Reconciling The Discrepancies In Initiating IRP Against Personal Guarantors

The law of insolvency is still in its nascent stage in India. Since its inception, it has constantly been evolving and expanding its various facets. One such is the initiation of the Insolvency Resolution Process (“IRP”) against the Personal Guarantor of a Corporate Debtor (“CD”) before the adjudicating authority viz., the National Company Law Tribunal (“NCLT”), under Section 95(1) of Insolvency and Bankruptcy Code, 2016 (“IBC”). This has been crucial and beneficial for the creditors in enforcing the contract of surety.

The genesis is guarantor agreements find a place in Chapter VIII of the Contracts Act. A “contract of guarantee” is a contract to perform the promise or discharge the liability, of a third person in case of his default. In this regard, the Ministry of Corporate Affairs gave effect to the provision relating to personal guarantors vide notification dated 1 December 2019, along with the Rules thereof.  It defines a guarantor as a “debtor who is a personal guarantor to a corporate debtor and in respect of whom the guarantee has been invoked by the creditor and remains unpaid in full or part”. The Code sets out that NCLT shall be the adjudicating authority for insolvency resolution and liquidation of corporate persons, including personal guarantors to CDs.

Nevertheless, there has been ambiguity in determining when an application of IRP can be against Personal Guarantor by different NCLTs. The Supreme Court discusses and upheld the constitutional validity of these provisions and re-established the co-extensive liability of the personal and corporate guarantors in insolvency proceedings.

Is Pendency of CIRP a Pre-requisite for Proceeding against Personal Guarantor?

The Apex Court has ruled in Mahendra Kumar Jajodia v. State Bank of India that proceeding against personal guarantors is independent, and pending CIRP with the CD is not a pre-requisite. This has come a long way after several contradicting orders by NCLTs in different jurisdictions. Some argued that the very purpose of bringing the personal guarantor within the jurisdiction of the NCLT was that it should consider the whole picture while determining the IRP of the CD, and proceeding against personal guarantors without initiating/ pending CIRP would go against the legislative intent of the provisions.

However, Madras High Court laid down in Mr. Rohit Nath v. KEB Hana Bank that initiation of IRP against personal guarantors the adjudicating authority (NCLT) can be admitted, even in absence of a CIRP/ liquidation. The Hon’ble NCLAT has unconditionally held that there is no need to initiate the CIRP against the CD before initiating IRP against the Corporate or Personal Guarantor. These issues were considered in PNB Housing Finance Ltd. V. Mr. Mohit Arora and Ors. Interpreting Section 128, the Court held that surety’s liability cannot be deferred until the creditor exhausted his remedies against the principal borrower (the CD). The contents of Section 60 (1), (2), & (3) indicate three different circumstances in which an application to AA can be made to initiate IRP, which is exclusive of the other.

Dispelling the Incongruity Argument: Mahendra Kumar Case

The tussle over the CIRP or liquidation proceeding against a CD as a condition for initiating IRP proceedings against a Personal Guarantor is resolved. The Court resolved by reinstating the Lalit Kumar ratio by emphasizing that Section 65(2) does not mandate an embargo on initiating IRP against the guarantor. The NCLAT held that the very premise on which the NCT rejected the IRP application was erroneous. The NCLT held that CIRP or liquidation proceeding of a Corporate Debtor under section 95(1) is a condition mandatory for proceeding against a Personal Guarantor. However, on appeal, this was overturned and the CIRP against the Personal Guarantor was allowed, by rightly interpreting Section 65(2).

“(2) Without prejudice to sub-section (1) and notwithstanding anything to the contrary contained in this Code, where a corporate insolvency resolution process or liquidation proceeding of a corporate debtor is pending before a National Company Law Tribunal, 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 such National Company Law Tribunal.”

It merely states that when a proceeding is pending in ‘a’ NCLT, IRP against the respective Personal Guarantor should also be proceeded before ‘such’ NCLT.  The object of the clause is to prevent NCLT in different jurisdictions to take up proceedings against the Personal Guarantor simultaneously.  The legislative intent was to clarify that such a proceeding will take place before the same NCLT. It does not, in any way, restrict the jurisdiction of NCLT when no such insolvency/ liquidation proceeding is pending before it.  It is also pertinent to note that it starts as ‘without prejudice to Section 65(1), vindicating the averment of the Petitioner that it does not stand as a requirement to proceed against the Personal Guarantor. It is, rather, supplemental to Section 65(1) lays down that any proceeding against the Personal Guarantor will lie within the ambit of an appropriate NCLT. Section 65(2) comes into play only when there is a pre-existing proceeding against the Corporate Debtor, and has no relevance in this case.

This position that the creditors can independently proceed against the guarantor is a necessary extension of the co-extensive liability of the personal guarantor, reinstated in the Lalit Kumar case. In that case, since the obligation, if the surety/guarantor arises out of an independent contract, the approval of an RP by the NCLT is not sufficient to absolve their liability. In another case, the Court held that simultaneous initiation of CIRP against a CD and its guarantor is permissible under the IBC. But the Mahendra Kumar case, went a step further to hold that creditors can proceed against personal guarantors, irrespective of a pending CIRP against the CD.

Conclusion and A Way Forward

The latest development in this area is to secure the rights of personal guarantors. Recently, there is a surge of petitions before the Supreme Court u/art. 32 contesting the validity of the provision of IBC concerning personal guarantors. The main contention was the impugned provisions violate the principles of natural justice, by not providing the guarantors with the opportunity to be heard. The Writ Petition submits that the moment an application under Section 95 is filed, the interim moratorium period commences thereby, deprives the Guarantor of the right to contest it and denuding their right to raise objections on jurisdictional issues, at the very threshold of proceedings. The Supreme Court, by interim relief, stayed the RPs from submitting the statutory report before the adjudicating authority. Further, it prohibited the Petitioner to transfer, alienate, encumber, or dispose of any of his assets or his legal rights. Although the Lalit Kumar judgement upheld the right of creditors to proceed against the personal guarantors under the provisions of IBC, it did not address the specific questions involving the natural justice argument. A careful assessment of the issues and a comprehensive decision would, hopefully, clear the atmosphere of uncertainty encircling the code on personal guarantors.

Author:  Yashaswini Manasa – a student of School of Excellence in Law, in case of any queries please write back us via email at support@ipandlegalfilings.com or  IP And Legal Filings.