Supreme Court upholds that IBC provisions are applicable to Personal Guarantors of Corporate Debtors

Supreme Court upholds that IBC provisions are applicable to Personal Guarantors of Corporate Debtors

The Supreme Court has ruled that approval of a resolution plan does not ipso facto discharge a personal guarantor (of a corporate debtor) of her or his liabilities under the contract of guarantee.

A bench of Justices L Nageswara Rao and Ravindra Bhat held that approval of a resolution plan relating to a corporate debtor does not operate so as to discharge the liabilities of personal guarantors (to corporate debtors).

A bunch of petitions were filed challenging a Central Government notification dated 15 November 2019, concerning the validity of the Insolvency and Bankruptcy (Application to Adjudicating Authority for Insolvency Resolution Process for Personal Guarantors to Corporate Debtors) Rules, 2019.

The main contention by the Petitioners was 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 Insolvency and Bankruptcy Code (Code). It was also contended 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. The Central Government's move to enforce Sections 78, 79, 94 to 187, etc. only in relation to personal guarantors to corporate debtors is an exercise of legislative power wholly impermissible in law and amounts to an unconstitutional usurpation of legislative power by the Executive.

The petitioners also argued that the impugned notification, to the extent it brings into force Section 2 (e) of the Code with effect from 01.12.2019 is hit by non-application of mind.

According to the Court, "The Parliamentary intent was to treat personal guarantors differently from other categories of individuals. 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. The fact that the process of insolvency in Part III is to be applied to individuals, whereas the process in relation to corporate debtors, set out in Part II is to be applied to such corporate persons, does not lead to incongruity."

It went on to hold that there appear to be sound reasons why the forum for adjudicating insolvency processes – the provisions of which are disparate- is to be common, i.e through the NCLT. As was emphasized during the hearing, the NCLT would be able to consider the whole picture, as it were, about the nature of the assets available, either during the corporate debtor's insolvency process, or even later; this would facilitate the CoC in framing realistic plans, keeping in mind the prospect of realizing some part of the creditors' dues from personal guarantors.

The Apex Court observed, "It is held that the impugned notification is not an instance of legislative exercise, or amounting to impermissible and selective application of provisions of the Code. There is no compulsion in the Code that it should, at the same time, be made applicable to all individuals, (including personal guarantors) or not at all. There is sufficient indication in the Code- by Section 2(e), Section 5(22), Section 60 and Section 179 indicating that personal guarantors, though forming part of the larger grouping of individuals, were to be, in view of their intrinsic connection with corporate debtors, dealt with differently, through the same adjudicatory process and by the same forum (though not insolvency provisions) as such corporate debtors.

The notifications under Section 1(3), (issued before the impugned notification was issued) disclose that the Code was brought into force in stages, regard being had to the categories of persons to whom its provisions were to be applied. The impugned notification, similarly inter alia makes the provisions of the Code applicable in respect of personal guarantors to corporate debtors, as another such category of persons to whom the Code has been extended. It is held that the impugned notification was issued within the power granted by Parliament, and in valid exercise of it. The exercise of power in issuing the impugned notification under Section 1(3) is therefore, not ultra vires; the notification is valid."

The next issue before the Court was that the impugned notification, by applying the Code to personal guarantors only, takes away the protection afforded by law. Reference was made to Sections 128, 133 and 140 of the Contract Act and the petitioners submitted that once a resolution plan is accepted, the corporate debtor is discharged of liability. As a consequence, the guarantor whose liability is co-extensive with the principal debtor, i.e. the corporate debtor, too is discharged of all liabilities.

It was therefore urged that the impugned notification which has the effect of allowing proceedings before the NCLT by applying provisions of Part III of the Code, deprives the guarantors of their valuable substantive rights.

The Court observed 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. As to the nature and extent of the liability, much would depend on the terms of the guarantee itself.

The Court concluded that that approval of a resolution plan does not ipso facto discharge a personal guarantor (of a corporate debtor) of her or his liabilities under the contract of guarantee. Further, the release or discharge of a principal borrower from the debt owed by it to its creditor, by an involuntary process, i.e. by operation of law, or due to liquidation or insolvency proceeding, does not absolve the surety/guarantor of his or her liability, which arises out of an independent contract.

Misha, Partner at Shardul Amarchand Mangaldas & Co. stated, "The Supreme Court has upheld the government notification, bringing into effect the provisions in relation to personal insolvency in respect to personal guarantors to corporate debtors. The Constitutional validity of notification of such provisions only to one category of individuals i.e. personal guarantors was challenged before the Supreme Court by way of several writ petitions. The Supreme Court while pronouncing its decision upholding the validity of the said notification, also held that upon approval of a resolution plan for a corporate debtor, the liability of the personal guarantor for the balance does not get extinguished. This will help settling the jurisprudence finally on simultaneous initiation and proceeding with insolvency resolution process against principal borrower and guarantors or co-guarantors/co-obligors as well."