21 May 2121

Approval of a resolution plan relating to a corporate debtor does not operate to discharge the liabilities of personal guarantors (to corporate debtor) - Supreme Court of India

Case : Lalit Kumar Jain v. Union of India & Ors. Transferred Case (Civil) No. 245/2020

Court : Supreme Court of India

Bench : Justice L. Nageswara Rao and Justice S. Ravindra Bhat

Decided on : 21 May 2121

Relevant Statutes

Article 32, 143, 246, 240, 304(b) of the Constitution of India

Section 1(3), 2(a) to(g), 3(7), 3(8), 3(23), 5(1), 5(5)(a), 6 to 32, 13(a), 14(3), 14(b), 15(c), 31(1), 29A, 33 to 44, 54, 60(1) to (4), 78, 78(3), 79, 94 to 187, 196, 197, 223, 227, 228, 229, 234, 235, 238, 239(1), 239(g) to (l), 239(2)(m) to (zc), 239(2)(zn) to (zs), 243, 244, 246-248, 249, 250-252 of the Insolvency and Bankruptcy Code, 2016

Section 3(7),7, 29, 128, 133, 134, 135, 136, 137, 138, 139, 140, 141, 145 of Indian Contract Act, 1872

Insolvency and Bankruptcy Code (Amendment) Bill, 2017

section 408 of the Companies Act, 2013

Section 1(3) of the Bihar Maintenance of Public Order Act, 1948

Delhi Laws Act, 1912

Section 2 of the Part ‘C’ States (Laws) Act, 1950

The Bombay Agricultural Debtors' Relief Act, 1947

Section 4 of the Bombay City Civil Courts Act

Rajasthan Tenancy Act No. III of 1955

Section 3(d), 16(1), 16(2), 16(2)(a), 16(2)(b), 14(1)(c), of the Drug and Magic Remedies (Objectionable Advertisement) Act, 1954

East Punjab Urban Rent Restriction Act, 1949

Chandigarh by the East Punjab Urban Rent Restriction Act (Extension to Chandigarh) Act 1974

Section 3 of the Ordinance that the Rajpramukh issued the impugned notification, and not as the legislative authority of the State

Section 3(1) of the Orissa Estates Abolition (Amendment) Act, 1952

Section 1(3) of the Employees State Insurance Act

Section 2 of the Part C States (Laws) (Act), 1950

Presidency Towns Insolvency Act, 1909 and the Provincial Insolvency Act, 1920.

Brief Facts & Procedural History

1. On 15th November 2019, a notification was issued by the Ministry of Corporate Affairs which bought into force Part III of the Insolvency and Bankruptcy Code, 2016 as per which insolvency against the personal guarantors to the Corporate Debtor could be initiated.

2. The Petitioner brought to light several issues, including the fact that on November 15, 2019, the Ministry of Corporate Affairs issued a notification enforcing Section 2(e), Section 78, 79, 94-187, 238(2)(g) (h) (i), 239(2)(m) to (zc); 238(2) (zn) to (zs) and Section 249 of the Insolvency and Bankruptcy Code, 2016 from December 1, 2019, in the exercise of the powers conferred by Section 1(3) of the Insolvency and Bankruptcy Code, 2016. The aforementioned restrictions, however, were only implemented in the case of personal guarantors to corporate debtors.

3. The Petitioners also argued that under Section 1(3) of the Insolvency and Bankruptcy Code, 2016 the Central Government cannot notify parts of the Insolvency and Bankruptcy Code, 2016 or limit the application of provisions to specific categories of persons and that the power delegated under Section 1(3) of the Insolvency and Bankruptcy Code, 2016 is only about when the various provisions of the Insolvency and Bankruptcy Code, 2016 can be brought into effect. The Notification was consequently ultra vires since only the rules relating personal guarantors to corporate debtors were implemented.

4. It was also arbitrary and unfair to apply only to personal guarantors. It was pointed out that Part III of the Insolvency and Bankruptcy Code, 2016 covers solely “Insolvency Resolution and Bankruptcy for People and Partnership Firms,” and that personal guarantor are explicitly excluded from the definition of individuals under Section 2(g) of the Insolvency and Bankruptcy Code, 2016. Furthermore, Section 95 of the Insolvency and Bankruptcy Code, 2016 allows a creditor to invoke specific provisions in Part III of the Insolvency and Bankruptcy Code, 2016 that allow the insolvency resolution process to be initiated against a personal guarantor, and thus the notification, which alludes to the contrary, is ultra vires and liable to be set aside.

5. Another irrelevant argument was that the notification, by extending the code to personal guarantors, simply removes the legal protection; Sections 128, 133, and 140 of the Indian Contract Act, 1872 were cited. Except to the degree recognized in the bankruptcy resolution process itself, it was argued that the personal guarantor's obligation is co-extensive with that of the corporate debtor. Section 31 of the Insolvency and Bankruptcy Code of 2016, which makes the Adjudicating Authority's resolution plan obligatory on the corporate debtor, its creditors, and guarantors, demonstrates this.

6. The notification was challenged in various High Courts, afterwards, the Hon'ble Supreme Court of India issued an order prohibiting the High Courts from admitting or hearing any writ petitions challenging the notification, and transferring all matters pending before the High Courts to the Hon'ble Supreme Court of India. The primary reasons for the challenge were that the Central Government lacked the authority to enforce certain portions of the law or to create a new category of personal guarantors.

The Issue of the Case

Whether the impugned notification dated 15 November 2019 issued by the Ministry of Corporate Affairs valid?

The Observations of the Court

1. Referring to case Rajendra K. Bhutta v. Maharashtra Housing and Area Development Authority, (2020) 13 SCC 208, according to Section 60(2) of the Insolvency and Bankruptcy Code, 2016 the insolvency process or liquidation of three categories of debtors, namely corporate debtors, corporate guarantors to corporate debtors, and personal guarantors to corporate debtors, is to be applied distributively, implying that insolvency resolution or liquidation process applies to corporate guarantors, whereas insolvency or bankruptcy process applies to personal guarantors who can't be subjected to liquidation.

2. Honourable Supreme Court of India observes that the concept of the law has always considered the foreign assets of a corporate debtor or its guarantor in a synonymous/identical manner following a comprehensive study of sections 234 and 235 of the Insolvency and Bankruptcy Code, 2016. This is in the framework of an insolvency proceeding, which focuses on sending letters of request to courts and authorities in other countries with the express purpose of dealing with assets within their jurisdiction.

3. Honourable Supreme Court of India also observes that the impugned notification authorizes the Central government and the board to establish a framework for allowing pending proceedings against a personal guarantor or corporate debtor to be heard by the Adjudicating Authority. The stated goal of the notification is to allow unresolved cases to be resolved by the Insolvency and Bankruptcy Code, 2016. The repeal of personal insolvency laws is mentioned in Section 243 of the Insolvency and Bankruptcy Code, 2016 but it has not yet been notified. In the case of a pending resolution or liquidation proceeding against a corporate debtor, Section 60(2) of the Insolvency and Bankruptcy Code, 2016 requires the personal guarantor of the corporate debtor to apply for resolution or bankruptcy with the National Company Law Tribunal in charge of the resolution process. In the event of personal guarantors, the Adjudicating Authority will be the National Company Law Tribunal if a simultaneous resolution procedure or liquidation procedure is underway for the corporate debtor for whom the guarantee is offered. When a personal guarantor is the subject of an insolvency or bankruptcy proceeding in a court or tribunal, and a resolution or liquidation proceeding is initiated against the corporate debtor, the same rationale applies under Section 60(3) of the Insolvency and Bankruptcy Code, 2016. If A, an individual, is the subject of a DRT resolution process and has offered a personal guarantee for a debt owed by a company B, the provision causes the DRT proceedings against A to be moved to the National Company Law Tribunal if a resolution process against B is initiated in the National Company Law Tribunal.

4. Honourable Supreme Court of India also observes that before the 2018 change, the Central Government had enough legal guidelines to distinguish and categorize personal guarantors from other persons. Sections 5(22), 60, 234, 235, and Section 60 (as modified) of the Insolvency and Bankruptcy Code, 2016 all indicate this. The court in State Bank of India v. V. Ramakrishnan (2018) 17 SCC 394, addressed the implications of several sections of the Code and how they apply to personal guarantors.

5. Honourable Supreme Court of India also observes that the court was fully aware that the modification was intended to strengthen the corporate insolvency procedure in terms of the introduction of Section 2(e) of the Insolvency and Bankruptcy Code, 2016 and the revision of Section 60(2) of the Insolvency and Bankruptcy Code, 2016. Simultaneously, because the Code did not apply to persons (including personal guarantors), the court had no chance to consider the implications of using the power under Section 1(3) of the Insolvency and Bankruptcy Code, 2016 in putting such provisions into force in the context of personal guarantors.

6. Honourable Supreme Court of India also observes that Parliament intended to treat personal guarantors differently from other sorts of people. Personal guarantors were classified as a separate type of person due to their close relationship with the corporate entities for whom they provided a guarantee, as well as the possibility of two separate processes taking place in different forums, each with its own set of uncertain results and outcomes. The fact that the insolvency procedure stated in Part III of the Insolvency and Bankruptcy Code, 2016 will apply to people while the process indicated in Part II of the Insolvency and Bankruptcy Code, 2016 will apply to corporate debtors creates no discrepancy. On the other hand, even though their provisions are different, there appear to be strong reasons for a common venue for adjudicating insolvency procedures. Given the aforesaid, it was decided that the impugned notification is neither a legislative exercise nor does it lead to incorrect and selective execution of the Code’s provisions. There is no obligation in the Insolvency and Bankruptcy Code, 2016 that the application of the code should be introduced to all persons. 

7. Honourable Supreme Court of India also observes that “All creditors and other classes of claimants, including financial and operational creditors, those entitled to statutory dues, workers, etc., who participate in the resolution process, are heard and those about whom the Committee of Creditors accepts or rejects pleas, are entitled to vent their grievances before the NCLT. After considering their submissions and objections, the resolution plan is accepted and approved. This results in finality as to the claims of creditors, and others, from the company (i.e., the company which undergoes the insolvency process). The question which the petitioners urge is that given this finality, their liabilities would be extinguished; they rely on Sections 128, 133, and 140 of the Indian Contract Act, 1872 to urge that creditor cannot, therefore, proceed against them separately”. The justification for allowing directors to attend Committee of Creditors meetings is that the directors' guarantee duty to creditors remains in place, and an authorized resolution plan can only result in a change in the total amount's value or exposure. This court dismisses the surety's liability owing to a discrepancy in contract conditions without her or his approval under Section 133 of the Indian Contract Act, 1872. As a result, it is apparent that the approval of a resolution plan and the finality conferred on it by Section 31 of the Insolvency and Bankruptcy Code, 2016 do not, in and of themselves, relieve the guarantor's obligations. The form and scope of the responsibility would be largely determined by the guarantee's terms. This court, on the other hand, has repeatedly stated that involuntary conduct of the primary debtor resulting in the loss of security does not free a guarantor of duty. Given the foregoing, it was determined that acceptance of a resolution plan does not ipso facto relieve a personal guarantor (of a corporate debtor) of her or his contractual obligations. The release or discharge of a principal borrower from its debt owed to its creditor by an involuntary process, such as by operation of law or due to liquidation or insolvency proceedings, does not absolve the surety/guarantor of his or her liability arising out of an independent contract, according to this court.

8. Referring to the case Vijay Kumar Jain v. Standard Chartered Bank 2019 SCC Online SC 103, Section 31(1) of the Insolvency and Bankruptcy Code, 2016 and the regulation makes it clears that the guarantors are interested in the resolution plan as it binds them.

9. Referring to the case Maharashtra State Electricity Board Bombay v. Official Liquidator, High Court, Ernakulum & Anr. 1982 (3) SCC 358, the obligation of the guarantor (in a case where the primary debtor's responsibility was discharged under the bankruptcy law or the company law) was examined. Because there is no discharge under Section 134 of the Indian Contract Act, it was determined that the guarantor's responsibility remains as a result of the unambiguous promise, and the creditor can collect it from the guarantor based on the language of Section 128 of the Contract Act.

The Decision Held by the Court

1. Honourable Supreme Court held that the impugned notification was issued within the power granted by Parliament and invalid 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.

2. The objective of the Insolvency and Bankruptcy Code, 2016 is not to allow such guarantors to escape from an independent and coextensive liability to pay off the entire outstanding debt, which is why Section 14 of the Insolvency and Bankruptcy Code, 2016 is not applied to them.

3. Honourable Supreme Court held 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. As held by this court, 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 contractor.

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