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POSITION OF PERSONAL/CORPORATE GUARANTORS IN AN INSOLVENCY & BANKRUPTCY PROCESS

Introduction

India is a country that is still developing and to boost this development, at the very core of it, is commercial activities and businesses which originate in the Indian subcontinent itself. The Government of India has also realized the importance of startups and have recognized the same. The Government of India has also to boost the startup culture have brought in several new plans and programs and one of the most prominent ones among them is revamping the legal compliance process along with the resolution of a dispute. This is where the Insolvency and Bankruptcy Code came in, in the year 2016 which was drafted precisely keeping in mind the position of all the major stakeholders who are involved in a commercial enterprise.

It is a no brainer that for a business to run funds are required and startups and businesses which aren’t listed cannot essentially obtain money from the public because for a company to be listed, it has to have a certain amount of turnover which is not possible for a company to have at the very inception. Hence, these enterprises choose to get the funds in the form of a loan from several sorts of creditors. Now, in India, the lending process has been such that the banks obtain collaterals and also in certain cases, personal guarantees from the promoter(s) of the company who is seeking the credit facilities.

Discussion

The eighth chapter of the Indian Contract Act, 1872 deals with the provisions relating to the Contract of Guarantee. Section 128 of the Indian Contract Act, 1872, lays down that “The liability of the surety is coextensive with that of the principal debtor unless the contract otherwise provides it[1]. This is the principal tenet of contract law which adjudicates the entire relationship between a principal borrower and a corporate/personal guarantor. The third part of the Insolvency and Bankruptcy Code, 2016 contains provisions relating to personal guarantors. In spite of this, since the inception of this code, there have been several instances wherein the Supreme Court had to decide several matters relating to corporate/personal guarantors and their relation and liability to the principal borrower when an Insolvency and/or a bankruptcy process is initiated. One of the major contentions that were brought before the Supreme Court was whether or not the moratorium under section 14 of the IBC is applicable to the guarantor of a corporate debtor who is going through the process of Corporate Insolvency Resolution. Section 14 of the IBC 2016 provides for “declaration of a moratorium by adjudicating authority during which period there shall be a prohibition in place on the institution and/or continuation of suits or proceedings against the corporate debtor with regard to transferring, alienating or disposing of any assets as well as any action to foreclose, recover or enforce any security interest created by the corporate debtor in respect of his property[2].

The question mentioned above was settled by the Supreme Court in the case of State Bank of India v. V. Ramakrishnan.[3] In this judgment dated August 14, 2018, The Hon’ble Supreme Court clarified that the moratorium is applicable only to the corporate debtor and not the personal guarantors. The court while delivering this judgement relied on the report of the Insolvency Law Committee dated 26th March 2018. The Committee in its report had clarified that “under section 14 of the IBC, the moratorium shall only be applicable to the assets of the corporate debtor and that the assets of the corporate guarantor shall remain out of the scope of the moratorium u/s 14”. The Court, in this case, noted that, “the creditor may go against either the principal debtor, or the guarantor, or both in no particular sequence”. The court also noted that the corporate guarantors cannot escape the coextensive liability as enshrined under section 128 of the Indian Contract Act, 1872.

Another significant question that arose with respect to the position of the corporate guarantor was that whether or not the process of Corporate Insolvency Resolution can be initiated against a corporate guarantor if the principal borrower is not essentially a “Corporate debtor or a Corporate person”.  To clarify this abovementioned point, the National Company Law Appellate Tribunal (NCLAT) decided that “it is not at all necessary to initiate CIRP against the Principal borrower before CIRP can be initiated against the corporate guarantor”. However, in the same decision, the NCLAT also held that if there is more than one guarantor to the same debt, then CIRP cannot be initiated against both of them or all of them simultaneously with respect to the same debt. Sub-section 2 of section 60 of the IBC 2016 mentions that “where CIRP or liquidation proceeding of the corporate debtor is pending before a National Company Law Tribunal (NCLT) an application relating to the insolvency resolution or liquidation or bankruptcy of a corporate guarantor or personal Guarantor, as the case may be, of such corporate debtor shall be filed before the NCLT”. Moreover, subsection 3 of section 60 of the IBC 2016 mentions that “in case CIRP or liquidation or bankruptcy proceeding of a corporate guarantor or personal Guarantor, of the corporate debtor is pending in any court or tribunal, it shall stand transferred to the Adjudicating Authority dealing with CIRP or liquidation proceeding of such corporate debtor.[4]

With respect to the abovementioned sections, the Supreme Court has held in the case of State Bank of India v. Athena Energy Ventures Private Limited[5], that “simultaneous initiation of CIRP against a Principal borrower and its corporate guarantor is permissible under the IBC”. In another widely discussed judgement of Nitin Chandrakant Naik v. Sanidhya Industries LLP and Ors.,[6] the NCLAT held that “the personal property of the corporate and personal guarantors cannot be transferred during the CIRP of the corporate debtor”. This was a very welcome decision in favour of the guarantors wherein at least their liability, though coextensive, did not amount to them losing their private property on accounts of the principal borrower/corporate debtor during the CIRP process.

Conclusion

In the above-discussed judgements both the Supreme Court of India and the National Company Law Tribunal along with the NCLAT have clarified the position of the guarantors to a large extent though still there remains a lot of questions which remain unanswered but with regard to them, we shall have to wait because one fundamental principle which needs to be realized is that the IBC is a fairly new code and the jurisprudential development of the same will require time but we all can hope that as time unfurls, we will get much more clarity regarding the liability of the guarantors with respect to the insolvency and bankruptcy procedures.

Author(s) Name: Rajdeep Bhattacharjee (Symbiosis International University, Pune)

References:

[1] Indian Contract Act, 1872, Section 128

[2] Dutta V and Sachdeva M, ‘Liability of Personal Guarantors under IBC: Clearing the Smokescreen’ (ibclaw.in October 2, 2021) <https://ibclaw.in/liability-of-personal-guarantors-under-ibc-clearing-the-smokescreen-by mr-vikas-dutta-ms-mansi-sachdeva/> accessed December 20, 2021

[3] State Bank of India v. V. Ramakrishnan and Ors., AIR 2018 SC 3876

[4] Supra Note 2

[5] 2020 SCC OnLine NCLAT 774

[6] 2021 SCC OnLine NCLAT 302

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