By Madhav Kanoria
The Insolvency and Bankruptcy Code, 2016 (IBC) introduced a creditor-in-handle, resolution specialist-managed insolvency regime for Indian firms. Importantly, the IBC course of action as a common rule excludes the promoters of any entity in IBC from retaining handle of the corporation or regaining handle of the corporation via the IBC course of action. This fundamentally changed the equation in between promoters and creditors, bringing about a paradigm shift in the insolvency resolution course of action in India. Since its inception, substantial legacy NPAs have been resolved beneath the IBC.
While the IBC initially only permitted creditors to proceed against corporate debtors or firms, the provisions permitting creditors to proceed against individual guarantors for corporate debtors became powerful on and from December 1, 2019. Several creditors-initiated insolvency proceedings against individual guarantors. Multiple proceedings have been also instituted prior to various High Courts to challenge the notification extending the IBC provisions to the individual guarantors. All of these have been transferred to the Supreme Court as they involved interpretation of typical queries of law pertaining to provisions of IBC. The Supreme Court, in its judgment of May 21, 2021, in Lalit Kumar Jain vs. Union of India, upheld the constitutionality of the notification extending the IBC provisions to individual guarantors.
Grounds for Challenge
The major ground for the challenge of the IBC extension to individual guarantors was that it selectively made the IBC powerful for only one category of people (i.e. individual guarantors) without having generating it powerful for person debtors frequently. The Supreme Court held that this was not discriminatory, considering the fact that individual guarantors have an “intrinsic connection” to corporate debtors. The course of action for debt resolution really should be prior to a typical authority, being the National Company Law Tribunal or NCLT. Any other mechanism would give rise to uncertainty of outcome for the creditors. By getting a typical adjudicatory authority, the creditors would also be in a position to approve realistic resolution plans, maintaining in thoughts the prospect of realizing some aspect of the creditors’ dues from individual guarantors.
Personal guarantors argued that after a resolution program for a corporate debtor is authorized, their assure is automatically discharged beneath the law. They also contended that creditors would have an chance to unjustly enrich themselves by recovering amounts from the corporate debtor as properly as the guarantors. Disagreeing with their contentions, the Supreme Court held that the discharge of a corporate debtor’s liabilities by an involuntary course of action of law (such as insolvency/liquidation) does not discharge a guarantor of their liability, which arises out of an independent contract.
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This judgment is a considerable milestone in the field of insolvency laws. It will support in making certain a extensive resolution of the corporate debtor and all its liabilities via a consolidated type of insolvency resolution/ bankruptcy of the corporate debtor along with the individual guarantor. The judgment also puts to rest contentions raised by guarantors as properly in various proceedings beneath the IBC relating to their liabilities right after completion of a resolution proceeding beneath IBC.
Implications on Resolution of MSMEs
Micro, Small, and Medium Enterprises (MSMEs) are the bedrock of the Indian economy. The Indian MSME sector contributes about 29 per cent to the GDP. Stress in the MSME sector may well have a cascading impact on the Indian economy and therefore a dynamic insolvency resolution framework is crucial in the context of MSMEs. A distinctive feature of credit extended to MSMEs is that it is frequently backed by individual guarantees supplied by promoters.
Parliament has recognized the peculiarities of MSMEs in the IBC course of action. The pre-packaged insolvency resolution course of action for MSMEs (or “pre-packs”) have also been introduced for dealing properly with stressed assets in the MSME sector. The underlying premise of these modifications is that there is merit in permitting current promoters to participate in the resolution course of action for MSMEs.
The Supreme Court has now clarified that the liability of individual guarantors will continue to survive even right after the approval of a resolution program. For current situations, this will encourage promoters of MSMEs to come across a resolution that is acceptable to the creditors and at the very same time, avoid them from getting topic to insolvency proceedings, which may well have social and company ramifications. Going forward, considering the fact that the default of the MSME could lead to insolvency of the promoter, MSME promoters will calibrate leverage to assets and money flow of the corporation. Promoters will be conscious that assure obligations can be enforced and may well outcome in insolvency and accordingly, will not assume commitments that can not be honoured. This judgment will also encourage the promoters to use the pre-pack regime for MSMEs to come across resolutions acceptable to the creditors and strengthen credit discipline across the debt market place.
Madhav Kanoria is the Partner at the law firm Cyril Amarchand Mangaldas. Views expressed are the author’s personal.