Experts have welcomed the Supreme Court’s judgment on November 9 upholding the constitutional validity of provisions in the Insolvency and Bankruptcy Code (IBC), 2016, relating to personal guarantors. Legal experts have opined that the judgment will enable the NCLT to clear over 2,000 personal guarantee cases that are currently pending.

“This judgment will lead to activation of all personal insolvency matters pending in the NCLTs due to this matter,” said Ashish Pahariya, Partner, DSK Legal.

According to the Insolvency and Bankruptcy Board of India (IBBI), 2,289 cases on personal guarantee were initiated from 2019, and the value of these cases was Rs 1.63 lakh crore. Of these cases, 150 were withdrawn or rejected while 282 were admitted. It is to be noted that the government introduced Sections 95 to 100 to the IBC pertaining to personal guarantors only in 2019, three years after the introduction of the code in 2016.

According to experts, the apex court’s decision has clarified the role of the Resolution Professional (RP) in the case of a personal guarantee to being a ‘facilitator’ and not an ‘adjudicator’. Meaning an RP appointed in a personal guarantor case can collate the information pertaining to a personal guarantor and cannot go beyond his remit to conduct a full-fledged enquiry against a personal guarantor.

“The judgment is a watershed moment, it reassures that adequate checks are in place for the functioning of a Resolution Professionals (RP) during the insolvency process,” said Aviral Kapoor, partner at law firm  Alagh and Kapoor law offices.

What are personal guarantors and what does the IBC say about them?

When a company defaults in repaying loans or credit facilities for a long period, the lenders move the National Company Law Tribunal (NCLT) to admit it into the insolvency resolution process. If the NCLT admits the company into the process, an RP is appointed to take stock of the company’s finances and to run the company to repay its lenders. An RP effectively takes over the operations of the company. The intention of the IBC is to make a debt-ridden company operational again.
A personal guarantor is a person who gives a written assurance to a lender that a company will repay the loan/ credit facility it has obtained. In the event the company does not repay the loan/credit facility, his personal assets can be attached by the lender. Prior to the IBC, banks would have had to move the Debt Recovery Tribunal (DRT) to enforce a personal guarantee.
“The personal guarantee is generally given by the promoters/ shareholders of the corporate houses in respect of a loan being availed from banks/ financial institutions (financial creditors),” said Jayant Joshi, partner at law firm RR legal partners.

However, in 2019, the government brought in new provisions in the IBC that enabled a creditor or the RP of a company to move applications under the IBC to enforce personal guarantees. For instance, if a company has been admitted into the insolvency resolution process and its promoter had given a personal guarantee to its lenders, the lenders, either on their own or through the RP, can move an insolvency plea against the promoter. The NCLT will then appoint another RP to represent the personal guarantor. The RP will collate the information related to the nature of the loan given to the company, the amount in default and the role of the personal guarantor. The NCLT, upon analysis of the RP’s report, will determine whether the personal guarantor must be admitted into the insolvency process or not. If a personal guarantor is admitted into the process, his assets will be attached by the RP for recovery of the loan.

These provisions were challenged on the ground that in the whole scheme of things, the personal guarantor would have no right to argue or present his case before an RP was appointed by the NCLT, thereby violating the principles of natural justice guaranteed by the constitution. It was further alleged that an RP’s report would essentially spell out the fate of a personal guarantor, thereby making such powers prone to abuse. The challenges to these provisions were mounted by many prominent industrialists, including Anil Ambani and Venugopal Dhoot.

What did the supreme court ruling say?

In its judgment delivered on November 9, the supreme court has held that principles of natural justice cannot be applied in straitjacket fashion to all legislation, and applies differently to different laws. “The key and principal element under challenge was that the personal guarantors were not given an opportunity of being heard before or at the time of appointment of the resolution professional. This has been upheld by holding that the IBC has sufficient provisions to take care of the personal guarantors’ interest,” said lawyer Shashank  Agarwal.

The judgment, while upholding the constitutional validity of the IBC provisions relating to personal guarantors, has clarified that the role of the RP is of a ‘facilitator’ and not an ‘adjudicator’. Meaning, the RP’s role is limited to facilitating the NCLT to form an opinion on the case and not decide on whether the personal guarantor should be appointed to insolvency or not. Similarly, the supreme court clarified that the NCLT need not pass judgment based on an RP’s report but can form its own opinion.

Explaining this further, Ateev Mathur, partner at law firm SNG & Partners, said, “The SC has observed that the power of the RP to seek and collate Information from the personal guarantors under these provisions does not result in any civil consequences for the guarantor.” Mathur noted that the judgment had clarified that the RP’s power was limited to collating information pertaining to a personal guarantor and preparing a report for the adjudicating authority.

Furthermore, upholding these provisions would mean that an individual who has stood guarantee to a loan/credit facility given to a company cannot wriggle out of his obligation. According to senior advocate and former additional solicitor general Sanjay Jain, “The supreme court has held that personal guarantors cannot claim ignorance about the affairs of the company under the insolvency process and the mechanism inbuilt in the process provides sufficient safeguards. It does not call for a separate hearing to be given by the RP to the personal guarantors.”