Personal Guarantors of Corporate Debtors Finally in the Net of IBC

   

The recent decision of the Supreme Court in Lalit Kumar Jain v. Union of India¹ has set at rest a serious controversy under the Insolvency and Bankruptcy Code, 2016 (“IBC” or “the Code”) relating to personal guarantors of the corporate debtors (“PGCD”), that is to say, individuals who furnish their own personal guarantees (as promoters, Directors, etc.) to lenders and creditors for securing financial loans, advances, etc. for corporate persons who turn out to be defaulters viz. corporate debtors (“CD”). The Court has rejected the challenge by PGCD to the Central Government Notification dated 15-11-2019 by which PGCD were brought within the same operational net and regime of IBC as governs the CD themselves.

The verdict of the Supreme Court in Lalit Kumar Jain¹ is an extremely elaborate one. IBC itself is a somewhat complex statute. Thus, in the very nature of things, the verdict too is a long, detailed and complicated one. PGCD advanced two main contentions before the Court in Lalit Kumar Jain¹. The short study in the present article with the help of the statutory background of IBC (including certain amendments in IBC) is an endeavour to analyse and explain the said verdict on those two contentions in simple terms.

THE PARLIAMENTARY SCHEME OF ENFORCEMENT OF THE CODE

Parliament enacted IBC in 2016 as a comprehensive code of insolvency resolution, liquidation, bankruptcy, etc. governing both corporate persons as well as individuals and partnership firms. However, it did not enforce the provisions of IBC itself at the time of the enactment². Rather it gave power to the Central Government under Section 1(3) to enforce the provisions of IBC by means of notification in the Official Gazette, enabling it to bring different provisions of IBC into force on different dates.

Accordingly, from time to time on different dates as early as in 2016 and 2017, the Central Government issued different notifications enforcing different provisions contained in Part II of IBC which pertained to insolvency resolution and liquidation for corporate persons. The notifications also enforced certain related provisions contained in Parts IV and V of IBC necessary for the working of Part II. These provisions pertained to the constitution of regulatory bodies; setting up of adjudicating and appellate authorities; ouster of jurisdiction of civil courts; overriding, repeal and amendment of sundry laws; power to make rules and regulations and so on for the sake of making Part II functional and operational.

However, the provisions contained in Part III of IBC pertaining to Insolvency Resolution and Bankruptcy for Individuals and Partnership Firms were not enforced by the Government at the same time as Part II. The result was that individuals and partnership firms continued to be governed by the old system and old laws of insolvency [namely, the Presidency Towns Insolvency Act, 1909 (PTA) and the Provincial Insolvency Act, 1920 (PIA)]. They remained unaffected by the modern mechanism, authorities and regulatory bodies set up under Part II IBC in keeping with UNO-advised international standards e.g. NCLT under Section 60, NCLAT under Section 61 and so on. In regard to such entities, Section 179 (Part III) provided a different body, the Debts Recovery Tribunal (DRT), as the adjudicatory authority. However, in the absence of enforcement of Part III (Sections 78 to 187) as a whole, even Section 179 (DRT) remained for creditors only a silent remedy on paper.

The “individuals” covered by Part III included the abovementioned class of PGCD i.e. individuals who had given personal guarantees to creditors for securing finances for corporate persons who had later defaulted in repayment to the creditors viz. “corporate debtors” or CD. Thus, as regards PGCD, as explained above, Section 179 (DRT) remained a silent remedy on paper. Though for the purposes of Section 60(2), Section 60(4) did vest in NCLT all the powers of the DRT as contemplated under Part III, in the absence of enforcement of Part III (Sections 78 to 187) itself, even Section 179 remained for NCLT and the creditors of CD wholly a chimerical and distant dream.

In other words, PGCD in actuality remained excluded from any resolution process going on against a CD before NCLT under Section 60 of Part II. So no remedy before NCLT and also no procedure under Part II or even Part III was available to the creditors in respect of PGCD.

THE AMENDING ACTS 8 AND 26 OF 2018

As mentioned above, different provisions of IBC were enforced by the Central Government on different dates by means of multiple notifications issued under Section 1(3) in 2016 and 2017. In addition, Parliament enacted Act 8 of 2018 and Act 26 of 2018 for amending IBC. The former amended Section 2(e) w.e.f. 23-11-2017³ and the latter amended Sections 60(2) and (3) w.e.f. 6-6-2018.⁴

Amendment and enforcement of Section 2(e)

The legislative amendment and evolution of Section 2(e) can be understood by taking into consideration the following different kinds of entities:

Corporate persons as debtors

Section 2 in Part I of IBC initially provided for “application” of IBC to different kinds of entities as mentioned in five different clauses : clauses (a) to (e). Clauses (a) to (d) of Section 2 enumerated certain kinds of corporate entities whereas clause (e) thereof described a combined group of non-corporate entities as “partnership firms and individuals”.

Part II Chapters I and II containing Sections 4 to 54 provided for insolvency resolution and liquidation for corporate persons.

Section 2(a) to (d) in Part I (titled “Preliminary”) and Sections 4 to 32 in Part II Chapters I and II (titled “Preliminary” and “Corporate Insolvency Resolution Process”, respectively) were enforced by the Central Government by means of Notification dated 30-11-2016 w.e.f. 1-12-2016. The remaining provisions, Sections 33 to 54 in Part II Chapter III (titled “Liquidation Process”) were enforced by the Central Government by means of Notification dated 9-12-2016 w.e.f. 15-12-2016.

Both the above notifications were issued on different dates under Section 1(3) IBC.

Personal guarantors to corporate debtors (a sub-group of Individuals)

As mentioned above, the provision in Section 2(e) originally read as “partnership firms and individuals”. At the outset, when the provisions for CD were enforced in 2016-2017, the provision in Section 2(e) was left unenforced. As regards this category, it is Part III containing Sections 78 to 187 which is relevant. Part III provides for matters pertaining to Insolvency Resolution Process and Bankruptcy for Individuals and Partnership Firms.

In 2018, the Code was amended twice over by Act 8 of 2018 and Act 26 of 2018. The first amendment trifurcated the original combined group of entities contained in Section 2(e) viz. “partnership firms and individuals” into three splinter sub-groups. The sub-groups were covered respectively by three newly framed clauses (e), (f) and (g) in Section 2 as follows:

(e) personal guarantors to corporate debtors;

(f) partnership firms and proprietorship firms; and

(g) individuals, other than persons referred to in clause (e).

After the above trifurcation stood effected by amendment through Act 8 of 2018, certain provisions viz. the new Section 2(e) itself (Part I), Sections 78, 79 and 94 to 187 (Part III)⁵ and some related clauses of Sections 239, 240 and 249 (Part V)⁶ were enforced by the Central Government by means of the Notification dated 15-11-2019 which came to be impugned before the Court in Lalit Kumar Jain¹. The enforcement was done w.e.f. 1-12-2019. The notification thus covered one particular sub-group and type of individuals viz. PGCD in the same insolvency resolution process and before the same adjudicating authority/appellate authority under IBC as govern the principal borrower in question, namely, the corporate debtor or the CD.

In other words, out of the larger group of “individuals”, a particular sub-group of individuals, namely, PGCD, came to be identified in the newly framed Section 2(e) and the new Section 2(e) was enforced by Notification dated 15-11-2019. The notification also enforced certain other provisions, namely, Sections 78, 79 and 94 to 187 (Part III) which provide for insolvency and bankruptcy of individuals and also Sections 239 (Power to make rules), 240 (Power to make regulations) and 249 ()(Part V) insofar as they relate to PGCD.

Amendment of Section 60

The provision in “Section 60 — Adjudicating authority for corporate persons” (Part II) had already been enforced earlier by a Notification in 2016⁷. It provided for NCLT as the adjudicating authority in respect of CD.

Initially, Sections 60(2) and (3) had envisaged a limited application only to bankruptcy of PGCD along with resolution and/or liquidation in respect of CD under Part II.

The second amendment of 2018 viz. Act 26 of 2018 amended Sections 60(2) and (3) by specifically including and bringing liquidation of a “corporate guarantor” of a CD also within the jurisdiction of the said adjudicating authority, namely, NCLT.

On the other hand, Section 179 in Part III had originally declared a different authority, the Debt Recovery Tribunal (DRT), to be the adjudicating authority for all individuals and partnership firms covered by Part III but with the rider “Subject to the provisions of Section 60”. Correspondingly, Section 60(2) in Part II had proclaimed that it applies “notwithstanding anything to the contrary contained in the Code”.

With the amended Section 2(e) and various other provisions in the Code pertaining to PGCD getting enforced under Notification dated 15-11-2019, it became possible, in a given case, for individuals classified as a sub-group viz. “PGCD” in the new Section 2(e) to be subjected to insolvency proceedings before the same adjudicating authority/appellate authority (NCLT/NCLAT) who decided matters relating to the CD. This made possible a “unified adjudication” of all parties and issues concerned with a CD under one umbrella. Now, if the CD’s debt remained unpaid in spite of his personal guarantor, the personal guarantor would not stand discharged but would himself be forced to face bankruptcy proceedings before NCLT. The procedure for him, however, would not be as per Part II meant for CD. It would be in accordance with the regime crafted by Parliament for individuals separately in Part III of IBC.

With the amendment of Section 2(e) w.e.f 23-11-2017 (vide Act 8 of 2018) coupled with its enforcement w.e.f. 1-12-2019 (vide Notification dated 15-11-2019), the class of PGCD fell straight into the lap of NCLT much to the delight of the creditors of CD.

THE GENESIS OF THE CHALLENGE BEFORE THE SUPREME COURT

Prior to the Notification dated 15-11-2019, the exclusion of the individuals, namely, PGCD, from the insolvency resolution process of CD had been much to the detriment and chagrin of the lenders and creditors of CD. PGCD, despite their personal guarantees, would remain incorrigibly elusive and immune to the resolution proceedings undertaken by the creditors under IBC. They would leave the creditors high and dry with their unending litigious and evasive malpractices. The creditors were deeply aggrieved. Hence, the Government resolved to address the woes of the creditors and bring PGCD effectively into the same net under IBC as the CD.

As noticed above, the Notification dated 15-11-2019 was issued by the Central Government under Section 1(3) to enforce certain provisions of Part III pertaining to Insolvency Resolution and Bankruptcy for Individuals and Partnership Firms insofar as they related to one particular class of individuals, namely, PGCD so as to bring them within the bounds of IBC. It, however, left the very same provisions still unenforced in respect of all remaining individuals and partnership firms covered by Part III.

As a consequence of the notification, the class of PGCD got picked up as a special class of individuals who could now be dealt with by the creditors alongside the insolvency resolution process undertaken by them (the creditors) under Part II against the CD itself. They could be brought to book and made to account before the same adjudicating and appellate authorities under IBC as applied to the CD viz. NCLT and NCLAT. But the other class of individuals/partnership firms covered by Part III still remained unaffected by IBC.

The discrimination between the above two classes of individuals led to the challenge by PGCD before the Supreme Court in Lalit Kumar Jain¹.

PGCD firstly questioned the power of the Government under Section 1(3) to enforce the provisions of IBC (Part III, etc.) selectively in respect of a particular class of individuals only, namely, PGCD without roping in all other individuals in general. This, according to PGCD, was not only outside and ultra vires the notifying (enforcing) power conferred upon the Central Government under Section 1(3) but also arbitrary and discriminatory towards PGCD. (Contention 1)

Another significant ground of challenge raised by PGCD before the Court was twofold : first, that as a consequence of the impugned notification, they had been deprived of their legal rights and protection as a surety (guarantor) under Sections 128, 133 and 140 of the Contract Act and second, that in spite of the fact that under Section 31(1) of IBC, an approved resolution plan in respect of a CD is final and binding for all concerned, the liability of PGCD is still kept alive. (Contention 2)

In re Contention 1 — Notification is ultra vires Section 1(3) and invalid

Submission by PGCD

The first contention of PGCD before the Court, in brief, was that when Section 1(3) gave to the Central Government power to issue different notifications for enforcing different provisions of the Code, it enabled the Government merely to issue such notifications on different “dates”, not for enforcing any provision only in respect of a selected class of persons to the exclusion of others. It is not possible for the Government to notify limited application of a provision meant for all individuals in general for one selected class of individuals only, namely, PGCD. Since the impugned notification did so, it is outside and ultra vires the power given to the Government under Section 1(3) and void.

PGCD conceded that in such situations the Government may be able to issue notifications at different “times” for enforcing the legislative provisions in phases in different territorial “regions” or “areas” of the State. But it cannot do so for applying the provisions to a limited class of persons, subjects or individuals when the provisions are intended to govern all of them in general. The submission was made with the help of various precedents. It had various constitutional offshoots, hues and shades which are broadly summarised as follows:

(i) Such application amounts to usurpation of essential legislative power by the executive which is unconstitutional. Parliament having enacted the law (IBC) in all its completeness as regards “place, person, laws, powers”, gave only a power of notification/enforcement of the law at such “time” as the Government may decide as an instance of “conditional legislation”. The Government has exceeded that power inasmuch as enforcement of the provisions only in respect of a certain class of individuals (PGCD) amounts to modification of the law (IBC). The Government is not authorised to do so by Parliament.

(ii) Provisions of Part III do not distinguish between an individual and a PGCD, both being referred to as the “debtors”. But the impugned notification in effect adds the words “only insofar as they relate to personal guarantors to corporate debtors” like a rider to each of the provisions/sections mentioned in the notification. That amounts to legislation by the executive.

(iii) The enforcement of the provisions in question in respect of PGCD alone is arbitrary and discriminatory, there being no intelligible differentia or rational basis to distinguish them from other individuals. Also the procedure in Part III is made available against PGCD now to both classes of creditors, financial and operational, who are otherwise entitled only to different sets of procedures under Part II governing insolvency of the CD. It treats unequals as equals.

(iv) There was also non-application of mind inasmuch as Section 243 which would have repealed the Presidency Towns Insolvency Act, 1909 (PTA) and Provincial Insolvency Act, 1920 (PIA) still remained unenforced. Resultantly, now insolvency proceedings against PGCD would lie before the adjudicating authority both under Part III of the Code as also under PTI and PIA—two self-contradictory legal regimes.

Submission by Union of India

For the Union of India and other respondents, the defense arguments were made on the lines that the Government or executive can always be entrusted with the task of implementing different provisions of a legislation as per its own wisdom and discretion at different times or in different geographical areas or from stage to stage or from one limited purpose to another. Such an exercise is not vitiated either on account of excessive delegation of legislative power or arbitrary exercise of administrative power by the Government. Various precedents were also cited in support.

By far the most direct, pertinent and outstanding authority in the context cited on behalf of the Union of India was Bennion on Statutory Interpretation : A Code (6th Edn., at p. 257). It endorses the use of power by the executive in such circumstances on different dates for different “purposes”. It is cited by the Court in para 35 of the judgment in Lalit Kumar Jain¹ as follows : (SCC para 35)

35. It was argued that the executive has the power to bring into force any one provision of a statute at different times for different purposes, and that the Government can exercise this power to commence a provision for one purpose on one day and for the remaining purposes on a later date. He relied upon the following extract from Bennion on Statutory Interpretation : A Code (6th Edn., at p. 257):

“Where power is given to bring an Act into force by order, it is usual to provide flexibility by enabling different provisions to be brought into force at different times. Furthermore, any one provision may be brought into force at different times for different purposes. …

Advantages. This method of commencement gives all the advantages of extreme flexibility. Before a new Act is brought into operation, any necessary regulations or other instruments which need to be made under it can be drafted.”

(emphasis supplied)

The Court has in its judgment upheld the above view of the Union of India and rejected that of PGCD. However, curiously, the above authority (Bennion), remarkably relevant though it is to the context, does not feature in the “Analysis and Conclusions” section of the judgment¹ of the Court contained in SCC paras 65 to 126.

Decision of the Court¹

The judgment¹ of the Court rejecting Contention 1 of PGCD is largely contained in SCC paras 90 to 114. Now that we have the benefit of the above introduction of statutory background of IBC and genesis of the challenge before the Supreme Court, one would do well, rather than paraphrasing the Court’s reasoning in one’s own words, to reproduce verbatim the reasoning of the Court in its original form from some of those paragraphs : (Lalit Kumar Jain case¹, SCC paras 94-96, 103-09 & 112-14)

94. It is quite evident that the method adopted by the Central Government to bring into force different provisions of the Act had a specific design : to fulfil the objectives underlying the Code, having regard to its priorities. Plainly, the Central Government was concerned with triggering the insolvency mechanism processes in relation to corporate persons at the earliest. Therefore, by the first three notifications, the necessary mechanism such as setting up of the regulatory body, provisions relating to its functions, powers and the operationalization of provisions relating to insolvency professionals and agencies were brought into force. These started the mechanism through which insolvency processes were to be carried out and regulated by law. In the next phase, the part of the Code dealing with one of its subjects i.e. corporate persons [covered by Sections 2(a) to 2(d) of the Code] was brought into force. The entire process for conduct of insolvency proceedings and provisions relating to such corporate persons were brought into force. The other notifications brought into force certain consequential provisions, as well as provisions which give overriding effect to the Code (as also the provisions that amend or modify other laws). All these clearly show that the Central Government followed a stage-by-stage process of bringing into force the provisions of the Code, regard being had to the similarities or dissimilarities of the subject-matter and those covered by the Code.

95. As discussed in a previous part of this judgment, 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 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). Given that the earlier Notification of 30-11-2016 had brought the Code into force in relation to entities covered under Sections 2(a) to 2(d), the Amendment Act of 2018 provided the necessary statutory backing for the Central Government to apply the Code, in such a manner as to achieve the objective of the amendment, i.e. to ensure that adjudicating body dealing with insolvency of corporate debtors also had before it the insolvency proceedings of personal guarantors to such corporate debtors.

96. The amendment of 2018 also altered Section 60 in that insolvency and bankruptcy processes relating to liquidation and bankruptcy in respect of three categories i.e. corporate debtors, corporate guarantors of corporate debtors and personal guarantors to corporate debtors were to be considered by the same forum i.e. NCLT.

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103. The theme of gradual implementation of law or legal principles, was also spoken about in Javed State of Haryana⁸ by this Court, which held that there is no constitutional imperative that a law or policy should be implemented all at once : (SCC p. 383, para 16)

“16. A uniform policy may be devised by the Centre or by a State. However, there is no constitutional requirement that any such policy must be implemented at one go. Policies are capable of being implemented in a phased manner. More so, when the policies have far-reaching implications and are dynamic in nature, their implementation in a phased manner is welcome for it receives gradual willing acceptance and invites lesser resistance.”

Similar observations were made in Pannalal Bansilal Pitti v. State of A.P.⁹ wherein the Court held that imposition of a uniform law, in some areas, or subjects may be counterproductive and contrary to public purpose. Sabanayagam¹⁰ too emphasised discretion to extend an enactment, having regard to the time, area of operation, and its applicability when it was emphasised that such power is “limited and almost ministerial function as an agent of the principal legislature applying the Act to the area at an appropriate time.”

104. The close proximity, or inter-relatedness of personal guarantors with corporate debtors, as opposed to individuals and partners in firms was noted by the report of the Working Group, which remarked that it:

“recognizes that dynamics, the interwoven connection between the corporate debtor and a guarantor (who has extended his personal guarantee for the corporate debtor) and the partnership firms engaged in business activities may be on distinct footing in reality, and would, therefore, require different treatment, because of economic considerations. Assets of the guarantor would be relevant for the resolution process of the corporate debtor. Between the financial creditor and the corporate debtor, mostly the guarantee would contain a covenant that as between the guarantor and the financial creditor, the guarantor is also a principal debtor, notwithstanding that he is guarantor to a corporate debtor.”

105. As noticed earlier, Section 60 had previously, under the original Code, designated NCLT as the adjudicating authority in relation to two categories : corporate debtors and personal guarantors to corporate debtors. The 2018 Amendment added another category : corporate guarantors to corporate debtors. The amendment seen in the background of the report, as indeed the scheme of the Code [i.e. Section 2(e), Section 5(22), Section 29-A, and Section 60], clearly show that all matters that were likely to impact, or have a bearing on a corporate debtor’s insolvency process, were sought to be clubbed together and brought before the same forum. Section 5(22) which is found in Part II (insolvency process provisions in respect of corporate debtors) as it was originally, defined personal guarantor to say that it “means an individual who is the surety in a contract of guarantee to a corporate debtor.” There are two more provisions relevant for the purpose of this judgment. They are Sections 234 and 235 of the Code; …

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106. These two provisions also reveal that 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.

107. The impugned notification operationalises the Code so far as it relates to personal guarantors to corporate debtors:

107.1. (1) Section 79 pertains to the definitional section for the purposes of insolvency resolution and bankruptcy for individuals before the adjudicating authority.

107.2. (2) Sections 94 to 187 outline the entire structure regarding initiation of the resolution process for individuals before the adjudicating authority.

108. 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. 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 NCLT concerned seized of the resolution process or liquidation. Therefore, the adjudicating authority for personal guarantors will be 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.

109. This Court in Ramakrishnan¹¹, noticed why an application under Section 60(2) could not be allowed. At that stage, neither Part III of the Code nor Section 243 had not been notified. This meant that proceedings against personal guarantors stood outside NCLT and the Code. The non-obstante provision under Section 238 gives the Code overriding effect over other prevailing enactments. This is perhaps the rationale for not notifying Section 243 as far as personal guarantors to corporate persons are concerned. …The impugned notification, as a consequence of the non obstante clause in Section 238, has the result that if any proceeding were to be initiated against personal guarantors it would be under the Code.

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112. The argument that the insolvency processes, application of moratorium and other provisions are incongruous, and so on, in the opinion of this Court, are insubstantial. The insolvency process in relation to corporate persons [a compendious term covering all juristic entities which have been described in Sections 2(a) to (d) of the Code] is entirely different from those relating to individuals; the former is covered in the provisions of Part II and the latter, by Part III. Section 179, which defines what the adjudicating authority is for individuals is “subject to” Section 60. Section 60(2) is without prejudice to Section 60(1) and notwithstanding anything to the contrary contained in the Code, thus giving overriding effect to Section 60(2) as far as it provides that the application relating to insolvency resolution, liquidation or bankruptcy of personal guarantors of such corporate debtors shall be filed before NCLT where proceedings relating to corporate debtors are pending. Furthermore, Section 60(3) provides for transfer of proceedings relating to personal guarantors to that NCLT which is dealing with the proceedings against corporate debtors. After providing for a common adjudicating forum, Section 60(4) vests NCLT “with all the powers of the DRT as contemplated under Part III of this Code for the purpose of sub-section (2)”. Section 60(4) thus (a) vests all the powers of DRT with NCLT and (b) also vests NCLT with powers under Part III. Parliament therefore merged the provisions of Part III with the process undertaken against the corporate debtors under Part II, for the purpose of Section 60(2) i.e. proceedings against personal guarantors along with corporate debtors. Section 179 is the corresponding provision in Part III. It is “subject to the provisions of Section 60”. Section 60(4) clearly incorporates the provisions of Part III in relation to proceedings before NCLT against personal guarantors.

113. It is clear from the above analysis that Parliamentary intent was to treat personal guarantors differently from other categories of individuals. 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 NCLT. As was emphasised during the hearing, 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 realising some part of the creditors’ dues from personal guarantors.

114. In view of the above discussion, it is held that 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. 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 notifications under Section 1(3), (issued before the impugned notification was issued) disclose that the Code was brought into force in stages, regard being had to the categories of persons to whom its provisions were to be applied. The impugned notification, similarly, inter alia, makes the provisions of the Code applicable in respect of personal guarantors to corporate debtors, as another such category of persons to whom the Code has been extended. It is held that the impugned notification was issued within the power granted by Parliament, and in valid exercise of it. The exercise of power in issuing the impugned notification under Section 1(3) is therefore, not ultra vires; the notification is valid.

(emphasis in original and supplied)

In re Contention 2 — PGCD deprived of their rights as “surety”

Submission by PGCD

The second contention raised by PGCD before the Court was twofold. The submissions in that regard were made by PGCD conjointly with reference to the Contract Act, 1872 and IBC. They are summarised below:

(i) Rights of guarantor under Sections 128, 131 and 140 of the Contract Act

First submission was that, as a consequence of the impugned Notification, PGCD had been deprived of their legal rights as a surety (guarantor) to discharge under Sections 128, 133 and 140 of the Contract Act¹². The liability of the surety under Section 128 being co-extensive with that of the principal debtor, the surety has a right under Section 133 read with Section 140 to be discharged from his liability as soon as there is “resolution” under Section 31(1) IBC, more so when the resolution amounts to “variance” in the terms of the contract with the surety.

(ii) Immunity under Section 31(1) IBC to all concerned

Secondly, in spite of the fact that as per Section 31 IBC¹³, an approved resolution plan in respect of a CD is final and binding on all concerned, the liability of PGCD is kept alive. It is settled law that upon the conclusion of insolvency proceedings against the CD, there is extinction of all claims against the CD, except to the extent admitted in the insolvency resolution process itself. That is why the resolution plan is made final and binding on all concerned by Section 31(1). Now, with the impugned notification, the creditors are enabled to unjustly enrich themselves by a “double dip” process by being allowed, after the resolution process against the CD under Part II, to claim in the insolvency process of the guarantor under Part III also without accounting for the amount already realised by them in the corporate insolvency resolution process of the CD under Part II of the Code.

Indeed, the Court summed up the intertwined twofold contention and grievance of PGCD in para 118 of the judgment as follows : (Lalit Kumar Jain case¹, SCC para 118)

118. All creditors and other classes of claimants, including financial and operational creditors, those entitled to statutory dues, workers, etc. who participate in the resolution process, are heard and those in relation to whom the CoC accepts or rejects pleas, are entitled to vent their grievances before NCLT. After considering their submissions and objections, the resolution plan is accepted and approved. This results in finality as to the claims of creditors, and others, from the company (i.e. the company which undergoes the insolvency process). The question which the petitioners urge is that in view of this finality, their liabilities would be extinguished; they rely on Sections 128, 133 and 140 of the Contract Act to urge that creditors cannot therefore, proceed against them separately.

(emphasis supplied)

Decision of the Court¹

The Court, however, rejected the above twofold contention of PGCD with an equally deft two-pronged and interwoven rationale. The rationale covered in its wings the objections raised by PGCD with reference to both the Contract Act and IBC.

As regards Sections 128, 133 and 140 of the Contract Act, the Court held that the guarantor gets relieved of his obligations under the provisions only if the terms of the contract are not worded otherwise and also only if it is the consequence of a voluntary act of variance of the contract of guarantee by the principal debtor. The guarantor does not get relieved when the principal debtor himself is subjected to any variation of the contract on account of operation of law such as a resolution plan being approved by the adjudicating authority under Section 31(1) IBC.

As regards Section 31(1) IBC, the Court founded its reasoning on various past precedents of the Court on the subject and held that the resolution plan, even on its approval under Section 31(1), does not necessarily end in discharge of the guarantor; on the other hand, it may well permit the creditors of the CD to continue to pursue the guarantor for recovering whatever gap or shortfall remains to be filled up in the recovery of their dues from the CD.

All in all, the Court dealt with both the issues in an extremely cogent and persuasive manner. Some of the observations of the Court are contained in SCC paras 119 to 125. The more salient observations are as follows : (Lalit Kumar Jain case¹, SCC paras 119-20 & 122)

119. In Vijay Kumar Jain Standard Chartered Bank¹⁴, this Court, while dealing with the right of erstwhile Directors participating in meetings of Committee of Creditors observed that : (SCC p. 475, para 19)

“19.3. … we find that Section 31(1) of the Code would make it clear that such members of the erstwhile Board of Directors, who are often guarantors, are vitally interested in a resolution plan as such resolution plan then binds them. Such plan may scale down the debt of the principal debtor, resulting in scaling down the debt of the guarantor as well, or it may not. The resolution plan may also scale down certain debts and not others, leaving guarantors of the latter kind of debts exposed for the entire amount of the debt.

19.4. The Regulations also make it clear that these persons are vitally interested in resolution plans as they affect them.”

120. The rationale for allowing Directors to participate in meetings of the CoC is that the Directors’ liability as personal guarantors persists against the creditors and an approved resolution plan can only lead to a revision of amount or exposure for the entire amount. Any recourse under Section 133 of the Contract Act to discharge the liability of the surety on account of variance in terms of the contract, without her or his consent, stands negated by this Court, in Ramakrishnan¹¹ wherein it was observed that the language of Section 31 makes it clear that the approved plan is binding on the guarantor, to avoid any attempt to escape liability under the provisions of the Contract Act. It was observed that : (SCC p. 411, para 25)

“25. … Section 31(1), in fact, makes it clear that the guarantor cannot escape payment as the resolution plan, which has been approved, may well include provisions as to payments to be made by such guarantor.”

***

122. It is therefore, clear 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. 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. In Maharashtra SEB¹⁵ the liability of the guarantor (in a case where liability of the principal debtor was discharged under the insolvency law or the company law), was considered. It was held that in view of the unequivocal guarantee, such liability of the guarantor continues and the creditor can realise the same from the guarantor in view of the language of Section 128 of the Contract Act as there is no discharge under Section 134 of that Act.

(emphasis supplied)

As regards the specific argument of “double dip” and unjust enrichment, the Court distinguished the concept of “double dip” from “double proof” and, with the help of a prior judgment, laid down the law as follows : (Lalit Kumar Jain case¹, SCC paras 124-25)

124. In Kaupthing Singer and Friedlander Ltd. (No. 2), In re¹⁶ the UK Supreme Court reviewed a large number of previous authorities on the concept of double proof i.e. recovery from guarantors in the context of insolvency proceedings. The Court held that : (AC p. 814, para 11)

“11. The function of the rule is not to prevent a double proof of the same debt against two separate estates (that is what insolvency practitioners call “double dip”). The rule prevents a double proof of what is in substance the same debt being made against the same estate, leading to the payment of a double dividend out of one estate. It is for that reason sometimes called the rule against double dividend. In the simplest case of suretyship (where the surety has neither given nor been provided with security, and has an unlimited liability) there is a triangle of rights and liabilities between the principal debtor (PD), the surety (S) and the creditor (C). PD has the primary obligation to C and a secondary obligation to indemnify S if and so far as S discharges PD’s liability, but if PD is insolvent S may not enforce that right in competition with C. S has an obligation to C to answer for PD’s liability, and the secondary right of obtaining an indemnity from PD. C can (after due notice) proceed against either or both of PD and S. If both PD and S are in insolvent liquidation, C can prove against each for 100p in the pound but may not recover more than 100p in the pound in all.”

125. In view of the above discussion, it is held that 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. As held by this Court, 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.

(emphasis in original and supplied)

CONCLUSION — HYBRIDISATION AND LEGISLATIVE FUSION

To sum up, the Supreme Court has in Lalit Kumar Jain¹ finally resolved the crisis in cases where the creditors of CD are not able to recover their dues from the assets of the CD in the resolution/liquidation proceedings under Part II IBC. It has shown the way for such creditors to pursue their remedies against the assets of PGCD under Part III of IBC and that too before the same fora, NCLT/NCLAT, as are entrusted with the task of adjudicating all matters pertaining to the CD.

The process was appropriately described before the Supreme Court by one of the respondents as a process of “parliamentary hybridisation and legislative fusion”. It was aptly and pithily encapsulated in the following words as stated in para 53 of the judgment : (Lalit Kumar Jain case¹, SCC para 53)

53. The learned Senior Counsel highlighted Sections 60(1), (2), (3) and (4) and urged that Parliament had merged the provisions of Part III with the process undertaken against the corporate debtors under Part II. The process of Part II and the provisions of Part III were legislatively fused for the purpose of proceedings against personal guarantors along with the corporate debtors. … It is contended that the hybridization achieved by the impugned notification does not create any anomaly or problem in enforcement.

(emphasis supplied)

The Supreme Court has upheld the above submission virtually in toto in Lalit Kumar Jain¹.

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