Rights of personal guarantors in insolvency proceedings: Judgement pronouncementRights of Personal Guarantors in Insolvency Proceedings
On 9 November 2023, a three-judge bench led by Chief Justice D.Y. Chandrachud, with Justices J.B. Pardiwala and Manoj Misra, upheld the constitutionality of Sections 95, 96, 97, 99, and 100 of the Insolvency and Bankruptcy Code, 2016. These provisions allow loan creditors to initiate insolvency proceedings against individual and partnership firm debtors.
The decision came after the Bench heard 391 petitions challenging the constitutional validity of these provisions over two days.
On July 11th, 2022, Reliance ADA Group Chairman Anil Ambani challenged several provisions of the Insolvency and Bankruptcy Code, 2016 (the Code) pertaining to the Personal Guarantors of a Corporate Debtor.
In 2016, Mr. Ambani gave personal guarantees for two loans taken by Reliance Communications Ltd ((RCom) and Reliance Infratel Ltd (RITL) amounting to Rs. 1,200 crores from the State Bank of India (SBI). A personal guarantee is a promise to repay a debt on behalf of a debtor (borrower) to the creditor (lender) if the borrower fails to repay the debt.
On August 26th, 2016, the loan accounts were classified as Non-Performing Assets (NPAs). An NPA is a loan for which payments on the principal amount or interest have been missed for a prolonged period of time.
When a corporate debtor is unable to pay back a loan, the creditor can initiate a ‘Corporate Insolvency Resolution Process’ (CIRP) to recover the debt amount (Section 95). When a CIRP is initiated, the assets of the debtor and personal guarantor are placed under an interim moratorium (Section 96).
A debtor and/or personal guarantor loses control of the assets attached to the loan when a moratorium is imposed. They cannot transfer or dispose of any assets. All other debtors are prohibited from pursuing legal proceedings against them with respect to loans and associated assets as well. A Resolution Professional is appointed under Section 97 of the Code to come up with a Resolution Plan to pay back the debtors.
SBI, Reliances’ creditor, filed an insolvency application under Section 95 of the Insolvency and Bankruptcy Code against Mr. Ambani in early 2020.
On August 20th, 2020, the National Company Law Tribunal (NCLT) in Mumbai allowed the appointment of an interim Resolution Professional (RP) to recover the debts. The NCLT further stated that action could be taken against the personal guarantor, Mr. Ambani, even before a Resolution Plan was accepted. This involved placing Mr. Ambani’s assets under an interim moratorium.
On July 11th, 2022, Mr. Ambani challenged the following provisions of the Code:
- Application for the initiation of the insolvency process under Section 95
- Interim moratorium under Section 96
- Appointment of a Resolution Profession under Section 97
- Submission of the Resolution Professional’s report under Section 99
- Admission or rejection of an application under Section 100
Mr. Ambani argues that these provisions are arbitrary, unconstitutional and violative of fundamental rights. Section 96 places an interim moratorium in relation to all the debts against the personal guarantor as soon as an insolvency application is filed by the creditor under Section 95, without giving them a chance to be heard.
Under Section 99 of the Code, a copy of the Resolution Professional’s report is not provided to the debtor and personal guarantor—depriving them of the right to know why an insolvency application has been accepted or rejected. The challenge further argues that the Code vests unfettered powers in the resolution professional to be a judge in his own cause—the resolution professional is not answerable to anyone when placing the debtor or personal guarantor’s assets under a moratorium.
How does a creditor initiate a proceeding?
The process of initiating an insolvency proceeding is stipulated under Sections 95, 96, 97, 99, and 100 of the IBC.
Under Section 95, a creditor can initiate the insolvency process by submitting an application to the adjudicating authority— the National Company Law Tribunal (NCLT). The application must include details about the outstanding debt and other relevant information. A copy of the application is to be shared with the debtor.
Upon filing of an application, Section 96 triggers an interim moratorium, temporarily suspending legal proceedings related to the debt. Petitioners argue that this immediate moratorium lacks fairness as it does not afford debtors an opportunity to be heard.
Subsequently, a resolution professional is appointed under Section 97. The NCLT directs the Insolvency and Bankruptcy Board of India (IBBI) to nominate a resolution professional. After the IBBI nominates a professional, the NCLT appoints them through an order.
Then, as mandated by Section 99, the resolution professional examines the creditor’s application and prepares a report. This report recommends either the approval or rejection of the application to the NCLT. Petitioners argued that the resolution professional enjoys an adjudicatory function. Additionally, the debtor is not included in this process which violates the principles of natural justice.
The NCLT accepts or rejects the application on the basis of this report, as outlined in Section 100. This is the starting point of the insolvency proceeding in the NCLT.
Resolution professional’s report is “recommendatory”
The Bench held that the resolution professional neither has an adjudicatory function nor imposes any binding conclusion on the creditor or the debtor. The judgement referred to how Section 99 narrows the scope of the resolution professional by relying on phrases such as “examine the application”, “ascertain”, “satisfies the requirements”, and “recommend acceptance or rejection.” This indicates that the resolution professional has a recommendatory function. This recommendation is made to the NCLT which is the sole adjudicating authority.
The Bench then stated that there was no violation of natural justice at this stage. Observing that the principles of natural justice cannot be “construed in a straight jacket,” the Bench held that the role of the resolution professional is not a unilateral process in the absence of the debtor. This was clarified on a careful reading of Section 99(4). The provision empowers the resolution professional to seek additional information from the debtor for preparing the report. This information must have a nexus with the application. They reiterated that the recommendatory role is only exercised after taking into account information furnished by the debtor.
NCLT cannot have an adjudicatory function prior to admission of application
The Bench dismissed the petitioner’s plea to incorporate an adjudicatory stage during the appointment of a resolution professional. The petitioners argued that, before appointing a resolution professional, the NCLT should consider two crucial factors: 1) the existence of a debt, and 2) the relationship between the creditor and the debtor. The Bench declined to entertain this argument.
Highlighting the nomination process, the Bench emphasised that the resolution professional is appointed by the NCLT only after being nominated by the IBBI. The professional’s sole purpose is to engage in the facilitative exercise of preparing a report under Section 99. According to the Bench, the legislative framework does not allow for an additional adjudicatory stage, and introducing such a stage would essentially amount to rewriting the terms of the statute.
Moreover, the Bench underscored that the entire process of appointing a resolution professional and submitting a report adheres to strict timelines. They said that introducing an adjudicatory stage would not only cause delays but also introduce complexity to this well-defined process.
Interim moratorium protects the debtor
The Bench held that the interim moratorium plays a “protective” role as it restricts any legal action or legal proceeding against the debtor.
At this stage, it is important to note that there are two stages of moratorium under the insolvency proceeding of an individual or partnership firm debtor. The first is the interim moratorium which starts instantly after an application by a creditor under Section 96. The second moratorium—Section 101—is after the NCLT accepts the application on the basis of the report submitted by the resolution professional.
The Bench stated that a moratorium under Section 101 is substantially distinct from an interim moratorium under Section 96. This distinction indicates that an interim moratorium secures the debtor. The interim moratorium prevents the initiation or continuation of a legal action “in respect of the debt.” On the other hand, the moratorium under Section 101, which is a consequence of the NCLT accepting the application, prevents the debtor from transferring, disposing, or alienating any of their assets.
CJI Chandrachud, while reading out the judgement, observed that the interim moratorium operates as a “matter of law without a judicial order.”