Insolvency and Bankruptcy of Personal Guarantors to Corporate Debtors: Part II

Bar & Bench November 30 2019
Swaroop George

The Central Government has, vide notification dated November 15, 2019, appointed December 1, 2019, as the date from which the provisions of the Insolvency and Bankruptcy Code, 2016 relating to personal guarantors to Corporate Debtors will come into effect. Subsequently, several regulations have been notified in this regard. The present article is part II of a two-part series with it attempting to present a bird’s-eye-view of the bankruptcy process for personal guarantors under the framework of the Insolvency and Bankruptcy Code, 2016, Insolvency and Bankruptcy (Application to Adjudicating Authority for Bankruptcy Process for Personal Guarantors to Corporate Debtors) Rules, 2019 and the Insolvency and Bankruptcy Board of India (Bankruptcy Process for Personal Guarantors to Corporate Debtors) Regulations, 2019.

Insolvency and Bankruptcy of Personal Guarantors to Corporate Debtors: Part I

1. Application for Initiation of Bankruptcy Process

An application for initiation of the bankruptcy process can be filed by the guarantor himself or by one or more creditors within 3 months from the Adjudicating Authority passing an order rejecting an application for initiation of corporate insolvency process against the guarantor in terms of sub-section 4 of section 100 of the Insolvency and Bankruptcy Code, 2016 (hereinafter referred to as the ‘Code’) or rejecting a repayment plan under the insolvency process in terms of sub-section 2 of section 115 of the Code or declaring that the repayment plan has not been fully implemented in respect of all persons bound by it within the period as mentioned in the repayment plan in terms of sub-section 3 of section 118 of the Code.

The application filed by the creditor or debtor must be accompanied by payment of fees of Rs. 2000 and must inter-alia include the records of insolvency resolution process undertaken under Chapter III of Part III of the Code, a copy of the order passed by the Adjudicating Authority under Chapter III of Part III permitting the applicant to file for initiation of bankruptcy, details of the debts owed by the debtor to the creditor as on the date of the application for bankruptcy if the applicant is a creditor, the statement of affairs of the debtor in such form and manner as may be prescribed, on the date of the application for bankruptcy if the applicant is the corporate guarantor, etc. The applicant may propose an insolvency professional to act as the bankruptcy trustee (hereinafter referred to as the ‘Trustee’) in its application.

The application for initiation of bankruptcy proceedings once filed, can only be withdrawn with the permission of the Adjudicating Authority. In case of the death of the corporate guarantor, the bankruptcy proceedings would be maintainable against their legal representatives.

An application made by a creditor in respect of a debt which is secured, has to be accompanied with a statement by the creditor having the right to enforce the security that he shall, in the event of a bankruptcy order being made, give up his security for the benefit of all the creditors of the bankrupt person or  a statement by the creditor stating  that the application for bankruptcy is only in respect of the unsecured part of the debt and also stating the estimated value of the unsecured part of the debt. If a secured creditor makes an application for bankruptcy qua the unsecured debt as stated aforesaid, the secured and unsecured parts of the debt shall be treated as separate debts.

2. Adjudication of Application

Interim Moratorium

On the date of making of an application of initiation of bankruptcy proceedings, an interim moratorium shall be declared till the bankruptcy commencement date and during such moratorium, no fresh legal action can be initiated nor any pending legal action be continued against the property of the corporate guarantor in respect of any of their debts.

Appointment of Trustee

If the applicant has along with his application recommended an insolvency professional to be appointed as trustee then the Adjudicating Authority will direct the Insolvency and Bankruptcy Board of India (hereinafter referred to as the ‘Board’) to confirm that there are no pending disciplinary actions against the insolvency professional. If no insolvency professional has been proposed, the Adjudicating Authority shall direct the Board to nominate a trustee. On the basis of such confirmation or nomination, the Adjudicating Authority shall appoint the trustee.  For the purpose of such confirmation or nomination, the Board may share the database as well as a panel of the insolvency professionals with the Adjudicating Authority.

Bankruptcy Order

Within fourteen days of receiving the confirmation or nomination from the Board, the Adjudicating Authority shall pass the order initiating bankruptcy. The Adjudicating Authority shall provide a copy of the application for bankruptcy and a copy of the bankruptcy order to the bankrupt person (hereinafter referred to as the ‘Bankrupt’), creditors and the trustee within seven days of the passing of the bankruptcy order.

On the passing of the bankruptcy order, the estate of the bankrupt shall vest in the trustee and the same shall be divided among their creditors. It is further provided that a creditor of the bankrupt indebted in respect of any debt claimed as a bankruptcy debt shall not initiate any action against the property of the bankrupt in respect of such debt or commence any suit or other legal proceedings except with the leave of the Adjudicating Authority and on such terms as the Adjudicating Authority may impose. However, the exception to such bar is that subject to the undertaking provided by an applicant secured creditor when filing the bankruptcy application giving up its exclusive right to its security interest as stated aforesaid, the bankruptcy order shall not affect the right of any secured creditor to realize or otherwise deal with his security interest in the same manner as he would have been entitled if the bankruptcy order had not been passed.

Within 7 days of passing of the bankruptcy order, the bankrupt has to submit his statement of financial position to the trustee within seven days from the bankruptcy commencement date.

3. Committee of Creditors

The Adjudicating Authority or on a direction by the Adjudicating Authority, the trustee, will send notices within ten days of the bankruptcy commencement date, to the creditors mentioned in the statement of affairs submitted by the bankrupt or in the application for bankruptcy submitted by the bankrupt if the bankrupt had filed the application for initiation of a bankruptcy. The Adjudicating Authority or on a direction by the Adjudicating Authority, the trustee, will also issue a public notice inviting claims from creditors mentioning inter-alia the last date for submission of claims.  The creditors shall register claims with the trustee within seven days of the publication of the public notice. The trustee shall prepare a list of creditors on the basis of the claims received as well as the statement of affairs submitted by the bankrupt or the application for bankruptcy submitted by the bankrupt if the bankrupt had filed the application for initiation of a bankruptcy. The trustee shall also give notice to each of the creditors to submit proof of debt within fourteen days of preparing the list of creditors. Future Claims i.e. claims, which are not due and payable on the bankruptcy commencement date, may also be submitted to the trustee. In the case of rent, interest and such other payments of a periodical nature, a creditor may claim only for any amounts due and unpaid up to the bankruptcy commencement date.

The trustee shall, within twenty-one days from the bankruptcy commencement date, issue a notice for calling a meeting of the creditors to every creditor mentioned in the list of creditors. During the meeting, the committee of creditors shall be established and any other business the trustee finds fit shall also be conducted. The trustee shall be the convener of the meeting and he has the authority to determine the quorum of the meeting. A meeting will only be conducted if the requisite quorum is there but where a meeting of the committee could not be held for want of quorum, unless the committee has previously decided otherwise, the meeting shall automatically stand adjourned to the same time and place on the next day and on that day, no quorum shall be required. The trustee shall not adjourn the meeting for more than 7 days at a time.

The voting share of each creditor shall be in proportion to the debt owed to such creditor but a creditor shall not be entitled to vote in respect of a debt for an unliquidated amount. Creditors who are not mentioned in the list of creditors and those who have not been given a notice by the trustee as well as creditors who are associates of the bankrupt shall also not be entitled to vote in the meeting.

A trustee may convene a meeting of the committee as and when he considers necessary and shall also convene a meeting on a request by creditors having not less than thirty-three percent of voting share. The bankrupt shall attend a meeting which the trustee may, by notice, require him to attend and any adjournment thereof. Unless otherwise provided in the Code, any decision of the committee shall require the approval of more than fifty percent of voting share of the creditors who voted.

4. Administration of Estate of Bankrupt

Estate

The estate of the bankrupt includes all property belonging to or vested in the bankrupt at the bankruptcy commencement date and also includes the exercise of rights relating to such property as might have been exercised by the bankrupt for his own benefit at the bankruptcy commencement date or before the date of the discharge order, discharging the bankrupt as well as all the property which by virtue of any of the provisions of Chapter  V of the Code is comprised in the estate.

The estate does not include excluded assets as defined under the Code and regulations, property held by the bankrupt on trust for any other person, all sums due to any workman or employee from the provident fund, the pension fund and the gratuity fund and such assets as may be notified by the Central Government in consultation with any financial sector regulator.

Restrictions Imposed on Bankrupt Person

The bankrupt shall, from the bankruptcy commencement date till the date the bankrupt is discharged or till the date the Adjudicating Authority modifies or recalls the bankruptcy order, be subject to the disqualifications provided under law including those provided under the Code i.e. the bankrupt shall be disqualified from being appointed or acting in certain capacities such as a trustee or representative in respect of any trust, estate or settlement, or as a public servant etc.. He shall also be prohibited from acting as a director of any company, or directly or indirectly take part in or be concerned in the promotion, formation or management of a company and he would further be prohibited, from creating any charge on his estate or taking any further debt without the previous sanction of the trustee. He would be required to inform his business partners that he is undergoing a bankruptcy process and prior to entering into any financial or commercial transaction of one lakh rupees and above, either individually or jointly, be required to inform all the parties involved in such transaction that he is undergoing a bankruptcy process. Without the previous sanction of the Adjudicating Authority, the bankrupt person would be incompetent to maintain any legal action or proceedings in relation to the bankruptcy debts and he would also not be permitted to travel overseas without the permission of the Adjudicating Authority.

Functions and Powers of Trustee

The trustee is responsible for investigating the affairs of the bankrupt, realizing the estate of the bankrupt and distributing the estate of the bankrupt. The estate of the bankrupt vests in the trustee immediately from the date of his appointment. All actionable claims forming part of the estate vest in the trustee without any notice of assignment. The Bankrupt, as well as all persons connected or relevant to the bankruptcy process, have to cooperate and assist the trustee. For performing his functions, the trustee is empowered to hold property of every description, make contracts, sue and be sued, enter into engagements in respect of the estate of the bankrupt, employ persons to assist him, execute any power of attorney, deed or other instrument and do any other act which is necessary or expedient for the purposes of or in connection with the exercise of his rights. The trustee also has general powers to sell any part of the estate of the bankrupt, give receipts for money received by him etc. The trustee before executing certain actions has to take the permission of the committee of creditors such as the bringing of legal action or defending any legal action regarding the estate of the bankrupt, appointing the bankrupt to manage any part of his business etc. The trustee has to take possession and control of the property, books, papers and other records relating to the estate of the bankrupt or affairs of the bankrupt.

The trustee also has the power to bring to the attention of the Adjudicating Authority, certain transactions as defined under the Code such as preferential transactions, undervalued transactions, acquisition of certain property etc. for setting aside or modification of such transactions in order to safeguard the smooth functioning of the bankruptcy process and to ensure the success of the same.

The trustee is also responsible for preparing and submitting a preliminary report as well as progress reports to the committee of creditors. The trustee has to furthermore submit a final report to the committee and also file the same with the Adjudicating Authority.

Interim Dividend

Whenever the trustee has sufficient funds in his hand, he may declare and distribute interim dividend among the creditors in respect of the bankruptcy debts which they have respectively proved while making provision for disputed claims, administrative expenses etc. 

Distribution of Property

The trustee may, with the approval of the committee of creditors, divide in its existing form amongst the creditors, according to its estimated value, any property which from its peculiar nature or other special circumstances cannot be readily or advantageously sold.

Final Dividend

After the entire estate of the bankrupt is realized or so much of it as could be realized in the opinion of the trustee, the trustee shall declare a final dividend after giving notice in appropriate form of his intention to do so, thirty days prior to the date specified for the distribution of dividend or if no further dividend is to be issued, give notice of the same. Such notice declaring intention to offer final dividend shall require all claims against the estate of the bankrupt to be established by a final date specified in the notice which can be extended by the Adjudicating Authority on an application being made. After the final date, the trustee shall defray the outstanding expenses from the estate, and declare and distribute the final dividend among the creditors who have proved their debts, without regard to the claims of any other persons. If a surplus remains after payment in full with interest to all the creditors of the bankrupt and the payment of the expenses of the bankruptcy, the bankrupt shall be entitled to the surplus. A creditor who has not proved his debt before the declaration of any dividend may not disturb the disbursement of such dividend but upon proving the debt, he shall be entitled to be paid any dividend or dividends which he has failed to receive, out of any money for the time being available for the payment of any further dividend before such dividend is paid to any other person.

Priority of Payment of Debts

The debts of the bankrupt person shall be paid to each class of creditors in the following priority provided that within the same class, each creditor shall be entitled to the same share:

  1. Firstly, the costs and expenses incurred by the trustee for the bankruptcy process in full.
  2. Secondly, the workmen’s dues for the period of twenty-four months preceding the bankruptcy commencement date and debts owed to secured creditors.
  3. Thirdly, wages and any unpaid dues owed to employees, other than workmen, of the bankrupt for the period of twelve months preceding the bankruptcy commencement date/
  4. Fourthly, any amount due to the Central Government and the State Government including the amount to be received on account of Consolidated Fund of India and the Consolidated Fund of a State, if any, in respect of the whole or any part of the period of two years preceding the bankruptcy commencement date.
  5. Lastly, all other debts and dues owed by the bankrupt including unsecured debts.
  6. Any surplus remaining after the payment of the aforesaid debts shall be applied in paying interest on those debts in respect of the periods during which they have been outstanding since the bankruptcy commencement date. Such Interest payments under sub-section shall rank equally irrespective of the nature of the debt.

Fees of Trustee

A trustee appointed for conducting the bankruptcy process shall be entitled to such fee and the fee shall be paid in such manner as decided by the committee. In any other case, the trustee shall be entitled to a fee as a percentage of the amount realised from the estate of the bankrupt and of the amount distributed from such realisation, in accordance with Schedule I of the Bankruptcy Process for Personal Guarantors to Corporate Debtors Rules, 2019.

Discharge of Bankrupt Person

On the completion of the administration and distribution of the estate of the bankrupt, the trustee shall convene a meeting of the committee of creditors and submit a report of the administration of the estate of the bankrupt for approval.

The trustee shall apply to the Adjudicating Authority for discharge of the bankrupt on the expiry of one year from the bankruptcy commencement date or within seven days of the approval of the committee of creditors of the completion of administration of the estates of the bankrupt, where such approval is obtained prior to elapse of one year from the bankruptcy commencement date and the Adjudicating Authority shall pass the order of discharge. Such order of discharge shall free the bankrupt from all bankruptcy debts except for certain debts such as debt incurred by means of fraud or breach of trust to which he was a party, excluded debt etc.

After filing the final report, the trustee shall, within three days from the date of such filing, apply to the Adjudicating Authority for an order to credit to the Insolvency and Bankruptcy Fund formed under the Code, any balance amount payable to the creditors, left with him. A person claiming to be entitled to any amount paid into the Insolvency and Bankruptcy Fund may apply to the Board for an order for payment of the claim.

 Effect of Death of Bankrupt Person

If a bankrupt dies, the bankruptcy proceedings shall, continue as if he were alive. However, the trustee shall consider the claims by the legal representative of the deceased bankrupt to payment of the proper funeral and testamentary expenses incurred by them and the same shall be ranked on the same pedestal as secured creditors. Any surplus arising after all the debts, interest and costs have been paid, will be paid to the legal representatives or dealt with in such manner as may be prescribed.

Replacement of Trustee

The Committee of creditors may, at a meeting, by a vote of seventy-five per cent of voting share, propose to replace the trustee and subsequently apply to the Adjudicating Authority for the same. A trustee may resign if he intends to cease practicing as an insolvency professional or if there is conflict of interest or change of personal circumstances which preclude the further discharge of his duties. In such circumstances or if there is a vacancy in the office of the trustee for any other reason than those stated aforesaid, the Adjudicating Authority will direct the Board to recommend a trustee and the Adjudicating Authority shall appoint such recommended person who shall take over the bankruptcy process and the old trustee shall be liable to cooperate with the new trustee.

5. Modification or Recall of Bankruptcy Order

The Adjudicating Authority may, on an application or suo motu, modify or recall a bankruptcy order, whether or not the bankrupt is discharged, on the ground of  existence of an error apparent on the face of such order or if both the bankruptcy debts and the expenses of the bankruptcy have, after the making of the bankruptcy order, either been paid for or secured to the satisfaction of the Adjudicating Authority and such modification or recall will be binding on all creditors.

Swaroop George is an independent advocate practicing at New Delhi