The Ship Sets Sail

Since inception, the Insolvency and Bankruptcy Code, 2016 (Code) has faced a barrage of amendments and course correction from both the Judiciary as well as the Legislature. The latest and perhaps the most significant amendment in the Code has been the Insolvency and Bankruptcy (Application to Adjudicating Authority for Insolvency Resolution Process for Personal Guarantors to Corporate Debtors) Rules, 2019 (PG Rules, 2019) and the Insolvency and Bankruptcy Board of India (Insolvency Resolution Process for Personal Guarantors to Corporate Debtors) Regulations, 2019 (PG Regulations, 2019) which, along with certain provisions in the Code in relation to insolvency of individuals (including personal guarantors) have come into force with effect from 01 December 2019 (New Regime).

The New Regime now establishes a framework which provides an easier and faster recourse for creditors seeking to enforce a contract of personal guarantee vis-à-vis the earlier regime which required the creditors to initiate recovery proceedings under the agreement and therefore, engage in prolonged litigation which could span multiple years without a meaningful resolution. Since the Code provides for a time bound process, the New Regime is expected to considerably reduce delays in recovery of dues of creditors.

The New Regime also permits creditors to initiate insolvency proceedings against personal guarantors, in addition to initiating proceedings against the corporate debtor. Such situations will definitely affect the current framework under the Code, as proceedings against the corporate debtor as well as personal guarantors may be initiated simultaneously, which may lead to chaos and confusion. It is currently unclear whether the resolution professionals of the corporate debtor and the personal guarantor would work separately or in tandem to ensure that there is no double dipping by any creditor.

Furthermore, while the general law relating to invocation of personal guarantees is still under the evolution stage and has several uncertainties within, interestingly, the New Regime prima facie does not appear to address the existing uncertainties. The newly introduced provisions leave the door wide open, and in fact evidently demand, for further interference by the tribunals and courts in India. While the existing precedents under the Code relating to guarantors is restricted to corporate guarantors, it is anticipated that similar principles may guide the evolving jurisprudence in relation to personal guarantors. This article seeks to highlight the areas in the New Regime, tested against the existing precedents and practicalities, which are expected to be brought before the courts in order to iron out the creases.

2. Turbulent Waters Ahead

2.1 Parallel Claims

The underlying principle of a guarantee is that its express terms are the repository of the obligations of the guarantor and therefore must be construed strictly.^[1] The Indian Contract Act, 1872 (Contract Act), makes the liability of a guarantor co-extensive with that of the borrower, unless otherwise provided or limited by the guarantee and the same is also joint and several,^[2] therefore a creditor has the option to sue the borrower or the guarantor separately or jointly or simultaneously to recover the debt.^[3]

After numerous varying decisions by the National Company Law Tribunals (NCLT), an amendment in 2018 finally settled the position, that the moratorium under Section 14 of the Code does not extend to the guarantor of the corporate debtor and therefore, a creditor may proceed against the guarantors even during the moratorium period of the corporate debtor.^[4] The rationale behind the amendment was that since the assets of the guarantor are separate from those of the corporate debtor, proceedings against the corporate debtor may not be seriously impacted by the actions against assets of third parties.^[5] This argument is in tune with the New Regime that separate proceedings may be initiated against the corporate debtor and its personal guarantor.

However, the National Company Law Appellate Tribunal (NCLAT), in Dr. Vishnu Kumar Agarwal v. Piramal Enterprises Ltd.^[6] held that while there is no bar in the Code for filing two applications simultaneously under Section 7 against the principal borrower as well as the corporate guarantor(s) or against both the guarantors, however once for the same set of claims an application is admitted against one of the corporate debtors (i.e. either principal borrower or corporate guarantor), a second application by the same creditor for the same set of claims and default cannot be admitted against the other corporate debtor (i.e. either principal borrower or corporate guarantor). As noted above, while the said decision was rendered in the context of corporate guarantors, it may be reasonably inferred that the same may also be applied to personal guarantors.

In other words, it is unclear whether a creditor can initiate proceedings against the personal guarantors for the same set of debt against which a corporate debtor is already undergoing insolvency proceedings. If this interpretation were to be adopted, it may render the New Regime ineffective/redundant qua such personal guarantors where a prior application is admitted against the corporate debtor. Thus, a creditor, in effect has to give up its remedy against the guarantor/borrower and will be forced to prefer its claim only against the guarantor/borrower against whom the insolvency proceedings were ostensibly first initiated and the claim was filed therein, regardless of the commercial viability of the same. It may be noted, however, that the Supreme Court, in Committee of Creditors of Essar Steel India Limited v. Satish Kumar Gupta,^[7] clarified several unsettled issues under the Code. With regard to the issue of the law of guarantors and the Code, the Supreme Court has followed its earlier decision in State Bank of India v. V. Ramakrishna^[8] wherein it recognized the ability of a creditor to invoke contracts of personal guarantees during insolvency proceedings, thereby allowing a creditor the maximum recourse to reclaim the debts owed to it.

Therefore, a reading of the Supreme Court’s decision in Essar Steel (supra) suggests that the insolvency of a personal guarantor can go on simultaneously to that of the corporate debtor. However, this appears to be contrary to the decision of the NCLAT in Piramal Enterprises (supra).

In view of the above, the Supreme Court will need to step in, not only to redress the apparent issues that have arisen consequent to Piramal Enterprises (supra) but also to clarify whether the principles in the said decision would apply to personal guarantors, specifically in light of V. Ramakrishnan (supra) and Essar Steel (supra). In the event that the principles declared in Essar Steel (supra) are applied in the appeal against Piramal Enterprises (supra), the New Regime would revert to its original and intended framework of permitting parallel proceedings against a personal guarantor and corporate debtor. However, the said position has the inherent flaw of leading to opening a floodgate of litigation and possibly overwhelming the NCLTs with multiple insolvency proceedings qua the same debt.

In view of the current position, however, it is possible that even under the New Regime, in case insolvency proceedings are sought to be initiated against a personal guarantor when the corporate debtor is already undergoing CIRP, such proceedings may be dismissed, thereby rendering the New Regime as a mere paper legislation.

2.2 Creditors’ remedy under the New Regime rendered infructuous

Piramal Enterprises (supra) also does not take into consideration that its necessary implication is that if both the borrower and guarantor are undergoing insolvency proceedings at the same time and a creditor has filed a claim in one insolvency, then the said creditor is precluded from filing a claim based on the same debt in the other insolvency. Therefore, a creditor’s remedy against the other is essentially infructuous. Such a scenario, in effect, renders the legal concept of co-extensive liability, a nullity in insolvency proceedings. In fact, in view of the decision in Piramal Enterprises (supra) and its appeal being pending before the Supreme Court, NCLTs across India dealing with the issue of parallel claims, while reiterating that the liability of a guarantor is co-extensive with that of the borrower, are routinely dismissing the claim of a creditor on the ground that the same creditor has already preferred a claim against one of the two.

Further, this complication is compounded in light of Essar Steel (supra) which clearly specifies that all creditors have to file their claims during the CIRP and no claim is maintainable thereafter. These two decisions are evidently conflicting and what remains to be seen is the Supreme Court’s decision in the pending appeal against Piramal Enterprises (supra) matter.^[9]

Thus in the current scenario, it appears that a separate claim may not be maintainable against a personal guarantor once the said claim has been made against the borrower or another guarantor.

2.3 Amount that may be recovered from a Guarantor

It may be pertinent to take note that the Contract Act specifically provides that any variance made in the terms of the contract between the borrower and the creditor or any discharge or release of the borrower, without the consent of the guarantor, would discharge the guarantor. However, such variance must materially affect the guarantor.^[10] The term ‘material variation’ has been held to include, inter alia, change in amount,^[11] rate of interest,^[12] period of contracts^[13] and a change in management of the borrower.^[14] Further, a composition/ satisfaction or time given to the borrower or an agreement not to sue the borrower, discharges the guarantor’s liability. Additionally, the discharge of a borrower discharges the guarantor if the release of the borrower is unconditional. However, there are two recognized exceptions to this principle, firstly where the discharge is due to the operation of law, and secondly where the guarantor expressly consents/waives its rights thereto. While discharge of the borrower by operation of law for which none of the parties had any control, does not discharge the guarantor even if the consent of the guarantor is not taken,^[15] it may be noted that ‘operation of law’ has been interpreted to include liquidation and bankruptcy proceedings or proceedings where the creditor has no control over the process.^[16]

The decisions of the Supreme Court in V. Ramakrishnan (supra) and more specifically in Essar Steel (supra) appear to put the above controversy to rest by observing that Section Section 31(1) of the Code binds the personal guarantors to the terms agreed upon in the resolution plan, which ostensibly is to ensure that guarantors are precluded from claiming substantial variance or a change in circumstance of the original contract and evading their liability on such basis.

However, despite the above decisions, the Courts have failed to take note of Section 128 of the Contract Act, as per which a statutory reduction or extinguishment of the borrower’s liability operates as a pro tanto reduction of the guarantor’s debt.^[17]

Therefore, in addition to the issue of whether the remedies against the guarantor are available to a creditor while proceedings against the borrower are ongoing, what still remains to be seen is how much may actually be recovered from the personal guarantor, in a situation where the liability of the corporate debtor is altogether extinguished after the creditor accepts a haircut amount in the corporate insolvency resolution of the corporate debtor. In other words, would insolvency proceedings be maintainable and if so, to what extent, against a personal guarantor of the corporate debtor who’s liability has been reduced or altogether discharged.

2.3 Multiplicity of Proceedings

Practical experience has shown that simultaneous insolvency proceedings are being initiated against different subsidiary companies of the same parent company by financial creditors, qua the same debt, in NCLTs across India. The New Regime now also permits parallel proceedings to be initiated against the personal guarantor as well, thereby necessarily adding to the number of proceedings and leading to a further fragmentation of the resolution process. In this context, it may be noted that in the recent case of State Bank of India v. Videocon Industries Limited,^[18] the NCLT, Mumbai was faced with the plea of consolidation of insolvency proceedings pending against various Videocon group companies some of which had also acted as corporate guarantors for each other. The NCLT, Mumbai allowed for consolidation of proceedings against several corporate debtors and guarantors observing that the exercise is beneficial to the stakeholders and that restructuring as a group of companies will ensure in maintaining the status as a going concern or maximization of value during liquidation.

Furthermore, in Edelwiess Asset Reconstruction Company Limited v. Sachet Infrastructure Pvt. Ltd.^[19] wherein the NCLAT itself, despite its earlier decision in Piramal Enterprises (supra), allowed appointment of a single Resolution Professional (RP) to conduct ‘group CIRP’ of certain corporate debtors who were acting as a consortium for a project and in fact were corporate guarantors for each other as well. Again, the primary driving force behind this order was to ensure a successful resolution process. The Edelwiess ARC case (supra), in fact, specifically takes note of Piramal Enterprises (supra) and distinguishes it on facts and relies on another decision in Mrs. Mamatha v. AMB Infrabuild Pvt. Ltd.,^[20] wherein it held that if two corporate debtors collaborate, the application under Section 7 of the Code would be maintainable against both the debtors jointly and as one.

These decisions evidently pertain to corporate guarantors and the law relating to co-obligors, however, in the absence of clear rules on the procedure under the New Regime, these may serve as guidelines for the courts and tribunals. When tested for a personal guarantor, the principle in the Videocon case (supra) and Edelwiess ARC (supra) may prima facie bring the independent and parallel proceedings, initiated against a personal guarantor under the New Regime, within the possible ambit of consolidation of proceedings and appointment of a common RP. Further, it may be argued that the principle of treating the corporate debtor and personal guarantor as ‘one’ as per the decision in AMB Infrabuild (supra) may be applicable. However, such an argument has obviously not yet been addressed by the courts, nor has the same been considered under the New Regime.

Therefore, there is a clear and glaring absence of clarity in law. A presumption that the facts and circumstances of each case would be determinative would lead to commercial and legal disarray as creditors would no longer be certain of the appropriate remedy. In this regard, the upcoming decision of the Supreme Court in the appeal against Piramal Enterprises (supra) may hold the key to resolving many issues in the current and New Regime.

2.4 Appropriate NCLT/ Jurisdiction

The Code specifically mentions that the proceedings against the personal guarantors would be held before the same NCLT before which the proceedings relating to the corporate debtor is ongoing. However, it is not clear, if a personal guarantor who has guaranteed loans for different entities which are undergoing respective CIRPs in different NCLTs, which would be the appropriate NCLT for the insolvency process of the said personal guarantor. It may be argued that the principle followed in the Videocon case (supra), i.e. the NCLT where the insolvency was first initiated or where majority cases are pending, ought to be the appropriate NCLT. However, what remains to be seen is whether the potential conferment of jurisdiction over an NCLT, that does not statutorily have the territorial jurisdiction over the assets of the personal guarantor, would be sustainable in law.

2.5 Right of Subrogation

In addition to the above, the Supreme Court in Essar Steel (supra) has clearly deviated from the settled principles under the Contract Act and expressly clarified that the guarantors are not entitled to the right of subrogation, if the resolution plan states so. Thus, in effect, a guarantor’s remedy against the borrower, i.e. a statutory right which is the substratum of a contract of guarantee, has been eroded. While this may serve the larger purpose when seen from the perspective of third parties or affiliate companies giving guarantees for another, it may not be applicable in the case of personal guarantors, as more often than not, a personal guarantor is the promoter of the borrower and thus has a personal interest in giving such a guarantee.

Having said that, the effect of erosion of the right of subrogation will, in the long term, affect the borrowing in the market as players will be more conservative and perhaps less interested in giving corporate/personal guarantees. Therefore, the business in India will take a necessary downturn. Though the courts are bound to interpret the law sans economic implications, restraining themselves to such a narrow view, will not serve the larger interest of the economy and public at large.

3. Conclusion

The New Regime is a welcome initiative of the legislature as its spirit is aimed at efficiency, maximization of asset valuation and optimization of the resolution process. However, it would appear that the legislature has yet again fallen into its age old trap of not covering the practicalities and realities of the insolvency process. The Courts would need to take the helm again to ensure the New Regime is effective and the insolvency proceedings against personal guarantors of corporate debtors does not lead to a situation of a creditor being lost at sea.

Amongst the various issues highlighted hereinabove, the most pressing concerns that require urgent attention of the courts is whether independent proceedings as contemplated by the New Regime are maintainable in law and if so, whether the same will run in parallel to each other and be unrelated. If held to be maintainable, the immediate next question of law that will arise for consideration relates to the appropriate jurisdiction and whether the principle of consolidation of proceedings may be applied. While it is believed consolidation of proceedings may be beneficial in the larger scheme of maximizing the value of liquidated assets, the courts will need to step in to determine which proceeding the insolvency of the personal guarantor ought to be consolidated with in cases where several corporate debtors, to which a personal guarantee has been extended, are undergoing CIRP.

Further, it is to be seen as to what amount the creditors can recover from the personal guarantors specifically after the former has taken a haircut in the resolution plan of the corporate debtor and have discharged the borrower in its insolvency against the entire debt, after taking the haircut amount. The courts will have to consider whether the principles enshrined under the Contract Act would be applicable in such situations to determine inter alia co-extensive liability and extent of liability of personal guarantors or whether alternate guidelines in itself may be framed. Furthermore, the courts ought to revisit its decision to take away the statutory right of subrogation and test it from a commercial lens.

The courts may be guided by the earlier decisions that seek to mould the law qua insolvency of corporate guarantors. Furthermore, despite the landmark decision of the Supreme Court in Essar Steel (supra) there still remains a huge vacuum that needs to be filled.

The pending decision of the Supreme Court in the appeal against Piramal Enterprises (supra) appears to hold the key to several questions that remain unanswered under the New Regime which are necessary to be addressed such that contracts of guarantee are not looked upon merely as pieces of paper once insolvency has been initiated against the borrower. Therefore, the urgent interference of the Supreme Court is felt necessary to settle these vital issues, else the New Regime will remain in a state of flux and will not be able to ensure the object and spirit it aims to achieve. If an effective resolution process is the proverbial ship, the present provisions in the New Regime are grossly inadequate in helping navigate it through the turbulent waters we foresee in insolvency proceedings of personal guarantors.

Padmaja Kaul is a Partner and Varun Khanna is an Associate at IndusLaw.

Disclaimer

This article is for information purposes only. Nothing contained herein is, purports to be, or is intended as legal advice and you should seek legal advice before you act on any information or view expressed herein.

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[1] New India Assurance Co. Ltd. v. Kusumanchi Kameshwara Rao (1997) 9 SCC 179

[2] Om Hari Agarwal v. State of Uttar Pradesh, (2006) 7 ADJ 390

[3] Industrial Investment Bank Ltd. v. Biswanath Jhunjhunwala (2009) 9 SCC 478

[4] Section 10, Act No. 26 of 2018

[5] The Insolvency Law Committee’s Report dated0 March 2018 as available at http://www.mca.gov.in/Ministry/pdf/ReportInsolvencyLawCommittee_12042019.pdf

[6] Company Appeal (AT) (Insolvency) No. 346 of 2018, decision dated 08 January 2019

[7] Civil Appeal No. 8766-67 of 2019

[8] Civil Appeal No. 3595 of 2018

[9] Civil Appeal No. 878 of 2019

[10]V. Kameshwarao v. M. Hemlathammarao, AIR 1959 AP 596; Ramlagan Jammadar v. Akleshwar Prasad, AIR 1958 Pat 211

[11] Shesh Narain Awasthi v. Chairpersons, Debt Recovery Appellate Tribunal, (2011) 2 ADJ 102

[12] S. Perumat Reddiar v. Bank of Baroda, AIR 1981 Mad 180

[13] M.S Anirudhan v. Thomco’s Bank Ltd., AIR 1963 SC 746

[14] Dharamchand Goyal v. Bihar State Financial Corporation, (2009) 1 JCR 218

[15] Industrial Finance Corporation of India v. Cannonore Spinning and Weaving Mills Ltd. (2002) 5 SCC 54

[16] Union Bank of India v. Chairperson, Debts Recovery Appellate Tribunal, (2011) 8 ADJ 506

Submromania v. Narainaswamy AIR 1951 Mad 48; Law Commission of India, 13th Report, at page 54, Para 109

[18] M.A. No. 1306/2018 in CP No. 2/2019 and other connected matters

[19] Company Appeal (AT) (Insolvency) No. 377 of 2019

[20] Company Appeal (AT) (Insolvency) No. 155 of 2018