notification was issued in order to effectively implement the law and how the legislature has implemented the law in stages with respect to its application on different categories of persons. On the issue of whether personal guarantors can be classified distinctively and separately from other individuals, the Court referred to Sections 5(22), 60, 234 and 235 to observe that even before the Amendment of 2018 came into effect, there was clear indication in support of this distinct classification. Personal guarantors stand on a different footing owing to their intrinsic connection with corporate debtors, having provided a personal guarantee to secure the loan granted to such corporate debtors. Thus, it was held that the impugned notification was issued within the powers granted by Parliament. 

2. Impugned Notification carves out a separate species of individuals viz. personal guarantors and classifies them separately, the same being impermissible under the Code.

The Petitioners argued that Part-III of the Code governs "Insolvency Resolution and Bankruptcy for Individuals and Partnership Firms". Part III of the Code has no express provision which provides for initiation of insolvency resolution process against the personal guarantors. It was further argued that the remedies available to creditor of individuals, under the two distinct schemes under Part II and Part III, stand extinguished since insolvency resolution of personal guarantors, will now be considered along with the insolvency resolution of corporate debtor by the same Adjudicating Authority. Petitioners also raised the ground that clubbing the insolvency resolution of corporate debtor with that of personal guarantor, may lead to incongruity, as one is covered by Part II and the other falls under Part III of the Code.

Decision: The Hon'ble Court referred to the two significant amendments carried out by the Second Amendment⁸ of the Code. The Second Amendment introduced Section 2(e) and created personal guarantors to corporate debtors, as a distinct category to which the provisions of the Code were applicable. Section 60(2) was also amended by inserting the expression "or liquidation" before the words "or bankruptcy" and the expression "of a corporate guarantor... as the case may be, of" such corporate debtor. The Court interpreted the amended Section 60(2) on the lines of the maxim "reddendo singular singulis"⁹. The Court emphasized on the scheme of the Code and the intent behind the amended Section 2(e) and Section 60(2) and held that it was intended that "all matters that were likely to impact, or have a bearing on a corporate debtor's insolvency process, were sought to be clubbed together and brought before the same forum."

The Hon'ble Court further referred to Section 234 and 235 of the Code, which are the provisions dealing with cross-border insolvency issues of corporate debtor or its personal guarantor, to strengthen the point of bringing all issues relating of personal guarantors' insolvency under the Code. The Court further held that Section 179, which defined Adjudicating Authority for individuals, is subject to Section 60. Section 60(2) and Section 60(3) of the Code have the effect of providing a common adjudicating forum, for personal guarantors to corporate debtors. The next provision, which is Section 60(4) stands on two limbs- (1) it vests powers of DRT with NCLT; and (2) it also vests NCLT with powers under Part III. The Court in effect, held that Section 60(4) of Part II and Section 179 of Part III operate together to create a scheme for personal guarantors and treats them as a separate species of individuals. The underlying reason or the parliamentary intent for such differential treatment is attributable to their intrinsic connection with the corporate debtors, and also for ruling out the possibility of two separate process being carried out in different forums for the same loan transaction.

The Court held that there was a clear legislative intent to treat personal guarantors as a separate species of individual and for whom the Adjudicating Authority was common with corporate debtor to whom they had stood guarantee. The Court further upheld the rationale for providing the same forum i.e., NCLT for both corporate debtors and their personal guarantors. It was held that when the insolvency processes are carried out by the same forum, it will give a clearer picture and would facilitate the Committee of Creditors to frame realistic plans, considering the prospect of realizing some dues from the personal guarantors as well.

3. The impugned notification has the illogical effect of creating two legal regimes for personal guarantors' insolvency, as Section 243 has not been brought into force.

Since, insolvency of individuals, is covered by the Presidency Towns Insolvency Act, 1909 (hereinafter "PTI") and the Provincial Insolvency Act, 1920 (hereinafter "PIA"), and Section 243 repeals PTI and PIA, it was imperative that the same was brought into effect, before notifying Part-III provisions for personal guarantors. In this respect, Petitioners assailed the impugned notification as one suffering from non-application of mind, because the Central Government failed to bring into effect Section 243 of the Code and created two parallel legal regimes.

Decision: The Hon'ble Court opined on the rationale for not notifying Section 243 of the Code and observed that in view of the non-obstante provision under Section 238, the Code has overriding effect over other prevailing statutes. The Court referred to Section 243(2) which saves the pending proceedings under PTI and PTA and held that if Section 243 was notified, such pending proceedings would remain in the exclusive domain of these enactments. By virtue of Section 238, impugned notification effectively brings under the ambit of the code, all proceedings initiated against the personal guarantors.

4. `The impugned notification has the effect of denying their substantive rights to personal guarantors, by applying the provisions of Part III.

The Petitioners argued that an approved resolution plan in respect of a corporate debtor amounts to extinction of all outstanding claims against that debtor; consequently, the liability of the guarantor, which is co-extensive with that of the corporate debtor, would also be extinguished. The Petitioner relied upon Section 128 and other provisions of the Indian Contract Act, 1872 to augment their argument in this regard. They further referred to Section 31 of the Code in as much as the same provides for approval of resolution plan, which bounds inter alia the guarantors. In this regard, it was further argued that the resolution plans, duly approved by the Committee of Creditors would propose to extinguish and discharge the liability of the principal borrower to the financial creditor. Therefore, the petitioners' liability as guarantors under the personal guarantee would stand completely discharged.

Decision: The Court relied upon its judgment in Vijay Kumar¹⁰ wherein it was held that as per Section 31(1), the guarantor cannot escape payment as the resolution plan which has been approved may well include provisions as to payments to be made by such guarantor. The Court further relied upon its dictum in Committee of Essar Steel (I)¹¹ to hold that the sanction of approval of a resolution plan shall not per se discharge the liability of the personal guarantor. The Court also referred to its decision in Maharashtra State Electricity Board Bombay¹², a judgment given under the company laws, where it was held that the guarantor is not discharged by a discharge of principal debtor's liability on account of operation of law.

After referring to various judgments¹³ on the issue of co-extensive liability of principal debtor and guarantor, Supreme Court held that discharge of debt of principal debtor through an involuntary process, i.e., by operation of law, or due to liquidation or insolvency proceedings, does not discharge the personal guarantor of his liability which arises out of an independent contract. Thus, the Court rendered a categorical finding that approval of resolution plan does not ipso facto discharge a personal guarantor.

D. Conclusion

The present judgment has ably captured the spirit of the Code and introduced an avant garde approach to the interpretation of provisions of the Code. The judgment has strengthened the Indian insolvency regime and paved way for better revival of corporates, as is the object of the Code. The mechanism to initiate insolvency process against personal guarantors, will give more breathing space to creditors and is likely to result in more efficient and holistic resolution plans.

The law of guarantee has been rightly read into the insolvency framework. In doing so, the Court has brought personal guarantors to corporate debtors, who are generally high net worth individuals, in the clutches of law.

Footnotes

1. Lalit Kumar Jain vs Union of India, pronounced on 21.05.2021, Transferred Case (Civil) No. 245/ 2020.

2. S.O. 4126 (E) issued by the Ministry of Corporation Affairs, Central Government

3. Queen v. Burah ([1878] 5 I.A. 178)

4. In re The Delhi Laws Act, 1912 ([1951] S.C.R. 747)

5. Hamdard Dawakhana vs Union of India, 1960 (2) SCR 671

6. Vasu Dev Singh & Ors. Vs Union of India, (2006) 12 SCC 753.

7. The Hon'ble Court referred to the Supreme Court's Judgment in Bishwambhar Singh vs State of Haryana 1954 SCR 842 and Javed and Ors vs. State of Haryana and Ors. (2003) 8 SCC 369, to hold that there is no constitutional imperative that a law or policy should be implemented at once.

8. The Insolvency and Bankruptcy Code (Second Amendment) Act, 2018.

9. Meaning of "reddendo singular singulis as per Black's Interpretation of Laws: "Where a sentence in a statute contains several antecedents and several consequences, they are to be read distributively, that is to say, each phrase or expression is to be referred to its appropriate object."

10. Vijay Kumar Jain vs Standard Chartered Bank, 2019 SCC OnLine SC 103.

11. Committee of Essar Steel (I) vs. Satish Kumar Gupta, (2020) 8 SCC 531.

12. Maharashtra State Electricity Board Bombay vs. Official Liquidator, High Court, Ernakulum & Anr, (1982) 3 SCC 358.

13. Industrial Finance Corpn. of India Ltd. v. Cannanore Spg. & Wvg. Mills Ltd, (2002) 5 SCC 54; In Re Kaupthing Singer and Friedlander Ltd. (in administration), 2012 (1) All ER 883.

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