Copyright © 2020 - Ex Gratia Law Journal

A New Reign: Personal Guarantors Under IBC

The increase in competition and increased requirement of funds is a battle that companies fight every day. In this fight, any irrecoverable debts will be considered a burden on the business of Micro, Small and Medium Enterprises (MSME). To avoid all this tension, the Insolvency and Bankruptcy Code came into effect on 2016, sighing relief to all the MSMEs. The IBC law has untangled the process of landing up with respect to companies which was earlier disintegrated due to abundance of statutes and forums. One of the major intentions of the Code is to sanction the creditor where the latter can recover the dues through CIRP- Corporate Insolvency Resolution Process or through liquidation of reverting debtor entries. In December 2019, IBC made an amendment that brought personal guarantors into the code as well. The advantage of this amendment is that, the creditors can file an appeal against the principal debtor and its personal guarantor simultaneously.

A personal guarantor is an individual or an organization that makes a promise to accept responsibility on behalf of the principal debtor. The person who makes the personal guarantee is known as a ‘co-signer’. A guarantor can be any party with a credit history. Insolvency and Bankruptcy Code (IBC), deals with a time-bound process to solve insolvency. When there’s a default in the repayment of loans, creditors gain control over the debtor’s assets and should take decisions to resolve insolvency. Insolvency is when a company deals with economic distress, whereas, in the case of a bankruptcy, the court will issue an order deciding how an insolvent debtor must deal with unpaid debts and obligations. The IBC was founded in 2016 to deal with cases that involve insolvency, bankruptcy, reclamation of debts and financial obligations, etc. the code was flushed with perks. The only disadvantage was creditors cannot sue a personal guarantor under the code to reclaim their money back. So far, cases involving personal guarantors were dealt with Debt Recovery Tribunals, be it a corporate insolvency, or individual or a partnership firm. “As per the latest rules, proceedings against the corporate debtor as well as personal guarantors may be initiated simultaneously. The Code now provides easier and faster recourse for creditors against personal guarantor vis-à-vis the earlier regime which required the creditors to initiate recovery proceedings under the guarantee agreement and therefore, engage in prolonged litigation. Since the Code provides for a time bound process, the same will considerably reduce delays in recovery of dues of creditors from personal guarantors,”[1]

If and when the creditors don’t get their money back, they can press charges against the individual corporate debtor and the personal guarantor simultaneously. If one of them replays the debts, the other appeal will become void. It is a deep-rooted position of law that the principle borrower and the guarantor is co-existent under Section 128 of the Contract Act, 1872. A creditor can press charges against the principal borrower and the guarantor simultaneously in order to recover its money. The concept of simultaneous liability arose before the National Company Law Tribunal (NCLT), Delhi Bench under the Insolvency and Bankruptcy Code, 2016. In a joint case of ICICI Bank Limited vs. CA Ritu Rastogi[2] connected with Main Petition DBS Bank Limited vs. Edu Smart Service Private Limited[3], the bench stated that the principal borrower and the personal guarantor are equally liable for the repayment of the loan taken from the creditors. The court stated that ‘the right of the parties under Section 128 of the Indian Contract Act, 1872[4] are subject to the terms of the agreement between the parties…’[5]  of the Code (IBC).

Since Section 128 creates a co-extensive liability between the surety and the principal debtor, a proceeding initiated against the debtor will also govern the guarantor’s conduct. Then again, the only exception to this is stated in the E.G. Bankruptcy: Jagannath vs. Shivnarayan[6] where the court stated that; “discharge of surety by discharge of law does not discharge the surety.”[7] The implication from this would be: 1. “A guarantor is also a creditor of varied degree.”[8] 2. “The right of a surety is co-extensive with that of the principal debtor.”[9]The co-extensiveness of the liability of the guarantor with that of the debtor empowers the creditor to proceed against the both parties simultaneously.[10] The bench through Sanjeev Shriya vs. State Bank of Indiainterpreted Section 60(2) of the Code and ensured the right of creditor to proceed against guarantor and the principal debtor. The line, “an application relating to the insolvency resolution or bankruptcy of a personal guarantor of such corporate debtor shall be filed before such NCLT”[11] identifies the intention of the legislature in making the guarantor of the corporate debtor equitably liable for the payment of debts accumulated. The 4 components of guarantee contract are: (a) A contract of guarantee, (b) Suretyship, (c) Principal debtor, (d) creditor.[12] In the absence of these 4 components, the contract is a simple contract. The existence of three parties in a contract broadens the privity of contract to tripartite privity of contract.[13]

Section 14 of the Insolvency and Bankruptcy Code, 2016 (IBC), makes it clear that whenever a Corporate Insolvency Resolution Process (CIRP) is set in motion against a corporate debtor, the company will undergo a 180 day period of Moratorium (plus 90 days of extension). During the Moratorium period, any action to foreclose, recover or enforce any security interest created by the corporate debtor in respect of its property[14] is prohibited. Here, it is important to note that whenever the guarantor settles the principal debtor’s debt, he automatically acquires a right against the debtor. So does this mean it gives rise to a pressure on the corporate debtor’s assets? On the face of it, Section 14 of the IBC, 2016 prohibits the same as it states that “transferring, encumbering, alienating or disposing of by the corporate debtor any of its assets or any legal right or beneficial interest therein”.[15] In the case of Mr. V. Ramakrishnan vs. M/s. Veesons Energy Systems Pvt. Ltd. and State Bank of India[16], wherein, Veesons Energy Systems Pvt. Ltd. Asked for a debt from the State Bank of India for which Mr. V. Ramakrishnan was the personal guarantor. After the non-payment of the debts, the creditor approached the personal guarantor to directly sell the personal guarantor’s property and obtain the portion of its debt. National Company Law Tribunal (NCLT) prohibited the SBI from doing so when the moratorium period was going on because this would require creating a charge on the assets of the principal debtor. This would amount to the violation of Section 14 of IBC, i.e., encumbering the assets of corporate debtor. Since the amendment of IBC on December 2019, the issue of waiting for 180 days (plus 90 days of extension) for one party and again the same for the other party, is terminated. The creditor can press charges on both the parties, i.e., the personal guarantor and the principal debtor simultaneously. Once the debt is settled by either of the parties, the other petition will become void. The concept of subrogation given under the Contracts Act states that the rights of one person may be transferred to another provided the latter is significant eliminating the debt of the former-debtor. Once the personal guarantor pays the debts on behalf of the principal debtor, the former becomes the creditor as he succeeds to the right including the right to claim the debt amount of the previous creditor. This concept arose from Morgan vs. Seymore[17]case, wherein the court held that after disposing off the obligations of the principal debtor, the guarantor acquires the right to stand in the shoes of the creditor.[18]

The ad rem question which arises here is whether under the Insolvency and Bankruptcy Code, 2016, the guarantor is liable to bring in Corporate Insolvency Resolution Process (CIRP) proceedings against the principal debtor? This was answered in the case of Davinder Ahluwalia and Ors. v. Sumit Aviation,[19]where the guarantors of the debtors paid 1 crore and 5 lakhs to the Punjab National Bank. The basis of subrogation put the guarantor in the place of the creditor. The debtor company again failed to pay the guarantors the amount paid towards pardoning of the debt created in exchange of paying the amount owed by the respondent, i.e., MS Sumit Aviation. The guarantors approached the National Company Law Tribunal (NCLT) under Section 7 of the Insolvency and Bankruptcy Code. The Tribunal then permitted the CIR proceedings against the principal debtor as the latter did commit a fault by not repaying the debts.

Personal guarantors included in the Insolvency and Bankruptcy Code can be viewed as an important change as it will have a strong effect on the power and strength of the creditors’ endeavors in resolution and the latter can achieve an effective decision regarding the debts that are owed by the corporate debtors and their personal guarantors thereby avoiding indictments in multiple tribunals. It also helps the guarantors to settle with the creditors through lawful processes and get dispensed from the creditors with regards to their liabilities.


[1] Padmaja Kaul, Personal guarantors now liable under IBC: Here’s what changes from 1 December, Livemint (29 Nov 2019, 03:35 PM IST), https://www.livemint.com/politics/policy/personal-guarantors-now-liable-under-ibc-here-s-what-changes-from-1-december-11575021757120.html

[2] ICICI Bank Limited vs. CA Ritu Rastogi. CA 366 (PB)/2017 (India).

[3]Id.                                                                                                                                                      

[4] Indian Contract Act,S.128 (1872).

[5] Id.

[6] Jagannath v. Shivnarayan AIR 1940 Bombay 387 (India).

[7] Id.

[8] United Nations Commission on International Trade, Legislative Guide on Insolvency Law (New York, 2005), para.1.

[9] Sanjeev Shriya vs. LML Industries, W.P. (C) No. 30285 of 2017 (India).

[10] Subankhan v. Lalkhan AIR 1947 Nag. 643 (India).

[11] The Insolvency and Bankruptcy Code,S.60 (2), 2016 No. 31, 2016.

[12] S.N Gupta, Law Relating to Guarantees with Pro-formas of Bank Guarantees and Indemnity Bonds (6th edn, Pitman, 1947).

[13] Id.

[14] The Insolvency and Bankruptcy Code,S.14 (1) (c), 2016 No. 31, 2016.

[15] The Insolvency and Bankruptcy Code,S.14 (1) (b), 2016 No. 31, 2016.

[16] Mr. V. Ramakrishnan vs. M/s. Veesons Energy Systems Pvt. Ltd. and State Bank of India, CIVIL APPEAL NO. 3595 OF 2018 (SC) (India)

[17] Morgan v. Seymore, 1 Rep Ch 120.(1638) (U.S.).

[18] Id.

[19] Davinder Ahluwalia and Ors.v. Sumit Aviation,2017, NCLT, IB No. (IB)-229 (India).

Print Friendly, PDF & Email

Author

Arjun A
Student - SASTRA Deemed to be University

Leave a Reply