Rahul Nair

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Introduction

Owing to the current pandemic, financial institutions across the globe are in varying states of disarray. This has held true for India even before the catastrophe struck. Banks were accruing continuous losses, which resulted in deteriorating investor confidence and increased volatility. This was only exacerbated by the blows of Non-Performing Assets, which was largely responsible for the downward spiral of the economy. The Insolvency and Bankruptcy Code, 2016 (“the Code”), a law enacted to consolidate the framework of existing insolvency and bankruptcy laws, has emerged as the major mode of recovery of these Non-performing assets. Intending to maximize the recovery of debts of the creditors under the Code, the Central Government issued a notification dated November 15, 2019 in the official gazette whereby w.e.f. December 1, 2019, Part III of the Insolvency and Bankruptcy Code, 2016 and other provisions in so far as they relate to personal guarantors to corporate debtors were brought into force.

Several writ petitions were arrayed before the High Courts, challenging the legality of this notification. Given the importance of the matter, the Supreme Court transferred all the cases to itself and heard the matter, thereafter rendering its judgement in Lalit Kumar Jain v. Union of India.

Arguments

While opposing a bill that aimed to charter the Bank of the United States for twenty years, Thomas Jefferson, worrying about the overreach of executive powers, had critiqued that to take a single step beyond the boundaries thus specifically drawn… is to take possession of a boundless field of power, no longer susceptible of any definition. He feared and spoke vehemently against the illegitimate usurpation of legislative power by the executive. This was, in essence, the primary contention that the petitioners raised in the instant case. It argued that Section 1 (3) of the Code, which enables the Central Government to bring the necessary provisions into force, is a piece of conditional legislation and that it could not have been resorted to in the manner as to extend the provisions of the Code only in so far as they relate to personal guarantors of corporate debtors. Such impositions of conditions on the enforcement of Code, the petitioners argued, is beyond the powers granted to it under the parent Act and lacked legislative authority.

Prior to the issuance of the impugned notification, individual insolvency could only have been initiated under Presidency Towns Insolvency Act, 1909 and the Provincial Insolvency Act 1920. However, subsequent to such issuance, and without a simultaneous notification of Section 243 (repeal of the aforementioned statutes) of the Code, insolvency proceedings can now be proceeded against personal guarantors to corporate debtors under Part III of the Code, in addition to the PTI Act and the PIA. The petitioners highlighted the illogical effect of creating two contradictory legal regimes, which would only lead to the duplicity of insolvency proceedings against personal guarantors to corporate debtors.

It was also argued that once a resolution plan in respect of a corporate debtor is approved, there is an extinction of all outstanding claims against the debtor; the personal guarantor’s liability, being co-extensive in nature, would consequently stand discharged as well.

The respondents, headed by the Attorney General, relied on several authorities to contend that the Central Government has the power to bring into force any one provision of a statute at different times for different purposes. It further argued that Section 1 (3) of the IBC has to be interpreted to give the Central Government sufficient flexibility to meet the objectives of the enactment. This submission pleads the Court to use a purposive interpretation of the statute while ascertaining legislative intent. Respondent cited various provisions of the Code to assert that the Code involves a parliamentary hybridisation along with legislative fusion of the provisions provided in Part III, in so far as personal guarantors to the corporate debtors are concerned, the object of which is to make the resolution process more synchronous.

Judgement

Dismissing the challenge to the validity of the impugned notification, the Court found the notification to fulfill the objectives underlying the Code, using powers that it classified to be within permissible limits. It relied on the Working Group of Individual Insolvency (Regarding Strategy and Approach for Implementation of the Provisions of the Insolvency and Bankruptcy Code, 2016) to recognise the uniquely interwoven connection between the corporate debtor and a guarantor and appreciated the consequent distinct treatment it necessitated.

The Court also observed that Section 243(2) provides for the pending proceedings under the Acts repealed (PIA and PTI Act) to be undertaken in accordance with those enactments. In the event Section 243 were to be notified, the impugned notification would not have had the intended effect of covering pending proceedings against personal guarantors. Thus the impugned notification, the Court noted, has the result that if any proceeding were to be initiated against personal guarantors, it would be under the Code.

It relied, inter alia, on the cases of State Bank of India v. V. Ramakrishnan & Ors. and Maharashtra State Electricity Board Bombay v. Official Liquidator which had observed that a guarantor cannot seek a discharge of its liability on account of a resolution plan or liquidation of principal debtor, as it is an instance of operation of law and since such liability arises out of an independent contract. Evidently, it is for this reason why the moratorium imposed under Section 14 of the Code is inapplicable to the guarantors. The Court thereby declared that the personal guarantor (to the corporate debtor) would not be ipso facto discharged of his liabilities even in cases where the default on the loans so guaranteed had led to insolvency resolution proceedings.

Analysis

With an extensive reading of conditional legislature, the Court recognized and allowed discretionary powers, as circumstances rendered it practicable, to be exercised to meet goals of the relevant statute. It is often seen that a full recovery of the credit extended to corporate debtors is not made possible owing to multiple factors, not least due to the depreciation of asset value. This judgement is a shot in the arm for the creditors, who can now invoke personal guarantee to make further recovery of bad debts.

The judgement thus preserves the sanctity and independent existence of the legal agreement entered into by the creditor and personal guarantor. It is, however, feared that the enterprising business community would hereupon be hesitant to embark upon business projects uninhibited by the thought of involving his/her entire present and future wealth. While the sustenance and revival of business organization is important, the sustenance of personal guarantors is equally crucial for the promotion and propagation of entrepreneurship and economic opportunities.

Conclusion

It would be interesting to see the implication of this judgement wherein proceedings are initiated against personal guarantors to corporate debtors who have given guarantees to multiple business enterprises. The regulatory framework in such a case must work towards protecting related business enterprises, especially when its promoter has lost all assets owing to a single business failure.  Consequently, once the law is clear, the risk-taking ability will have to be factored in by the market. It is likely that the personal guarantors will now limit their liability to a manageable concrete number, since it is only when the loan proposal is dubious that the promoter’s personal guarantee is sought by the creditor. The judgement rightly stamps its approval to this policy decision, the requirement of which is evidenced by the current state of affairs, exemplified by the likes of Mehul Choksi, Vijay Mallya, et al.

Reference

¹ Amarjit Chopra & Sabyasachee Dash, The NPA Conundrum, The Statesman, https://www.thestatesman.com/opinion/the-npa-conundrum-1502938071.html.

² S.O. 4126 (E) issued by the Ministry of Corporation Affairs, Central Government.

³ MANU/SC/0352/2021.

⁴ Id at para 5.

⁵ Supranote 3, para 16.

⁶ FE Bureau, Old Individual Insolvency Norms Still Valid, Financial Express, https://www.financialexpress.com/india-news/old-individual-insolvency-norms-still-valid/831937/.

⁷ Supra note 3, para 9.

⁸ Supra note 3, para 28.

⁹ Supra note 3, para 91.

¹⁰ Supra note 3, para 96.

¹¹ Supra note 3, para 108.

¹² Supra note 3, para 111.