MORATORIUM UNDER SECTION 14 OF IBC, 2016: PERSONAL GUARANTOR’S CONUNDRUM

Recently, The Supreme Court in the case of State Bank of India vs. V. Ramakrishnan [1] has held that moratorium under section 14 of The Insolvency and Bankruptcy Code, 2016 would not apply to a personal guarantor of a corporate debtor. Section 14 of the IBC, 2016 provides for moratorium for the limited period mentioned in the code, on an admission of an insolvency petition, where no judicial proceedings for recovery, enforcement of security interest, sale or transfer of assets, or termination of essential contracts can be instituted or continued against the Corporate Debtor. 

The conundrum prevailing about the Personal Guarantors inclusion along with Corporate Debtor within the definition of this Section 14 was due to the various contrary orders of NCLT and NCLAT but this Apex court ruling now settled the position where it has held that ‘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.’ While deciding so, the honorable court has also observed that Section 14(3) of the Code (introduced vide 2018 amendment) which states that provisions of sub-section (1) of Section 14 shall not apply to a surety in a contract of guarantee for a corporate debtor, is retrospective.

It is pertinent to note that the court, in this case, has confirmed the Bombay High court ruling in M/s. Sicom Investments and Finance Ltd. v. Rajesh Kumar Drolia and Anr.[2], and held that the corporate debtor and personal guarantor are separate entities and that a corporate debtor undergoing insolvency proceedings under the Code would not mean that a personal guarantor is also undergoing the same process.

One of the keynote observations of the court in this matter was regarding Section 31, where it ruled that Section 31(1) 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. This is why the Annexure VI(e) to Form 6 contained in the Rules and Regulation 36(2) requires information as to personal guarantees that have been given in relation to the debts of the corporate debtor. Thus, section 31 is one more factor in favour of personal guarantor having to pay for debts due without any moratorium applying to save him.

Surety’s Co-extensive Liability with Principal Debtor

The Insolvency and Bankruptcy Code (Amendment) Ordinance, 2018 has amended section 14 to make explicit that the guarantor’s assets are not protected by the moratorium provisions of section 14 of the Code. Therefore, the creditor can proceed against the assets of the surety (i.e. the guarantor) while the corporate insolvency resolution process is continuing in respect of the corporate debtor.

Also, Section 128 of the Indian Contract Act, 1872 provides for the co-extensiveness of the liability of the surety to that of the principal debtor. This brings the right of the creditor to proceed against either the principal borrower or surety or both in any order unless a contrary stipulation has been made in the contract. It is pertinent to note that the assets of the surety are separate from those of the corporate debtor and that the availability of remedy with the creditor against both the surety and the corporate debtor in a contract of guarantee is the basis for extending loans in most cases. Examining such situation, Insolvency Law Reforms Committee in its report recommended exclusion of the assets of the guarantor from the applicability of moratorium under Section 14 of IBC, 2016 and which has been incorporated by the Ordinance.  

Guarantor’s Assets are not a component of liquidation estate

This Apex court judgment has now made clear that the assets of the surety are separate from those of the corporate debtor. Relating this settled position of law with the liquidation proceedings, it can be stated that a loan agreement, incorporating guarantee as a collateral, confers no power on the liquidator to liquidate the assets of the guarantor and any interpretation inconsistent with this would contravene the settled principle of contract law.  

As regards the formation of liquidation estate for recovery, sections 36(3) and 36(4) of the Code enlist those assets which would fall or not fall, respectively, within the liquidation estate of the corporate debtor. The assets of guarantor are nowhere included in section 36(3). Moreover, section 36(4) expressly provides for the exclusion of personal assets of any shareholder or partner of a corporate debtor from the liquidation estate unless such assets are held on account of avoidance transactions. It follows that the guarantor’s assets can only be put into the liquidation estate where the assets form a subject matter of vulnerable transactions, dealt with under sections 43 to 51 of the Code.

In fact, it is clear now that the assets of the corporate debtor do not include the assets of guarantor and thus the creditors have to take a separate independent recourse against the guarantor, outside the liquidation proceedings. 

How far this judgment resolves the prevailing Conundrum?

In the case of State Bank of India vs. V. Ramakrishnan, Apex court has resolved the prevailing conundrum to a larger extent and hence the state of confusion created by the various orders of NCLT and NCLAT has now cleared to a great extent. Prior to the judgment, the Tribunals order has called into question the very ability of the lenders to rely on having immediate recourse to the credit of guarantors where the borrower is in financial difficulty and which is an inconsistency with the rationale behind obtaining a guarantee primarily. It is to be noted that section 14 clearly states that it applies to security interests over the assets of the corporate debtor. The rulings of NCLT and even NCLAT do not consider that a guarantee rendered by a third party is not a security interest over the assets of the borrower. The main area of concern emerged was that the NCLTs order has extended the purview of a moratorium to bank guarantees (relying on the unwarranted carve out for performance guarantees in the definition of security interest under the Code) without considering the long-standing jurisprudence in relation to the independence of bank guarantees. 

It is evident that Tribunals could not make a distinction in the language between the code and section 22 of the Sick Industrial Companies (Special Provisions) Act, 1985, (“SICA”) which now stands repealed. Under section 22 of SICA, promoters were for decades able to evade paying on their guarantees once a company was declared as a sick, which was seen as a significant problem for creditors. This very fact ought to guide the decisions of the NCLTs in relation to the treatment of guarantees under the Code, but it has not. Even NCLATs have also adopted different positions in respect to guarantees and third-party security, Therefore the Apex Court decision was much awaited in this respect and thus it has now resolved the prevailing conundrum to a great extent.   

The Question that remains Unanswered

The IBC primarily envisages a resolution process for a corporate debtor, and only if it is unsuccessful contemplates an adversarial process.[3] Thus, any claims made by individual creditors must not be allowed to supersede the process of resolution, i.e., when CIRP is underway. In fact, recovery can be considered as an end by virtue of the resolution process laid down by it. Therefore, in the case of multiple creditors if any creditor is allowed to enforce the personal guarantee given by the third party would lead to the interest of one financial creditor unfairly prevailing over the other financial creditors. Also, it is pertinent to note that the Corporate Debtor is obliged to repay dues of all the banks in due proportion and its capacity. Thus, the question arises is that, wouldn’t such liberty given to creditors to enforce guarantee, a clear violation of equality to be maintained inter-se amongst the creditors?

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References:

[1] State Bank of India v. V. Ramakrishnan, 2018 (9) SCALE 597.

[2] M/s. Sicom Investments and Finance Ltd. v. Rajesh Kumar Drolia and Anr., (2017) SCC Online Bom 9725.

[3] Prowess International Pvt. Ltd. v. Parker Hannifin India Pvt. Ltd., 2017 (9) TMI 1447.

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