Insolvency Resolution Process For Personal Guarantors To Corporate Debtors – Part 1 By CS Nishant Mishra


This is the First Part of my write-up on Insolvency resolution process for personal guarantor.

In this part I will attempt to explicate the provisions related to the definition of the personal guarantor, adjudicating authority for making application and process of making application and rule related to these issues including the rule for the withdrawal of the application under the Insolvency Resolution process for personal guarantors to corporate debtors and some unanswered question related to these issues. In the second part, I will try to explicate the remaining issues like interim moratorium and final moratorium etc.  

Ministry of Corporate Affair vide its notification dated 15th November, 2019 bought the provision dealing with the insolvency and bankruptcy of personal guarantors to corporate debtors into force with effect from 1st December, 2019.

It is to be noted that provisions related to the insolvency and bankruptcy of personal guarantors to corporate debtors are provided in Part III of Insolvency and Bankruptcy Code. 2016, however, provisions related to personal guarantors to corporate debtors have only been made effective and no other provisions have been made effective.

SO WHO IS PERSONAL GUARANTOR TO CORPORATE DEBTOR

To understand the definition of the “Personal Guarantor” in its entirety we need to go through its both the definition i.e. one as per Section 5 clause (22) and other as per Rule 3 clause (e) of Insolvency and Bankruptcy (Application to Adjudicating Authority for Insolvency Resolution Process for Personal Guarantors to Corporate Debtors) Rules, 2019 (Hereinafter called as Rules).

As per Section 5(22) “personal guarantor” means an individual who is the surety in a contract of guarantee to a corporate debtor;

As per Rule 3(e) “guarantor” means a debtor who is a personal guarantor to a corporate debtor and in respect of whom the guarantee has been invoked by the creditor and remains unpaid in full or part;

DEFINITION OF SECTION 5 CAN BE EXPLICATED IN THE FOLLOWING MANNER;

  1. Personal Guarantor shall always be an individual
  2. To understand “Surety” and “Contract of Guarantee” we have to go to Section 126 of the Indian Contract Act, 1862;

As per Section 126, “Surety” means the person who gives the guarantee and “contract of guarantee means a contract to perform the promise, or discharge the liability, of a third person in case of his default.

  1. Principal Debtor should be corporate. Principal Debtor means the person in respect of whose default the guarantee is given

DEFINITION AS PER RULE 3 CAN BE EXPLICATED IN THE FOLLOWING MANNER.

Guarantor means a debtor- and as per Section 79 sub-section 12 debtor includes judgment-debtor.

Now the question is who is debtor including judgment debtor. The Debtor is the person who owes debt and debt under section 3 sub section (11) means a liability or an obligation in respect of a claim which is due from any person and includes a financial debt and operational debt.

Judgment Debtor is defined under Civil Procedure Code, 1908 under section 2 clause 10 as any person against whom a decree has been passed or an order capable of execution has been made.

Personal Guarantor is already defined above. Corporate Debtor is defined under section 2 clause 8 means a corporate person who owes a debt to any person  

Invoking guarantee, guarantee to invoked as per the contract of guarantee entered as per the provision of Indian Contract Act, 1872, however, in general parlance it can be invoked by sending the notice to the surety.

And the last condition for being a guarantor is that the amount which he needs to pay as surety remains unpaid either in full or in part.

THRESHOLD LIMIT FOR THE APPLICABILITY OF PROVISIONS

Section 78 prescribes the threshold limit for making an application for insolvency and the bankruptcy of individual of Rs. 1000, however, the rule issued by the MCA does not talk about any monetary limit for the personal guarantor for filing of an application for insolvency rather provide for sending of the notice to invoke guarantee and same is treated sufficient for making an insolvency application if the amount remains unpaid either in full or part.

AUTHORITY FOR MAKING APPLICATION

Section 60 talks about the adjudicating authority and its jurisdiction for filing of an application for insolvency. Application for insolvency of a corporate person including corporate debtor and personal guarantor to be made in the NCLT having territorial jurisdiction over the place where the registered office of the corporate person is situated.

For better understanding lets see the following example, A Ltd, having registered office at New Delhi, borrowed the fund and Mr Z, who is the resident of the Mumbai, is the personal guarantor. So if the application for insolvency to be filed against Mr Z then it is to be filed in the NCLT, Delhi Bench.

However, the practical problem will arise in the case where more than one insolvency application is filed for the same person who has provided multiple personal guarantees.

For example, if Mr. Z has provided a personal guarantee for A Ltd, having registered office at New Delhi, B Ltd, having registered office at Kolkata, and C Ltd, having registered office at New Delhi, then which NCLT will be appropriate for insolvency proceeding. Answer to this problem can be solved if we follow the principle laid down in the Venugopal Dhoot v. State Bank of India & Ors., (CA- 1022(PB)/2018- decision dated 24.10.2018), in this case, NCLT, New Delhi, Principal Bench, allowed all the petition to be placed before one bench sighting the following reason “It will serve the basic purpose of avoiding conflicting order and facilitating the hearing

INSOLVENCY RESOLUTION PROCESS

APPLICATION BY DEBTOR TO INITIATE INSOLVENCY RESOLUTION PROCESS

Section 94 provides that debtor (Personal Guarantor) himself or through resolution professional can make an application to NCLT having territorial jurisdiction over the corporate person of whom he is the personal guarantor for his insolvency. Application to be made in Form A along with Fees of Rs. 2000 and copy of such form shall also be submitted to all the financial creditor and corporate debtor.

No application will be admitted in respect of excluded debt; excluded debt as per clause 15 of Section 79 means-

  1. liability to pay fine imposed by a court or tribunal;
  2. liability to pay damages for negligence, nuisance or breach of a statutory, contractual or other legal obligation;
  3. liability to pay maintenance to any person under any law for the time being in force;
  4. liability in relation to a student loan;
  5. any other debt as may be prescribed;  

Personal Guarantor shall not be eligible either himself or through Resolution Professional in the following circumstance.

  1. An undischarged bankrupt;
  2. Undergoing a fresh start process;
  3. Undergoing insolvency resolution process;
  4. Undergoing a bankruptcy process
  5. If the application made under this chapter has been admitted in respect of debtor during the period of 12 months preceding the date of making the application under this section.

APPLICATION BY CREDITOR TO INITIATE INSOLVENCY RESOLUTION PROCESS

Section 95 provides that the creditor either himself or jointly with other creditors, however, in case of a joint application all the creditor may nominate anyone creditor to act on their behalf, file application to NCLT either themselves or through the resolution process in Form C along with fees of Rs. 2000 and copy of such application shall also be sent to the corporate debtor of whom such debtor is personal guarantor, however, before making such application notice of demand in the Form B must be sent to the debtor and 14 days must lapse from such notice of demand.

Along with application in Form C following documents shall also be submitted;

  1. Documents evidencing the debt owed by the debtor to the creditor or creditors, as the case may be.
  2. Failure of Debtor to pay the debt within 14 days of notice to pay the debt.
  3. Evidence for non-payment of debt.

After reading and understanding Section 94 and Section 95, two very pertinent questions arise, one is whether guarantee can be invoked before claiming it from the principal debtor and if guarantee can be invoked then can we file an application for insolvency against guarantor before making such application against the principal debtor. The second question relatively more important since Section 10A, Section 7, 9 and 10 is suspended and subject to certain condition no new insolvency proceeding may be initiated.

INVOKING GUARANTEE BEFORE CLAIMING IT FROM PRINCIPAL DEBTOR

To understand this in its perspective, we have to understand Section 128 of the Indian Contract Act, 1872, which says that surety’s (Personal Guarantor’s) liability are coextensive unless the contract provides otherwise that is both principal debtor and guarantor stand on the same pedestal as far as liability for the debt is concerned and same has been established by the Hon’ble NCLAT in case of Dr. Vishnu Kumar Agarwal v. M/s. Piramal Enterprises Ltd. NCLAT held that guarantee can be invoked before claiming the same from the principal debtor.

INVOKING INSOLVENCY PROCEEDING AGAINST PERSONAL GUARANTOR BEFORE CORPORATE DEBTOR

As mentioned above this point become more important for coming one year at least since the insertion of Section 10A suspended insolvency proceeding subject to condition for coming sometime due to the current situation created by the pandemic.

The answer to this question is beyond doubt is “YES”, same is established by Hon’ble supreme court in the case of Rai Bahadur Shree Ram and Company Pvt. Ltd. (the shareholder and promoter of Ferro Alloys Corporation Limited) and affirmed the landmark judgment passed by the National Company Law Appellate Tribunal (NCLAT) in the matter of Ferro Alloys Corporation Limited v Rural Electrification Corporation Limited (Comp. App (AT) (Ins) No. 92 of 2017) and other connected appeals, in favour of Rural Electrification Corporation Limited (REC), the financial creditor.

In the said decision, the Supreme Court affirmed the NCLAT judgment which held that insolvency proceedings against the corporate guarantor may be undertaken without initiating prior proceedings against the principal debtor under the Insolvency and Bankruptcy Code 2016 (Code).

GOING AGAINST PERSONAL GUARANTOR IN CASE COMPANY IS UNDER MORATORIUM

Since the moratorium period under section 14 does not cover the guarantor, so it might be possible that the company may go for insolvency against the guarantor rather than going against the company since it is in the moratorium. However, as per Section 96 once the application is filed under Section 94 or Section 95, no new proceeding can be initiated against the personal guarantor.

WITHDRAWAL OF APPLICATION

Rule 11 of Insolvency and Bankruptcy (Application to Adjudicating Authority for Insolvency Resolution Process for Personal Guarantors to Corporate Debtors) Rules, 2019 provide for the withdrawal of application under the following circumstances.

(a) before its admission, on a request made by the applicant;

(b) after its admission, on the request made by the applicant, if ninety per cent. of the creditors agree to such withdrawal.

An application for withdrawal under clause (b) of sub-rule (1) shall be in Form D.

SOME UNANSWERED QUESTION

LACK OF CLARITY OVER THE CO-EXTENSIVE NATURE OF SURETY

It is amply clear that in case the company is under moratorium under Section 14 then the company may move against the personal guarantor since such moratorium does not provide any kind of protection to the personal guarantor, however, it is not clear whether for the same set of claim can same creditor file application against the corporate debtor and personal guarantor.

In the case where both principal debtor and guarantor is the corporate person then if the application is admitted against anyone of them, the same creditor for the same set of claim application cannot be filed against the other as decided by the NCLAT in Dr. Vishnu Kumar Agarwal v. Piramal Enterprises.

If the same judgment is applied to the case where the personal guarantor is individual then the application may be filed either against the principal debtor that is the corporate debtor or the personal guarantor. The basic problem with this judgment of the NCLAT is that its challenge the basic tenets of the Contract of guarantee i.e. both principal debtor and surety have co-extensive liability. However, The Supreme Court in case of  Essar Steel has taken the same view as it was taken by it in the case of State Bank of India v. V. Ramakrishnan, where the court has given the following observation,  the moratorium of Section 14 of the Code does not apply to the personal guarantor, Section 31 of the code will prevail over Section 133 of the Indian Contract Act, 1872, i.e. surety will be liable to pay guaranteed amount even if there is the change in the terms of the contract due to the resolution plan and does creditors may go for maximum recourse available to it.

RESOLUTION PLAN VIS-À-VIS PERSONAL GUARANTOR

One more grey area is the extent of liabilities of the personal guarantor, during the preparation and submission of the resolution plan, how the liability of the personal guarantor will be accounted and how for the liability of the personal guarantor will go. In  the case of principal borrower i.e. corporate debtor is discharged from the liability pursuant to any resolution plan then whether insolvency proceeding is still maintainable against the corporate debtor.  

CONCLUSION

While bringing the provision related to personal guarantor into the force is need of the hour, however, it certainly lacks clarity in a different dimension of its applicability, be it the co-extensive liability of the surety or the extent of liability of the personal guarantor pursuant to resolution plan or chance of multiplicity of the proceeding. We have to wait and watch how the judiciary takes views on these ambiguous issues and whether the government come-up with some clarification. 

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