• Commercial Law Advisors

Supreme Court affirms liability of personal guarantors under IBC

The Hon’ble Supreme Court on 21.05.2021 delivered its landmark verdict in the case of Lalit Kumar Jain v. Union of India & Ors. relating to the scope of liability of personal guarantors under the Insolvency and Bankruptcy Code (Code).

The predominant matter under contention was the constitutional validity of a notification dated 15.11.2019 issued by the Central Government (Impugned Notification), which brought into effect certain parts (i.e., part III) of the Code exclusively to personal guarantors of corporate debtors. The petitioners argued that the power exercised by the Central Government vide the Impugned Notification was arbitrary and ultra vires, as the Central Government selectively implemented provisions of part III of the Code with respect to personal guarantors of corporate debtors, despite partnership firms and other individuals falling within the scope of part III of the Code as well.

The Apex Court dismissed the arguments of the petitioners and upheld the validity of the Impugned Notification, which in effect permitted lenders to initiate proceedings against personal guarantors of a corporate debtor for recovery of their outstanding debts under the Code. The key takeaways from the two-bench verdict can be summarized as follows:

  1. Section 60(2) of the Code requires proceedings of corporate debtors and their personal guarantors to be held before a common forum i.e the National Company Law Tribunal (NCLT). Therefore, the court held that there was “sufficient legislative guidance” for the Central Government to distinguish personal guarantors from other individuals, so as to provide such a common forum (the NCLT) for lenders to seek recovery of their debts from both the corporate debtors and personal guarantors to the corporate debtors. The court in coming to this conclusion reasoned that “the intimate connection between such individuals and corporate entities to whom they stood guarantee, as well as the possibility of two separate processes being carried on in different forums, with its attendant uncertain outcomes, led to carving out personal guarantors as a separate species of individuals, for whom the Adjudicating authority was common with the corporate debtor to whom they stood guarantee.”

  2. Although the process of insolvency in parts II and III of the Code vary in scope, where different adjudicating authorities govern corporate persons and individuals respectively, a conjoint reading of parts II and III of the Code with respect to personal guarantors would have to be adopted to bring about the true objective of the code for the benefit of all stakeholders involved. The court stated that such an approach would not be inconsistent with the provisions of the Code and held that “there appear to be sound reasons why the forum for adjudicating insolvency processes – the provisions of which are disparate – is to be common, i.e. through the NLCT. The NCLT would be able to consider the whole picture, as it were, about the nature of the assets available, either during the corporate debtor’s insolvency process or even later; this would facilitate the CoC in framing realistic plans, keeping in mind the prospect of realizing some part of the creditors’ dues from personal guarantors.

  3. The method followed by the Central Government in notifying the provisions of the Code was on a stage-by-stage basis, depending on the subject matters covered by the Code. The court held that the Impugned Notification did not amount to a legislative exercise or selective application of provisions of the Code, as there was no obligation imposed by the Code on the Central Government to make the provisions of the Code applicable to all individuals at the same time or not at all.

  4. The court placed reliance on the case of SBI v. V. Ramakrishnan (2018) 17 SCC 394, and the provisions of the Indian Contract Act relating to ‘contract of guarantee’ and held that the approval of a resolution plan under section 31 of the Code does not discharge the personal guarantor from potential liability under such approved plan. The court clarified that despite the discharge of a principal debtor from his or her debt by operation of law or due to liquidation or insolvency proceedings, the same does not absolve the surety/guarantor of his or her liability, which arises out of an independent contract.

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