LALIT KUMAR JAIN V. UNION OF INDIA: Uncertain Future for Personal Guarantors Under IBC
Background and Judgment
On November 15, 2019, the Central Government issued a notification invoking Part III of the Insolvency and Bankruptcy Code 2016 (“IBC”), which empowered the creditors to start insolvency proceedings against the personal guarantors. This notification paved the way for creditors to file insolvency procedures against the personal guarantors of corporate debtors. Simultaneous proceedings against personal guarantors and corporate debtors can be initiated as a result of this notification. This can result in an elevated personal risk for guarantors as well as unjust enrichment for creditors if they file for the same set of claims against corporate debtors and personal guarantors simultaneously. It led to multiple suits in various courts and tribunals, resulting in contrasting and conflicting judgments. However, the recent case of Lalit Kumar Jain v. Union of India put to rest all the conflicting views.
The case dealt with the following two principal issues.
1. The first issue the court dealt with was whether the notification has violated section 1(3) of the IBC since it applied the Code's provisions selectively to a specific group of people, namely personal guarantors. The petitioners contended that the impugned notification is ultra vires of the Code. Under IBC, the government is not empowered to create a subcategory of individuals, i.e. personal guarantors. It was argued that IBC is a conditional legislation, as indicated from Section 1(3) of the Code. Therefore, the government is not empowered to modify the provisions of Part III of the IBC. The petitioner relied on the judgment pronounced in the case of Sardar Inder Singh v. the State of Rajasthan, wherein the court held that when the legislation is complete in itself, the executive can only determine the time and manner of its application. It cannot make a law that is outside the ambit of the powers conferred to it. However, the court rejected all the contentions and ruled that the notification was not an instance of misuse of legislative powers. The court held that the impugned notification was not ultra vires of Section 1(3) of the Code.
2. The second issue talked about was the approval of the resolution plan by the adjudicating authority discharging the liability of personal guarantors as well. The arguments of the petitioner rested upon the fact that the impugned notification of 2019 is also violative of the Indian Contract Act, 1872 (“ICA”). According to the Section 128 of the ICA, the liability of the guarantor is co-extensive with that of the debtor. Therefore, the acceptance of the resolution plan should extinguish the liability of the personal guarantors as well. Additionally, Section 31 of the IBC states that the Adjudicating Authority's resolution plan is binding for corporate debtors, creditors, and guarantors. InKundanlal Dabriwala v. Haryana Financial Corporation, it was decided that as the liability of the guarantor is co-extensive with that of the principal debtor, the accountability of the guarantor is also extinguished upon the extinguishment of the liability of the debtor.
Furthermore, in Dr. Vishnu Kumar Agrawal v. Piramal Enterprises, the court held that "for the same set of debts, a claim cannot be filed, by the same financial creditor in two separate corporate insolvency resolutions processes." However, the court rejected this argument and relied upon the judgement of SBI v. V Ramakrishnan and Maharashtra State Electricity Board Bombay v. Official Liquidator. The court ruled that approval of the resolution plan would not ipso facto discharge the guarantor of his liability. The Supreme Court has held that discharge of debt by the principal debtor through an involuntary process does not mitigate the liability of a personal guarantor who's a part of a separate contract altogether.
While the judgement cleared the air regarding the status of implementation of Part III of the Code and opened new avenues for the creditors to claim their money, it has left a lot of questions regarding the insolvency proceedings open-ended. It has generated several concerns for the personal guarantors such, as the lack of subrogation rights and double-dipping, which are detailed below.
1. Double-dipping- A personal guarantor's liability is co-extensive to that of a corporate debtor according to section 128of the ICA. In the case of State Bank of India v. M/s. Athena Energy Ventures Pvt. Ltd., NCLAT relied on the case of SBI v. Ramakrishnan and held that there is no prohibition under the IBC to file for simultaneous applications against both the personal guarantor and principal debtor. Simultaneous applications can be filed under sections 60(2) and 60(3), against the same borrower and same claim and it can also be maintained under the IBC regime. In the instant case, the Supreme Court has held that discharge of debt by the principal debtor through an involuntary process does not mitigate the liability of a personal guarantor who's a part of a separate contract altogether. It was held that the objective of IBC is not to aid the personal guarantors to run away from their liabilities. Thus, the judgement opens new avenues for the creditor to simultaneously proceed against both the principal debtor as well as personal guarantor. It might unjustly enrich the creditor if it decides to proceed against both the parties simultaneously for the entire amount.
2. Absence of Rights of Subrogation for the Guarantor- Section 140 of the ICA provides for the right of subrogation. As per this section, a guarantor has a right of subrogation for the debt amount paid on behalf of the principal debtor. The Supreme Court in the instant case affirmed the case of SBI v. Ramakrishnan, where it was held that the liability of the guarantor isn't extinguished after the liability of the principal debtor is discharged after an involuntary process. It was stated that IBC's aim was not to allow the personal guarantor to escape their liability once the resolution plan gets approved. According to the case of Committee of Creditors of Essar Steel India Limited v. Satish Kumar Gupta and Others, once the resolution plan is approved by the adjudicating authority, it becomes obligatory on all the parties including, personal guarantors. Further, this judgment also made it apparent that the rights of subrogation of guarantors cannot be used after the resolution plan is adopted as it produces a negative influence on the clean slate idea, which is the notion that forms the foundation of the resolution process. This, in turn, leaves the creditors with no remedy whatsoever once the resolution plan is approved, thereby putting them in a disadvantageous position.
3. Non- fulfillment of requirements of section 1(3) - The authors are of the opinion that the judgement was silent on the requirements under section 1(3) of the Code that were not met within the notification. The court clearly emphasized the intent of parliament to allow a smooth insolvency process by making the same forum for filing applications for both personal guarantors and corporate debtors. However, it did not delve into the proviso of section 1(3), which was the main contention of the Petitioners. They contended that the section only allowed the government to set different dates for the enforcement of provisions and not to decide the application of provision on only a certain kind of individuals, i.e. personal guarantors. Section 1(3) makes it clear that the government shall only decide the dates on which different provisions may apply and not the kind of people it may apply to. It meant that the government was only authorized to select the date on which Part III of the IBC was to be implemented and does not have the authority that Part III was to be applied on personal guarantors alone. Therefore, the government had exceeded the powers given to it by the proviso.
The current judgement aims to further the objectives and purposes of the 2016 IBC. The court has endeavored to introduce a more elaborate mechanism for debt collection by holding personal guarantors liable through this decision. The judgment aims to protect creditors' interests by permitting them to take action against both the corporate debtor and personal guarantors.
The judgement made it clear that the impugned notification is not an instance of misuse of legislative powers. The impugned notification broadens the scope to include personal guarantors. The applicability of the provisions to different classes of people at different times was done to ensure that the objectives of the IBC regime are fulfilled. However, the Court did not delve into the proviso of section 1(3). The petitioners contended that the section only allowed the government to set different dates for the enforcement of provisions and not to decide the application of provision on only a certain kind of individuals. Additionally, it was contended that according to the Section 128 of the ICA, the liability of the guarantor is co-extensive with that of the debtor. Therefore, the acceptance of the resolution plan should extinguish the liability of the personal guarantors. In Kundanlal Dabriwala v. Haryana Financial Corporation, it was decided that due to co-extensive liability of debtors and personal guarantors, the accountability of the guarantor is extinguished upon the extinguishment of the liability of the debtor. The court ruled that approval of the resolution plan would not discharge the guarantor of his liability. The Court has held that discharge of debt by the principal debtor through an involuntary process does not mitigate the liabilities of a personal guarantor, who is a party to a different contract.
While the ruling aims to improve the efficiency of insolvency processes, it may also have some negative implications. In this case, the Court held that the personal guarantor's liability cannot be discharged through an involuntary process i.e., discharge of debt by the corporate debtor when the personal guarantor is a part of a separate contract. Further, this judgment also states that the rights of subrogation of guarantors cannot be used after the resolution plan is adopted as it produces a negative influence on the clean slate idea, which states that once the resolution plan is approved by the adjudicating authority, it becomes obligatory on all the parties including, personal guarantors. While the judgement benefits creditors, and there may be fewer defaults on the part of personal guarantors, personal guarantors may be unwilling to be a party to a contract where their subrogation rights are lost, and they have no avenue of recovering their money. As a result, the available sources of finance might be reduced.