Updated: Aug 21, 2020
Author: Shreya Shukla, Co-Author: Mohd Yasin, (Faculty of Law, Jamia Millia Islamia)
With the Parliament in full swing to garnish The Insolvency and Bankruptcy Code, 2016 with viable amendments, it has endeavored to shun the infirmities of moratorium law. The object of Moratorium under Section 14 of the Code is to stay institution or continuation of proceeding, suits, etc.against the corporate debtor and its assets. Applicability of moratorium law on personal guarantors’ and ‘corporate guarantors’ of the corporate debtors has been one of the significant aspects hovering in any corporate insolvency proceedings. An answer to this issue, to no avail, unfortunately, emanates out with contradicting views, one, restricting to the literal interpretation of Section 14giving life third parties/personal guarantors, and the other, holding the guarantor responsible for the surety under the garb of elaborative interpretation.[i]Section 128 of the Indian Contract Act, 1872 also provides for surety’s liability and in light of this provision, NCLT and NCLAT have construed the applicability of moratorium against the personal guarantor. [ii]
Viability of Insolvency and Bankruptcy Code (Second Amendment) Act, 2018:
Section 5A inserted by Insolvency and Bankruptcy Code (Second Amendment) Act, 2018, provides for the definition of ‘corporate guarantor’. This definition segregates the meaning of a ‘personal guarantor’ from a ‘corporate guarantor’. Personal guarantees, in the vast majority of cases, are given by Directors who are in the management of the companies. The object of the Code is not intended to aid such guarantors to get away from an independent, and co-extensive liability to pay off the entire outstanding amount, and which is why Section 14 does not apply to them. To bring plausibility to this averment, Section 5A was inserted by the 2018 Amendment defining ‘corporate guarantor’ explicitly. Since Part II applies over Corporate Persons, and Section 5A as encapsulated under this Part makes it vehement that it segregates and removes the applicability of Section 14 over ‘personal guarantors.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.[iii]
Discussing the Report of Insolvency Law Committee’s Report 2018 vis-à-vis Judicial Pronouncements:
The Insolvency Law Committee, appointed by the Ministry of Corporate Affairs, by its Report dated 26.03.2018 tried to remove confusion regarding the applicability of Moratorium law under the IBC.The Committee tried to remove conspicuousness regarding the treatment of assets of guarantors of the Corporate Debtor vis-à-vis the moratorium on the assets of the corporate debtor. It recommended that all assets of such guarantors to the corporate debtor shall not fall within the ambit of moratorium under Section 14. In-State Bank of India V. Ramakrishnan and Another[iv], Justice R.F. Nariman and Justice Indu Malhotra overturned the order of the Tribunal and held that Section 14 of the Code shall not apply to ‘personal guarantors’.
In the case of ScheweitzerSystemtek India Private Limited v. Phoenix ARC Pvt. Ltd. & Ors.[v]the Hon’ble NCLT, quite interestingly ruled a contradictory order with respect to the State Bank of India case. The Tribunal held that ‘Moratorium’ had no application on the properties beyond the ownership of Corporate Debtor. This averment is based on a bare perusal of Section 14 (1)(b) which incorporates the word ‘its assets’ in relation to the ‘Corporate Debtor’. Preventing itself to apply the doctrine of ‘caususomissus’, the Tribunal, however, on the contrary, felt prudent to apply the doctrine of ‘noscitur a sociis’. Hon’ble NCLAT also upheld the same in the case of Alpha & Omega Diagnostics (India) Ltd.v.Asset Reconstruction Company of India Ltd.[vi]
The Supreme Court while heavily relying on the recommendations of the Insolvency Law Committee upholds the idea that it is the creditors who will be at the losing end if the applicability of moratorium is extended to ‘personal guarantors’.To its malaise, the contradicting judgments and opinions by the same Tribunal have left the courts befuddled, let alone litigators and advocates.
Conundrum between Part II and Part III of the Code:
Technically, no conundrum lies between Part II and Part III of the Code with respect to the liability of ‘personal guarantors’ and ‘corporate guarantors’ after the enactment of the Insolvency and Bankruptcy Code (Second Amendment) Act, 2018. Part II entitled “Insolvency Resolution and Liquidation for Corporate Persons” applies only on ‘corporate persons’ as defined under section 3 (7) whereas Part III entitled “Insolvency Resolution and Bankruptcy for Individuals and Partnership Firms” applies only on ‘individuals’ and ‘partnership firms’.
Whether an insolvency petition is filed against the ‘corporate debtor’ and ‘corporate guarantor’ simultaneously?
In ICICI Bank Limited VadodaravVista Steel Private Limited, Kolkata[vii]the Hon’ble NCLT held that it is true that guarantors’ liability is given co-extensive with that principal borrower. But it does not mean that an insolvency petition can be filed against the principal borrower and corporate guarantor simultaneously. The insolvency petition has already been admitted u/s. 7 of Code against the principal borrower. Therefore, another insolvency proceeding against the corporate guarantor is barred on account of the moratorium order passed u/s. 14(l)(a) of Code against the principal borrower.
The Allahabad High Court subsequently took a differing view in Sanjeev Shriya v. State Bank of India,[viii] by applying a moratorium to the enforcement of guarantee against personal guarantor to the debt. The rationale being that if a CIRP is going on against the corporate debtor, then the debt owed by the corporate debtor is not final till the resolution plan is approved, and thus the liability of the surety would also be unclear. The Court took the view that until the debt of the corporate debtor is crystallized, the guarantor's liability may not be triggered. The Committee deliberated and noted that this would mean that surety’sliabilities are put on hold if a CIRP is going on against the corporate debtor, and such an interpretation may lead to the contracts of the guarantee being infructuous, and not serving the purpose for which they have been entered into.
[i]State Bank of India v. V. Ramakrishnan and Veeson Energy Systems, NCLAT, New Delhi, Company Appeal (AT) (Insolvency) No. 213/2017 (Date of the decision - 28 February 2018). [ii]M/s. Sicom Investments and Finance Ltd. v. Rajesh Kumar Drolia and Anr. (2017) SCC Online Bom 9725 (decided on 28.11.2017). [iii]The Insolvency Law Committee, appointed by the Ministry of Corporate Affairs, by its Report dated 26.03.2018. [iv]Civil Appeal No. 3595 of 2018, Civil Appeal No. 4553 of 2018. [v] Company Appeal (AT) (Insolvency) No. 129 of 2017. [vi]Company Appeal (AT) (Insolvency) No. 116 of 2017. [vii]CP (IB) No. 552/KB/2017. [viii] 2017 (9) ADJ 723.