Case Comment: Lalit Kumar Jain v. Union of India & others SCC OnLine SC396 2021

Facts

The lawsuit revolves around the Government of India’s notification dated September 15, 2019. Part III of the Code, which broadly specifies the execution of various rules on the Personal Guarantor, is the subject of the notification. The petitioners gave guarantees in their capacity as directors, promoters, chairman, and managing directors of the companies, which have been invoked and procedures against the companies with which they are associated are pending.

Insolvency filings, settlement plans, and other cases are still active at various levels. Following the announcement, the petitioners received many demand notifications, indicating insolvency proceedings under the Code, and recovery operations commenced following the invocation of guarantees under Part-III of the Code. The Petitioners argued that the Government’s authority under Section 1(3) of the Code could not be used to limit the Code’s provisions to personal guarantors of corporate debtors.^[1]

On November 15, 2019, the Ministry of Corporate Affairs issued the said notification about the implementation of certain provisions of the International Business Code (IBC) that primarily addresses the personal guarantors’ liabilities.^[2] The Insolvency and Bankruptcy Board of India (IBBI) then contested the decision.

After the notification, the petitioners’ personal guarantees were used in a number of cases. As a result, various parties’ insolvency cases were at various levels, with some reaching the end. Many received demand notifications and were subjected to insolvency procedures due to the code.

Issues in Lalit Kumar Jain v. Union of India & others

1. Is the MCA’s notification dated 15.11.2019 (“notification”) lawful and within the scope of the government’s powers and authority?
2. Does sanctioning a corporate debtor’s resolution plan relieve the corporate debtor’s personal guarantor?

Legal provisions dealt in Lalit Kumar Jain v. Union of India & others

On November 15, 2019, the Union Ministry of Corporate Affairs (“MCA”) issued a notification implementing provisions of Part III of the Insolvency and Bankruptcy Code 2016 (“the Code”), which dealt with personal guarantors to corporate debtors in bankruptcy and insolvency resolution processes.

Banks were able to file insolvency procedures against the personal guarantor of corporate creditors as a result of this notification. The goal was to hold promoters, directors, and, in some cases, managing directors or chairpersons personally accountable for the debts their company took out on their personal guarantee.

Section 1(3) of the IBC states that the Code shall come into effect when the Central Government issues a notification in the Official Gazette. The Petitioners alleged that the Central Government acted Ultra Vires of its power vested in them by Section 1(3). In this case, the government selectively enforced provisions such as Section 78, 79, 94-187 of the IBC through the impugned order.3

In the case of Rajendra K Bhuta vs Maharashtra Housing and Area Development Authority, the court stated that under section 60(2) of the IBC^[3], the insolvency process of the three categories which are of the corporate debtor, corporate guarantors to corporate debtors, and personal guarantors to corporate debtors have to be applied in such a manner that the liquidation resolution applies to corporate guarantors or the bankruptcy process apply to personal guarantors who cannot be subjected to liquidation.

The amendment to the Section was meant to formulate a unified adjudication process through the same forum for bankruptcy and insolvency processes.

Prior to the 2018 amendment, the Central Government had legal guidelines to distinguish and categorise personal guarantors from other individuals. Sections 5(22), 60, 234, 235, and Section 60 (as amended) all indicate this. The court in V. Ramakrishnan addressed the impact of various sections of the Code and how they apply to personal guarantors. Section 31 of the IBC lays down a clear resolution plan, and hence it does not discharge a guarantor from their liability.

Analysis of Judgement in Lalit Kumar Jain v. Union of India & others

The Supreme Court held that the impugned notification was valid. The Court further stated that the information was not passed in Ultra Vires to the powers of the Central Government given to it under Section 1(3) of the Code. Section 1(3) confers powers on the Central Government to enforce numerous provisions of the Code at different times; it does not, however, permit the government to classify to apply provisions to only a certain category of people. This ‘conditional legislation’ allows the executive to bring into the law at any time.

The Court also stated that there is an ‘intrinsic connection’ between corporate debtors and personal guarantors. In many cases, the court has reiterated that an involuntary act of the principal debtor, which leads to a loss of security, does not absolve the guarantor of its liability.

The Apex Court held that the personal guarantor is not ipso facto discharged if a resolution plan is passed. As this court has decided, the sanction of a resolution plan and the finality conferred on it by Section 31 does not function as a discharge of the guarantor’s liability. An involuntary procedure, such as by operation of law or owing to liquidation or insolvency, does not absolve the surety/guarantor of their duty arising from an independent contract.

The resolution plan on its approval would then become binding on the corporate debtor, members, guarantors and other stakeholders involved in the resolution plan. The court held that the object of the IBC was to make sure that personal guarantors were not able to evade their liability once the resolution plan was approved.

This would affect the rights of a third party who is not part of the contract as it would not allow him to file for subrogation rights under Section 140 of the Indian Contract Act, 1872. The judgement given by the court, in this case, will ensure a dip in the number of defaults by personal guarantors, but because of the judgement, it could also make it challenging to find a personal guarantor for a business.

Comparison with the bankruptcy code of the united states

In this case, the Supreme Court has opined that the exercise of the right to subrogation by the personal guarantor’s would be antithetical to the ‘clean slate theory’.^[4] The resolution process is aimed at providing applicant with a chance to start afresh. The right to subrogation would enable the guarantor to file claims against the debtor after the debts have been discharged. The insertion of Section 32A in 2020 limits the liability of the corporate debtor to the terms agreed in the resolution plan.

The Bankruptcy Code of the United States however, makes no distinction between the periods before and after the approval of the resolution. It also explicitly provides for the right to subrogation. This is supported by the reasoning that though the co-debtor is made liable every time a claim is initiated and a guarantor is made liable only when the debtor defaults, both parties ultimately discharge the liabilities of the corporate debtor.

Further, the Insolvency and Bankruptcy Code of India does not have a statutory provision dealing specifically with the right to subrogation but is governed by the provisions of the Indian Contract Act, 1872. Section 238 states that in cases of conflict, the provisions of the IBC would be applicable.

Conclusion

The Supreme Court ruled that the notification was not ultra vires since it was not excessive legislation, and that the IBC should be implemented in stages. The liability of the personal guarantor is coextensive with that of the principal borrower, according to petitioners; nevertheless, the liability is not only coextensive but also joint, and therefore the resolution plan cannot completely absolve the personal guarantor. Personal guarantors are included in the scope of liquidation or bankruptcy, according to Section 60(2) of the IBC.

All of the writ petitions in this case were dismissed because the notification was found to be valid. In closing, the judgement reinforces the objective of the IBC, that is to revive the company. It effectively strikes a balance between the rights of the creditors and personal guarantors. Further, disregarding the rights of the personal guarantor would discourage them from standing as guarantors in the future which would make raising funds challenging.

End Notes

^[1] (2021) 9 SCC 321

^[2]  S.O. 4126 (E) issued by the Ministry of Corporation Affairs, Central Government

^[3]M.S. Nandini, Miheer Jain, ‘Analysis of Initiation of Insolvency Proceedings Against Personal Guarantors in Light of Lalit Kumar vs. Union of India’ (IBC Laws, 30 May 2021) <https://ibclaw.in/analysis-of-initiation-of-insolvency-proceedings- against-personal-guarantors-in-light-of-lalit-kumar-vs-union-of-india-by-ms-nandini- shenai-mr-miheer-jain/> accessed 13 November 2022.

^[4] Aditya Saraswat, ‘“Clean Slate Theory” under the Insolvency & Bankruptcy Code: An Analysis’( IndiaCorpLaw, 20 May 2021) <https://indiacorplaw.in/2021/05/clean- slate-theory-under-the-insolvency-bankruptcy-code-an-analysis.html> accessed 9 February 2022.

By: Apoorva Gopal Katti (CHRIST (deemed to be) University)