On 5th June 2020 , the Ministry of Law and Justice through an Ordinance inserted Section 10A to the Insolvency and Bankruptcy Code, 2016 ("IBC"), suspending the initiation of Corporate Insolvency Resolution Process (CIRP) under Section 7, 9 and 10 of the IBC for a period of six (6) months, w.e.f. 25th March, 2020. Subsequently, repacing the Ordinance, the Parliament on 21st September 2020 , passed the Insolvency and Bankruptcy Code (Second Amendment) Bill, 2020. Days before the expiry of the six-month period as per the said Ordinance, the Government issued a fresh Notification No. S.O. 3265(E) dated 24th September 2020, extending the suspension of Sections 7, 9 and 10 of the IBC by a further period of three months.
Section 10A of IBC
"Notwithstanding anything contained in sections 7,9 and 10, no application for initiation of corporate insolvency resolution process of a corporate debtor shall be filed, for any default arising on or after 25th March 2020 for a period of six months or such further period, not exceeding one year from such date, as may be notified in this behalf:
Provided that no application shall ever be filed for initiation of corporate insolvency resolution process of a corporate debtor for the said default occurring during the said period.
Explanation – For the removal of doubts, it is hereby clarified that the provisions of this section shall not apply to any default committed under the said sections before 25th March 2020.
Much has been said about this insertion to the IBC. Legal scolars have have pointed out the merits and demerits of the suspension of initiation of CIRP and its application post 25th March 2020. The suspension of initiation of CIRP solely in respect of any Corporate Debtor, has created an anomalous situation as the same benefit has not been extended to the personal guarantors of such corporate debtors (CD).
Section 128 of the Indian Contract Act, 1872 (ICA), enumerates the principle that the liability of a guarantor is co-extensive with that of the borrower. The guarantor is liable to pay the dues to the creditor in the event of default of payment by the principal borrower. When it comes to enforcement of the creditor's rights, the borrower and guarantor are treated alike.
As per the law as it stands today, when a CD is undergoing the Corporate Insolvency Resolution Process (CIRP), the moratorium under Section 14 of the IBC is applicable only to proceedings against the CD, and not in respect of its guarantors. The Supreme Court of India, in State Bank of India v. V. Ramakrishnan has held that creditors are at liberty to avail their remedies against guarantors and proceed with action for recovery. In Lalit Mishra and Ors. v. Sharon Bio Medicine Ltd. and Ors. (Judgment dated 19.12.2018 passed in Company Appeal (AT) (Insolvency) No. 164 of 2018), the National Company Law Appellate Tribunal (NCLAT) held that the Resolution Process under the IBC is not a recovery mechanism for creditors, and the intention of the legislature is not to aid the defaulter promoters, directly or indirectly, by excluding the legal remedies available to the creditors against their personal guarantors. This decision stands affirmed by the Supreme Court vide its Order dated 05.04.2019 passed in the C.A. No. 1603 of 2019, captioned 'Lalit Mishra and Ors. v. Sharon Bio Medicine Ltd. and Ors., whereby the appeal against the decision of the NCLAT was dismissed. Thus, it can be understood that the liability of a personal guarantor does not get extinguished even on the approval of a Resolution Plan.
While accepting the legal position as above, assuming that initiation of CIRP against Corporate Debtors had been suspended in a bid to ensure that companies remain a 'going concern' and to mitigate the devastating effects of the COVID-19 pandemic, the question that arises is whether it would then be justifiable to proceed against personal guarantors, who have been equally affected by the pandemic.
Treating equals unequally
A 'guarantor' under Section 126 of the ICA, is a person who promises to pay the debt to the creditor in the event of default by the borrower. For the purposes of recovery, borrowers and guarantors belong to the same class. Although law has now been suspended action against CDs under a statute for a specific reason, namely the COVID-19 pandemic, which has impacted business, financial markets and the economy all over the world, the question that arises is whether equity demands that the same relief ought to be extended to the guarantors to the Corporate Debtors, who are similarly situated persons in terms of pandemic. This discriminatory treatment of guarantors amounts to violation of Article 14 of the Constitution of India, which warrants equal treatment of equals.
The above throw up the following questions -
- Assuming that a personal guarantor to a CD is referred to the Debt Recovery Tribunal ("DRT") under Part III of the IBC, and is ordered to clear the liabilities of CD by repaying the debts to the creditor, would the guarantor upon the said repayment acquire subrogation rights against the borrower and consequential rights under Sections 140 and 141 of the ICA?
- Going forward, if the guarantor acquires subrogation rights, would he then be entitled to lodge a claim as a Financial Creditor in the event of a CIRP being initiated against the borrower on expiry of the CIRP suspension period?
- Further, if the guarantor also acquires the security interest as stated above, does he also acquire the status of a secured creditor in respect of the CD?
While the provisions under Part III of the IBC are under challenge before the Supreme Court, the selective suspension of action against CDs without affording any protection to the guarantors is a matter of concern.
Acknowledging the hardships faced by lakhs of borrowers due to the ongoing COVID-19 pandemic, the Supreme Court has extended the relief of classification of loans as NPAs, as well as moratorium for loan repayment, and has also been repeatedly questioning the rationale for charging 'interest on interest' during the period of moratorium, the guarantors deserve a similar equitable remedy ..
Views are personal.
(Author is a Practicing Lawyer at Chennai)