Legal Implications to be a personal guarantor for a corporate company in India.


Legal Implications to be a personal guarantor for a corporate company in India.


Introduction


In India to conduct a lawful business an entity can be registered under the regulation of The Companies (Amendment) Act 2019. This means the companies are governed by the same legislation upon its registration.


It is important to note that a company registered under this regulation is termed to be a corporate person or a corporate company. A corporate company is conferred with the same rights as a private Individual or Citizen of India, provided the said company is in its existence as per the regulations prescribed therein.


A Guarantor is a person who acts as a surety or guarantee involving a promise to assume responsibility for the debt obligation of a borrower from an organization.

As an industry practice in the lending industry, for a debt by a corporate company, the lending institution in India request a guarantee or surety towards the lending sanctioned to it. In such cases of lending by financial institutions a person who acts as a surety or guarantee enters into a bond with the lending intuitions to be legally obligated to his commitments for the transaction.


Ideally, the Guarantors are of various categories i.e. personal guarantor (guaranteed by a private individual), intuitional guarantor (guaranteed by a company), asset guarantee (guaranteed by pledging property, shares, gold etc.)


As far as personal guarantor is concerned, they have certain rights and liabilities towards the debts incurred by the company when they execute guarantee contracts as a guarantor with the lending institutions.


In India for a debt incurred by a corporate company, the lending institutions can exercise their right to recover the debt that fell due. One of the legislation under which it ideally seeks a legal discourse is The Insolvency and Bankruptcy Code of India 2016.

As per The Insolvency and Bankruptcy Code of India 2016, the purpose of the said legislation in India is to have insolvency resolution of corporate persons, partnership firms and individuals in a time-bound manner for maximisation of value of assets of such persons, to promote entrepreneurship, availability of credit and balance the interests of all the stakeholders including alteration in the order of priority of payment of Government dues.


The courts to have authority to entertain such issues related to the dues to be paid by a corporate company is as an adjudicating authority for the purpose of the Insolvency and Bankruptcy Code of India 2016, known as the National Company Law Tribunal (NCLT)


In such a situation corporate company facing a default of dues is summoned to the National Company Law Tribunal, upon application preferred by the lending institution to recover their dues to National Company Law Tribunal.



Position of law


This brings us to the important question about the legal implications for a personal guarantor for a corporate company. The legislation Insolvency and Bankruptcy Code of India 2016 were provided with subsequent notification by the Ministry of Corporate Affairs Government of India on 15.11.2019[1] , which provided that from 1st December of 2019 the provision related to the personal guarantors shall come into force. This specifically meant that after the notification of the said provision in the regulation, it is well within the preview of the law to enforce the legal remedy for any entity to initiate insolvency proceedings including against the personal guarantor.


However, due to the enforcement of the said provisions in the regulation by the Government of India, various concerns were raised by scores of individuals who were personal guarantors to corporate companies.

In order to exercise their right scores of writ petitions were preferred by them in different High Courts across the country in India challenging the constitutional validity of the provision of the regulation Insolvency and Bankruptcy Code of India 2016 itself. To avoid confusion and recognizing the legal implication of the issue regarding the provisions of personal guarantors to corporate companies, the Hon’ble Supreme court of India has transferred the said writ petitions to itself exercising its inherent powers under the Constitution of India.

The main contention of the writ petitions preferred was about the excessive delegation of power to the Government of India by issuing notification related to the enforcement of sections in the regulation regarding initiate insolvency proceedings including the personal guarantor.

When the said issue came before the Hon’ble Supreme Court Of India, in Lalit Kumar Jain vs. Insolvency and Bankruptcy Board of India issued judgment [2] which has created a precedent in the contemporary regulation.


It has categorically observed in its judgment as below:

- 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 the NCLT. As was emphasized during the hearing, the 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 realizing some part of the creditors' dues from personal guarantors.",


- 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 invalid 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."


- 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."


Conclusion


In view of the above, it can be concluded that the current regulations under the Insolvency and Bankruptcy Code of India 2016 dealing with a personal guarantor for a corporate company can be enforced as it is an independent contract and does not absolve the obligation of the guarantor of their lability.


The Insolvency and Bankruptcy Code of India 2016 is a regulation that is at the centre of protecting the interest of creditors at the same time reviving the enterprise in a situation they face bankruptcy due to unwanted business decisions. As the courts have distinctly observed in their various judgment that it is important to protect the interest of not only the creditors but also the corporate debtors when possible. The courts have also observed that ordering the liquidation of the corporate debtors should be avoided to the extent possible and at the same time considered as a last resort in order to give reasonable space to have a revival of business ventures, which can save the corporate companies from facing unwanted Insolvency.


By

Harshad Rathod.

[1] https://ibbi.gov.in//uploads/legalframwork/1fb8c2b785f35a5126c58a2e567be921.pdf [2] LL 2021 SC 257 Justices L. Nageswara Rao and S. Ravindra Bhat Transferred Case (CIVIL) NO. 245/2020.

Disclaimer:

The content of this article is intended to provide a general guide to the subject matter only. Specialist advice should be sought about your specific circumstances.

Should you have any legal query you may contact us at Need Legal Assistance.