Confusions ahead. New rules leave stakeholders to navigate the complexities of third-party guarantees | Photo Credit: istock.com

The issue of release/enforcement of third party guarantees as part of a resolution plan of the borrower has been the subject of litigation across various judicial forums in India.

To clarify this issue, the Insolvency and Bankruptcy Board of India (IBBI) has proposed amendments to IBBI (Insolvency Resolution Process for Corporate Persons) Regulations 2016 as part of its recent discussion paper.

The genesis of this issue stems from a 2019 central government notification which made certain provisions of the Insolvency and Bankruptcy Code, 2016 (IBC) — relating to to insolvency of individuals and partnerships — applicable to personal guarantors.

Not surprisingly, the notification was challenged on constitutional grounds. However, the Supreme Court upheld the validity of the notification and struck down the challenge in 2021 (Lalit Kumar Jain vs Union of India & Ors). Soon after, the number of applications filed against personal guarantors for initiation of insolvency increased significantly.

The Lalit Kumar Judgment also clarified a position in law which until then was getting debated — can the liability of a guarantor survive despite the corporate debtor being resolved under the IBC.

Since the Indian Contract Act, 1872, finds liability of a guarantor co-extensive with that of principal debtor, severing the guarantee from the principal debt was not a well settled position until the Lalit Kumar Judgment. The Supreme Court held that the guarantee is an independent contract giving rise to such liability and the beneficiary of this guarantee continues to hold the right to recover such liability.

Unanswered questions

In another case before the Supreme Court filed by multiple petitioners, the constitutional validity of Sections 95-100 of the IBC — which deal with insolvency of individuals and partnership firms (made applicable to personal guarantors of corporate debtors) — was also challenged. In November 2023, the Supreme Court struck down this challenge as well and ruled in favour of the constitutionality of such provisions.

Both the Supreme Court judgments have collectively removed any legal hindrance for action against personal guarantors to corporate debtors. They have however remained silent on how such a guarantor can be treated during insolvency resolution process, and rightfully so. This leaves flexibility for the resolution applicant and the Committee of Creditors (CoC) to deal with guarantees in a manner that is commercially agreeable.

Being mindful of the established principle, Mumbai Bench of the National Company Law Tribunal, in Vijendra Kumar Jain, (Resolution Professional of the Television Network Ltd vs Sab Events & Governance Now Media Ltd (December 2023), held that where CoC has passed a resolution plan with the requisite majority after deliberating on the plan, and such plan provides for extinguishment of personal guarantee, the adjudicating authority cannot interfere with the commercial wisdom of CoC.

While the judgments referred to specifically relate to the extinguishment of personal guarantees, the principles will also apply to corporate guarantees.

IBBI’s revisions

IBBI’s discussion paper proposes that “CIRP Regulations to be amended to clarify that the resolution plan submitted by the resolution applicant shall not extinguish the rights of the creditors to proceed against guarantors and enforce realisation of guarantees governed through various guarantee agreements”.

Under the present jurisprudence, a resolution plan submitted under IBC can typically treat a guarantee in the following three ways: (i) extinguish it, (ii) assign to the resolution applicant (or an entity nominated by it), or (iii) retain it with the creditors for independent action.

The first option primarily involves extinguishing the guarantee since there may be cases where the resolution applicant specifically provides a certain sum towards extinguishment of guarantees under the resolution plan. The latter two options involve survival of the guarantee, wherein either the creditor or the assignee retains the right to enforce the guarantee.

Leaving no choice

The proposal made in the IBBI discussion paper seems to take away the flexibility to commercially negotiate the survival, assignment or extinguishment of the guarantee.

While the option of enforcing/retaining guarantee on a standalone basis is now available to creditors in view of the Lalit Kumar Judgment, this option is now intended to move from an ‘enabling power’ to a ‘mandatory requirement’. The CoC, especially the banks and NBFCs in India, will also face a plethora of practical challenges such as what the guarantee is pegged against, whether it is an exposure for the creditor for prudential purposes, whether it needs to provide capital charge in relation to it and more importantly does it need consent of the guarantor to be extinguished.

At its very core, insolvency resolution process is meant to be a commercially driven process and so long as the basic requirements provided under IBC are met, the resolution plan ought to be considered compliant. Against this backdrop, mandatorily retaining the guarantee and enforcing the same and not having the right to assign or extinguish it, raises more concerns than what the IBBI discussion paper seeks to answer.

(Sivaramakrishnan is a partner and Marwah is a senior associate at Shardul Amarchand Mangaldas & Co)

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Published on July 14, 2024