Effect of IBC Ordinance, 2020 on Creditor’s strength to Realise debt from Personal Guarantors
Part III of the Insolvency and Bankruptcy code, 2016 deals with the provisions for insolvency resolution and bankruptcy of individuals and partnership firms. For the purpose of implementing individual insolvency in a phased manner, the Code categorises individuals into three classes, namely, partnership firms and proprietorship firms, personal guarantors to CDs, and other individuals. The Personal Guarantors to a corporate debtor were included under the ambit of the Insolvency and Bankruptcy Code, 2016 by a MCA notification issued on this behalf on November 15, 2019. Further, to ensure smooth implementation of insolvency proceedings and adjudication, the MCA also notified the Insolvency and Bankruptcy (Application to Adjudicating Authority for Insolvency Resolution Process for Personal Guarantors to Corporate Debtors) Rules, 2019 ( Rules) and the Insolvency and Bankruptcy (Application to Adjudicating Authority for Bankruptcy Process for Personal Guarantors to Corporate Debtors) Regulations, 2019 (Regulations) which came into effect on December 1, 2019.
Personal guarantor to a corporate debtor has been defined under Section 5(22), part II of IBC as a person who has entered into a contract of guarantee as the surety to the corporate debtor. Further, the Rules define “guarantor” as a debtor who is the personal guarantor to a corporate debtor and in respect of which the creditor has invoked guarantee which remains unpaid in full or part. A contract of guarantee as per Section 126 of the Indian Contract Act, 1872 (ICA) is a tripartite agreement entered into between the principal debtor, the creditor and the surety; where the idea is to provide for a back pocket to the creditor in case the principal debtor defaults in payment. Thus, the applicability of IBC on personal guarantors was a step towards achieving this idea.
Further, according to Section 128 of the ICA, the essential feature of a contract of guarantee is that the surety can be asked to fulfil his obligation before the creditor as exhausted his remedies against the principal debtor; thereby, both the surety and the debtor can be sued simultaneously by the creditor. Therefore, the inclusion of personal guarantors under Part III of IBC, was intended to manifestly allow the creditor to initiate and maintain proceedings against both the corporate debtor and the personal guarantor simultaneously and before the same forum.
Under Part III of the Code, insolvency proceedings against a personal guarantor can be initiated either by the guarantor itself or by the creditor(s) under Sections 94 and 95, respectively. As per Section 78, any insolvency proceeding under this part can only be initiated if the default amount is not less than Rs. 1,000. However, the central government has been empowered to increase this threshold limit to not more than 1 lakh rupees.
Application by Creditor
Insolvency proceedings against a personal guarantor can be initiated by the creditor in accordance with Section 95 which states that the creditor can either himself or jointly with the other creditors apply by submitting an application for initiating insolvency proceedings to the NCLT. The application can be filed only in relation to the debt that is owed to the creditor against either the firm or any one or more partners of the firm. Further, the application must contain the following details and documents-
the debt owed, as on the date of application, to creditor who is submitting the application;
failure of the debtor to pay the debt within fourteen days from service of the notice of demand; and
Evidence that is relevant to prove such default or non-repayment of debt.
Moreover, the creditor is bound to provide a copy of this application to the guarantor.
Effect of IBC Ordinance
The COVID-19 situation has resulted in great financial distress for most individuals and companies. To safeguard the companies from being dragged into insolvency under the Code due to this pandemic, the Government of India has made certain announcements which could affect the strength of creditors’ efforts to realise their debt under the Code. Starting with the MCA notification dated24th march, 2020 to the Amendment Ordinance, the scope of attaining an effective resolution under the Code has become narrower for the creditors. At this phase, the option of initiating insolvency against personal guarantors could be the only alternative remedy available to the creditors.
Part I of the Code contains provisions for initiating corporate insolvency resolution process against corporate debtors. Section 4 of the Code provides that, for initiating insolvency proceedings against any corporate debtor, the minimum default amount must be 1 Lakh rupees. It also empowers the central government to increase this threshold limit to not more than 1 Crore rupees. While exercising this power, the central government on 24th March, 2020, issued a notification increasing the default limit to 1 Crore rupee. Thus, a creditor cannot initiate insolvency proceeding against a corporate debtor if the default amount is less than 1 Crore rupees, thereby restricting the option of a creditor to realise the debt owed to him.
Following this, on 17th may, 2020 the finance minister announced certain government reforms which suspended fresh initiation of insolvency proceedings up to 1 year, depending upon this pandemic situation. It further excluded COVID-19 related debt from the definition of “default” for the purpose of insolvency proceedings. In furtherance of this announcement, the central government introduced the Insolvency and Bankruptcy Code (Amendment) Ordinance, 2020 (hereinafter referred to as “Ordinance”) on 5 June, 2020 .
The ordinance inserted Section 10A to the Code, giving effect to the announcement made on 17th may, 2020. Section 10A thus reads that no fresh application for initiation of insolvency proceedings under Sections 7, 9 and 10 can be filed for default that has arisen after 25th march 2020 for a period of 6 months. Thus, blanket immunity has been given to the corporate debtors for a period of 6 month which can further be increased to 1 year, depending upon the COVID- 19 situation. Further, the proviso states that for any default arising during this period, no application for insolvency can ever be filed. Moreover, the Explanation to Section 10A specifies that the provision will not be applicable to any default that had arisen before March 25th, 2020. Hence, the creditors are left with no remedy to realise their debts from the corporate debtors for the defaults arising during the said period.
These amendments to the Code were made with the intention to provide security to the corporate debtors, especially the MSMEs. Even though the Ordinance is beneficial for the corporate debtors, these amendments are detrimental to the interests of the creditors. The amendments seem to provide a blanket protection from insolvency in this time of financial distress and the creditors are left with only few alternative remedies to realise their money.
However, the amendment does not affect the debt arising before 25th march, 2020 or the already pending applications. i.e. those applications which were filed but are yet to be admitted before the NCLT. On this issue, NCLT has observed that the amendment does not have a retrospective effect and therefore would not affect the pending applications. The issue still remains that the creditors are restricted from achieving an effective resolution for debt. The amendments only bar any fresh initiation of insolvency proceedings under Sections 7, 9 and 10 under Part II of the Code; thereby implying that a fresh application for insolvency can be filed under Part III and the creditors can avail the option of realising their debts from the personal guarantor to corporate debtors. It was also observed by Supreme Court in the case of State Bank of India v. Ramakrishna that “...Enforcement of guarantee may not have a significant impact on the debt of the corporate debtor as the right of the creditor against the principal debtor is merely shifted to the surety, to the extent of payment by the surety. Thus, contractual principles of guarantee require being respected even when a moratorium against a corporate debtor under Section 14 of the Code is in effect."
Therefore, the very objective of taking a personal guarantee from an independent third party is to ensure that the creditor is not asked to sit on his rights against the guarantor till the time his remedies against the principal debtor are not exhausted. In these circumstances, the right of the creditors to invoke guarantee against Personal guarantors could be the best remedy available to them.
Even though the default limit for initiation of insolvency proceedings against corporate debtors has been increased to Rs.1 crore, the default limit to initiate insolvency against a personal guarantor still remains at Rs. 1000, which can be fatal for the financial situation of the personal guarantors. This difference between the two default limits implies that there is a need to simultaneously amend the default limit for initiating insolvency proceedings against personal guarantors to protect them from the potential flow of insolvency proceedings for debt realisation during this pandemic.
*Sakshi Dewangan is a student at Hidayatullah National Law University, Raipur.