In Lalit Kumar Jain v. Union of India & Ors (Transferred Case (Civil) No. 245/2020), the Supreme Court Bench comprising of Justices L. Nageswara Rao and S. Ravindra Bhat, while hearing several Writ Petitions on the matter, held that since the contract of guarantee is a separate and independent contract altogether, even if the debtor / borrower is discharged of its debts owed to creditors due to any operation of law, i.e., insolvency or liquidation, it would not release the guarantor of its liability.
The Petitioners had challenged the vires and validity of the Notification dated 15.11.2019 on the ground that since the Corporate Debtor is discharged of its liabilities once the Resolution Plan is accepted, the Guarantor should also be absolved since its liability is mutually extensive with the Corporate Debtor. It is pertinent to note that the following provisions pertaining to Personal Guarantors was brought into force by the above mentioned Notification:
- Section 2(e)
- Section 78 (except with regard to fresh start process)
- Section 79
- Sections 94 to 187
- Section 239(2)(g), (h) & (i)
- Section 239(2)(m) to (zc)
- Section 239 (2)(zn) to (zs)
- Section 249.
Another argument by the Petitioners was that the Central Government, under Section 1(3) of the Code, cannot notify parts of the Code or limit the application of provisions to certain categories of persons only and that the power delegated under Section 1(3) is only with regards to when the different provisions of the Code can be brought into effect. Since only the provisions pertaining to Personal Guarantors to Corporate Debtors were brought into force, therefore, the Notification was ultra vires
Section 1(3) is reproduced as under:
“It shall come into force on such date as the Central Government may, by notification in the Official Gazette, appoint: Provided that different dates may be appointed for different provisions of this Code and any reference in any such provision to the commencement of this Code shall be construed a reference the commencement of that provision.”
COURT OBSERVATIONS
Relying on multiple precedents on similar questions posed over the last few decades, the Court observed that the Central Government is not mandated to bring in effect all the provisions of a statute at the same time. Unless it is specifically prohibited in law, the provision can be brought in force at any point of time and for any category of person that it originally applies to.
“101. 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 in valid 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.”
The Bench also rejected the other contention of the Petitioners that in light of Section 128, 133 and 140 of the Indian Contract Act, 1872, the creditors cannot proceed against the Personal Guarantors of the Corporate Debtor if the Corporate Debtor has been absolved of its liabilities. Reliance was also placed by the Petitioners on Section 31 of the Code contending that once the Resolution Plan was approved, the Personal Guarantors cannot be separately made liable. This contention was also rejected by the Court.
The Court observed as under:
“105. In Vijay Kumar Jain v. Standard Chartered Bank 2019 SCC OnLine SC 103, this court, while dealing with the right of erstwhile directors participating in meetings of Committee of Creditors observed that:
We find that Section 31(1) of the Code would make it clear that such members of the erstwhile Board of Directors, who are often guarantors, are vitally interested in a resolution plan as such resolution plan then binds them. Such plan may scale down the debt of the principal debtor, resulting in scaling down the debt of the guarantor as well, or it may not. The resolution plan may also scale down certain debts and not others, leaving guarantors of the latter kind of debts exposed for the entire amount of the debt. The regulations also make it clear that these persons are vitally interested in resolution plans as they affect them.
- The rationale for allowing directors to participate in meetings of the CoC is that the directors’ liability as personal guarantors persists against the creditors and an approved resolution plan can only lead to a revision of amount or exposure for the entire amount. Any recourse under Section 133 of the Contract Act to discharge the liability of the surety on account of variance in terms of the contract, without her or his consent, stands negated by this court, in V. Ramakrishnan where it was observed that the language of Section 31 makes it clear that the approved plan is binding on the guarantor, to avoid any attempt to escape liability under the provisions of the Contract Act. It was observed that:
- Section 31(1), in fact, makes it clear that the guarantor cannot escape payment as the resolution plan, which has been approved, may well include provisions as to payments to be made by such guarantor.…
And further that:
26.1 Section 14 refers only to debts due by corporate debtors, who are limited liability companies, and it is clear that in the vast majority of cases, personal guarantees are given by Directors who are in management of the companies. The object of the Code is not to allow such guarantors to escape from an independent and coextensive liability to pay off the entire outstanding debt, which is why Section 14 is not applied to them. However, insofar as firms and individuals are concerned, guarantees are given in respect of individual debts by persons who have unlimited liability to pay them. And such guarantors may be complete strangers to the debtor — often it could be a personal friend. It is for this reason that the moratorium mentioned in Section 101 would cover such persons, as such moratorium is in relation to the debt and not the debtor.
Similarly reliance was also placed by the Court on the Essar judgment as below:
“107. In Committee of Creditors of Essar Steel (I) Ltd. v. Satish Kumar Gupta (2020) 8 SCC 531. (the “Essar Steel case”) this court refused to interfere with proceedings initiated to enforce personal guarantees by financial creditors; it was observed as follows:
- Following this judgment in V. Ramakrishnan case [SBI v. V. Ramakrishnan, (2018) 17 SCC 394], it is difficult to accept Shri Rohatgi’s argument that that part of the resolution plan which states that the claims of the guarantor on account of subrogation shall be extinguished, cannot be applied to the guarantees furnished by the erstwhile Directors of the corporate debtor. So far as the present case is concerned, we hasten to add that we are saying nothing which may affect the pending litigation on account of invocation of these guarantees. However, NCLAT judgment being contrary to Section 31(1) of the Code and this Court’s judgment in V. Ramakrishnan case [SBI v. V. Ramakrishnan, (2018) 17 SCC 394], is set aside.”
- It is therefore, clear that the sanction of a resolution plan and finality imparted to it by Section 31 does not per se operate as a discharge of the guarantor’s liability. As to the nature and extent of the liability, much would depend on the terms of the guarantee itself. However, this court has indicated, time and again, that an involuntary act of the principal debtor leading to loss of security, would not absolve a guarantor of its liability……”
CONCLUSION
The Court held that the Notification is valid and legal and that approval of a Resolution Plan does not absolve a Personal Guarantor of its liability under the Contract of Guarantee just because the liability of the Corporate Debtor has extinguished due to an operation of law, i.e. insolvency or liquidation.
AMLEGALS REMARKS
This judgment has resolved the issue once and for all and has paved the way for multiple litigations to start against Personal Guarantors of Corporate Debtors.
This issue has gotten its much needed clarity and the Supreme Court has made it clear that it will take a more Creditor centric approach in the matters of insolvency.
The Legislative intent has been duly recognized by the Court and it will be interesting to see how things unfold in the times to come.
For any query or feedback, feel free to connect with rohit.lalwani@amlegals.com.
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