SC upholds Centre’s Notification enforcing IBC provisions to the insolvency of personal guarantors

A Division Bench of the Hon’ble Supreme Court comprising Justices L. Nageswara Rao and S. Ravindra Bhat in Lalit Kumar Jain v. Union of India and Others, REED 2021 SC 05510, vide its judgment dated 21 May 2021, upheld the validity of the Central Government’s notification dated 15 November 2019, whereby provisions of the Insolvency and Bankruptcy Code, 2016 in so far as they relate to the insolvency of personal guarantors to corporate debtors were brought into force. The Apex Court also ruled that the approval of a resolution plan does not ipso facto discharge a personal guarantor of a corporate debtor of his/her liabilities under the contract of guarantee. This post elucidates the salient facts of the case, the issues involved and the judgment pronounced by the Supreme Court.

BACKGROUND

The Central Government in the exercise of its powers conferred by sub-section (3) of Section 1 of the Insolvency and Bankruptcy Code, 2016 (IBC), issued a notification dated 15 November 2019 (impugned notification) whereby the provisions of the IBC in so far as they relate to the insolvency of personal guarantors to corporate debtors were brought into force w.e.f. 1 December 2019. These provisions were Section 2(e), Section 78 (except with regard to fresh start process), Sections 79, 94-187 (both inclusive); Section 239(2)(g), (h) & (i); Section 239(2)(m) to (zc); Section 239 (2)(zn) to (zs) and Section 249 of IBC. Subsequently, a number of writ petitions under Section 32 of the Constitution were filed before the Supreme Court challenging the constitutional validity of the impugned notification.

The petitioners primarily argued that the executive government could not have selectively brought into force the IBC, and applied some of its provisions to one sub-category of individuals, i.e., personal guarantors to corporate creditors, despite partnership firms and other individuals falling within the scope of part III of the IBC as well. All the petitioners in unison submitted that the impugned notification, in seeking to achieve that end, was ultra vires. 

ANALYSIS

Section 60(2) of the IBC stipulates that the proceedings of corporate debtors and their personal guarantors are to be held before a common forum i.e., the National Company Law Tribunal (NCLT). In light of this, the Supreme Court observed that there was sufficient legislative guidance for the Central Government to distinguish personal guarantors from other individuals, so as to provide such a common forum for lenders to seek recovery of their debts from both the corporate debtors and personal guarantors to the corporate debtors. Further, according to Supreme Court, the NCLT would be able to consider the whole picture effectively about the nature of the assets available, either during the corporate debtor’s insolvency process or even later. This would facilitate the Committee of Creditors in framing realistic plans, keeping in mind the prospect of realizing some part of the creditors’ dues from personal guarantors. 

The Supreme Court, hence, reasoned that “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 stood guarantee.”

The Supreme Court also noted that the method followed by the Central Government in notifying the provisions of the IBC gradually on a stage-by-stage basis, depending on the subject matters covered by the IBC is permissible. It added that the impugned notification did not amount to a legislative exercise or selective application of provisions of the IBC, as there was no obligation imposed by the IBC on the Central Government to make its provisions applicable to all individuals at the same time. 

Further, placing reliance on SBI v. V. Ramakrishnan, REED 2018 SC 08560, Creditors of Essar Steel (I) Ltd. v. Satish Kumar Gupta, REED 2019 SC 11505, and the provisions of the Indian Contract Act, 1872 relating to the contract of guarantee, the SC held that the approval of a resolution plan under section 31 of the IBC, does not ipso facto discharge a personal guarantor of a corporate debtor) of her or his liabilities under the contract of guarantee. The SC also clarified 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. 

In view of the foregoing reasons, the Supreme Court held that the impugned notification is valid and the writ petitions were accordingly disposed of.