IBC (Amendment) Ordinance, 2020: Hanging Sword On Personal Guarantors To Corporate Debtors

Ashutosh Choudhary & Gaurav Baheti are students at the National Law University, Odisha.

The nationwide lockdown enforced all over India due to the outbreak of Covid-19 pandemic is turning out to be a curse for the Indian economy. The uncertainty and distress created for corporate persons in businesses and the financial market of the Indian economy have severely disrupted the financial operations at large scales which may lead corporate entities into liquidation.[i] The Indian government has come up with several reforms to rescue corporate persons from economic distress in the current Covid-19 times from being pushed into insolvency proceedings under the Insolvency and Bankruptcy Code, 2016 (“Code”) for such defaults owing to the current time which might lead them into liquidation.[ii]

Recently, the Insolvency & Bankruptcy Code (Amendment) Ordinance, 2020 (“Ordinance”) inserted section 10A in the Code. Thereby, suspending the enabling provisions i.e. section 7, 9 and 10 of the Code initiating a corporate insolvency resolution process (“CIRP’) against a Corporate Debtor for ‘any default’ arising on or after 25th March 2020, for six months or for such further period, not exceeding one year from such date. The Ordinance is a ray of hope for corporate debtors who would have been unable to repay their debts, but concomitantly; it poses a challenge for personal guarantors to corporate debtors. Given the fact, that State Bank of India recently took Anil Ambani to the National Company Law Tribunal (“NCLT”) Mumbai Bench, for personal guarantee given on loans, worth over ₹ 1,200 crores, to Reliance Communications and Reliance Infratel.[iii] From the above move, it appears that the focus of creditors may have been partially shifted to the personal guarantor(s) from corporate debtors for the repayment of debts due to the suspension of initiation of CIRP. 

In this article, the authors critically examine the Ordinance which overlooked the financial distress of personal guarantor(s) by not insulating personal guarantor(s) from the proceedings under the Code and thereby defeated the objective sought to be achieved by the Ordinance. The article concludes by suggesting that the ‘default’ under section 3(12) of the Code would have been declared as ‘non-actionable’ in order to safeguard personal guarantor(s) from being dragged to courts for such defaults on part of the debtor.

OVERLOOKING OF THE PERSONAL GUARANTORS IN THE ORDINANCE

The Ordinance was enacted with the objective of excluding the defaults arising on account of financial difficulties due to unprecedented times and to prevent corporate persons from being pushed under the Code.[iv] However, the Ordinance has overlooked the distress of the personal guarantors to corporate debtors as they could be dragged before the courts for insolvency proceedings. Therefore, the purpose of the Ordinance appears to be defeated as it gives breather to thousands of corporate persons battered by Covid-19, but it doesn’t stop creditors from initiating the insolvency process against a personal guarantor to a corporate debtor.

Section 5(22) of the Code defines a personal guarantor as an individual who is the surety in a contract of guarantee to a corporate debtor which is only applicable to Part II of the Code, dealing with matters relating to the insolvency and liquidation of corporate debtors. However, the amendment to section 2(e) of the Code vide notification dated 15 November 2019 significantly broadened the scope of ‘personal guarantor’ to Part III of the Code by inserting the terms personal guarantors to corporate debtors. This amendment brought into effect Part III of the Code, dealing with insolvency resolution framework of individuals, as applicable to personal guarantors to a corporate debtor.

Similarly, it is pertinent to understand that the application of definitions of ‘personal guarantors’ under section 5(22) and section 2(e) of the Code is different, as pointed out by the Report of Insolvency Law Committee 2020.[v] The Report delving into the discussion of the definition of personal guarantors, clearly stated that section 5(22) of the Code, pertaining to the liability of ‘personal guarantors’ only applies to Part II of the Code. Therefore, by the way of this Ordinance, the default has been suspended for the purpose of initiating the insolvency proceeding under Part II of the Code and not under Part III of the Code which deals with individual insolvency as applicable to personal guarantor(s). Hence, section 10A of the Code is not applicable to the initiation of Insolvency Resolution Process (“IRP”) against personal guarantor(s) under Part III of the Code.

Moreover, MS Sahoo (Chairman, IBBI) has stated that the Covid-19 related defaults have been suspended for the purpose of the CIRP, and not for other purposes under the Code, including individual insolvency, and it is possible to initiate an insolvency proceeding against a personal guarantor of a corporate debtor.[vi] Hence, section 2(e) is still effective irrespective of the fact that the power to initiate CIRP is suspended vide the Ordinance and it is possible to initiate an insolvency proceeding against a “personal guarantor to a corporate debtor”.

ROADMAP TO INITIATE IBC PROCEEDINGS AGAINST PERSONAL GUARANTOR:

An application for initiation of IRP in respect of a personal guarantor to a corporate debtor may be preferred either by the debtor personally or by the creditor(s) under section 94 and section 95 of the Code, respectively. In either case, the key element is that the IRP can be initiated only in the event of a ‘default’ on the part of the personal guarantor. As per section 3(12), ‘default’ means non-payment of debt ‘by the debtor or the corporate debtor as the case may be.’ For the purpose of ‘default’ in the case of initiation of IRP against a personal guarantor, the question arises as to whether the personal guarantor to a corporate debtor can be considered as a ‘debtor’ under section 3(12) of the Code.

The definition of ‘guarantor’ in rule 3(e) of the Insolvency and Bankruptcy (Application to Adjudicating Authority for Insolvency Resolution Process for Personal Guarantors to Corporate Debtors) Rules, 2019 states that ‘guarantor’ means a ‘debtor’ who is a personal guarantor to a corporate debtor and in respect of whom guarantee has been invoked by the creditor and remains unpaid in full or part. In the Report of Insolvency Law Committee 2020, it was pointed out that “a personal guarantor should be considered a ‘debtor’ for the purposes of Part III of the Code when the liability of such personal guarantor has arisen in law.”[vii] Therefore, the ‘default’ that will trigger the IRP is the invocation of the personal guarantee and the personal guarantor’s failure to pay the amount due under the same.

Considering the suspension of power to initiate CIRP vide the Ordinance, the further question arises as to whether the IRP can be initiated directly against a personal guarantor without invoking CIRP against a corporate debtor? For this purpose, section 128 of the Indian Contract Act, 1872 defines the liability of surety (guarantor) as co-extensive with that of personal debtor (corporate debtor).

In the case of Urgo Capital Limited v. Bangalore Dehydration and Drying Equipment Co. Pvt. Ltd., NCLT held that “the liabilities of the ‘Corporate Debtor’, Personal Guarantors and Principal Borrower were joint and several to discharge their obligations of the decree above, leaving it to the sole discretion of the Plaintiff/Appellant to recover the said amount from any of the defendants….” which implies that the lender can choose action against principal borrower or surety either separately or jointly. Further, in the case of Vishnu Kumar v. Piramal Enterprise, NCLAT held that it is not necessary for the financial creditors to initiate CIRP against the principal borrower before approaching the guarantors for the recovery of the debt amount.

The further question arises as to who will be the adjudicating authority in the case of initiation of IRP against a personal guarantor? For this purpose, as per section 179(1) of Part III of the Code, the adjudicating authority in relation to insolvency matters of individuals and firms shall be the Debt Recovery Tribunal (“DRT”). However, under Section 60(2) of the Code, if there is already a pending application against a corporate debtor in NCLT then an application to the insolvency resolution shall be filed to NCLT. It is pertinent to mention that under section 60(4) of the Code, NCLT is vested with all the powers of the DRT as contemplated under Part III of this Code for the purpose of section 60(2) of the Code.

In that sense, section 95 of the Code is an alternative and independent remedy to the lenders against personal guarantor(s) to a corporate debtor. Therefore, IRP can be initiated against a personal guarantor without first invoking CIRP against a corporate debtor.

CONCLUDING REMARKS AND SUGGESTIONS:

The Ordinance does not provide umbrella protection as it has overlooked the distress of the personal guarantor(s) and they could be dragged before the courts for insolvency proceedings. Therefore, the Ordinance is currently acting as a hanging sword on the personal guarantor(s) during this pandemic period. Since the objective of the Ordinance was to exclude the defaults arising on account of economic disruptions for the purposes of insolvency proceeding under the Code; instead of terminating CIRP, the government should have declared ‘default’ under Section 3(12) as ‘non-actionable’ for this period. The mandatory root cause for the initiation of insolvency proceedings under the Code is the ‘default’ and if the ‘default’ would have been declared as “non-actionable”, the CIRP or IRP proceedings could not have been initiated against any person.

For this purpose, an amendment in the definition of “default” should have been made by adding a proviso in the Section 3(12) of the Code which would bar the invocation of ‘any default’ under the Code on or after the given period mentioned in the Ordinance i.e. 25^th March, 2020. This amendment would have completely satisfied the objectives enumerated in the Ordinance and would not have overlooked the distress of personal guarantors to corporate debtors under Part III of the Code.

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[i] Firms get 6-month relief from IBC rules, (Jun 05, 2020) The Economic Times, available at https://economictimes.indiatimes.com/news/economy/policy/covid-19-govt-amends-insolvency-law-suspends-initiation-of-fresh-proceedings-for-six-months/articleshow/76221981.cms?from=mdr.

[ii] Arpan Behl & Rohit Sharma, IBC (Amendment) Ordinance, 2020 – Ensuring Companies’ Survival, (Jun 11, 2020) Law Street India, available at http://www.lawstreetindia.com/experts/column?sid=405.

[iii] Piyush Pandey, SBI drags Anil Ambani to NCLT for guarantees, (June 11, 2020) The Hindu, available at https://www.thehindu.com/business/sbi-drags-anil-ambani-to-nclt-for-guarantees/article31807309.ece#:~:text=State%20Bank%20of%20India%20has,Reliance%20Infratel%20Limited%20(RITL).&text=These%20Resolution%20Plans%20are%20awaiting,Mr.

[iv] The Insolvency and Bankruptcy Code (Amendment) Ordinance, 2020 (Jun 05, 2020) Ministry of Law & Justice, available at https://ibbi.gov.in/uploads/legalframwork/741059f0d8777f311ec76332ced1e9cf.pdf.

[v] Report of the Insolvency Committee, (February 2020) Ministry of  Corporate Affairs Government of India, available at https://www.ibbi.gov.in/uploads/resources/c6cb71c9f69f66858830630da08e45b4.pdf.

[vi] Banikinkar Pattanayak, No bar on invoking insolvency against personal guarantors: IBBI chairman, (Jun 16, 2020) Financial Express, available at https://www.financialexpress.com/industry/no-bar-on-invoking-insolvency-against-personal-guarantors-ibbi-chairman/1992440/.

[vii] Report of the Insolvency Committee, (February 2020) Ministry of  Corporate Affairs Government of India, available at https://www.ibbi.gov.in/uploads/resources/c6cb71c9f69f66858830630da08e45b4.pdf.

Views are personal. The authors can be contacted at 17ba027@nluo.ac.in (Ashutosh Choudhary) or 16bba022@nluo.ac.in (Gaurav Baheti)