Insolvency and Bankruptcy Code| Nothing wrong with IBC Notification treating personal guarantors differently from other categories of individuals: Supreme Court

Supreme Court: Adding to the series of verdicts on the Insolvency and Bankruptcy Code, 2016, the bench of L. Negaswara Rao and S. Ravindra Bhat* has upheld the legality of the notification dated 15.11.2019 which notified provisions of Part III of the Code only in respect of personal guarantors to corporate debtors and has held that approval of a resolution plan does not ipso facto discharge a personal guarantor to a corporate debtor of her or his liabilities under the contract of guarantee.

What was under challenge?

The provisions of IBC were brought into force through different notifications issued on different dates.

The impugned notification dated 15.11.2019 read as:

“In exercise of the powers conferred by sub-section (3) of section I of the Insolvency and Bankruptcy Code. 2016 (31 of 2016). the Central Government hereby appoints the 1st day of December,2019 as the date on which the following provisions of the said Code only in so far as they relate to personal guarantors to corporate debtors. shall come into force:

(1) clause (e) of section 2;

(2) section 78 (except with regard to fresh start process) and section 79;

(3) sections 94 to 187 (both inclusive);

(4) clause (g) to clause (i) of sub-section (2) of section 239;

(5) clause (m) to clause (zc) of sub-section (2) of section 239;

(6) clause (zn) to clause (zs) of’ sub-section (2) of section 240; and

(7) Section 249.”

The validity of a notification dated 15.11.2019 issued by the Central Government which notified provisions of Part III of the Code only in respect of personal guarantors to corporate debtors, was under challenge. Part III of the Code governs “Insolvency Resolution and Bankruptcy for Individuals and Partnership Firms”.

Why was it challenged?

It was argued before the Court that the executive government could not have selectively brought into force the Code and applied some of its provisions to one sub-category of individuals, i.e., personal guarantors to corporate creditors.   

(i) There is no intelligible differentia or rational basis on which personal guarantors to corporate debtors have been singled out for being covered by the impugned provisions, particularly when the provisions of the Code do not separately apply to one sub-category of individuals, i.e., personal guarantors to corporate debtors. Rather, Part III of the Code does not apply to personal guarantors to corporate debtors at all.

(ii) the provisions of Part III of the Code, which are partly brought into effect by the impugned notification, provide a single procedure for the insolvency resolution process of a personal guarantor, irrespective of whether the creditor is a financial creditor or an operational creditor. Treating financial creditors and operational creditors on an equal footing in Part III of the Code is in contrast to Part II of the Code, which provides different sets of procedures for different classes of creditors.

“Unlike delegated legislation, they say, conditional legislation is a limited power which can be exercised once, in respect of the subject matter or class of subject matters. As long as different dates are designated for bringing into force the enactment, or in relation to different areas, the executive acts 41 within its powers. However, when it selectively does so, and segregates the subject matter of coverage of the enactment, it indulges in impermissible legislation.”

Analysis

Why does the impugned Notification not amount to impermissible and selective application of provisions of the Insolvency and Bankruptcy Code?

Insolvency proceedings relating to individuals is regulated by Part-III of the Code. Before the amendment of 2018, all individuals (personal guarantors to corporate debtors, partners of firms, partnership firms and other partners as well as individuals who were either partners or personal guarantors to corporate debtors) fell under one descriptive description under the unamended Section 2(e). The unamended Section 60 contemplated that the adjudicating authority in respect of personal guarantors was to be the NCLT. Yet, having regard to the fact that Section 2 brought all three categories of individuals within one umbrella class as it were, it would have been difficult for the Central Government to selectively bring into force the provisions of part –III only in respect of personal guarantors. It was here that the Central Government heeded the reports of expert bodies which recommended that personal guarantors to corporate debtors facing insolvency process should also be involved in proceedings by the same adjudicator and for this, necessary amendments were required. Consequently, the 2018 Amendment Act altered Section 2(e) and subcategorized three categories of individuals, resulting in Sections 2(e), (f) and (g).

The earlier notification dated 30.11.2016 had brought the Code into force in relation to entities covered under Section 2(a) to 2(d).

The scheme of the Code always contemplated that overseas assets of a corporate debtor or its personal guarantor could be dealt with in an identical manner during insolvency proceedings, including by issuing letters of request to courts or authorities in other countries for the purpose of dealing with such assets located within their jurisdiction. The impugned notification authorises the Central Government and the Board to frame rules and regulations on how to allow the pending actions against a personal guarantor to a corporate debtor before the Adjudicating Authority.

“There is sufficient indication in the Code- by Section 2(e), Section 5(22), Section 60 and Section 179 indicating that personal guarantors, though forming part of the larger grouping of individuals, were to be, in view of their intrinsic connection with corporate debtors, dealt with differently, through the same adjudicatory process and by the same forum (though not insolvency provisions) as such corporate debtors.”

The intent of the notification, facially, is to allow for pending proceedings to be adjudicated in terms of the Code.

Section 243, which provides for the repeal of the personal insolvency laws has not as yet been notified. Section 60(2) prescribes that in the event of an ongoing resolution process or liquidation process against a corporate debtor, an application for resolution process or bankruptcy of the personal guarantor to the corporate debtor shall be filed with the concerned NCLT seized of the resolution process or liquidation. Therefore, the Adjudicating Authority for personal guarantors will be the NCLT, if a parallel resolution process or liquidation process is pending in respect of a corporate debtor for whom the guarantee is given.

The same logic prevails, under Section 60(3), when any insolvency or bankruptcy proceeding pending against the personal guarantor in a court or tribunal and a resolution process or liquidation is initiated against the corporate debtor.

“Thus if A, an individual is the subject of a resolution process before the DRT and he has furnished a personal guarantee for a debt owed by a company B, in the event a resolution process is initiated against B in an NCLT, the provision results in transferring the proceedings going on against A in the DRT to NCLT.”

Hence, it was safe to conclude that the Parliamentary intent was to treat personal guarantors differently from other categories of individuals and hence, the impugned Notification does not amount to impermissible and selective application of provisions of the Insolvency and Bankruptcy Code.

“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 had stood guarantee.”

The fact that the process of insolvency in Part III is to be applied to individuals, whereas the process in relation to corporate debtors, set out in Part II is to be applied to such corporate persons, does not lead to incongruity. On the other hand, 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 NCLT. As was emphasized during the hearing, 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.

Hence, the impugned notification is not an instance of legislative exercise, or amounting to impermissible and selective application of provisions of the Code. There is no compulsion in the Code that it should, at the same time, be made applicable to all individuals, (including personal guarantors) or not at all.

Does approval of a resolution plan ipso facto discharge a personal guarantor of liabilities?

The sanction of a resolution plan and finality imparted to it by Section 31 does not per se operate as a discharge of the guarantor’s liability. As to the nature and extent of the liability, much would depend on the terms of the guarantee itself. However, this court has indicated, time and again, that an involuntary act of the principal debtor leading to loss of security, would not absolve a guarantor of its liability.

Hence, the approval of a resolution plan does not ipso facto discharge a personal guarantor (of a corporate debtor) of her or his liabilities under the contract of guarantee and,

“the release or discharge of a principal borrower from the debt owed by it to its creditor, by an involuntary process, i.e. 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.”

[Lalit Kumar Jain v. Union of India, 2021 SCC OnLine SC 396, decided on 21.05.2021]


Judgment by: Justice S. Ravindra Bhat

Know Thy Judge| Justice S. Ravindra Bhat

For petitioners: Senior Advocates Harish Salve, P.S. Narasimha, Sudipto Sarkar and Advocates Rohit Sharma, Pruthi Gupta, Rishi Raj Sharma, and Manish Paliwal

For Union of India: Attorney General K.K. Venugopal, Solicitor General of India Tushar Mehta,

For State Bank of India: Senior Advocate Rakesh Dwivedi

For other respondents: Senior Advocates K.V. Vishwanathan and Ritin Rai

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