The “Forum Conundrum” in the Insolvency and Bankruptcy Code, 2016

[By Soumyodeep Halder

The author is a student at Government Law College, Mumbai. 

The Insolvency and Bankruptcy Code, 2016 (“IBC” or “Code”) was envisioned as a means to rescue businesses from financial distress. The Code sought to consolidate the extant legal framework into a single piece of legislation. As a result, the IBC repealed two Victorian legislation – i.e. the Presidency Towns Insolvency Act, 1909 and Provincial Insolvency Act, 1920 (“Extant Laws”). The Central Government also amended 11 other ancillary legislation to streamline the insolvency and liquidation procedure stipulated under the Code.

Ever since the Code was notified, it has undergone periodic amendments to be in sync with the changing business requirements. However, few of these amendments and modifications have been done with myopic vision resulting in excruciating delay and uncertainty. Over the course of this paper, the author shall elucidate (i) the historic development of jurisprudence with respect to proceedings against personal guarantors under this Code, (ii) the legislature’s ineptitude in crystallizing the legal framework for proceeding against personal guarantors and (iii) the incidental apathy with respect to the appropriate forum.

The IBC became effective from December 2016 with certain provisions of it being notified from August 2016. Thereafter, the government established various benches of the National Company Law Tribunal (“NCLT”) across the country. The Code is structured in 5 parts. Part I and II inter alia deal with an introduction, corporate insolvency resolution process[i] (“CIRP”) and liquidation of corporate debtors[ii]. These parts were made operative at the outset. Over the course of the years, the parties involved realized that there were teething issues that were creating bottlenecks in a smooth resolution process. The predominant issue here was the inability of financial creditors to pursue effective action against the promoters of the corporate debtors. Section 60 of the Code states that the NCLT shall be the adjudicating authority for CIRP. There were instances when financial creditors attempted to bring in promoter assets into the asset pool for the purpose of enforcing promoter guarantees. An argument was put forth that the NCLT, under section 60 of IBC could only adjudicate matters related to the corporate debtors and not individuals. Therefore, they did not have the requisite jurisdiction to hear cases against promoters (individuals). Numerous cases of promoters ring-fencing their assets and being unaffected by the CIRP came to light[iii]. Financial creditors had to mount multiple litigations in various courts of law in order to enforce promoter guarantees[iv]. This resulted in higher costs, prolonged and multiplicity of proceedings and erosion of asset value. The genesis of this issue could be traced to the fact that Part III of the Code which dealt with “Insolvency and Bankruptcy for Individuals and Partnership Firms” was not notified. Therefore, to combat this issue, the Central Government amended (“2018 Amendment”) section 60 of the Code to introduce adjudication of personal guarantors before the NCLT[v].

Pursuant to the 2018 Amendment, section 60 (2) now reads,

“Without prejudice to sub-section (1) …….. an application relating to the insolvency resolution or 1[liquidation or bankruptcy of a corporate guarantor or personal guarantor, as the case may be, of such corporate debtor] shall be filed before such National Company Law Tribunal.”

Therefore, proceedings against personal guarantors which were originally governed under Part III of the Code and adjudicated by the Debt Recovery Tribunal (“DRT”) pursuant to section 179 of the Code, were now before the NCLT. The 2018 Amendment may have given the impression of solving a simple forum issue but in reality, it further muddled the existing provisions of the Code.

Post the amendment, financial creditors began making promoters (who had provided personal guarantees) party to the insolvency proceedings to optimize their recoveries. However, unlike the procedure established for insolvency of corporate debtors, no procedure was established for the insolvency of those promoters who were parties to these proceedings before the NCLT. Detailed procedure for insolvency of individuals stipulated from section 78 to 187 was provided for in Part III of the Code. However, Part III was not notified. Therefore, NCLTs across the country struggled to deal with adjudication of personal guarantors due to the inadequacy of the legal framework.

To ease the burden on the NCLT and clarify the procedure of adjudication of personal guarantors, the Central Government notified Part III of the Code[vi] (“Impugned Notification”) in so far as it dealt with personal guarantors to corporate debtors. The Impugned Notification which may have been legislated with the best of intentions, stirred the hornet’s nest. It resulted in a plethora of legal questions. The most pertinent of them are:

  1. Previously, insolvency against personal guarantors would be initiated under the Extant Laws. By notifying section 243 of the Code (which would repeal the Extant Laws), the Central Government has created two self-contradictory legal regimes.
  2. A guarantor whose liability under section 128 of the Indian Contracts Act, 1872 is co-extensive with the principal debtor. Hence, under CIRP, when the resolution plan is accepted, the corporate debtor is discharged of its liability and by extension, the surety (i.e. the guarantor) too is discharged[vii]. However, by the effect of this Impugned Notification, the financial creditors can now continue to proceed against the guarantors after the corporate debtor is discharged of its liability pursuant to the resolution plan.
  3. Before Part III of the Code was notified, cases against personal guarantors were adjudicated before the NCLT under section 60 (2) of the Code pursuant to the 2018 Amendment. The Impugned Notification was brought in to aid NCLT with the procedure of adjudication of personal guarantors as provided in Part III. However, under section 179 of Part III of the Code, adjudicating authority against individuals rests with the DRT. Therefore, parties in an insolvency proceeding did not know which forum to approach for proceedings against personal guarantors.

Due to such inconsistent law making by the Executive, matters had to be finally decided by the Supreme Court (“Court”) in the Lalit Kumar Jain vs. Union of India & Ors[viii]. This judgement was one of the landmark insolvency cases since it answered long pending convoluted legal questions. Among the various issues raised in this case, the author would analyze the court’s approach regarding the appropriate jurisdiction in cases involving personal guarantors.

The Court delved into the issue of jurisdiction and looked at NCLT’s position viz. the DRT. It held that the Impugned Notification was valid and legal. It held that the NCLT had jurisdiction over proceedings against individuals in matters involving personal guarantees. Section 60 of IBC which granted NCLT the adjudicating power over personal guarantors was not incongruous with section 179 of the Code which provided adjudicating powers to DRT over individuals.

Analysis

If insolvency resolution proceedings against corporate debtors were continued without the Impugned Notification and the 2018 Amendment, then in the event of a default, the entire machinery of the Code would be limited to the corporate debtor without any recourse to the personal guarantors. This would give rise to a two-pronged problem. First, the resolution applicant, who would be preparing to submit the resolution plan will be staring at a huge debt liability in the corporate debtor’s balance sheet. The excess liability would make it onerous for the resolution applicant to continue the corporate debtor as a “going concern.” Second, the personal guarantor (primarily responsible for the insolvency of the corporate debtor) would be excused from the entire resolution process and the creditors would have to proceed separately against him/her.

Through the judgement, the Court attempted to plug the loopholes in the Code as well as iron out any asymmetries caused due to the various amendments and notifications. It held that the Central Government was within its rights to limit the scope of the Impugned Notification to just personal guarantors. The Court accepted that personal guarantors by their very nature would fall within the scope and definition of “individuals” and therefore, by logical extension, motions against personal guarantors must be adjudicated before the DRT (Section 179 of the Code). However, it also took cognisance of the reasons why the Central Government was compelled to usher in the 2018 Amendment which provided NCLT the adjudicatory powers to deal with cases involving personal guarantors. Thus to settle the debate around the “appropriate forum”, the Court carved out a distinction between “personal guarantors of corporate debtors” and “individuals” under Part III of the Code. The Court held that the 2018 Amendment and the Impugned Notification have to be viewed harmoniously. When read harmoniously, the personal guarantor’s debt shall be presented before the NCLT, and the procedure laid down in Part III of the Code would be employed. Part III of the Code would solve NCLT’s issues of an inadequate procedural framework which was precluding its ability to proceed against a personal guarantor. By unifying the two different procedures under one forum (one for corporate debtors under Part II and the other for personal guarantors to corporate debtors under Part III of the Code), it allowed the adjudicatory mechanism to “have a clear vision of the extent of debt of the corporate debtor, its available assets and resources, as also the assets and resources of the personal guarantor.” This would have been impracticable and unfeasible if the insolvency of the personal guarantor was before another body.

The 2018 Amendment and the Impugned Notification when read together, would result in a more optimized resolution procedure. First, it would culminate in a lower debt volume for the resolution applicant if the personal guarantor’s assets were taken into consideration. Second, it would result in greater financial prudence on part of the personal guarantors. The personal guarantor, who creates a charge on his personal assets to obtain the debt, would exercise higher business caution and exhibit agility in arranging monies in case of a default on part of the corporate debtor, in order to discharge any liabilities/encumbrances likely to be created on his personal assets. The rationale employed by the Court to bracket corporate debtors and personal guarantors before the same adjudicatory forum (i.e. the NCLT) was also stead fasted on sound legal and commercial prudence. The Court iterated that, personal guarantors to corporate debtors may be “individuals” in the ordinary sense, but for the purpose of commercial wisdom and insolvency resolution they were intrinsically linked with the corporate debtor. Their liability arose from the existence of the corporate debtor and they shared a symbiotic debt relation. Therefore, it would only be logical to move before the DRT against a corporate guarantor if the default was one of a personal character. However, if the default accrued to the personal guarantor out of events linked with the corporate debtor, then its debt liability ceases to be that of a personal character and is co-jointed with that of the corporate debtor. Hence, the court concluded that an insolvency petition against an individual would lie before the DRT under section 179 of the Code but as soon as that individual puts on the hat of a personal guarantor and an insolvency petition arises due to the corporate debtor, the petition must be moved before the NCLT. Thereby, the Court laid to rest one of the most protracted questions of “appropriate forum” for insolvency cases.

[i] Vide Notification S.O. 3594(E) dated November 30, 2016 https://ibbi.gov.in//webadmin/pdf/legalframwork/2017/Jul/01st%20Dec%202016%20Provisions%20relating%20to%20Corporate%20Insolvency%20Resolution%20process.pdf

[ii] Vide Notification S.O. 3687(E) dated December 9, 2016 https://ibbi.gov.in//webadmin/pdf/legalframwork/2017/Jul/15th%20Dec%2016%20Provisions%20relating%20to%20liquidation.pdf

[iii] https://economictimes.indiatimes.com/industry/banking/finance/banking/supreme-court-verdict-banks-explore-option-of-invoking-personal-guarantee-of-promotion/articleshow/84349392.cms?from=mdr

[iv] https://economictimes.indiatimes.com/industry/banking/finance/banking/banks-move-drt-to-enforce-guarantees-provided-by-dhoots-for-videocon-loans/articleshow/66834865.cms?from=mdr

[v] The IBC (Second Amendment) Act, 2018, dated August 17, 2018 https://ibclaw.in/wp-content/uploads/2018/08/The-Insolvency-and-Bankruptcy-Code-Second-Amendment-Act-2018_2018-08-18-18_40_34.pdf

[vi] Vide Notification S.O. 4126(E) dated November 15, 2019 https://www.mca.gov.in/Ministry/pdf/Notification_18112019.pdf

[vii] Kundanlal Dabriwala vs. Haryana Financial Corporation, Punjab and Haryana High Court

[viii] MANU/SC/0352/2021

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