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Accountability of Personal Guarantors to Debtor Companies To Be Held Accountable Under IBC

Accountability of Personal Guarantors under the Insolvency & Bankruptcy Code, 2016: Supreme Court of India lays controversy to rest

Introduction

In December 2019, certain provisions of the Insolvency and Bankruptcy Code, 2016 (the “Code”) came into force by a notification dated November 15, 2019 (the “Notification”). This set into motion, certain provisions for initiating insolvency proceedings against personal guarantors to debtor companies. The Notification was challenged before the

Supreme Court of India and on May 21, 2021, a cluster of petitions on this issue were decided with the Supreme Court upholding the constitutional validity of the Notification while clarifying several connected issues.

Key highlights of the Judgment

The key observations of the Supreme Court were that:

i. approval of a resolution plan of a debtor company, does not discharge the liability of a personal guarantor;

ii. legislative intent is clear, that personal guarantors to debtor companies were to be treated differently from other categories of individuals, on account of the intimate connection between the personal guarantors and debtor companies;

iii. expert bodies had recommended that such personal guarantors be involved in proceedings before the same authority that is monitoring the corporate debtor. The National Company Law Tribunals would be able to assess the picture wholistically;

iv. the release or discharge of liability of a debtor companies by an involuntary process, such as operation of law, liquidation or insolvency process, does not absolve such personal guarantors of their liability, since the liabilities arise out of independent contracts;

v. an approved Resolution Plan may modify the liability of an erstwhile Director (personal guarantor) participating in the insolvency proceedings, but not extinguish it; and

vi. Section 31 of the IBC specifically provides that a resolution plan is binding on the guarantors of a corporate debtor.

KLA Analysis

Since inception of the IBC, the country has witnessed a giant wave of corporate insolvency resolution which engulfed smaller players as well as market leaders in the power and steel sectors. Banks and financial institutions approved resolution plans that provided for significant hair cuts on their lendings. Hence, they continued to rely on their ability to later claim the balance debt from the personal guarantors (in most cases, the promoters). This stipulation forms part of most resolution plans which include saving provisions for the creditors to recover the balance debt from the personal guarantor(s) and extinguishment of the guarantor’s right of subrogation, effectively ring fencing the debtor company and securing the creditor at once. Ever since such provisions in resolution plans have surfaced, another school of thought was, that once a resolution plan was approved, personal guarantors would be automatically discharged of their liability. While this issue was being argued pan India before Debt Recovery Tribunals, National Company Law Tribunals and even some High Courts, the judgment lays to rest all controversies on this point of law.

The judgment also leaves personal guarantors with very little to say, particularly in cases of financial debt, since the defence of being discharged on account of approval of resolution plan will not stand.

With the ruling of the Supreme Court, we can expect to see another wave of insolvency resolutions; this time of personal guarantors to debtor companies.

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