Are Personal Guarantors Left Without Any Remedy?

Ashu Kansal, Rachit Mathur | August 2022

Guarantor is one who gives guarantee for a loan facility availed by a borrower and a Personal Guarantor is an individual person who stand as a surety to loan facility availed by any Individual or a Corporate Entity. We all know that Insolvency and Bankruptcy Code, 2016 (IBC) was initially applicable only on Corporate Debtor but thereafter it was also applied to Personal Guarantor. Once Insolvency Process is initiated under the IBC by the Financial Creditors or the Operational Creditors of the Corporate Debtor, they also have different rights as provided under the law and during the time of such process, it is to be verified whether the Adjudicating Authority or the Code has kept a proper balancing between the rights of Corporate Debtors and Financial Creditors or/and Operational Creditors.

As per the Code, the Creditors of the Corporate Debtor can initiate insolvency proceedings against Personal Guarantors even before initiation of Corporate Insolvency Resolution Process (CIRP) against the Principal Borrower/Corporate Debtor, but initiation of insolvency proceeding against Personal Guarantor at any time prior to initiation or before conclusion of CIRP against Corporate Debtor can cause great prejudice to the Personal Guarantor in terms of discharging the liabilities of Corporate Debtor. The Creditor claiming entire amount from the Guarantor even when his liability is limited under the contract of guarantee and since the Personal Guarantor has no right to defend himself, the unjustified claims of such creditors might be admitted which shall cause irreparable loss to the individual who stood as a guarantor.

The Hon’ble Supreme Court recently clarified that even if in case of absence of any pending CIRP the against Principal Borrower, an application under Section 95 of IBC against the Personal Guarantors of the Corporate Debtor is still maintainable before the Adjudicating Authority

A Personal Guarantor is duty bound by contract of guarantee which is a contract to perform the promise, or discharge the liability, of a Principal Borrower in case of its default. It is a dilemma that even after Personal Guarantor is bound by such contract, the liability of the Personal Guarantor is uncertain and hence it is limited to the amount promised under the contract. A Creditor of the Corporate Debtor can invoke Personal Guarantee even when the liabilities are discharged by the Principal Borrower with slight hair-cut are done.

In a landmark judgment, the Hon’ble Supreme Court also held that the liability of a Guarantor/ Surety is co-extensive, joint and several with that of the Principal Borrower unless otherwise is provided by the contract and resolved the crisis in cases where the creditors of Corporate Debtor are not able to recover their dues from the assets of the Corporate Debtor in the Resolution Proceedings. It has shown the way for such creditors to pursue their remedies against the assets of Personal Guarantor of the Corporate Debtor and that too before the same Adjudicating Authority, as are assigned with the task of adjudicating all matters relating to the Corporate Debtor.

The Creditor of the Corporate Debtor can also initiate CIRP against Corporate Debtor and Personal Guarantor simultaneously. In such a scenario, the Creditor seeks discharge of liability from the debtor and the guarantor for the same set of debt obligations arising out of the same loan agreements. Hence, it is not crystallized that in what manner the debt shall be discharged. Thus such circumstances enhances the difficulty for the Personal Guarantor even more because the liability is uncertain, uncrystallised and undetermined which could lead to unjust enrichment to the creditors as they might get paid twice or more than what is due and recoverable by them.

DISCRIMINATION AGAINST THE PERSONAL GUARANTOR

The IBC was enacted to provide a streamlined and faster process for dealing with the insolvency of individuals and corporate entities. The objective of the IBC is to provide the resolution scheme which could result in the revival of the business of a Corporate Debtor. The idea of the legislature was to protect the interest of the Creditors as well as the Corporate Debtor.

The Code is unfair to the Personal Guarantors as compared to the Corporate Debtor to some extent because the Code does not provide any opportunity to the Personal Guarantor to defend himself before filing of an application for its Resolution. In such scenario, it is only the case of the creditor and it has to prove the existence of debt and thereafter application against the Personal Guarantor is admitted. The Adjudicating Authority then straight away appoints an Interim Resolution Professional and Interim moratorium is imposed upon their satisfaction and hence Creditor’s claim remains uncontested and the same cause great prejudice to the Guarantor unlike the Corporate Debtor, who is provided with appropriate opportunities to defend itself before admission or rejection of an application for initiation of CIRP. This Lack of opportunity to the Personal Guarantor to defend himself also violates principles of natural justice.

The Provisions which are related to Resolution of the Personal Guarantor violates the fundamental rights which are protected under Article 14, 19 (1) (g) and 21 Constitutional Right under Article 300(A) of the Constitution of India because these provisions do not provide any occasion of being heard to the Personal Guarantor at any stage before initiation of the Insolvency Resolution Process against them.

The Adjudicating Authority without adjudicating the fact that there is actual existence of any debt, determination of quantum of debt or legality of claim of creditors etc. which scheme is wholly violative of the right to procedural due process protected in Article 14 and 21 of the Constitution of India.

The Code have not provided any right to the Personal Guarantor of the Corporate Debtor to contest to prove his case in any manner whatsoever and at no point is the Adjudicating Authority statutorily mandated to give the alleged debtor an opportunity to be heard or raise objections related to abuse of court process, such as suppression of facts or object on the grounds of limitation, illegal claim and other issues relating to the jurisdiction.

There are different procedures applicable with respect to the Corporate Debtor and Personal Guarantor without any rationale for an elimination of the right to be heard before adverse civil action. Part II of the IBC provides for the Adjudicating Authority to determine the existence of default upon receiving of an application to initiate CIRP against a Corporate Debtor and once the existence of such a default is determined only then the application is admitted and the Adjudicating Authority passes an order for the declaration of a moratorium as per the appropriate provisions laid down in the IBC.

UNCONSTITUTIONALITY OF PROVISIONS WHICH RELATES WITH THE CIRP OF THE PERSONAL GUARANTOR

The Code provides for the appointment of a Resolution Professional at the request of a creditor seeking remedy against the aggrieved party without providing any opportunity to contest his case is clearly arbitrary and illegal because they allow an official to take care of a person’s monetary affairs without giving the affected party a chance to be heard and the same is violative of principle of natural justice which is genesis of the Indian Judicial System.
The Code empowers the Resolution Professional to seek personal information including IT Returns, details of assets and liabilities from the guarantor without providing it with the opportunity to be heard and the same is threat to the privacy and personal liberty of an individual which is violative of A.21 of Indian Constitution.
The Provisions related to Resolution Process of the Personal Guarantor laid down under the IBC are arbitrary, biased and favours only the creditors which violates fundamental right of equality because at any level prior to the initiation of Insolvency Resolution Process against the Personal Guarantor no chance is provided to contest and only upon the word of creditors the Resolution Process is initiated or rejected but the Corporate Debtor/ Principal Debtor enjoys complete freedom to prove his case and contest it accordingly. Therefore, Personal Guarantor’s right to equality is infringes under A.14 of Indian Constitution.
The Provision for implementing the interim moratorium is violative of the fundamental right of such individual (i.e., the Personal Guarantors) to carry on business under Article 19(1)(g) of the Constitution of India.

CONSEQUENCES

Absence of adequate provisions leads to grave consequences with respect to the Personal Guarantor. Some effects of unavailability of appropriate provisions are as follows:

In case when the Resolution Process is initiated against the Personal Guarantor then complete outstanding liability of the Principal Borrower is discharged by the Guarantor irrespective of the contract of guarantee. Thus, the liability of the Personal Guarantor is not determined appropriately which could lead to misappropriation of the assets of Personal Guarantor and further it may lead to unjust enrichment to the Creditors.
That the Resolution Professional is enable to call for private financial documents along with other personal details of the Personal Guarantor immediately after its appointment. Such breach of the fundamental right to privacy is unprincipled if there is absolutely no application of mind prior to the appointment of the Resolution Professional.
The Personal Guarantor of a Corporate Debtor gets deprived of its fundamental right of being heard and its goodwill gets damaged in the process without even having an opportunity to prove its case or defend himself in the Court of law.
The provisions for initiation of CIRP against Personal Guarantor basically facilitate the bankruptcy or insolvency of the guarantor without providing a meaningful opportunity to defend himself. Despite Article 21 of the Indian Constitution guarantees principles of natural justice and such Provisions violate Article 21 of the Indian Constitution and are ultra-vires the Indian Constitution.
That in case of the admission of Personal Guarantor in an Insolvency Process, immediate interim moratorium is imposed which shifts the control of business and management of the assets from the guarantor to a Resolution Professional which leads to vulnerability of Personal Guarantor and grave consequences are faced by his without his actual fault.

SUGGESTIONS

The Code can provide right of being heard to the Personal Guarantor before admitting the claim
The Code can introduce for provisions which may direct the Creditors to justify their claim before the Adjudicating Authority along with the relevant documents to which the guarantor can raise objections or contest his case before the Authority before appointment of Resolution Professional.
The Code may provide certain provisions which may allow the Personal Guarantor to challenge the alleged claim of creditors or defend himself and could at least be granted some time period to settle the disputes amongst the parties.
The Code may provide equal rights to the Personal Guarantor as ensured to the Corporate Debtor or Creditors or any other stake holders.
The Code may provide such provision that may restore the principals of natural justice and repeal all the unconstitutional provisions from the IBC.

The legislature and the Adjudicating Authority shall protect the rights of every party whose interest are vested in the fair Resolution Process of the corporate entity and any Individual to such an extent that they shall not be insecure while entering a Resolution Process.

About Author

Ashu Kansal

Ashu Kansal is a Partner at Adhita Advisors, having more than fifteen years of experience. His main areas of expertise are banking and finance laws, securitization - related matters, recovery of debts, suits, and arbitration matters. Apart from drafting various pleadings, he also advises/ gives opinions and strategies to clients on various litigation matters in various forums including the Supreme Court, High Courts and various other Tribunals across the Country. He has also briefed top Senior Counsels across the country for multinational clients.

Rachit Mathur

Rachit Mathur is a law graduate from the Delhi Metropolitan Education, Sector 62 Noida. He is actively involved in various litigation matters in various forums including Delhi High Court District Courts and various Tribunals of Delhi. He is currently working as an Associate at Adhita Advisors and have interest in the area of Arbitration and Conciliation, Insolvency and Bankruptcy, Contracts, and Criminal Law.