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Recently, the Supreme Court in a very crisp and well-reasoned judgment in the case of State Bank of India v. V Ramakrishnan, dealt with the controversy surrounding the applicability of the moratorium declared under Section 14 of the Insolvency & Bankruptcy Code, 2016 (IBC) on the personal guarantors of the corporate debtor.
The spirited defence put forth by the personal guarantors during the course of the hearing reminded the author of the Phoenix, a Greek mythological bird that cyclically obtains a new life by arising from the ashes of its predecessor. The author will deal with this aspect later in the article.
It is a prevalent commercial practice for the promoters of an entity to provide personal guarantees in respect of debts undertaken by the entity concerned. A separate agreement known as the “Guarantee Agreement” is entered into between the lender (i.e. the financial creditor, under the IBC regime) and the personal guarantor.
The underlying understanding is that in case the debtor (i.e. the corporate debtor, under the IBC regime) fails to repay the debt, then, independent of the legal remedies available to the financial creditor, the latter can, under the different legal remedies available to it, institute an action involving sale of assets or invoke the personal guarantor to act upon her guarantee in respect of the debts undertaken by the corporate debtor.
In that sense, the financing agreement between the corporate debtor and the financial creditor is quite independent and distinct from the Guarantee Agreement between the financial creditor and the personal guarantor.
Modus Operandi adopted by Personal Guarantors
With a view to at least securing their personal assets from being alienated, the personal guarantors saw a ray of hope in the moratorium provided under Section 14. Since multiple proceedings would already be pending against the corporate debtor, such a corporate debtor would itself move an application for insolvency under section 10 of the IBC.
This ensured that the debts are resolved under the IBC regime and due to Section 14, all other proceedings qua the corporate debtor would also be stayed. However, the personal guarantors went a step further – they claimed that the moratorium under Section 14 of the IBC would apply to the personal guarantees given by them in respect of the debt of the Corporate Debtor.
Controversy before the Court
In view of the above, the short question before the Supreme Court was whether the moratorium declared under Section 14 of the IBC in respect of the Corporate Debtor’s assets would include within its ambit the enforcement of personal guarantees in respect of debts of the Corporate Debtor.
To clarify the legislative scheme in a nutshell, Section 13 of the IBC provides that once a corporate insolvency resolution process is initiated, the NCLT, after admission of such an application, shall by order, declare a moratorium for the purposes referred to in Section 14. Section 14 in effect prohibits, inter alia, institution or continuation of proceedings, the transferring, encumbering or alienating of assets, action to recover security interest, or recovery of property by an owner which is in possession of the corporate debtor.
This controversy has travelled from the National Company Law Tribunal (NCLT) and the National Company Law Appellate Tribunal (NCLAT) to the various High Courts in the country. In particular, the Bombay High Court in the case of Sicom Investments and Finance Ltd. v. Rajesh Kumar Drolia has taken a literal view of Section 14 and has held that merely by virtue of a moratorium order, the suit against the personal guarantor cannot be stayed.
However, the Allahabad High Court in the case of Sanjeev Shriya v. State Bank of India has taken an expansive and broad view of Section 14 and has held that the moratorium order shall be applicable to the enforcement of guarantee against the personal guarantor to the debt.
Before the Supreme Court, the personal guarantors mainly contended as follows:
All this would show that since the personal guarantor is very much part of the overall process, the moratorium contained in Section 14 of the Code should apply to the personal guarantor as well.
Decision of the Supreme Court
Rejecting the contentions of the personal guarantors, the Supreme Court has held as follows:
1. A plain reading of Section 14 leads to the conclusion that the moratorium referred to in Section 14 can have no manner of application to personal guarantors of a corporate debtor
2. The scheme of Section 60(2) and (3) is very clear. The moment there is a proceeding against the corporate debtor pending under the IBC, any bankruptcy proceeding against the individual personal guarantor will, if already initiated before the proceeding against the corporate debtor, be transferred to the NCLT or, if initiated after such proceedings had been commenced against the corporate debtor, be filed only in the NCLT.
3. The argument that “bankruptcy” would include SARFAESI proceedings must be turned down as “bankruptcy” has reference only to the two Insolvency Acts referred to above. Thus, SARFAESI proceedings against the guarantor can continue under the SARFAESI Act.
4. The binding nature of the approved plan under Section 31 is for the reason that otherwise, under Section 133 of the Indian Contract Act, 1872, any change made to the debt owed by the corporate debtor, without the surety’s consent, would relieve the guarantor from payment. Section 31(1), in fact, makes it clear that the guarantor cannot escape payment as the Resolution Plan, which has been approved, may well include provisions as to payments to be made by such guarantor.
5. Parliament, when it enacted Section 14, took a conscious decision and specifically did not provide for any moratorium along the lines of Section 22 of the Sick Industrial Companies (Special Provisions) Act, 1985 in Section 14 of IBC.
6. Amendment to Section 14(3), which excludes a surety in a contract of guarantee to a corporate debtor, is a clarificatory amendment and thus retrospective in nature.
Thoughts on the Judgment
The spirit of the erstwhile Section 22(1) was tried to be invoked under Section 14 of the IBC, much like the rising of the Phoenix from the ashes. In view of the above discussion, the author takes the liberty of stating that the attempted flight of the Phoenix has been nipped in the bud by the Hon’ble Supreme Court in the present case.
Deepak Joshi is a dually qualified professional. He is a 2016 graduate of Campus Law Centre, Faculty of Law, University of Delhi and a Fellow Chartered Accountant. He currently practices law in the courts of Delhi. He can be reached at email@example.com