Personal Guarantors to Corporates can be Invoked by Lenders: SC

Surety is not absolved by release of the principal borrower because of IBC proceedings’

The Supreme Court on Friday upheld a government move to allow lenders to initiate insolvency proceedings against personal guarantors, who are usually promoters of big business houses, along with the stressed corporate entities for whom they gave guarantee.

In a judgment that can shake up the business community, a Bench of Justices L Nageswara Rao and S Ravindra Bhat held that the November 15, 2019 notification of the Centre allowing creditors, usually financial institutions and banks, to move against personal guarantors under the Insolvency and Bankruptcy Code (IBC) was “legal and valid”.

The notification invoking the IBC against personal guarantors of corporate debtors was challenged before several High Courts initially. The Supreme Court transferred these petitions to itself at the Government’s request.

The apex court said there was an “intrinsic connection” between personal guarantors and their corporate debtors.

‘Intimate connection’

Justice Bhat, who authored the 82-page verdict, said it was this “intimate” connection that made the government recognise personal guarantors as a “separate species” under the IBC.

It was again this intimacy which made the government decide that corporate debtors and their personal guarantors should be dealt by a common forum — the National Company Law Tribunal (NCLT) — through the same adjudicatory process.

True to IBC’s intent

Justice Bhat referred to how the November 2019 notification had not strayed from the original intent of the IBC. In fact, Section 60(2) of the Code requires bankruptcy proceedings of corporate debtors and their personal guarantors to be held before a common forum — the NCLT.

“The adjudicating authority for personal guarantors will be the NCLT if a parallel resolution process is pending in respect of a corporate debtor for whom the guarantee is given,” Justice Bhat noted.

A side-by-side bankruptcy proceedings before the same forum for both corporate debtors and their personal guarantors would help the NCLT “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 Committee of Creditors to frame realistic plans, keeping in mind the prospect of realising some part of the creditors’ dues from personal guarantors,” the judgment reasoned.

The court further corrected a misunderstanding among petitioners that approval of a resolution plan in respect of corporate debtors would also extinguish the liability of the personal guarantor.

The petitioners, mostly personal guarantors, had argued that an approved resolution plan amounts to extinction of all outstanding claims against that debtor. Consequently, the liability of the guarantor would also be extinguished.

But Justice Bhat clarified that “The release or discharge of a principal borrower from the debt by operation of law, or due to liquidation or insolvency proceeding, does not absolve the surety/guarantor of his/her liability, which arises out of an independent contract.”

The concept of ‘guarantee’ is derived from Section 126 of the Indian Contracts Act, 1872. The creditor reserves the right to begin insolvency proceedings against the personal guarantor if the latter does not pay. Usually, promoters of big businesses submit personal guarantees to creditors to secure loans and assure repayment.

During the hearing, the government had justified the November 2019 notification extending bankruptcy proceedings to personal guarantors. Attorney General K.K. Venugopal had argued that by roping in guarantors, there was a greater likelihood that they would “arrange” for the payment of the debt to the creditor bank to obtain a quick discharge.

Whereas, in some cases, on the other hand, the creditor bank would be prepared to take a haircut or forego the interest amounts to enable an equitable settlement of the corporate debt, as well as that of the personal guarantor.

“This would result in maximising the value of assets and promoting entrepreneurship, which is one of the main purposes of the Code,” the Centre had argued in court.