Lenders initiate insolvency proceedings against personal guarantors
With the recovery procedure under the Insolvency and Bankruptcy Code, 2016 (“Coded”) not evolving at the rate it should, the government published on November 15, 2019 a new provision empowering banks to file an insolvency request against personal guarantors, who are generally promoters of large trading houses . The intention was to hold accountable the promoters of failing companies who had provided personal guarantees for the loans taken out by their companies.
Petitions have been filed in several high courts challenging the government’s notification dated November 15, 2019, the 2019 Insolvency and Bankruptcy Rules (Application to Adjudicating Authority for Insolvency Resolution Process of Personal Guarantors to Corporate Debtors) Rules, 2019 and articles 95, 96, 99, 100, 101 of the Code as unconstitutional insofar as they apply to the personal guarantor of the debtor company. The promoters’ main argument was that they should not be held responsible for defaulting on debt alone.
In October 2020, the Supreme Court of India transferred all the written petitions pending before various high courts, and by that time, more than seventy-five (75) petitions had already been filed.
Six months after the transfer, the Supreme Court finally put an end to an abnormal situation. Recently in “Lalit Kumar Jain v Insolvency and Bankruptcy Board of India “ the judiciary composed of Justices L Nageswara Rao and Ravindra Bhat upheld the government’s notification and the code’s provisions, allowing creditors, usually financial institutions and banks, to object to personal guarantors under the code. During the hearing, Judge Ravindra Bhat observed that:
“The approval of the resolution plan relating to the debtor company does not have the effect of releasing the responsibilities of the personal guarantor.”
The preliminary argument raised by the petitioners was that the notification constituted an exercise of excessive delegation, the central government not having the power to impose conditions on the application of the code. It has further been argued that the application of some articles of the Code with regard to the disputed notification, only as regards personal guarantors, is ultra vires the powers granted to the central government. The Court, which rejected this plea, observed:
“The contested notification does not constitute a legislative exercise or does not constitute an inadmissible and selective application of the provisions of the Code. The Code does not oblige to make it at the same time applicable to all the individuals, (including the guarantors) or not at all. There is sufficient guidance in the Code – by Article 2 (e), Article 5 (22), Article 60 and Article 179 that personal guarantors, although part of the larger group of individuals, had to be, given their intrinsic link with the debtor companies, treated differently, by the same judicial process and by the same body (but not by the insolvency provisions) as these debtor companies.
In addition, agreeing with Parliament’s intention to treat personal guarantors differently from other categories of persons, the judiciary observed:
The fact that the insolvency process of Part III must be applied to natural persons, while the process relating to debtor companies, described in Part II, must be applied to such legal persons, does not lead to an incongruity.
On the other hand, there seem to be good reasons why the adjudicator of insolvency proceedings – the provisions of which are disparate – should be common, i.e. through the NCLT. As was pointed out at the hearing, the NCLT would be able to have an overview, so to speak, of the nature of the assets available, either during the insolvency proceedings of the debtor company or even later; this would make it easier for the CDC to draw up realistic plans, bearing in mind the prospect of making a part of the contributions of the creditors with the personal guarantors. “
The petitioners even argued that once a resolution plan is accepted, the debtor company is relieved of its liability. Consequently, the guarantor whose responsibility is coextensive with the principal debtor, that is to say the debtor company, is also released from all its obligations. In this regard, the Chamber reiterated the legal position that the release or release of a principal borrower from the debt that he owes to his creditor, by an involuntary process, i.e. by effect of the law, or due to liquidation or insolvency proceedings, does not exempt the guarantor / guarantor from its liability, which arises from an independent contract. On the basis of established precedents and law, the Court ruled:
“that the approval of a resolution plan does not ipso facto discharge a personal guarantor (of a debtor company) from his obligations under the guarantee contract. ”
In other words, if a company’s debt is not repaid as part of the resolution plan, the personal guarantor not only would not remain discharged but could be bankrupted by creditors.
The verdict is definitely a boost for lenders as it allows them to seek recovery of contributions from loan guarantors even during ongoing corporate bankruptcy proceedings. The judgment makes it clear that by initiating insolvency proceedings against personal guarantors, there is a greater likelihood that they ‘organize’ for the payment of the debt to the creditor bank in order to obtain prompt release. The creditor bank would be prepared to discount or waive interest in order to allow fair settlement of the debt of the company, as well as that of the personal guarantor, which would result in maximizing the value of assets and promoting equity. entrepreneurship.