The Personal Guarantors Saga: Analyzing the Supreme Court’s Decision in Dilip B. Jiwrajka v. Union of India

[By Nidhi & Pratham Mohanty]

The authors are students of National Law University, Jodhpur.

 

Introduction 

Over the years following the enactment of the Insolvency and Bankruptcy Code, 2016 [IBC”], the position of the creditors has been strengthened with respect to realizing their dues, including in the case of the position of personal guarantors under the Indian insolvency regime. Personal guarantors were incorporated under Part III of the IBC related to individuals and partnerships firms vide Central Government Notification dated November 15 2019, which was upheld in the landmark Lalit Kumar Jain v. Union of India. 

Through another significant decision in Dilip B. Jiwrajka v. Union of India [Judgement”], the Hon’ble Supreme Court [Court”] has upheld the validity of Section 95 to Section 100 under Part III of the IBC, pertaining to the insolvency of individuals, including personal guarantors. The judgement brought an end to the long-standing debate regarding the constitutionality of the key provisions related to the insolvency of personal guarantors.  

Personal guarantors under IBC 

Under the law of contract, the liability of the principal debtor and the guarantor is co-extensive. However, IBC allows creditors to move against the personal guarantors at various stages, including after the conclusion of the Corporate Insolvency Resolution Process [CIRP”] of the principal borrower. In Lalit Kumar Jain v. Union of India, the Supreme Court clarified that the discharge of the principal borrower upon the sanction of a resolution plan or conclusion of CIRP does not lead to ‘discharge’ of the liability of the guarantor. This can be justified because often the creditors are driven to initiate IRP against the personal guarantors to remedy excessive haircuts incurred in the CIRP of the principal borrower. Due to such dynamics, the creditors are afforded enhanced rights to invoke personal guarantees.  

Furthermore, the NCLAT has clarified that guarantors cannot exercise the right of subrogation conferred upon them in contract law, since proceedings under IBC are not recovery proceedings” as in the cases of Lalit Mishra v. Sharon Biomedicine Ltd. and in State Bank of India v. Jayaprakash, by excluding guarantors from the ambit of secured creditors under the code. Moreover, the right of subrogation can be extinguished in the resolution plan while preserving the liabilities of the personal guarantors. 

As the judiciary continued curtailing the rights of personal guarantors, they tried challenging the very provisions governing their insolvency under the IBC. Before understanding the recent judgement, it is important to understand the scheme of insolvency provided under Chapter III, Part III of the IBC, governing personal guarantors.  

The Operation of Chapter III of Part III of IBC 

The procedure provided under the Insolvency Resolution Process [IRP”] for Corporates and Individuals, under Part II and Part III of the IBC, respectively, differs substantially.  

Unlike Part II, under Part III of the Code, upon filing an application for IRP under Section 95, the following steps automatically take place, without admission of the same by an Adjudicating Authority [“AA”]: 

An automatic interim moratorium: 

As per Section 96 of the IBC, upon filing of an insolvency application under Section 95, an automatic interim moratorium is put in place in relation to all the debts of the debtor, and any legal action or proceeding pending in respect of any debt shall be deemed to have been stayed. 

The appointment of a resolution professional 

Section 97 provides for the appointment of a Resolution Professional [“RP”], by the AA nominated by the Board. On the other hand, if the application is filed through a RP, the Board shall confirm his/her appointment.  

Report by the Resolution Professional 

The RP is required to investigate the application and furnish a report to the AA, recommending approval or rejection of the application. Only after the submission of such a report by the RP are the doors of the AA are knocked open for judicial determination to confirm the validity of the application. 

The Judgement: Dilip B. Jiwrajka v. Union of India 

On November 9th, 2023, the Supreme Court, in the landmark decision of Dilip B. Jiwrajka v. Union of India, upheld the validity of Section 95 to Section 100 of the IBC, pertaining to the insolvency of individuals, including personal guarantors.  

Arguments by the Petitioners 

The petitioners challenged the validity of Chapter III of Part III of the IBC, primarily on the following three grounds: 

Firstly, the scheme under Part III provides for the appointment of a RP, even prior to the admission of the petition and without judicial determination of jurisdictional questions such as the existence of debt by the AA.  

Secondly, the powers provided to the RP under Section 99 of the IBC are too wide and are judicial in nature, making them ultra vires to the object of the IBC.  

Thirdly, the appointment of the RP and the initiation of an interim moratorium without providing an opportunity for the PG to be heard in front of a judicial body are arbitrary, a violation of principles of natural justice, and a violation of Art. 14 of the Constitution.  

Judgment of the Court 

The court analyzed the contentions of the petitioners and divided its observations into primarily four parts, covering primarily four issues. The judgement can thus be summarized as follows: 

The role of the resolution professional in corporate as opposed to individual insolvency 

The Court, in its analysis, noted that the RP exercise any judicial role under Part III, but that of a facilitator and is limited to the collection of information. The Court highlighted that the IBC specifically used the terms examine the application,” “ascertain,” “satisfies the requirements,” and recommend” in relation to the acceptance or rejection of the application. These statements clearly indicate that the resolution professional is not meant to engage in an adjudicatory role or make any judicial determinations regarding facts.  

It further noted that since the threshold of default for filing an application is only Rs. 1000, as per Section 78 of the IBC, the AA would be overburdened if all amounts of alleged defaults as low as one thousand rupees were to be judicially determined. Thus, the RP acts as a facilitator by collating the data and information in relation to the application filed and recommends that the AA either reject of accept the application.  

The impact of a moratorium under Section 14 of Part II, in comparison to an interim-moratorium under Section 96 of Chapter III of Part III 

Secondly, the Court clarified that the interim moratorium under Section 96 of the Code is intended to be protective in nature, in contrast to the moratorium provided under Section 14, which restrains the transfer, encumbrance, alienation, or disposal by the corporate debtor of any of its assets or any legal right or beneficial interest therein. The Court further noted that the interim moratorium primarily applies to a debt rather than a debtor.  

The role of the AA in applications under Part II, in comparison to Part III.  

The Court noted that the determination by the AA under Part III begins when the resolution professional submits a recommendatory report. This is clearly distinct from the IRP for corporate provided under Part II, where the AA is the first forum for jurisdictional confirmation before the appointment of a RP and the placement of a moratorium.  

The Court further emphasized that the AA does not blindly accept or reject applications purely based on the report submitted by the RP. Instead, it provides the debtor with a fair chance to be heard before the AA under Section 100 of the IBC.  

Application of principles of natural justice 

In its fourth part of its analysis, the Court clarified that the principle of natural justice is not violated for primarily two reasons: 

Firstly, the judicial determination of the question of facts arises under Section 100 only after the submission of the report by the RP. At this stage, the Court conducts an independent enquiry to reach its conclusion and the debtor is allowed to make its submissions and gets its right to be heard before the admission of claim against him/her.  

Secondly, even at the stage of investigation by the RP, the RP has the authority to demand proof of debt repayment from the debtor. Thus, the provisions of Section 99 make it clear that the process before the RP is not ex parte, and a just opportunity is provided to the debtor to furnish his case. 

Therefore, at both the stages of determination under Part III, the principles of natural justice are being followed, by giving ample opportunity to the debtor to furnish his case, before admission of the insolvency application. 

An Analysis: Key issues in the Judgement 

In the opinion of the authors, the analysis provided by the Court in the case has several lacunas and misses out on a detailed substantive reasoning before reaching its decision. Some of the key issues are as follows: 

Distinction of procedure under Part II and Part III of the IBC is unreasonable.  

The procedure for IRP under Part II and Part III of the IBC is significantly distinct. The Court in its judgement justified the additional steps in Part III on the basis that this scheme is specially devised by the legislature to cater to the insolvency of individuals. However, the Court failed to create a link between the nature of insolvency and its resultant change in the scheme of IRP, i.e., why an individual insolvency required addition of the two steps before approval of the application by the AA.  

Even under Section 271 of the UK’s Insolvency Act, 1986, upon filing of a bankruptcy petition by a creditor against an individual, the petition is scrutinized by a court, and upon confirmation of the debt and non-payment, an Official Receiver (like that of a RP) is appointed to facilitate the IRP/ bankruptcy.  

Similarly, under Section 41 read with Section 40(1)(g) of the Australian Bankruptcy Act, 1966, an Official Receiver can issue bankruptcy notice and initiate an individual’s bankruptcy, only after a creditor has obtained a court order, confirming the existence of debt, its non-repayment, and court’s assent to initiation of bankruptcy against the debtor. 

Further, the argument put forth by the Court that the present differential scheme was devised by the legislature to lower the burden on the AA, does not stand true. The Court has noted that the RP, under Part III, acts as a facilitator, and the report submitted by the RP shall help the AA in determining the approval of the insolvency application, under Section 100. However, in a recent discussion paper released by the IBBI on the appointment of RPs, the board has observed that on plethora of cases, the RPs face significant challenges in collating data while making the report. Thus, making the entire IRP more complex, and time consuming.  

On the other hand, in case of an CIRP under Part II, at the stages of sections 7, 8, and 9, the evidence in relation to the existence of debt and non-payment is furnished before the AA by both the creditor and the debtor making it convenient for the court to determine the admissibility of the application, and adhering to the objective of time bound IRP, as envisioned by the IBC. Thus, in the opinion of the authors, the differential treatment of individual insolvencies under Part III lacks sufficient reasoning and is arbitrary.  

The scheme provided under Part III is violative of the principles of natural justice.  

Firstly, the court noted that the RP has the authority to demand proof of debt repayment from the debtor, as specified in Section 99. The phrase may require the debtor to prove repayment of the debt” in the provision, thus, clearly refers to the debtor’s requirement to provide evidence regarding repayment of the debt. However, the provision goes with the word may”, and thus puts any requirement for the debtor to prove repayment (or grant to put forth its case) in front of the RP, under the whims of the RP itself. Such discretion violates the right of the debtor to be heard, and thus is a violation of the principle of natural justice.  

Secondly, the authors acknowledge that such a process of examination and moratorium is provided by the IBC itself, and there is no statutory requirement for the debtor to be heard before the judicial determination under Section 100. However, in the case of Cooper v. Sandworth Board of Works, the court has noted that even if the statute does not mandate that a party may be heard before, justice under common law requires the court to provide such a right in accordance with the principles of natural justice. Similarly, in the case of Dharampal Satyapal v. Deputy Commissioner of Central Excise, Gauhati, it was specifically held that the application of principle of natural justice also extends to administrative enquiries, and the accused has the right to be heard before a court of law.  

Thus, as under Part III of the IBC, the investigation by RP and placement of an interim moratorium take place before the debtor gets an opportunity to put forth its case under Section 100, the scheme is violative of principles of natural justice.  

Conclusion  

The insolvency regime of personal guarantors has great significance for all stakeholders, including creditors, debtors, and the institute of guarantee itself. The recent judgement aims to pave the way for the disposal of the massive number of applications pending against personal guarantors, aiding the creditor’s debt recovery and boost their confidence.  

However, we should not lose sight of the importance of protecting the rights of personal guarantors and disincentivize guarantors in the process. In the opinion of the authors, the judgment fails to address the logical flaw in the scheme provided under Part III and its violation of principles of natural justice. This may pose a serious hindrance to the flow of credit in the absence of sufficient guarantees provided by personal guarantor, due to their unjust treatment under the law. This may prove detrimental to Indian corporates in the future. 

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