The Supreme Court of India recently upheld a 2019 Central Government notification allowing lenders to initiate insolvency proceedings against personal guarantors. This decision empowers lenders to recover their remaining debt from personal guarantors following the conclusion of the Corporate Insolvency Resolution Process (CIRP). The CIRP is a mechanism for creditors to recover their dues under the Insolvency and Bankruptcy Code, 2016 (IBC).
Understanding the Role of Personal Guarantors
A personal guarantor is an individual or entity that promises to pay off another person’s debt if the latter fails to do so. This role often comes into play in situations where the original debtor is unable to meet their financial obligations.
Impact of the 2019 Central Government Notification
The 2019 Central Government Notification added personal guarantors to companies undergoing insolvency proceedings to the scope of the IBC. Section 1(3) of the IBC permits the central government to implement different provisions of the code at varying dates. It essentially allows the law to be rolled out in phases. The rules under this section provide a guideline for commencing insolvency resolution and bankruptcy proceedings against personal guarantors to corporate debtors, inviting claims from creditors, withdrawal of applications, and more.
Simultaneous Proceedings Against Principal Borrower and Personal Guarantors
One significant impact of these regulations is the capacity for creditors to proceed simultaneously against both the principal borrower, that is, the company, and the personal guarantor. Prior to the change, the IBC code only included insolvency resolution and liquidation of corporate debtors.
Counter Argument Against the Regulation
Some argue that the Central Government lacks the authority to selectively apply IBC provisions to personal guarantors of corporate debtors, and single them out. Critics say this infringes upon the fundamental right to equality.
The Supreme Court’s Verdict
The highest legal authority in India established an “intrinsic connection” between personal guarantors and their corporate debtors. The court held that bankruptcy proceedings of corporate debtors and their personal guarantors should happen at a common forum, the National Company Law Tribunal (NCLT). The court also confirmed that if a parallel resolution process is ongoing for a debtor, the NCLT will be the adjudicating authority for the personal guarantors. The simultaneous proceedings before the same tribunal provide the NCLT with a holistic view, allowing it to make more informed decisions.
Concept of Guarantee under Indian Law
In Indian law, the concept of ‘guarantee’ traces back to Section 126 of the Indian Contracts Act, 1872. A contract of guarantee involves three parties: the debtor, creditor, and the guarantor. If the debtor defaults, the guarantor becomes liable to pay the debt.
Potential Benefits of the Regulation
Initiating insolvency proceedings against personal guarantors increases the probability that they would arrange for the debt to be paid to the creditor bank swiftly. The creditor bank may even be willing to accept a loss or forego interest amounts to facilitate a fair settlement of the corporate debt, as well as that of the personal guarantor. This process could maximize asset value and boost entrepreneurship.
Understanding Insolvency and Bankruptcy
Insolvency refers to a situation where individuals or companies cannot replay their outstanding debt. Meanwhile, bankruptcy occurs when a court declares a person or entity insolvent, and passes orders to rectify the situation and defend creditors’ rights. It is a legal assertion of one’s inability to pay off debts.