The Supreme Court on Friday upheld a government move to allow lenders initiate insolvency proceedings against personal guarantors, who are usually promoters of big business houses, along with the stressed corporate entities for whom they gave guarantee.
In a judgment, which will ring loud and clear across the business community, a Bench of Justices L. Nageswara Rao and S. Ravindra Bhat held that the November 15, 2019 government notification allowing creditors, usually financial institutions and banks, to move against personal guarantors under the Indian Bankruptcy and Insolvency Code (IBC) was “legal and valid”.
The November 15, 2019 notification was challenged before several High Courts initially. The Supreme Court had transferred the petitions from the High Courts to itself on a government request.
‘Intrinsic connection‘
The apex court said there was an “intrinsic connection” between personal guarantors and their corporate debtors.
Justice Bhat, who authored the 82-page verdict, said it was this “intimate” connection that made the government recognise personal guarantors as a “separate species” under the IBC.
It was again this intimacy that made the government decide that corporate debtors and their personal guarantors should be dealt by a common forum – National Company Law Tribunal (NCLT) – through the same adjudicatory process.
In this context, Justice Bhat referred to how the November 2019 notification had not strayed from the original intent of the IBC. In fact, Section 60(2) of the Code had required the bankruptcy proceedings of corporate debtors and their personal guarantors to be held before a common forum – the NCLT.
“The adjudicating authority for personal guarantors will be the NCLT if a parallel resolution process is pending in respect of a corporate debtor for whom the guarantee is given,” Justice Bhat noted.
In fact, side by side bankruptcy proceedings before the same forum for both the corporate debtors and their personal guarantors would help the NCLT “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 Committee of Creditors to frame realistic plans, keeping in mind the prospect of realising some part of the creditors’ dues from personal guarantors,” the judgment reasoned.
Correction of a misunderstanding
The court further corrected a misunderstanding among petitioners that approval of a resolution plan in respect of corporate debtors would also extinguish the liability of the personal guarantor.
The petitioners, mostly personal guarantors to stressed companies, had argued that an approved resolution plan in respect of a corporate debtor amounts to extinction of all outstanding claims against that debtor. Consequently, the liability of the guarantor, which is co-extensive with that of the corporate debtor, would also be extinguished.
“The release or discharge of a principal borrower from the debt 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 contract,” Justice Bhat clarified.
The concept of ‘guarantee’ is derived from Section 126 of the Indian Contracts Act, 1872. A contract of guarantee is made among the debtor, creditor and the guarantor. If the debtor fails to repay the debt to the creditor, the burden falls on the guarantor to pay the amount. The creditor reserves the right to begin insolvency proceedings against the personal guarantor if the latter does not pay. Usually, promoters of big businesses submit personal guarantees to creditors to secure loans and assure repayment.
Govt justification of notification
During the hearings, the government had justified the November 2019 notification extending bankruptcy proceedings to personal guarantors. Attorney General K.K. Venugopal argued that by roping in guarantors, there was a greater likelihood that they would “arrange” for the payment of the debt to the creditor bank in order to obtain a quick discharge.
Whereas, in some cases, on the other hand, the creditor bank would be prepared to take a haircut or forego the interest amounts so as to enable an equitable settlement of the corporate debt, as well as that of the personal guarantor.
“This would result in maximising the value of assets and promoting entrepreneurship, which is one of the main purposes of the Code,” the Centre had argued in court.
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