The Supreme Court, in a recent judgment titled Lalit Kumar Jain vs. Union of India & Others (along with numerous other matters)1, has held that a personal guarantor cannot be absolved of their responsibilities to pay back the lenders, as they are bound by separate contracts, for a corporate undergoing resolution under the Insolvency and Bankruptcy Code, 2016 (Code). It was also held by the court that the approval of a resolution plan does not ipso facto discharge a personal guarantor (of a corporate debtor) of their liabilities under the contract of guarantee.
The provisions of the Code were brought into force through different notifications issued on different dates. The Central Government issued a Notification dated 15.11.2019 (Impugned Notification)2 and the following provisions of the Code, only in so far as they relate to personal guarantors to corporate debtors, were brought into force with effect from 01.12.2019 i.e. (A) Clause (e) of Section 2; (B) Section 78 (except with regard to fresh process) and Section 79; (C) Section 94 to 187 (both inclusive); (D) Clause (g) to Clause (i) of sub-section (2) of Section 239; (E) Clause (m) to Clause (zc) of sub-section (2) of Section 239; (F) Clause (zn) to Clause (zs) of sub-section (2) of Section 240; and (G) Section 249. The primary intent in issuing the notification was to treat personal guarantors differently from other categories of individuals.
Numerous Writ Petitions were filed before various High Courts as well as before the Supreme Court, challenging the Impugned Notification and a declaration was sought that Section 95, 96, 99, 100 and 101 of the IBC are unconstitutional as they apply to personal guarantors of Corporate Debtors. Since, all the Writ Petitions had raised similar questions of law, hence, all the proceedings were transferred to the Supreme Court from various High Courts under Article 139A of the Constitution, by way of Transfer Petition and were decided together by the Supreme Court. At some stage or the other, these Writ Petitioners had furnished personal guarantees to banks and financial institutions which led to release of advances to various companies which these Petitioners were associated with as Directors, Promotors or in come instances, as Chairman or Managing Directors. After publication of the impugned notification, many Writ Petitioners were served with demand notices proposing to initiate insolvency proceedings under the Code. These demand notices were based on various counts, including that recovery proceedings were initiated after invocation of the guarantees. This led to initiation of insolvency resolution process under Part-III of the Code against some of the petitioners.
Contentions of the Writ Petitioners
The Writ Petitioners contended that the power conferred upon the Central Government under Section 1(3) of the Code could not have been resorted to in the manner as to extend the provisions of the Code only as far as they relate to personal guarantors of corporate debtors. It was argued that the powers delegated under Section 1(3) of the Code is only as regards the points in time when different provisions of the Code can be brought into effect and that it does not permit the Central Government to notify parts of the provisions of the Code, or to limit the application of the provisions to certain categories of persons. It was argued by the Writ Petitioners that the provisions of the Code brought into effect by the impugned notification are not in severable, as they do not specifically or separately deal with or govern insolvency proceedings against the personal guarantors to corporate debtors and the provision only deals with individuals and partnership firms. The main argument advanced in all the Writ Petitions is that the Impugned Notification is an exercise of excessive delegation. It is contended that the Central Government has no authority, legislative or statutory, to impose conditions on the enforcement of the Code. It is further contended as a corollary, that the enforcement of Sections 78, 79, 94-187 etc. in terms of the impugned notification of the Code only in relation to personal guarantors is ultra vires the powers granted to the Central Government.
It was argued that the impugned notification is ultra vires the provisions of the Code in so far as it notifies provisions of Part III of the Code only in respect of personal guarantors to corporate debtors. Part III of the Code governs "Insolvency Resolution and Bankruptcy for Individuals and Partnership Firms". Also, Section 2(g) of the Code defines an individual to mean "individuals, other than persons referred to in clause (e)". Section 2 (e) relates to personal guarantors to corporate debtors. A joint reading of Section 2(e) with Section 2(g) and Part III of the Code shows that personal guarantors to corporate debtors are not covered by Part II, which only deals with individuals and partnership firms, and personal guarantors to corporate debtors stand specifically excluded from the definition of individuals. 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.
Contentions of the Respondents
It was submitted by the Union of India that the Code was amended in 2018 which substituted the pre-amended definition in Section 2(e) by introducing three different classes of debtors, which were personal guarantors to corporate debtors [Section 2(e)], partnership firms and proprietorship firms [Section 2 (f )] and individuals [Section 2(g)]. The purpose of splitting the provision and defining three separate categories of debtors was to cover three separate sets of entities. The Parliament wanted to deal with personal guarantors [under Section 2(e)], differently from partnership firms and proprietorship firms [under section 2(f ),] and individuals other than persons referred to in Section 2 (e) [under Section 2(g)]. The intention was to clearly distinguish personal guarantors to corporate debtors from other individuals.
This was because Section 60 of the Code which deals with the adjudicating authority for corporate debtors too was partially amended in 2018. The amendment to Section 60(2) added that it applied to insolvency proceedings or liquidation/bankruptcy of a corporate guarantor or personal guarantor as the case may be, to a corporate debtor. The result of the amendment is that when a corporate debtor faces insolvency proceedings, insolvency of its corporate guarantor too can be triggered. Likewise, a personal guarantor to a corporate debtor, facing insolvency, can be subjected to insolvency proceedings. It was argued that if insolvency resolution proceedings against corporate debtors were continued without this amendment, and without the unification, (of the adjudicatory body) on the default of the corporate debtor to a debt owed to a financial creditor, the entire machinery of the Code relating to the corporate debtor would work itself out, to the exclusion of personal guarantors.
It was argued that Section 2(e) being complete and distinct and is a provision within the meaning of Section 1(3), and the Central Government acted intra vires to bring it into force, as well as certain provisions in Part III of the code. It was argued that the executive has the power to bring into force any one provision of a statute at different times for different purposes, and that the government can exercise this power to commence a provision for one purpose on one day and for the remaining purposes on a later date. The Central Government relied upon Basant Kumar Sarkar v. Eagle Rolling Mills Ltd.3 and Bishwambhar Singh v. State of Orissa.4
It was argued that the Bankruptcy Law Reforms Committee (BLRC) also recognized that personal guarantors were a category of entities to whom individual insolvency proceedings applied and acknowledged the link between them and corporate debtors and found that under a common Code, there could be synchronous resolution. It was argued that common oversight of insolvency processes of the corporate debtor, its corporate guarantor, and personal guarantors, through one forum, under the Code, (which, by reason of Section 238, overrides all other laws), was the objective of the amendment of 2018 and the impugned notification. It was further pointed out that as per Section 30 an Adjudicatory authority approved resolution plan binds all stakeholders. However, at the same time, in the event a resolution plan permits creditors to continue proceedings against the personal guarantor, then such personal guarantors would continue to be liable to discharge the debts owed to the creditor by the corporate debtor, which would be limited of course to the extent of debt that did not get repaid under the resolution plan. The judgment of Supreme Court in Embassy Property Developments (P) Ltd. v. State of Karnataka5, was relied upon where the court had examined and dealt with the interplay between Sections 5(22), 60 and 179 of the Code.
The Supreme Court after relying upon numerous judgements citied by all the parties, observed that the method adopted by the Central Government to bring into force different provisions of the Act had a specific design viz. to fulfill the objectives underlying the Code, having regard to its priorities. It was observed that before the amendment of 2018, all individuals (personal guarantors to corporate debtors, partners of firms, partnership firms and other partners as well as individuals who were either partners or personal guarantors to corporate debtors) fell under one descriptive description under the unamended Section 2(e). Further, it was observed that the unamended Section 60 contemplated that the adjudicating authority in respect of personal guarantors was to be the NCLT. It was observed by the Supreme Court that having regard to the fact that Section 2 brought all three categories of individuals within one umbrella class as it were, it would have been difficult for the Central Government to selectively bring into force the provisions of Part –III only in respect of personal guarantors. Accordingly, it was observed that the Central Government heeded the reports of expert bodies which recommended that personal guarantors to corporate debtors facing insolvency process should also be involved in proceedings by the same adjudicator and for this, necessary amendments were required.
The Supreme Court observed that the 2018 Amendment Act altered Section 2(e) and subcategorized three categories of individuals, resulting in Sections 2(e), (f ) and (g). The amendment of 2018 also altered Section 60 in that insolvency and bankruptcy processes relating to liquidation and bankruptcy in respect of three categories, i.e., corporate debtors, corporate guarantors of corporate debtors and personal guarantors to corporate debtors were to be considered by the same forum i.e., NCLT.
The Supreme Court observed that though "personal guarantor" was not defined, and fell within the larger title of "individual" under the Code, the adjudicating authority for insolvency process and liquidation of corporate persons including corporate debtors and personal guarantors was the NCLT- even under the unamended Code. It was also observed by the Supreme Court that the 2018 Amendment clearly shows 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 court observed that the scheme of the Code always contemplated that overseas assets of a corporate debtor or its personal guarantor could be dealt with in an identical manner during insolvency proceedings, including by issuing letters of request to courts or authorities in other countries for the purpose of dealing with such assets located within their jurisdiction.
The Supreme Court held that the Impugned Notification operationalizes the Code so far as it relates to personal guarantors to corporate debtors: (1) Section 79 pertains to the definitional section for the purposes of insolvency resolution and bankruptcy for individuals before the Adjudicating Authority and (2) Sections 94 to 187 outline the entire structure regarding initiation of the resolution process for individuals before the Adjudicating Authority. The court held that the Impugned Notification authorizes the Central Government and the Board to frame rules and regulations on how to allow the pending actions against a personal guarantor to a corporate debtor before the Adjudicating Authority. The intent of the notification, facially, is to allow for pending proceedings to be adjudicated in terms of the Code. In the opinion of the court, there was sufficient legislative guidance for the Central Government, before the amendment of 2018 was made effective, to distinguish and classify personal guarantors separately from other individuals which is evident from Sections 5(22), 60, 234, 235 and unamended Section 60.
The court also held that the insolvency process in relation to corporate persons is entirely different from those relating to individuals; the former is covered in the provisions of Part II and the latter, by Part III. It was held that Section 179, which defines what the Adjudicating Authority is for individuals is "subject to" Section 60. Section 60(2) is without prejudice to Section 60(1) and notwithstanding anything to the contrary contained in the Code, thus giving overriding effect to Section 60(2) as far as it provides that the application relating to insolvency resolution, liquidation or bankruptcy of personal guarantors of such corporate debtors shall be filed before the NCLT where proceedings relating to corporate debtors are pending. Furthermore, Section 60(3) provides for transfer of proceedings relating to personal guarantors to that NCLT which is dealing with the proceedings against corporate debtors. After providing for a common adjudicating forum, Section 60(4) vests the NCLT "with all the powers of the DRT as contemplated under Part III of this Code for the purpose of sub-section (2)". Section 60 (4) thus (a) vests all the powers of DRT with NCLT and (b) also vests NCLT with powers under Part III. The Parliament, therefore, merged the provisions of Part III with the process undertaken against the corporate debtors under Part II, for the purpose of Section 60(2), i.e., proceedings against personal guarantors along with corporate debtors. Section 179 is the corresponding provision in Part III. It is "subject to the provisions of Section 60". Section 60 (4) clearly incorporates the provisions of Part III in relation to proceedings before the NCLT against personal guarantors.
The intimate connection between such individuals and corporate entities to whom they stood guarantee, as well as the possibility of two separate processes being carried on in different forums, with its attendant uncertain outcomes, led to carving out personal guarantors as a separate species of individuals, for whom the adjudicating authority was common with the corporate debtor to whom they had stood guarantee. Hence, it was held by the Supreme Court that the impugned notification is not an instance of legislative exercise, or amounting to impermissible and selective application of provisions of the Code; it was issued within the power granted by Parliament; and in valid exercise of it. Hence, the exercise of power in issuing the impugned notification under Section 1(3) is therefore, not ultra vires; the notification is valid. It was further held by the Supreme Court that the sanction of a resolution plan and finality imparted to it by Section 31 does not per se operate as a discharge of the guarantor's liability and as to the nature and extent of the liability, much would depend on the terms of the guarantee itself.
The 2019 Impugned Notification sought to make the Guarantors personally liable for that part of the debt that had remained outstanding in the resolution proposal of the companies under insolvency. Hence, if the debt owed by a company is not repaid under the resolution plan, the personal guarantor would not only not stand discharged but could find himself taken into bankruptcy proceedings by the creditors.
1. Judgment dated 21.05.2021, passed in Transferred case (Civil) No. 245/2020 along with various other Writ Petitions
2. No. S.O. 4126(E)
3. (1964) 6 SCR 913
4. 1954 SCR 842
5. (2020)13 SCC 308
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