Moratorium, Personal Guarantees and the attempted Flight of the Phoenix - Section 14, IBC

Bar & Bench August 23 2018

Deepak Joshi 

Recently, the Supreme Court in a very crisp and well-reasoned judgment in the case of State Bank of India v. V Ramakrishnan, dealt with the controversy surrounding the applicability of the moratorium declared under Section 14 of the Insolvency & Bankruptcy Code, 2016 (IBC) on the personal guarantors of the corporate debtor.

The spirited defence put forth by the personal guarantors during the course of the hearing reminded the author of the Phoenix, a Greek mythological bird that cyclically obtains a new life by arising from the ashes of its predecessor. The author will deal with this aspect later in the article.

Brief Background

It is a prevalent commercial practice for the promoters of an entity to provide personal guarantees in respect of debts undertaken by the entity concerned. A separate agreement known as the “Guarantee Agreement” is entered into between the lender (i.e. the financial creditor, under the IBC regime) and the personal guarantor.

The underlying understanding is that in case the debtor (i.e. the corporate debtor, under the IBC regime) fails to repay the debt, then, independent of the legal remedies available to the financial creditor, the latter can, under the different legal remedies available to it, institute an action involving sale of assets or invoke the personal guarantor to act upon her guarantee in respect of the debts undertaken by the corporate debtor.

In that sense, the financing agreement between the corporate debtor and the financial creditor is quite independent and distinct from the Guarantee Agreement between the financial creditor and the personal guarantor.

Modus Operandi adopted by Personal Guarantors

With a view to at least securing their personal assets from being alienated, the personal guarantors saw a ray of hope in the moratorium provided under Section 14. Since multiple proceedings would already be pending against the corporate debtor, such a corporate debtor would itself move an application for insolvency under section 10 of the IBC.

This ensured that the debts are resolved under the IBC regime and due to Section 14, all other proceedings qua the corporate debtor would also be stayed. However, the personal guarantors went a step further – they claimed that the moratorium under Section 14 of the IBC would apply to the personal guarantees given by them in respect of the debt of the Corporate Debtor.

Controversy before the Court

In view of the above, the short question before the Supreme Court was whether the moratorium declared under Section 14 of the IBC in respect of the Corporate Debtor’s assets would include within its ambit the enforcement of personal guarantees in respect of debts of the Corporate Debtor.

To clarify the legislative scheme in a nutshell, Section 13 of the IBC provides that once a corporate insolvency resolution process is initiated, the NCLT, after admission of such an application, shall by order, declare a moratorium for the purposes referred to in Section 14. Section 14 in effect prohibits, inter alia, institution or continuation of proceedings, the transferring, encumbering or alienating of assets, action to recover security interest, or recovery of property by an owner which is in possession of the corporate debtor.

This controversy has travelled from the National Company Law Tribunal (NCLT) and the National Company Law Appellate Tribunal (NCLAT) to the various High Courts in the country. In particular, the Bombay High Court in the case of Sicom Investments and Finance Ltd. v. Rajesh Kumar Drolia has taken a literal view of Section 14 and has held that merely by virtue of a moratorium order, the suit against the personal guarantor cannot be stayed.

However, the Allahabad High Court in the case of Sanjeev Shriya v. State Bank of India has taken an expansive and broad view of Section 14 and has held that the moratorium order shall be applicable to the enforcement of guarantee against the personal guarantor to the debt.

Before the Supreme Court, the personal guarantors mainly contended as follows:

  • Section 60(2) of the IBC provides that where the insolvency proceeding of a corporate debtor is pending before the NCLT, an application relating to insolvency resolution or bankruptcy of a personal guarantor of such a corporate guarantor will also be before NCLT.
  • Furthermore, Section 60(3) provides that any pending insolvency resolution or bankruptcy proceeding pending against the personal guarantor shall be transferred to NCLT dealing with the insolvency of such a corporate debtor.
  • Section 31(1) provides that the resolution plan approved by the NCLT shall be binding on the guarantors.
  • The Insolvency and Bankruptcy Code (Amendment) Act, 2018 makes the IBC applicable to the personal guarantors of corporate debtor.

All this would show that since the personal guarantor is very much part of the overall process, the moratorium contained in Section 14 of the Code should apply to the personal guarantor as well.

Decision of the Supreme Court

Rejecting the contentions of the personal guarantors, the Supreme Court has held as follows:

1. A plain reading of Section 14 leads to the conclusion that the moratorium referred to in Section 14 can have no manner of application to personal guarantors of a corporate debtor

2. The scheme of Section 60(2) and (3) is very clear. The moment there is a proceeding against the corporate debtor pending under the IBC, any bankruptcy proceeding against the individual personal guarantor will, if already initiated before the proceeding against the corporate debtor, be transferred to the NCLT or, if initiated after such proceedings had been commenced against the corporate debtor, be filed only in the NCLT.

3. The argument that “bankruptcy” would include SARFAESI proceedings must be turned down as “bankruptcy” has reference only to the two Insolvency Acts referred to above. Thus, SARFAESI proceedings against the guarantor can continue under the SARFAESI Act.

4. The binding nature of the approved plan under Section 31 is for the reason that otherwise, under Section 133 of the Indian Contract Act, 1872, any change made to the debt owed by the corporate debtor, without the surety’s consent, would relieve the guarantor from payment. Section 31(1), in fact, makes it clear that the guarantor cannot escape payment as the Resolution Plan, which has been approved, may well include provisions as to payments to be made by such guarantor.

5. Parliament, when it enacted Section 14, took a conscious decision and specifically did not provide for any moratorium along the lines of Section 22 of the Sick Industrial Companies (Special Provisions) Act, 1985 in Section 14 of IBC.

6. Amendment to Section 14(3), which excludes a surety in a contract of guarantee to a corporate debtor, is a clarificatory amendment and thus retrospective in nature.

Thoughts on the Judgment

  • Firstly, the Hon’ble Supreme Court has opted for the “literal view” of Section 14 and has discarded the “expansive and broad view”. In doing so, it has upheld the view taken by the Bombay High Court and rejected the view taken by the Allahabad High Court. The Supreme Court has very clearly drawn a distinction between Section 14 and Section 96 and Section 101 of the IBC which pertain to interim moratorium and moratorium “in respect of” any debt due. The outcome of this decision is that Section 14 prohibits action against the assets of the Corporate Debtor. The moratorium has no application on the assets beyond the ownership of the Corporate Debtor.
  • Secondly, it is pertinent to note that this decision is in a context which involved personal guarantors and is thus restricted only to personal guarantee. The applicability of this decision read with the statutory provisions under IBC on corporate guarantee is open to interpretation and has not been decided by the Hon’ble Supreme Court in the present case.
  • Thirdly, even though the judgment has held that the amendment to Section 14(3) is retrospective, in taking this view, the Court has relied upon the Insolvency Law Committee which made a recommendation “to clarify by way of an explanation that all assets of such guarantors to the corporate debtor shall be outside scope of moratorium imposed under the Code”. It is respectfully submitted that the express language of the amended section 14(3) doesn’t support the view taken by the Hon’ble Supreme Court. Having said so, it is important to note that the scheme of the provisions outlined by the Court read with the Insolvency Law Committee make it quite clear that the position of law was always such. The Hon’ble Supreme Court could have perhaps, lent a little more weight behind its reasoning to arrive at the finding of restrospectivity as far as the language of the provision is concerned.
  • Fourthly, if a financial creditor is able to satisfy the debt by an action against the personal guarantor, the inter-party dispute between the financial creditor and the corporate debtor would be resolved. However, by virtue of Section 140 of the Indian Contract Act, the personal guarantor would be invested with the same rights against the corporate debtor as the operational creditor would have had. Neither the IBC nor the judgment is clear on this aspect. Can the waiver of debt by the promoter (against his own company) after satisfaction by way of paying up personal guarantee alter the outstanding debt and also the composition of the committee of creditors? This is just one of the many unanswered questions that this judgment leads us to.
  • Fifthly, it is also very interesting to note that the arguments put forth by the personal guarantors were very similar to an erstwhile provision contained under Section 22(1) of the Sick Industrial Companies (Special Provisions) Act, 1985. As per Section 22(1), creditors could not proceed against guarantors as well after the company had been declared sick under the said Act, without permission from the Board for Industrial and Financial Reconstruction. However, the said statute was later repealed and the spirit of Section 22 was not carried forward in any of the later enactments (including the IBC). This has been specifically held by the Hon’ble Supreme Court in the case of Madras Petrochem Ltd v. BIFR.
  • Hence, Section 22(1) of the Sick Industrial Companies Act of the was burned down to ashes by Parliament. However, the personal guarantors in the present case, by virtue of their arguments, had tried to resurrect the spirit of Section 22(1) and bring it back from the dead.

The spirit of the erstwhile Section 22(1) was tried to be invoked under Section 14 of the IBC, much like the rising of the Phoenix from the ashes. In view of the above discussion, the author takes the liberty of stating that the attempted flight of the Phoenix has been nipped in the bud by the Hon’ble Supreme Court in the present case.

 

Deepak Joshi is a dually qualified professional. He is a 2016 graduate of Campus Law Centre, Faculty of Law, University of Delhi and a Fellow Chartered Accountant. He currently practices law in the courts of Delhi. He can be reached at [email protected] 

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