The Hon’ble Supreme Court in a landmark judgment dated May 21, 2021 in Lalit Kumar Jain vs. Union of India & Ors. 1 has decided on the constitutionality of the provisions of the Insolvency and Bankruptcy Code, 2016 (‘the Code’) that allow insolvency process to be initiated against personal guarantors, including promoters, of a corporate debtor facing insolvency.

The Ministry of Corporate Affairs notified and brought into force the provisions of insolvency of personal guarantors of the corporate debtor vide Notification dated 15.11.20192. In furtherance of the notification, the Insolvency and Bankruptcy (Application to Adjudicating Authority for Insolvency Resolution Process for Personal Guarantors to Corporate Debtors) Rules, 2019, and the Insolvency and Bankruptcy (Application to Adjudicating Authority for Bankruptcy Process for Personal Guarantors to Corporate Debtors) Regulations, 2019 were brought into force.

This move by the Central Government came to the detriment of many promoters and directors who had provided personal guaranties for credit facilities availed by their companies. In light of the aforesaid notification, big industrialists and promoters including Mr. Anil Ambani, Mr. Arvind Dham, Mr. Lalit Jain, Mr. Sanjay Seghal, etc. were served with demand notices from various Banks and Financial Institutions thereby proposing to commence insolvency proceedings against them, in their capacity as personal guarantors of their companies, as per the Code.

In light of these notices, a large number of petitions were filed before various High Courts by the promoters & directors challenging the said notices as well as the validity of the Notification dated 15.11.2019. Due to the multiplicity of suits on the same issue, all the Writ Petitions were transferred to the Hon’ble Supreme Court for deciding in the common issue of law pertaining to the said Notification, as has occurred in the Lalit Kumar case.

The primary contention of the Petitioners was that the Notification was ultra vires to the powers of the Central Government and amounted to impermissible and selective application of provisions of the Code. The Court opined that as per Section 1(3) of the Code (which was in force before the impugned Notification was issued), the Central Government has followed a stage by stage process of bringing into force the provisions of the Code. The 2018 Amendment3 to the Code added corporate guarantors to corporate debtors as a category under Section 60 of the Code whereby the Adjudicating Authority, being NCLT, may be approached for proceeding against the corporate guarantor. The amendment’s objective was that all matters likely to impact, or have a bearing on a corporate debtor’s insolvency are to be clubbed together and brought before the same forum. Therefore, the Hon’ble Court held that the aforesaid notification was not an instance of legislative exercise for selective application of the provisions of the Code.

The Supreme Court while upholding the provisions of the Notification held that the release or discharge of the Corporate Debtor/principal borrower from the debt owed to the creditor through an involuntary process such as insolvency does not release the guarantor from their liability, as this liability arises from an independent contract. Therefore, the approval of a resolution plan does not ipso facto discharge a personal guarantor’s liability in a contract for guarantee. The Court opined that the terms and conditions of the guarantee will need to be examined on a case-by-case basis to determine whether the guarantor’s liability has been discharged. Thus, the clubbed Petitions of the Promoters were dismissed and the provisions of Insolvency process against Personal Guarantors were upheld.

Aarna Law Comment:-

The Supreme Court in the historic judgment of Lalit Kumar Jain vs. Union of India & Ors. has paved a way for creditors to file insolvency process against personal guarantors of a corporate debtor that is undergoing insolvency or liquidation proceedings. This judgment is particularly favourable to Banks and Financial Institutions, who are the leading creditors to corporate companies and initiating insolvency process against guarantors of the corporate debtor will help in ensuring that the public money involved in such transaction gains a sense of security. However, from a critical point of view, this may also lead to heavy concentration of power with Banks and FI’s who may not chose to opt for settlement, especially with MSMEs who have limited resources, as they now have the option of initiating insolvency process against the corporate debtor as well as the guarantors along-with their assets. This might ultimately hamper the object of the Code which is recovery of the Corporate Debtor in the existing regime.

1 Transferred Case (Civil) No. 245 /2020, Supreme Court of India.

2 Notification No. G.S.R. 855(E) dated 15.11.2019, w.e.f. 01.12.2019.

3 The Insolvency and Bankruptcy Code (Second Amendment) Act,2018 dated 17.08.2018