[2023] 152 taxmann.

com 705 (Article)

[2023] 152 taxmann.com 705 (Article)

Date of Publishing: July 31, 2023

Personal Guarantors under the Insolvency and Bankruptcy Code, 2016: A study
in light of the recent amendments, and judgements of Adjudicating Authorities

DR. R.P YADAV PRINCE MOHAN SINHA

Associate Professor, Sharda University, Greater Noida PhD Scholar, Sharda University, Greater Noida

Guarantee as encompassed in the Indian Contract Act, 1872 provides – "the liability of the surety is coextensive
with that of the principal debtor unless the contract otherwise provides it." 1 . At the time of enactment, the
Insolvency and Bankruptcy Code, 2016 contained provisions related to personal guarantors. However, the non-
commencement of Part III created multiple ambiguities and a safe passage for the personal guarantors in
Corporate Insolvency Resolution Processes. This was discussed at length in leading cases such as SBI v. V.
Ramakrishnan2. In an attempt to dispel the ambiguities, the Ministry of Corporate Affairs effected an
amendment in 2019 which brought about drastic changes in the field of personal guarantors. Sub-sections (e),
(f) and (g) were added in Section 2, which elaborates as to which entities are under the ambit of the code, to
trifurcate the definitions of the individuals and partnership firms. While sub-section (e) defined personal
guarantors to corporate debtors, sub-section (f) defined partnership firms and proprietorship firms and sub-
section (g) defined individuals, other than those defined in (e). This enabled the extended applicability of the
Chapter-II (Corporate Insolvency Provisions) upon the personal guarantors without invoking the provisions of
Chapter III (Personal or Individual Insolvency Provisions). Immediately after the enactment, the provision was
challenged in various High Courts primarily on the ground that the provisions are violative of Section 1(3) of the
code due to its selective applicability upon personal guarantors. The matter was finally laid to rest in Lalit Kumar
v. UOI3 wherein the Hon'ble Supreme Court adjudicated all the objections in respect to the Insolvency Resolution
of the Personal Guarantors. The researcher will try to understand all the aspects related to the resolution process
of the Personal Guarantors especially after the decision of the Supreme Court in Lalit Kumar Case and the
possible outcomes and challenges to be faced by the stakeowners in this regard.

Keywords: Insolvency, Bankruptcy, Personal Guarantors, Insolvency and Bankruptcy Code, CIRP, Corporate
Insolvency

Introduction

For decades, India has faced bankruptcy and insolvency issues. This has led to various banks, and other
financial institutions facing severe risks of credit default. A number of laws and codes have been passed as
a corrective measure, but have proved ineffective and have failed to provide creditors with any relief.
Insolvency and Bankruptcy Code, 2016 ("IBC2016") is a comprehensive legislation which is applicable to
both corporate and non-corporate entities. A key promise of the IBC 2016 is to bring about greater
transparency, simpler methods, and infrastructure within the entire liquidation system. The shift from
"Debtor-in-possession" to "Creditor-in-Control" doctrinehas enabled it to bring much-needed relief to the
creditors and also provide the companies with a chance at turnaround and revival.

Background

The first attempt to address the issue of insolvency was made with the enactment of "Presidency Towns
Insolvency Act, 1909 (PTIA, 1909)" which catered to the insolvencies in the presidency towns of Bombay,
Madras and Calcutta. Soon the need for an insolvency act in other areas was felt and the "Provincial
Insolvency Act, 1920" was passed. At the time these acts catered to corporate (companies) and personal
insolvencies alike. After independence it was felt that corporate insolvencies needs special attention and
hence, a provision under the companies act was added to address the matters related to corporate
insolvencies4. This further enhanced the remedies available to the creditors as now they can file for the
dissolution of companies if they are unable to pay.

A need for change in the legislative framework of the country and hence the Department of Company
Affairs set up a committee under the leadership of Mr. ND Tiwari which recommended the enactment of the
"Sick Industrial Companies (Special Provisions) Act, 1986 (SICA1986)"5. This law provided a separate
framework for industrial companies and provided for the revival and rehabilitation of such entities.
However, the applicability and use of SICA has been quite a debated topic. The subsequent misuse of the
law prompted the government to set up another committee under the leadership of Justice VB Eradi which
recommended the repeal of SICA and enactment of Companies Amendment Act, 20026. This
recommendation was further put into action through the amendment, however, was never notified. The
amendment provided for the setup of special tribunals to adjudicate the matters related to corporate
insolvencies and to aid in reviving them.

Since the amendment of 2002 was never notified, the Government of India set up a committee in the
chairmanship of Mr. TK Vishwanathan which proposed the enactment of the IBC20167. IBC2016 came as a
necessary jolt to the Indian legal and economic set-up which provided for the quick resolution of insolvent
companies and aims at maximizing the returns from the resources employed. The framework laid down by
the code was dynamic and in light of the current global trends. IBC2016 notified the adjudicating authorities
with specialized knowledge and expertise to tackle the matters related to insolvencies, namely: 'National
Company Law Tribunal for Corporates, and Debt Recovery Tribunal for non-corporates'. It also provides for
the registration of professionals who shall undertake the insolvency process, namely insolvency
professionals, and the setting up of a professional body, namely the Insolvency and Bankruptcy Board of
India which shall govern these professionals.

Till now only Chapter II of the IBC2016 has been notified this implied that only the procedure for corporate
insolvencies has been brought into action and the procedure for individual insolvencies has not been
notified. Although for the most part, there was no problem with the only applicability of Corporate
Insolvencies, but the status of Personal Guarantees baffled the IPs and the Government alike. Although
corporates were under the purview of IBC2016, personal guarantors were still under the purview of PTIA
and PIA which made the situation very complex.

Literature Review

The law as silent about the unique status of the personal guarantors and was therefore clubbed under the
individual insolvencies in Part III. In order to give clarity to the status of personal guarantors and hence, the
law was amended8 and new definition of individual which was further divided into three kinds, namely:
personal guarantors9, partnership and proprietorship firms10 and other individuals11. The amendment
clarified and thereafter further attributed to further complexities. Every creditor has right to approach the
adjudicating authority under IBC2016 provided the pre-requisite conditions laid down are satisfied 12 This
in sense provided that if the creditor is eligible, he may initiate multiple resolution process for same default.
However, the moratorium13 coupled with provisions related to personal insolvencies14, any creditor was
not entitled to proceed against the personal guarantors, if the CIRP has initiated for a corporate debtor15.

However, it was later understood that there is co-existence of liability of principle and surety and the
creditor is very well in his rights to proceed simultaneously against the creditor and its guarantors16. The
NCLAT had given divergent views on similar matters and hence, the matter travelled to the Hon'ble
Supreme Court, which laid the issue to rest in the leading matter of 'Lalit Kumar Jain v. Union of India17. It
was clarified that although the default action is one, there are multiple rights arising out of the same default
and hence, the creditors are well within rights to proceed against the personal guarantors as well. The
matter further upheld the constitutional validity of the amendment and further laid down the judicial
framework for the adequate applicability of the above amendment.

Objective

The research is aimed at understanding the concept and status of personal guarantors in a Corporate
Insolvency Resolution Process ("CIRP"). This can be further crystallized into the following questions:

(a) What is the status of the Personal Guarantors in CIRP?

(b) When can a Creditor take action against Personal Guarantors?
(c) What is the liability of the Personal Guarantors be invoked in CIRP?
Methodology

The research is carried out through "black letter" or "doctrinal" method wherein the data is collected
through reliable secondary sources. Secondary sources such as case laws, research papers, publications by
eminent scholars, and bare acts have been relied upon. No primary data is collected. Care has been taken to
ensure that the sources cited are from reliable sources.

The methodology for the research is as follows:

(a) Development of general understanding of the subject through assailment of the secondary
sources;
(b) Formulation of research objectives and questions;
(c) Carrying out the research to achieve the research objectives and answer research questions;
Findings and Discussions

Personal guarantor is an individual who, in the contract of guarantee, acts as a surety to a debtor18. In
closely held companies, it is a market norm that the lenders seek personal guarantees of promoters in
order to safeguard their advances. It is pertinent to point out that the term only uses individual and it
cannot be stretched to include other business forms, such as Hindu Undivided Family.19 The liability of the
guarantor is co-extensive with that of the debtor and is due in case of default by the debtor20. This implied
that the creditor is in full right to act against the guarantor in case of a default. However, the problem at
hand was that the provisions related to personal insolvencies21 has not been notified under the code. It
meant that the creditors can pursue the matter as per the previous applicable laws (PTIA1909 and PIA1920).
This enabled the guarantors to evade the applicability of the IBC2016 and its stricter provisions.
Furthermore, many lenders were unable to recover any fruitful returns as the debtors were mere shells
which were being run by the name of the promoters.

In order to plug the gap, an amendment22 to the IBC2016 was made in order to clarify the legal position of
the personal guarantors. The amendment set the wheels moving to include personal guarantors into the
purview of the IBC2016.

The amendment clarified upon whom the code shall be applicable. The class of individuals and firms was
thus trifurcated into three kinds namely:

(a) Personal Guarantors23;

(b) Firms24
(c) Other individuals25
The amendment provided the needed legislative freedom to the government to implement the provisions
and applicability to the personal guarantors.

However, the matter fell into a turmoil when it was adjudicated by the NCLAT26 that no two actions shall lie
for single default. In other words, till the pendency of the CIRP, the creditor cannot proceed against the
personal guarantors. Although the co-existence of the liability of the guarantor was acknowledged, yet the
right of the creditors to proceed against the personal guarantors was curtailed. The lenders, were thus,
stuck with the debtors with less resources who has obtained loans on the basis of the resources of the
guarantors. This judgement further barred the lenders from pursuing such matters in civil courts.

In the meantime, the Government notified the provisions related to the resolution of insolvencies of
personal guarantors.27 The notification provided that the provisions of personal insolvencies are
commenced vis-à-vis personal guarantors. Furthermore, the adjudicating authority in the case of personal
guarantors is entrusted with the NCLT28

The legal position as subsisting was challenged before the Hon'ble Supreme Court in a multitude of cases
on grounds that the notification was selective and in contravention to the Fundamental Rights29. The
judgement was finally delivered in Lalit30 case wherein, the validity of the notification was upheld. It was
further held that the code may be made applicable in parts and upon different classes of persons in
different manner. Furthermore, the court held that there is a close and intimate relationship between the
corporate debtors and their personal guarantors.

In the matter related to selective applicability, the court held that it has been made it clear that the personal
guarantor is separate from other kinds of individuals. Coupled with the intimate relationship between
debtors and their personal guarantors, personal guarantors are as separate class and hence can be treated
separately.

The notification was also challenged on the ground that since, the debt of the debtor is settled in the wake
of the resolution plan being accepted and the terms of the advances amended, the guarantors shall stand
discharged from their liabilities. The court, however, opined that guarantee emanates from a different
contract from the loan or advance and hence, approval of resolution plan cannot act as a discharge of
liability of personal guarantor. This shall also imply that liability of the guarantor shall be governed by the
guarantee agreement and the terms agreed therein. Operation of law and discharge of debtor due to the
insolvency proceedings cannot be ipso-facto grounds for discharge of personal guarantors.

The judgement by the apex court ensured that the intent of the legislature is followed in the matter related
to personal guarantors, however, it also opens floodgates to further practical problems. These problems
can be further enumerated as follows:

(a) Initiation of CIRP of Personal Guarantor in case CIRP of debtor is not pending
(b) Double Dipping
(c) Right of subrogation;
A. Initiation of CIRP of Personal Guarantors in case CIRP of debtor is not pending

IBC2016 provides that in the case of personal guarantors, the adjudicating authority shall be the NCLT31
with the Bench having the jurisdiction in the matters related to the debtor32. It has been further provided
that in case the matter is pending before any other Bench, then the same shall be transferred to the
relevant bench where the CIRP of the debtor subsists33. Thus, it can be understood that the creditor has the
power to initiate CIRP both for the debtor and its personal guarantor before the same bench of NCLT.

In the current situation, different benches have differing opinions. The Bench at Delhi opines that the
pendency of the petition for initiation of CIRP is not 'sine qua non' for initiation of CIRP against the personal
guarantor34. The creditor may choose to proceed against the personal guarantors even in the absence of
pendency of CIRP against the debtor35. However, according to the Mumbai Bench of the NCLT, the
pendency of the CIRP for a debtor is mandatory for the initiation of CIRP for the personal guarantor.

NCLAT, however, has taken a view similar to the Delhi Bench, holding that the pendency of CIRP of the
debtor is not a pre-requisite for initiation of CIRP of a personal guarantor36. The Supreme Court, in the
appeal, refused to entertain the same adjudicating it to be premature.37 Since the matter was never
adjudicated on merits, the question whether the CIRP against personal guarantors be initiated in the
absence of pendency of the CIRP of debtor is still quite wide open.

B. Double Jeopardy

The basis behind this concept is that during the pendency of the CIRP of either debtor or personal
guarantor, the application for initiation CIRP for others on the basis of the same debt and default leads to
double jeopardy or double dipping. This concept is based on the jurisprudence as laid down by the
Supreme Court of the United Kingdom stating that although collecting the dividend twice on the same debt
is prohibited (which is termed as double proof) but collecting the same debt against two distinct estates is
legal (which is termed as double dipping)38. The concept is also prevalent in the jurisprudence of the United
States, wherein they allow the creditor to realize all his claims from the debtor / all parties involved as long
as only the amount that is owed is sought.39

In India, NCLAT has opined that creditors cannot file separate CIRP against the Corporate Debtors and/or
their guarantors on the same set of defaults.40 In another judgement, NCLAT observed that multiple CIRPs
cannot be initiated against multiple guarantors for the same debts.41 However, creditors are free to go
against any of them. Principal Bench of NCLT has held that in case the personal guarantee is allowed after
acceptance of the claim in the CIRP of the debtor will lead to claim duplication.42
A balance needs to be maintained between the rights of the creditors to claim and the rights of the debtors
in order to ensure that no party is unjustly benefitted. Legally, as of today, parallel processes are allowed
and the creditors can proceed against the debtors as well guarantors simultaneously.

C. Right Of Subrogation

IBC2016 provides for a clean slate for the resolved debtors. However, as per the Indian Contract Act, 1872,
the guarantor upon the satisfaction of the debts of the debtor becomes its creditor.43 Now both principles
are in contradiction as one provision creates rights and the other extinguishes it in the same operation of
law.

US Bankruptcy Code is pretty clear on the principle of subrogation and provides that the guarantor must
establish that it is liable to the debtor for a creditor's claim against the debtor and that it has paid that claim.
Unlike the United States, India's Law does not include a specific provision dedicated to the concept of
subrogation. Instead, Indian Contract Law governs it. In the case of a conflict between two laws in force,
Section 238 of the IBC expressly says that the IBC's provisions take precedence. However, this presents
several issues that the court has yet to consider. A subrogation rests upon the doctrine of equity and the
principles of natural justice and not on the privity of contract. One of these principles is that a person
paying money that another is bound by law to pay is entitled to be reimbursed by the other. This principle
is enacted in Section 69 of the Contract Act, 1872. Another principle is found in equity: 'he who seeks equity
must do equity."

Conclusions

Banks and other Financial Institutions often ask for personal guarantees from the promoters to ensure that
their funds remain safe. However, with the exclusion of the power to exercise personal guarantees under
the IBC2016 in the initial code, let to the creditors are unable to maximize the value of the resources in
stressed corporates. The personal guarantors are now liable to bear the CIRP in the same manner as the
debtor. While the law has been made clear, the jurisprudence relating to it still has a long way to go.

Limitations

The paper is limited in scope to the topic, i.e. other aspects of the IBC2016 have not been touched upon in
this research. Since the research is based on secondary data, the bias of the individual researcher and the
limitation of those researches have a bearing on the current research.

■■

1. Indian Contract Act, 1872, § 128, No. 9, Act of British Parliament, 1872 (UK)
2. State Bank of India v. V Ramakrishnan [2018] 96 taxmann.com 271/149 SCL 107
3. Lalit Kumar Jain v. Union of India [2021] 127 taxmann.com 368 (SC)
4. Companies Act, 1956, § 433, Act No. No. 1, Acts of Parliament, 1956, (India)
5. T Tiwari, Report of the Committee to Examine the Legal and Other Difficulties Faced by
Banks and Financial Institutions in Rehabilitation of Sick Industrial Undertakings and
Suggest Remedial Measures Including Changes in Law (Bombay, 1984)
6. Justice VB Eradi, Report of High Level Committee on Law Relating to Insolvency and Winding
Up of Companies, 2000
7. T.K. Vishwanathan, The Report of the Bankruptcy Law Reforms Committee Volume I:
Rationale and Design Bankruptcy Law Reforms Committee, 2015.
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India
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10. Insolvency and Bankruptcy Code, 2016, § 2(f), No. 37, Acts of Parliament, 2016, India
11. Insolvency and Bankruptcy Code, 2016, § 2(g), No. 37, Acts of Parliament, 2016, India
12. Insolvency and Bankruptcy Code, 2016, No. 37, Acts of Parliament, 2016, India
13. Insolvency and Bankruptcy Code, 2016, § 14, No. 37, Acts of Parliament, 2016, India
14. Insolvency and Bankruptcy Code, 2016, Chapter III, No. 37, Acts of Parliament, 2016, India
15. Vishnu Kumar Agrawal v. Piramal Enterprises [Company Appeals (AT) 343/2018]
16. State Bank of India v. Athena Energy Ventures (P.) Ltd. [2021] 123 taxmann.com 82/164 SCL 293
(NCL – AT)
17. Lalit Kumar Jain' case (supra)
18. Insolvency and Bankruptcy Code, 2016, § 5(22), No. 37, Acts of Parliament, 2016, India
19. L Jugal Kishore v. WTO AIR 1961 All 487, 491 FB
20. Ram Kishun v. State of Uttar Pradesh AIR 2012 SC 2288
21. Insolvency and Bankruptcy Code, 2016, Chapter III, No. 37, Acts of Parliament, 2016, India
22. Insolvency and bankruptcy Code (Amendment) Act, 2018, No. 8, Acts of Parliament, 2018,
India
23. Insolvency and Bankruptcy Code, 2016, § 2(e), No. 37, Acts of Parliament, 2016, India
24. Insolvency and Bankruptcy Code, 2016, § 2(f), No. 37, Acts of Parliament, 2016, India
25. Insolvency and Bankruptcy Code, 2016, § 2(g), No. 37, Acts of Parliament, 2016, India
26. Vishnu Kumar Agrawal' case (supra)
27. Notification No. 3704, S.O. 4126(E) dated 15.11.2019
28. Insolvency and bankruptcy Code (Second Amendment) Act, 2018, No. 26, Acts of
Parliament, 2018, India
29. Constitution of India, Article 14
30. Lalit Kumar Jain's case (supra)
31. Insolvency and Bankruptcy Code, 2016, § 60(1), No. 37, Acts of Parliament, 2016, India
32. Insolvency and Bankruptcy Code, 2016, § 60(2), No. 37, Acts of Parliament, 2016, India
33. Insolvency and Bankruptcy Code, 2016, § 60(3), No. 37, Acts of Parliament, 2016, India
34. PNB Housing Finance Ltd. v. Mohit Arora 2021 SCC Online NCLT 488
35. PNB Housing Finance Ltd. v. Goldy Gupta 2021 ibclaw.in 736 NCLT
36. State Bank of India v. Mahender Kumar Jajodia [2022] 136 taxmann.com 371/171 SCL 232 (NCL
– AT)
37. Mahender Kumar Jajodia v. State Bank of India [2022] 139 taxmann.com 33/172 SCL 278 (SC)
38. Kaupthing Singer Freidlander Ltd., In re [2011] UKSC 48
39. Ivanhoe Building Loan Association of Network v. Orr 295 US 243 (1935)
40. Dr. Vishnu Kumar Agarwal v. Piramal Enterprises Ltd. [2019] 101 taxmann.com 464/151 SCL 555
(NCL - AT)
41. State Bank of India v. Visa Infrastructure Ltd. [2023] 152 taxmann.com 17 (NCLAT – New Delhi)
42. IL & FS Financial Services Ltd. v. Golden Glow Estates (P.) Ltd. (2019) ibclaw.in 737/[2020] 116
taxmann.com 647 (NCLT – New Delhi)
43. Indian Contract Act, 1872, § 140, No. 9, Act of British Parliament, 1872 (UK)