The Insolvency and Bankruptcy Code, 2016, came into effect in August 2016 but for Part III of the Code that related to insolvency and bankruptcy of individuals including personal guarantors to the corporate debtor. In November 2019, the government notified that Part III of the Code would come into effect from 1 December 2019. Before this notification, there were a series of different and conflicting views by tribunals; this notification was challenged before various High Courts that led to a rather anomalous situation. It is finally in Lalit Kumar Jain v. Union of India that the Supreme Court transferred all the cases to itself in order to avoid these conflicting views and put this issue to rest finally. The court has held that the notification was valid and not ultra vires. It is important to trace the rationale and reason behind the challenges as well as the judgment of the court.
The challenges primarily rest on the fact that the said notification was in excess of authority, and not what was prescribed under Section 1(3) of the Code and that the government could not have notified certain parts relating to personal guarantors only. The reason behind the same was the proviso to the above section that enabled the government to notify the provisions in a staged manner but not specifically the parts of the provision. The provision states that different provisions may be notified at a different date. The petitioners also highlighted the fact that under the impugned notification, there is no distinction between the procedure to be followed in terms of whether it is a financial creditor or an operational creditor, a classification that was thought necessary in case of corporate debtors. Lastly, the liability of the guarantor is always coextensive with that of the debtor as stated under Section 128 of the Indian Contract Act and it essentially would violate the rule of double dip and will lead to unjust enrichment of the creditor.
After giving due regard to the plethora of precedents on the subject matter of delegated and conditional legislations and the power of the executive in this regard, the court held that the proviso of Section 1(3) was not being violated. It disagreed with the challenges made by the petitioners primarily because of the scheme and the purpose of the Code. After analysing the dates on which the provisions came into effect, the court held that from the manner adopted by the Central government in notifying various provisions, it was clear that it was done to fulfil the purpose of the Code and for dealing with the priorities at hand. The inter-relatedness of the personal guarantors with the corporate debtor was posing difficulties in implementation of the resolution process against the corporate debtor. Precisely for this reason, the amended Section 60 of the Code contained provisions for resolution of insolvency and bankruptcy of the corporate debtor and the personal guarantor by the same forum, that is the National Company Law Tribunal.
Section 243, which contemplates the repealing of all the personal insolvency laws, has not come into force but it would not be necessary due to the presence of Section 238, which gives the Code an overriding effect over all other laws in cases of conflict as has been settled in an earlier judgment, SBI v. V Ramakrishnan. In the same judgment, the court had given enough reasons to treat personal guarantors differently from other individuals and that Section 31 of the Code gives finality to the resolution plan approved by the Committee of Creditors, which is binding on the corporate debtor and the personal guarantor. In fact the provisions relating to moratorium are also wider in case of the personal guarantors’ assets. Therefore, after the resolution plan is finalised under Section 31, it does not discharge the personal guarantor of their liability as the resolution plan is a result of an involuntary process i.e., insolvency or bankruptcy of the corporate debtor, which will not result in extinguishment of the security. The court however recognised that the extent of the liability depends on the terms of the guarantee contract itself. This also clarifies the court’s position on the double dip and double proof doctrines where it would allow the creditor to recover the amount due by proving against either or both the debtor and the guarantor to the extent of the amount due. Essentially, the common law rule prevents double dividend out of the same set of assets. The court, therefore, gave due regard to the principles of common law and contract while arriving at the conclusion.
By holding that the implementation of the Code is perfectly legal and the approval of the resolution plan does not ipso facto result in discharge of the guarantor’s liability, the court has put the creditors in a comfortable position to claim the dues from the personal guarantors without also simultaneously proceeding against the corporate debtor. It also acts as a note of caution for the personal guarantors to prudentially and critically analyse the guarantees so given on behalf of the companies.
(The writer is a legal scholar based out of Delhi and can be reached at lalchandani.kavya@gmail.com)