Case Number: Transferred Case (Civil) No. 245/2020 and other Writ petitions 

Judges Name: Hon’ble Judges Justice L. Nageswara Rao; and Justice S. Ravindra Bhat.

Order dated: 21.05.2021

“Approval of a resolution plan does not discharge the liability of the personal guarantor under the contract of guarantee, as the same arises out of an independent contract”

Facts of the case:

• The issue before the Hon’ble Supreme Court in the present case was the validity of the Notification dated 15.11.2019 (“Impugned Notification”) issued by the Central Government. The Central Government issued the Impugned Notification by exercising its powers under Section 1(3) of the Code whereby certain provisions of the Code in relation to personal guarantors to corporate debtors was notified. The Impugned Notification was challenged before various High Courts on the ground that the Impugned Notification was ultra vires the Code. All the Writ Petitions filed before various High Courts in this regard was transferred to the Hon’ble Supreme Court for final adjudication. 

Issue:

• It is the case of the Petitioners that the Impugned Notification issued was in excess of authority conferred upon the Central Government. The Impugned Notification is in relation to Part III of the Code which provides for Insolvency processes for Individuals and Partnership firms. However, by way of the Impugned Notification the Central Government has brought into force the said Part III only in relation to Personal Guarantors to Corporate Debtors.

The contentions raised by the Petitioners in this regard are as follows:

(i) That Section 1(3) of the Code empowers the Central Government only to appoint different dates for bringing into force different provisions of the Code. Section 1(3) is a conditional legislation, wherein the Legislature has itself made the law in all its completeness and there is no legislation left for the Government to make, i.e., the Central Government while exercising its powers under a conditional legislation, cannot legislate or in any manner add or alter the effect of the law already laid down. It was further contended that, assuming Central Government had such powers under Section 1(3) of the Code, it would amount to an unconstitutional delegation of power. 

(ii) It was contended that Part III of the Code does not make any distinction between individual and a personal guarantor, it only provides for Insolvency Resolution and Bankruptcy for Individuals and Partnership Firms. However, the Impugned Notification in substance modifies the text of the actual provisions of Part III, despite the absence of any such power conferred upon the Central Government.

(iii) By the Impugned Notification, the Central Government has effected classification of individuals, by ensuring insolvency proceedings of one category of individuals, i.e., personal guarantors to corporate debtors, whereby the distinction between Part II and Part III, the forum and the remedies available to creditors is no longer available to personal guarantors. It was argued that such classification is legislative in nature and by the Impugned Notification, the Government exceeded its jurisdiction in exercising power not granted to it under the Code.

(iv) It was contended that Section 2 of the Code provides for application of the Code to various entities and the amended Section 2(e) of the Code, provides for application of the Code to personal guarantors of corporate debtors. It was argued that the application of a provision depends on its plain language and not on the enumeration of entities to whom the Code applies. The provisions brought into force by the Impugned Notification does not limit itself to personal guarantors of corporate debtors but apply generally to individuals and other entities. However, by the Impugned Notification, the provisions of Part III are limited only to the extent of their application to personal guarantors of corporate debtors alone, which is illegal and beyond the powers conferred by the legislature.

(v) It was further contended that the liability of a surety is co-extensive with that of the principal debtor and that when an resolution plan is approved in respect of the principal debtor, it amounts to extinction of all outstanding claims against the debtor and consequently the liability of the surety which is co-extensive with that of the principal debtor would also be extinguished.

Contentions raised by the Central Government:

(i) The Central Government submitted that Section 2(e) of the Code was amended to introduce three different classes of debtors, which are – 

• Personal Guarantors to Corporate Debtors (Section 2(e));
• Partnership firms and Proprietorship firms (Section 2(f)); and 
• Individuals (Section 2(g))

The purpose of the Amendment was to cover three separate entities, as the Legislature wanted to deal with personal guarantors to corporate debtors differently from the aforesaid entities under Clauses (f) and (g). This was done with the intent of achieving a unified adjudication of insolvency of both the corporate debtor and its personal guarantor before the same Adjudicating Authority under Section 60(2) of the Code.

(ii) It was argued that by unifying the insolvency process for both the entities under one forum enables the Adjudicating body to have a clear vision of the extent of the debt of the corporate debtor, its available asset and resources and also as to the assets and resources of its personal guarantor, which could not have been viable if the insolvency resolution process of the personal guarantor continued before another body.

(iii) It was submitted that the expression “provision” as held in Re: Chettian Veettil Amman Vs. Taluk Land Board is as follows, “A provision is therefore a distinct rule or principle of law in a statute which governs the situation covered by it. So, an incomplete idea, even though stated in the form of a section of a statute, cannot be said to be a provision for, by its incompleteness, it cannot really be said to provide a whole rule or principle for observance by those concerned. A provision of law cannot therefore be said to exist if it is incomplete, for then it provides nothing.” Therefore, it was contended that Section 2(e) of the Code is a complete and distinct provision within the meaning of Section 1(3) and the Central Government has acted intra vires to bring it into force. 

(iv) It was submitted that Section 1(3) of the Code has to be interpreted in a manner so as to give flexibility to the Central Government to implement provisions of the Code to meet the objectives of the Code and the Central Government has enforced various provisions of the Code on different dates. It was with this intention the Central Government has enforced the provisions of Part III and Section 2(e) through the Impugned Notification.

(v) It was further submitted that Section 60(4) of the Code vests the National Company Law Tribunal with all the powers of the Debt Recovery Tribunal for the purposes of Section 60(2) of the Code. It was submitted that unified insolvency resolution process of the corporate debtor, its corporate guarantor and personal guarantors through one forum was the objective of the Impugned Notification.

(vi) It was further submitted that the liability of a guarantor is co-extensive with that of the principal debtor unless the contrary is provided by the contract and discharge of a principal debtor from its liability by operation of law does not absolve the liability of the guarantor. Hence, until the entire debt of the creditor is settled in entirety, the guarantor is not absolved of its liability to make payment of the amounts outstanding in favour of the creditor.

Observations made by the Hon’ble Supreme Court:

(i) Before the Amendment to Section 2(e), all individuals fell under one descriptive description under the said Section. Hence, it was difficult for the Central Government to selectively bring into force the provisions of Part III only in respect of personal guarantors. It was in this regard that the Amendment Act of 2018 amended Section 2(e) and subcategorized three categories of individuals. Therefore, the Amendment Act of 2018 provided the necessary statutory backing for the Central Government to apply the Code in such a manner as to achieve the objective of the amendment, i.e., to ensure that adjudicating body dealing with insolvency of corporate debtors also had before it the insolvency proceedings of personal guarantors to such corporate debtors.

(ii) The Amendment Act of 2018 also amended Section 60 of the Code in that insolvency and bankruptcy processes relating to liquidation and bankruptcy in respect of three categories, i.e. corporate debtors, corporate guarantors of corporate debtors and personal guarantors to corporate debtors were to be considered by the same forum, i.e. NCLT.

(iii) The Hon’ble Court observed that the unamended Section 60 designated NCLT as the Adjudicating Authority in relation to corporate debtors and personal guarantors. The Amendment Act of 2018 added another category, viz. corporate guarantors to corporate debtors. The Amendment clearly shows that all matters that were likely to impact or have a bearing on a corporate debtors insolvency process, were clubbed together and brought before the same forum.   

(iv) The Hon’ble Court while referring to its judgement in State Bank of India v. V. Ramakrishnan &Ors., observed therein that the proceedings against personal guarantors stood outside the NCLT and the Code, as neither Part III nor Section 243 of the Code was notified at that stage. Since Section 243 of the Code was not notified, the insolvency process of individuals is dealt under the provisions of Presidency Towns Insolvency Act, 1909 and Provincial Insolvency Act 1920. However, the Court opined that the non-obstante provision under Section 238 of the Code has the overriding effect over other prevailing enactments. The Hon’ble Court observed that the Impugned Notification, as a consequence of Section 238 of the Code, has the result that if any proceeding were to be initiated against personal guarantors it would be under the Code.

(v) The Hon’ble Court opined that there was sufficient legislative guidance for the Central Government to distinguish and classify personal guarantors separately from other individuals, before the Amendment Act of 2018 was made effective, which is evident from Sections 5(22), 60, 234 and 235.

(vi) The Hon’ble Court opined that the insolvency process in relation to corporate persons is entirely different from those relating to individuals. The Court opined that the Adjudicatory Authority for individuals under Section 179 of the Code is subject to Section 60 and Section 60(2) of the Code is without prejudice to Section 60(1), which has overriding effect to Section 60(2) as far as it provides that the application relating to insolvency resolution, liquidation or bankruptcy of personal guarantors of such corporate debtors shall be filed before the NCLT where proceedings relating to corporate debtors are pending.

(vii) The Hon’ble Supreme Court opined that the legislative intent was to treat personal guarantors differently from other categories of individual in light of the connection between such individuals and corporate entities to whom they stood surety. The intent was to deter the possibility of two separate processes being carried on in different forums, which will result in uncertain outcomes, led to carving out personal guarantors as a separate species of individuals.

(viii) In view of the above, the Hon’ble Supreme Court held that the Impugned Notification is not an instance of legislative exercise or amounting to impermissible and selective application of provisions of the Code. The Hon’ble Court held that there is no compulsion in the Code that it should at the same time be made applicable to all individuals. The Hon’ble Court stated that there is sufficient indication in the Code under Sections 2(e), 5(22), 60 and 179 indicating that personal guarantors though forming part of the larger grouping of individuals, were to be, in view of their intrinsic connection with corporate debtors, dealt with differently, through the same adjudicatory process and by the same forum as such corporate debtors.

The Hon’ble Court further held that, the earlier Notifications under Section 1(3), (issued before the impugned notification was issued) disclose that the Code was brought into force in stages, regard being had to the categories of persons to whom its provisions were to be applied. The Impugned Notification, similarly inter alia makes the provisions of the Code applicable in respect of personal guarantors to corporate debtors, as another such category of persons to whom the Code has been extended. Therefore, it was held that the Impugned Notification was issued within the power granted by Parliament, and in valid exercise of it., and therefore not ultra vires the Code.

(ix) Another issue raised before the Supreme Court was regarding the discharge of liability of the personal guarantor on the approval of resolution plan in relation to the corporate debtor. The Hon’ble Court opined that the approval of a resolution plan under Section 31 of the Code, does per se operate as a discharge of the guarantor’s liability. The Hon’ble Court referred to its earlier decision in Re: Maharashtra State Electricity Board Bombay v. Official Liquidator, High Court, Ernakulum & Anr, wherein it was held that “in view of the unequivocal guarantee, such liability of the guarantor continues and the creditor can realise the same from the guarantor in view of the language of Section 128 of the Contract Act as there is no discharge under Section 134 of said Act.” 

(x) In view of the above, the Hon’ble Supreme Court held that the approval of a resolution plan does not discharge the liability of the personal guarantor under the contract of guarantee, as the same arises out of an independent contract.