9/17/2018 0 Comments
SUPREME COURT COMES TO CREDITORS’ RESCUE: MORATORIUM UNDER SECTION 14 OF IBC TO NO LONGER PROTECT PERSONAL GUARANTORS
DELEP GOSWAMI, FCS
SUPREME COURT OF INDIA
Ph: (+91) 9891169035
GOSWAMI & GOSWAMI
Ph: (+91) 9711117019
As Published in ICSI's Journal 'CHARTERED SECRETARY' SEPTEMBER 2018 ISSUE
In a significant judgement dated 14th August, 2018, the Hon’ble Supreme Court of India in State Bank of India versus V. Ramakrishnan & Anr (Civil Appeal No.3595/2018) has held that the moratorium contained in Section 14 of the Insolvency and Bankruptcy Code, 2016 does not apply to the personal guarantor who stood guarantee for the loan obtained by the corporate debtor. This judgement of the Supreme Court has cleared the confusion that was created by the order of National Company Law Tribunal, Chennai Bench in V. Ramakrishnan versus Veesons Energy Systems Pvt. Ltd. where the NCLT held that after admission of insolvency proceedings against the corporate debtor and the initiation of corporate insolvency resolution process (CIRP) and participation by the Committee of Creditors (CoC), the lender/creditor of loans given to the corporate debtor, cannot invoke the guarantee that was given by the guarantor to secure the loan obtained by the corporate debtor. When this decision of the NCLT (Chennai) was appealed against, the Appellate Authority, namely, the National Company Law Appellate Tribunal (NCLAT), vide its final order dated 28th February 2019 also upheld the decision of the NCLT in the said matter. The NCLAT held that the moratorium imposed under Section 14 of the Code would also apply to the personal guarantor.
The impact of the aforesaid NCLT order of 18th September, 2017 and the subsequent NCLAT order of 28th February, 2018 created a difficult situation for lender banks/creditors who wanted to invoke the personal guarantee of the guarantor even though the debtor company was under the CIRP.
The brief background of the appeal filed by the State Bank of India before the Supreme Court is that the Respondent No.1 was the Managing Director of the corporate debtor, namely, the Respondent No.2 company, and also the personal guarantor in respect of credit facilities that had been availed from the Appellant. The Guarantee Agreement entered into between the Appellant and the Respondent No.1 was dated 22.02.2014. As the Respondent No.2 company did not pay its debts in time, the account of Respondent No.2 was classified as a “non-performing asset” on 26.05.2017. Consequent thereto, the Appellant issued a notice dated 4.8.2015 u/s 13(2) of the SARFAESI Act demanding an outstanding amount of Rs.61,13,28,785.48 from the Respondents within the statutory period of 60 days. As no payment was forthcoming, a possession notice u/s 13(4) of the SARFAESI Act was issued on 18.11.2016.
As matter stood thus, an application was filed by the corporate debtor under section 10 of the IBC on 20.5.2017 to initiate the CIRP against itself. On 19.6.2017, the said application was admitted, followed by the moratorium that is imposed statutorily u/s 14 of the IBC. During pendency of the proceedings, an interim application was filed by Respondent No.1 as personal guarantor to the corporate debtor, where he took up the plea that section 14 of the IBC would apply to the personal guarantor as well, as a result of which proceedings against the personal guarantor and his property would have to be stayed. The Adjudicating Authority before whom the proceedings under the IBC were pending, vide order dated 18.9.2017 held that since u/s 31 of the IBC, a Resolution Plan made thereunder would bind the personal guarantor as well, and since, after the creditor is proceeded against, the guarantor stands in the shoes of the creditor, s.14 would apply in favour of the personal guarantor as well. The interim application filed by Respondent No.1 was thus allowed and the Appellant was restrained from moving against Respondent No.1.
An appeal filed by the SBI before the NCLAT against the aforesaid NCLT order was dismissed. The NCLAT, vide the impugned judgement dated 28.2.2018 relied upon s.60(2) and s.60(3) as well as s.31 of the IBC to hold that moratorium imposed u/s 14 would also apply to the personal guarantor. The reasoning was that since the personal guarantor can also be proceeded against, and forms part of a Resolution Plan which is binding on him, he is very much part of the insolvency process against the corporate debtor, and that, therefore, the moratorium imposed u/s 14 should apply to the personal guarantor as well.
At the Supreme Court, the Appellants argued that the corporate debtor and personal guarantor are separate entities and that a corporate debtor undergoing insolvency proceeding under the IBC would not mean that a personal guarantor is also under the same process. As the guarantor’s liability is distinct and separate from that the corporate debtor, a suit can be maintained against the surety, though the principal debtor has not been sued. Reliance was heavily placed on s.128 of the Indian Contract Act, 1872 and the reasoning contained in a judgement of the Single Judge of the Bombay High Court in M/s Sicom Investments and Finance Limited versus Rajesh Kumar Drolia & Anr. [(2017) SCC Online Bom 9725]. The Appellants also referred to Part III of the IBC, and in particular to Sections 96 and 101. Although Part III of the IBC has not been brought into force, it is clear that if an insolvency resolution process is to be carried out against a personal guarantor, it can be done only under Part III, which contains a separate moratorium provision, namely, sections 96 and 101, both of which apply only if a separate insolvency process were carried out as against the personal guarantor. The Appellant relied heavily upon the difference in language between sections 14 and 101 of the IBC and stressed that section 14, in all its sub-sections, speaks only of the corporate debtor. When contrasted with section 101, it becomes clear that section 14 cannot possibly attach to a personal guarantor as well, as section 101 does not speak of a “debtor”, but speaks “in relation to the debt” and is not only wider than section 14, but would attach only if Part III proceedings were to be instituted against the personal guarantor.
The Appellants also relied heavily upon the Amendment Ordinance dated 6.6.2018, by which section 14(3) of the IBC was substituted, including a surety in a contract of guarantee to a corporate debtor. Reliance was placed upon the proceedings of the Insolvency Law Committee (ILC) which led to the aforesaid amendment, stating that it had been recommended to clarify, by way of an explanation, that all assets of such guarantors to the corporate debtor shall be outside the scope of the moratorium imposed under section 14 of the IBC. Interestingly, the same impugned judgement that was assailed in the present proceedings before the Supreme Court, was also referred to by the ILC stating that such broad interpretation of section 14 would curtail significant rights of the creditor. They relied upon judgements which made it clear that clarificatory statutes, like this amendment, would have retrospective operation and that, therefore, in any case, the impugned judgement would have to be set aside.
On the other hand, the Respondents took shelter under section 60(2) of the IBC and contended that the said section precludes Banks from proceeding against the personal guarantor under SARFAESI Act or any other Act outside the IBC. They also relied upon the reasoning of the NCLT and took shelter under Section 31 of IBC. Reliance was also placed on Allahabad High Court’s judgement in Sanjeev Shriya Vs. State Bank of India & Ors. (2018) 2 All LJ 769, which stated that as the proceeding relatable to the corporate debtor is pending adjudication in two forums, it is not permissible to proceed against the personal guarantor and that a financial creditor cannot operate in a manner that imperils the value of the property of the personal debtor. The Respondents also referred to the Insolvency and Bankruptcy Code (Amendment) Act, 2018 which came into effect on 23rd November 2017, by which, Clause (e) of Section 2 of IBC was substituted so as to include within the sweep of the IBC, personal guarantors to corporate debtors. The Respondent’s counsel also relied upon the Statement of Objects of the Amendment Act of 2018 which was, inter alia, to extend the provisions of IBC to personal guarantors of the corporate debtors, to further strengthen the CIRP. He further relied on certain statutory forms under the IBC which provide that information as to personal guarantees have to be given in relation to the debts of the corporate debtor when an insolvency process is initiated against the corporate debtor and that all this would show that since the personal guarantor is very much part of the overall process, the moratorium contained in Section 14 of the IBC should apply to the personal guarantor as well.
The Supreme Court had appointed an Amicus Curiae who pointed out that the whole idea of the IBC was that the history of debt recovery had shown that the earlier statutes were loaded heavily in favour of the corporate debtors and that, as a result, huge outstanding debts to banks and financial institutions had not been repaid. He also pointed out that Section 22 of the Sick Industrial Companies (Special Provisions) Act 1985 applied to guarantors as well and as a result the creditors could not proceed against the guarantors as well after the company had been declared sick industrial company under the said Act, without permission from the Board for Industrial and Financial Reconstruction (BIFR). Now that SICA had been repealed and the fact that several later enactments, including the Companies Act 2013 had omitted a provision akin to Section 22 of the SICA, it would go to show that the enactment of Section 14 of the IBC was deliberate and that the idea was that there should be no stay of proceedings against a guarantor while the corporate debtor is undergoing an insolvency proceeding. For this, the Amicus Curiae cited various judgements and also relied upon the Amendment Act of 2018 and stated that since the Act was to get over the impugned judgement of the NCLT in particular, and since it was clarificatory, the position in law would be that it would be retrospective, and would thus govern the SBI Appeal that was being heard by the Supreme Court.
After referring to various applicable provisions of the IBC, some of which are yet to be enforced, the Supreme Court observed that Section 14 refers to four matters that may be prohibited once the moratorium comes into effect. However, moratorium against the personal guarantor is conspicuous by its absence because the corporate debtor is the only one referred to in that Section of the Code. The Court also noted that a plain reading of the said Section 14 leads to the conclusion that the moratorium referred to therein can have no manner of application to personal guarantors of a corporate debtor.
The Supreme Court thereafter observed that under the scheme of Section 60(2) and (3), the moment there is a proceeding against the corporate debtor pending under the 2016 Code, any bankruptcy proceeding against the individual personal guarantor will, if already initiated before the proceeding against the corporate debtor, be transferred to the NCLT or, if initiated after such proceedings had been commenced against the corporate debtor, be filed only in the same bench of the NCLT where the proceedings were pending. However, the Tribunal is to decide such proceedings only in accordance with the Presidency-Towns Insolvency Act, 1909 or the Provincial Insolvency Act, 1920, as the case may be. It is clear that Section 60(4), which states that the Tribunal shall be vested with all the powers of the Debt Recovery Tribunal (DRT), as contemplated under Part III of this Code, for the purposes of sub-section (2), would not take effect, as the DRT has not yet been empowered to hear bankruptcy proceedings against individuals under Section 179 of the Code, as the said Section has not yet been brought into force. The Court further noted that as could be seen from Section 249, dealing with the consequential amendment of the Recovery of Debts Act to empower DRTs to try such proceedings, has also not been brought into force. It is thus clear that Section 2(e), which was brought into force on 23.11.2017 would, when it refers to the application of the Code to a personal guarantor of a corporate debtor, apply only for the limited purpose contained in Section 60(2) and (3), as stated hereinabove. This is what is meant by strengthening the CIRP in the Statement of Objects of the Amendment Act, 2018.
In the abovementioned SBI Appeal in the Supreme Court, the Respondents strongly relied upon Section 31 of the IBC. However, it was noted that section 31 only states that once a Resolution Plan, as approved by the CoC takes effect, it shall be binding on the corporate debtor, as well as the guarantor. This is for the reason that otherwise, under section 133 of the Indian Contract Act, 1872, any change made to the debt owed by the corporate debtor, without the surety’s consent, would relieve the guarantor from payment. It was pointed out that in fact section 31(1) of IBC makes it clear that the guarantor cannot escape payment as the Resolution Plan, which has been approved, may well include provisions as to payments to be made by such guarantor. This is perhaps the reason that Annexure VI (e) to Form 6 contained in the Rules and Regulation 36(2) require information as to personal guarantees that have been given in relation to the debts of the corporate debtor. The Court observed that far from supporting the stand of the Respondents, it is clear that in point of fact, Section 31 of IBC is one more factor in favour of a personal guarantor having to pay for debts due without any moratorium applying to save him.
The Supreme Court also noted that Section 14 of the IBC refers to debts due by the corporate debtors, who are limited liability companies, and it is clear that in the vast majority of cases, personal guarantees are given by Directors who are in management of the companies and that the object of IBC is not to allow such guarantors to escape from an independent and co-extensive liability to pay off the entire outstanding debt, which is why the provisions of section 14 of IBC are applied to them. For the purposes of interpretation, the Supreme Court observed that it is certainly open for the court to contrast section 14 with sections 96 and 101, as sections 96 and 101 are laws made by the Legislature, even though they have not yet been brought into force.
With regard to the difficulties faced by the Creditors to enforce personal guarantees in respect of sick industrial companies, the Supreme Court also noted that as per provisions of section 22(1) of the SICA (since repealed on 1.2.2016), suits for the enforcement of any guarantee in respect of loans or advances granted to the sick industrial company, could not lie or proceeded with further, expect with the consent of the BIFR and that by notification dated 30.11.2016, section 14 of the IBC was brought into force with effect from 1.12.2016. In this regard, the Supreme Court referred to the judgement in re. Madras Petrochem Limited and Another versus BIFR & Ors (2016-4-SCC-1) wherein it was observed that even the Companies Amendment Act, 2002 omitted a provision similar to section 22(1) of SICA and consequently creditors were given liberty to file suits or initiate other proceedings for recovery of dues despite pendency of proceedings for the revival or rehabilitation of sick industrial companies before the NCLT. The Court also noted that Chapter 19 of the Companies Act, 2013 which contains provisions of sections 253 to 269 dealing with revival and rehabilitation of sick companies along the lines of sections 424A to 424H of the amended Companies Act, 1956, yet, conspicuous by its absence was a provision akin to section 22(1) of the SICA. The Supreme Court thus observed that it is clear that for this reason also, it is obvious that Parliament when it enacted section 14 had this history in mind and specifically did not provide for any moratorium along the lines of section 22 of SICA into section 14 of IBC. The Supreme Court also observed that the reasoning of the Bombay HC in Sicom Investments (supra) commends itself to the SC and that the reasoning of the Allahabad HC on the other hand was not acceptable.
The Supreme Court also noted that the amendment of 2018 which makes it clear that section 14(3) is now substituted to read that the provisions of sub-section (1) of section 14 shall not apply to a surety in a contract of guarantee for corporate debtor. The Supreme Court also noted that the Insolvency Law Committee, appointed by the Ministry of Corporate Affairs, by its Report dated 26.3.2018 made certain key recommendations, one of which was:-
“(iv) to clear the confusion regarding treatment of assets of guarantors of the corporate debtor vis-à-vis the moratorium on the assets of the corporate debtor, it has been recommended to clarify by way of an explanation that all assets of such guarantors to the corporate debtor shall be outside the scope of moratorium imposed under the Code.”
The said Committee had also noted that there have been contradicting views on the scope of the moratorium regarding its application to third parties affected by the debt of the corporate debtor, like guarantors or sureties. While some courts have taken the view that section 14 may be interpreted literally to mean that it only restricts actions against the assets of the corporate debtor, a few others have taken an interpretation that the stay applies on enforcement of guarantee as well, if a CIRP is going on against the corporate debtor then the debt owed by the corporate debtor is not final till the resolution plan is approved and thus the liability of the surety would also be unclear. Hence, until the debt of the corporate debtor is crystallised, the guarantor’s liability may not be triggered. The Committee also took note of the decision of the NCLAT (which was impugned before the Supreme Court) and felt that a broad interpretation of the moratorium may curtail significant rights of the creditor which are intrinsic to a contract of guarantee. The Committee also noted that as per section 128 of the Indian Contract Act, 1872, the liability of the surety is co-extensive with that of the principal debtor and the creditor may go against either the principal debtor, or the surety, or both, in no particular sequence. The Committee further noted that a literal interpretation of section 14 is prudent, and a broader interpretation my not be necessary in the context of cases admitted by the Adjudicating Authority under the IBC. The Committee also noted that to abuse the provision of moratorium, many companies have filed applications u/s 10 of IBC to initiate corporate insolvency resolution process primarily to save their personal assets/guarantees which were given to the lender banks/institutions/creditors to secure the loans obtained by the corporate debtor company promoted by them. The Committee concluded that section 14 does not intend to bar actions against assets of guarantors to the debts of the corporate debtor and recommended that an explanation to clarify this may be inserted in Section 14 of the IBC and that the scope of the moratorium may be restricted to the assets of the corporate debtor only.
The Supreme Court noted and observed that the said Committee makes it clear that the object of the amendment to the IBC was to clarify and set at rest what the Committee thought was an overbroad interpretation of section 14 of IBC and that such clarificatory amendment is retrospective in nature and in this regard relied on the earlier SC judgement in CIT versus Shelly Products (2003-5-SCC-461) and the decision in CIT versus Vatika Township (2015-1-SCC-1) and held that the amendment basically clarified the law so as to remove doubts and being clarificatory in nature, it must be held to be retrospective, in the facts and circumstances of the case. The SC also noted that an explanatory Act is generally passed to supply an obvious omission or to clear up doubts as to the meaning of the previous Act and it is well settled that if a statute is curative or merely declaratory of the previous law, it is in plain terms retrospective in the absence of clear words indicating that the amendment Act is to be applied prospectively. For all these reasons, the SC set aside the impugned judgement of the NCLAT and the appeals filed by SBI were allowed.
It needs to be appreciated that the IBC has prescribed certain limitations which are inbuilt and must not be overlooked. The moratorium imposed under Section 14 of the IBC shall prohibit action against the properties reflected in the balance sheet of the corporate debtor and that moratorium has no application on the properties beyond the ownership of the corporate debtor. Therefore, the plain language of Section 14 is that on the commencement of insolvency process, the moratorium shall be declared prohibiting any action to recover or enforce any security interest created by the corporate debtor in respect of “its property”.
The way bad debts and non-performing assets have mounted up and adversely affected the Indian economy and put a question mark on the way the banks indiscriminately granted loans to business entities/industrial companies, it needs forensic audit of the debtor companies and unless stricter measures are initiated to recover the outstanding debt amounts, it is feared that the system would collapse. At this juncture, the aforesaid SC judgement will at least pave the way for recovery of outstanding amount by invoking personal guarantee given by the promoters/other personal guarantors in respect of companies undergoing corporate insolvency resolution process under the IBC.
Anirrud Goswami, Advocate, Goswami & Goswami, Associates and Advocates,