Case Analysis: Lalit Kumar Jain vs. Union of India.
Forum: Supreme Court of India
Bench: Justice L. Nageswara Rao and Justice S. Ravindra Bhat.
Case No/Citation: Transfer Case (Civil) No. 245/2020, 2021 SCC OnLine SC 396.
Date of Decision: 21.05.2021.
In what came as a landmark judgment, the Hon'ble Supreme Court upheld the Notification[i] dated 15th November 2019 passed by the Central Government, which allows creditors to initiate insolvency proceedings against personal guarantors, i.e., the bankers can pursue insolvency proceedings against promoters, guarantors, etc. of defaulter companies simultaneously or after the conclusion of the Corporate Insolvency Resolution Process ("CIRP") under the Insolvency and Bankruptcy Code, 2016 ("Code").
Backdrop of the case:
The judgment was passed on a common question of law arising out of the various petitions that were filed by defaulting promoters of companies such as Bhushan Power and Steel, Reliance Communications, Bhushan Steel and Punj Lloyd in various High Courts under Article 226 of the Constitution of India.[ii] The Apex Court transferred[iii] all these cases to itself to decide on the common question of law relating to the validity of the notification.[iv]
Prior to the said notification which was challenged by the petitioners, the jurisdiction for initiating insolvency and bankruptcy proceedings against Personal Guarantors vested with the Debt Recovery Tribunal. While the notification was welcomed amongst the creditors on account of greater accountability of the Personal Guarantors, various writ petitions were filed in different High Courts challenging the said notification and the associated rules thereto.
The issue that was raised by the various petitioners, who being either directors, or promoters, or in some instances chairman or managing directors was that the Government could not have selectively brought into force the Code and applied some of its provisions to only one sub-category of individuals, i.e., personal guarantors to corporate creditors.
Arguments by the Petitioners:
It was contended by the petitioners that the notification issued by the Central Government was an act of ‘excessive delegation’ and that the Central Government did not have any authority - legislative or statutory – to impose conditions on the enforcement of the Code. It was further contended as a corollary, that the enforcement of Sections 78, 79, 94-187, etc. of the Code in terms of the impugned notification solely in relation to personal guarantors is ultra vires the powers granted to the Central Government.
Further, it was argued that according to Section 1(3) of the Code[v] the government cannot selectively choose to make the insolvency proceedings made applicable only to the personal guarantors. Thus, the power delegated under Section 1(3) is only as regards the point(s) in time when different provisions of the Code can be brought into effect and that it does not permit the Central Government to notify parts of provisions of the Code, or to limit the application of the provisions to certain categories of persons. The notification, however, notified various provisions of the Code only in so far as they relate to personal guarantors to corporate debtors, therefore, being ultra vires to the proviso to Section 1(3) of the Code.
This argument was premised on the nature and content of Section 1(3), which the Petitioners characterize to be "conditional legislation". 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 within its powers. However, when it selectively does so, and segregates the subject matter of coverage of the enactment, it indulges in impermissible legislation.
Further, the petitioners argued that the Central government did not bring into effect Section 243 of the IBC which would have repealed the only two Acts[vi] under which the insolvency proceedings against an individual could be initiated. Therefore, now there were two self-contradictory legal regimes for insolvency of the personal guarantors.
Moreover, it was also argued that the liability of a guarantor is co-extensive with that of the principal debtor[vii]. However, the impugned notification allows creditors to unjustly enrich themselves by claiming in the insolvency process of the personal guarantor as well in that of the corporate debtor. Initiating proceedings against the corporate debtor as well as the personal guarantor to a corporate debtor would amount to a "double recovery" which is impermissible under the Code. Thus, since the claims against the principal debtor are extinguished upon the conclusion of the insolvency process, any liability owed by its guarantors must also be extinguished, being coextensive by virtue of Section 128 of the Indian Contract Act, 1872.
Counter Arguments by the Respondents:
On the other hand, the Union of India being the respondents argued that the Parliament always wanted to deal with personal guarantors differently from partnership firms and proprietorship firms, and other individuals and this can be seen from the amendments done in 2018, whereby IBC was amended to include three classes of debtors, which were personal guarantors to the corporate debtor[vii], partnership firms and proprietorship firms[ix] and individuals.[x] Thus the respondents submitted that there had been a clear distinction between personal guarantors to corporate debtors from partnership/proprietorship firms and other individuals.
Along with this, even Section 60(2) was also amended to include the words a "corporate guarantor or personal guarantor as the case may be". Thus implying that, a personal guarantor could be subjected to insolvency proceedings which could be resolved and decided by the NCLT.
It was contended by the respondents that, Section 1(3) of the IBC calls for flexibility during its interpretation to better implement the objectives of the IBC. Further reliance was placed on numerous decisions such as Basant Kumar Sarkar v. Eagle Rolling Mills Ltd.[xi] and Bishwambhar Singh v. State of Orissa,[xii] to show that a stage-wise implementation was valid and not ultra vires as it helps in understanding the impact that is caused by the implementation.
The Supreme Court looking at contentions of both sides held that the Notification is not an instance of 'legislative exercise', or amounting to impermissible and selective application of provisions of the IBC. There is no compulsion in the IBC that it should, at the same time, be made applicable to all individuals, (including Personal Guarantors) or not at all. The Central Government envisaged a stage-by-stage induction of the Code keeping in mind the object and purpose of the Code, which is permissible in law.
The Supreme Court stated that looking at the previous amendments it can be said that they were brought with the objective of furthering and strengthening the objectives of the IBC. The Apex Court also observed that even in the unamended IBC prior to 2018, the adjudicating authority for insolvency and liquidation for corporate persons, including corporate debtors and personal guarantors, was NCLT.
Thus, the Supreme Court observed that the forum for adjudicating insolvency processes must be common, i.e., the NCLT, in order to look at the complete picture about the nature of the assets available, either during the corporate debtor's insolvency process or even later. Moreover, keeping in mind the intimate connection between personal guarantors and corporate debtors, allowing insolvency proceedings in separate forums in relation to the aforementioned parties could lead to uncertain outcomes which will defeat the purpose of the Code.
The Supreme Court further held that "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." Relying upon its earlier decisions[xiii], the Supreme Court noted that "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". The Supreme Court relied upon a UK judgment[xiv] to explain that a creditor can proceed against either the corporate debtor or the surety or both. It was observed that 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.
The Supreme Court further noted that Section 243, which provides for the repeal of the personal insolvency laws has not been notified. It was noted that Section 238 gives the IBC an overriding effect over the other prevailing enactments and maybe this is the rationale for not notifying Section 243. Section 243(2) saves pending proceedings under PTI Act and PIA Act[xv] and if Section 243 is notified, the impugned notification would not cover proceedings which are pending against personal guarantors in other forums, thereby defeating the purpose of bringing the proceedings under the scope of adjudicating authorities/IBC.
This judgment is perceived as a welcome move by creditors, who may now recover their dues from both the corporate debtor and the personal guarantor thereof under one forum simultaneously. Further, now even if any creditor wants to proceed against the personal guarantor to the corporate debtor following the CIRP of the latter, it shall be permissible under the IBC, as the judgment clearly lays down that the resolution plan does not extinguish the guarantors' liability. However, when viewed from a different perspective, the effect of this judgment will necessarily result in disincentivizing individual personal guarantors from extending a guarantee cover to the corporate debtors.
Further, in view of this judgment passed by the Supreme Court as well as by the NCLAT in Lalit Mishra & Ors. v. Sharon Bio Medicine Ltd. & Ors.[xvi], the right of subrogation available to the personal guarantor, ceases to exist in furtherance of the larger purpose of the Code to revive corporate entities.
The aforesaid right of subrogation is an essential principle of law fo guarantee and is envisaged in the Contract Act under Section 140 which states that "Where a guaranteed debt has become due, or default of the principal - debtor to perform a guaranteed duty has been taken place, the surety, upon payment or performance of all that is liable for, is invested with all the rights which the creditor had against the principal – debtor".
Thus, cessation of this right would adversely affect a personal guarantor, thereby, leaving him/her virtually remediless if the resolution plan (which is approved by the COC) envisages extinguishment of the personal guarantor's right of subrogation. For instance, the NCLT has in the past approved of resolution plans extinguishing such rights of personal guarantors in State Bank of India v. Calyx Chemicals & Pharmaceuticals Limited[xvii], and IDBI Bank Ltd. v. EPC Constructions India Limited[xviii].
The Supreme Court has hence selectively applied the principle of guarantee, stating that the Code, under Section 238, is equipped with overriding powers vis-à-vis other statutes. The resultant situation is that while the liability of a personal guarantor under the Contract Act is retained, his corresponding right is restricted, which goes against established general principles of law and equity, and would amount to 'unjust enrichment' by the corporate debtor.
The judgment is a welcome move for the creditors as the same has been passed keeping in mind the objectives of the IBC. This judgment gives NCLTs the jurisdiction to deal with personal guarantors of corporate debtors alongside the CIRP proceedings of corporate debtors/principal borrowers, thereby having a more comprehensive system in place for the recovery of debts. The combined process would also ensure that those responsible do not skirt their liabilities, which was previously possible due to the separate frameworks that existed for recovery of dues from borrowers and their guarantors.
In contrast, the position as settled by the Supreme Court in the present judgment, in order to benefit creditors, has left personal guarantors in a precarious position. The Supreme Court in Swiss Ribbons Private Limited v. Union of India[xix], noted that the object and purpose of the Code is to ensure the revival of the corporate debtor and have warned against using the Code as a mere 'recovery tool'. However, the present 'creditor-centric model' has led to just that, at the cost of general principles of contract and law. The Code has thus become virtually a tool benefitting the creditors by allowing them to proceed against the personal guarantor for recovery of their dues without providing the corresponding right of subrogation to the personal guarantor. Further, the creditors themselves, through the committee of creditors (CoC) are the ones approving the resolution plan under Section 30 of the Code, which would leave the guarantor with no recourse if his contractual rights are extinguished.
[i] Notification dated 15 November 2019 issued by the Ministry of Corporate Affairs, https://www.mca.gov.in/Ministry/pdf/Notification_18112019.pdf, last accessed on June 15,2021. [ii] Delhi, Madhya Pradesh, Telangana, etc. [iii] Article 139A of the Constitution of India,1950. [iv] Supra at [i]. [v] Section 1(3), Insolvency and Bankruptcy Code, 2016. [vi] Presidency Towns Insolvency Act, 1909 and Provincial Insolvency Act, 1920. [vii] Section 128 of Indian Contract Act, 1872. [viii] Section 2 (e), Insolvency and Bankruptcy Code, 2016. [ix] Section 2(f), Insolvency and Bankruptcy Code, 2016. [x] Section 2(g), Insolvency and Bankruptcy Code, 2016. [xi] 1964 6 SCR 913 [xii] 1954 SCR 842.
[xiii] 1982 (3) SCC 358, (2002) 5 SCC 54, (2002) 5 SCC 80.
[xiv] 2012 (1) All ER 883 Paras 11, 12, 53-54.
[xv] Supra at [vi].
[xvi] 2018 SCC OnLine NCLAT 669.
[xvii] 2018 SCC OnLine NCLT 28227.
[xviii]2018 SCC OnLine NCLT 28227.
Authors: Ayushi Srivastava, Paralegal, S&D Legal Associates.