Corporate debt discharge
On 15 November 2019, the Indian government issued rules for initiating insolvency proceedings against personal guarantors as a distinct class other than individuals. It also issued a notification regarding the coming into force of part III of the Insolvency and Bankruptcy Code 2016 (IBC) for insolvency proceedings against personal guarantors.
The Supreme Court, in Lalit Kumar Jain v Union of India, upheld the 15 November 2019 notification, holding that personal guarantors, although forming part of a larger grouping of individuals, were to be dealt with differently, considering their intrinsic connection with corporate debtors. The Court also held that the approval of a resolution plan and the discharge of the borrower from the debt by an involuntary process (ie, through the operation of law in insolvency proceedings) does not discharge a personal guarantor of its liabilities under the independent contract of guarantee.
While a significant upsurge in personal guarantor insolvencies was expected upon the Court settling the validity of the notification, the pace has been slow due to various uncertainties in the nascent jurisprudence relating to this emerging sphere of the IBC.
In view of the obligations of the debtor and the guarantor, personal guarantors seek to escape liability on the basis of the underlying debt being discharged as an effect of the resolution plan of the corporate debtor. In a recent decision by the Ahmedabad debt recovery tribunal (DRT) in State Bank of India v Prashant Ruia, the DRT declined an application seeking the recovery of debt against the personal guarantor on the basis of the underlying debt of borrower being fully discharged under the resolution plan.
Debt discharge on account of the operation of law does not preclude the creditor's rights to pursue against the personal guarantee. However, if an assignment of debt under the resolution plan and transactions results in the repayment in cash or kind (eg, capitalisation) of the underlying debt to the assignee, the ability to pursue the personal guarantee may be at risk on account of the underlying debt being discharged.
Section 60(1) of the IBC vests the national company law tribunal (NCLT) with the jurisdiction to act as the adjudicating authority for the insolvency resolution and liquidation of corporate debtors and personal guarantors. However, section 60(2) provides for applications for the insolvency resolution of a personal guarantor to be filed before the NCLT where the corporate insolvency resolution process or liquidation proceeding of the corporate debtor is pending. Several personal guarantors relying on section 60(2) have disputed that the NCLT is the appropriate forum for the insolvency resolution of personal guarantors on account of the corporate insolvency resolution process or liquidation not having commenced or having been concluded.
The National Company Law Appellate Tribunal (NCLAT), in State Bank of India v Mahendra Kumar Jajodia, which was subsequently upheld by the Supreme Court, resolved this issue and held that the NCLT was the appropriate adjudicating authority for the initiation of all insolvency proceedings against personal guarantors, even if there is no pending corporate insolvency resolution process or liquidation against the corporate debtor. The NCLAT provided for a limited notice requirement only at the stage of admission of insolvency under section 100, and not for an order of interim moratorium and the appointment of a resolution professional.
A constitutional challenge was recently raised in a writ filed before the Supreme Court on the ground of the violation of principles of natural justice, seeking the personal guarantor's right to be heard before the appointment of the resolution professional. This may create another ground for personal guarantors to seek a stay against the admission into insolvency.
The framework for insolvency proceedings against personal guarantors under the IBC does not provide for clawback in case of avoidance or fraudulent transactions, despite the existence of such provisions for corporate debtors, and in the bankruptcy of individuals. There are apprehensions of diversion of assets before the resolution professional takes custody of the assets of the personal guarantor. In the absence of a framework to claw them back, the estate of the personal guarantor would stand eroded from the diverted, or siphoned off, assets.
Creditors should put adequate safeguards in the resolution plan of corporate debtors to ensure that the unpaid debt continues to remain outstanding to the assignee until the personal guarantor's insolvency proceedings conclude. The simultaneous initiation of insolvency proceedings against corporate debtors and personal guarantors will improve efficiency and maximise. Necessary amendments to the IBC should be considered to provide for the clawback of diverted assets.
For further information on this topic please contact Saurav Panda or Ahkam Khan at Shardul Amarchand Mangaldas & Co by telephone (+91 11 4159 0700) or email ([email protected] or [email protected]). The Shardul Amarchand Mangaldas & Co website can be accessed at www.amsshardul.com.