Can a Personal Guarantor Face Insolvency First?

The people before the Court were not hypothetical companies. Many of the individual challengers had furnished personal guarantees to banks and financial institutions, which led to the release of advances to companies they were associated with as directors, promoters, chairmen or managing directors. In many cases the guarantees were invoked. Recovery proceedings and later insolvency proceedings followed, at different stages across the cases.

They then challenged the Central Government's notification dated 15 November 2019 (S.O. 4126(E)). It appointed 1 December 2019 as the date on which specified IBC provisions would come into force "only in so far as they relate to personal guarantors to corporate debtors". The provisions listed in the notification, as the judgment reproduces it, were:

• clause (e) of section 2;
• section 78 (except with regard to fresh start process) and section 79;
• sections 94 to 187 (both inclusive);
• clause (g) to clause (i) of sub-section (2) of section 239;
• clause (m) to clause (zc) of sub-section (2) of section 239;
• clause (zn) to clause (zs) of sub-section (2) of section 240; and
• section 249.

After publication, many challengers were served with demand notices proposing insolvency proceedings against them under the Code.

Their attacks were practical as well as constitutional. They said Section 1(3) allowed different commencement dates but not selective application of Part III to one sub-category of individuals. They also said that under Section 128 of the Contract Act a guarantor's liability is co-extensive with the principal debtor's, so an approved corporate resolution plan should extinguish the guarantor's liability. They warned that creditors would unjustly enrich themselves and that a moratorium would disrupt the company's pending proceedings.

The challenges came from various High Courts and under Article 32, and were transferred because they raised common questions of law. On 21 May 2021, Justices L. Nageswara Rao and S. Ravindra Bhat dismissed them without ordering costs. The Court rejected both arguments.

Section 1(3) permits the Central Government to bring the Code into force by notification, with different dates for different provisions. The challengers argued that this was a power to decide timing only: the executive could not decide which sub-category of individuals would be covered. In their view, applying Part III only to personal guarantors was an impermissible legislative exercise.

The Union said Parliament itself had made the classification. The 2018 amendment split the old Section 2(e) into Sections 2(e), (f) and (g). The Code separately defined a personal guarantor in Section 5(22). Under the original Code, Section 60 had already designated the National Company Law Tribunal (NCLT) as the adjudicating authority for two categories: corporate debtors and personal guarantors to corporate debtors. The 2018 amendment added a third category, corporate guarantors to corporate debtors.

The Court found sufficient indication in Sections 2(e), 5(22), 60 and 179 that personal guarantors were to be dealt with differently from other individuals. It also noted that the earlier notifications under Section 1(3) showed the Code being brought into force in stages, regard being had to the categories of persons to whom it applied.

The Court's central holding went against the guarantors' most consequential argument. Section 31 makes an approved corporate resolution plan binding on stakeholders, but it does not, by itself, end the guarantor's liability.

The Court reasoned that the guarantee arises from an independent contract. It relied on State Bank of India v. V. Ramakrishnan and Maharashtra State Electricity Board Bombay v. Official Liquidator for that principle. The notification survived. So did the guarantor's liability. The Court closed the two routes on which the notification had been attacked:

• The Section 1(3) attack failed because the Code did not have to be made applicable to all individuals at the same time. Personal guarantors were to be dealt with differently, through the same adjudicatory process and the same forum as the corporate debtor.
• The Contract Act attack failed because the release or discharge of a principal borrower by an involuntary process, meaning by operation of law or through liquidation or insolvency proceedings, does not absolve the guarantor, whose liability arises from an independent contract.

The outcome depends on who stands behind the guarantee and where the corporate debtor's proceedings stand. NCLT means National Company Law Tribunal, and DRT means Debt Recovery Tribunal.

• Start with the deed of guarantee, the creditor's demand or invocation notice, and records showing the unpaid amount. The proceedings in this case arose after personal guarantees were invoked and recovery or insolvency proceedings followed.
• Trace the company's pending resolution or liquidation. If it is pending, Section 60(2) sends the related personal guarantor application to the same NCLT. If a bankruptcy proceeding against the guarantor is already pending elsewhere, Section 60(3) transfers it to that NCLT. Under Section 60(4), that NCLT also holds the DRT's powers under Part III for this purpose.
• Note that Section 179 makes the DRT the Adjudicating Authority for insolvency matters of individuals and firms, but it is expressly "subject to the provisions of Section 60".
• Avoid the most expensive mistake in this judgment: treating an approved corporate resolution plan as the end of the guarantee. The Court held that it does not automatically discharge the personal guarantor.