Lenders’ dilemma resolved as guarantors caught in net

By Shweta Bharti and Sukrit Kapoor, Hammurabi & Solomon
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The impact of economic and financial crises and the accumulation of non-performing assets paved way for the Insolvency and Bankruptcy Code, 2016 (IBC). The aim of the IBC was to curtail the financial uncertainty, loss of market confidence and reduction in liquidity in the credit markets.

Shweta BhartiSenior partnerHammurabi & Solomon
Shweta Bharti
Senior partner
Hammurabi & Solomon

The IBC brought about substantial moderation in non-performing assets of banks and financial institutions and helped them recover more than 50% of their dues, but various controversial issues marred the IBC in its original form. These included the issue of “moratorium” granted to corporate debtors under section 14, which was sought to be extended to the personal guarantors of corporate debtors, thus defeating the purpose of seeking a guarantee by lenders.

Unlike the earlier provision under section 22 of the Sick Industrial Companies (Special Provisions) Act, 1985, which provided guarantors with a shelter, the IBC left much subject to interpretation, resulting in a spate of conflicting judgments by the National Company Law Tribunal (NCLT), the National Company Law Appellate Tribunal (NCLAT) and various high courts.

In view of conflicting judgments on the issue, and recommendations of the Insolvency Law Committee and various stakeholders, the IBC was amended, with effect from 6 June 2018, to enable filing under section 60 of an application relating to the insolvency resolution, liquidation or bankruptcy of a personal guarantor of the corporate debtor before the same NCLT.

The issue was subsequently settled with the Supreme Court’s recent judgment in State Bank of India v V Ramakrishnan, which cleared the menacing clouds that loomed over the understanding of moratoriums in insolvency proceedings by conclusively interpreting that the scope of the moratorium as provided under section 14 of the IBC excludes the personal guarantor and consequently setting aside the decision of the NCLAT.

Sukrit KapoorSenior associateHammurabi & Solomon
Sukrit Kapoor
Senior associate
Hammurabi & Solomon

Importantly, the judgment is in keeping with advancing the object and purpose of the IBC as was discussed in the Supreme Court ruling in Mobilox Innovations Private Limited v Kirusa Software Private Limited earlier this year. In that case, while interpreting sections 8 and 9 of the IBC, a reference was made to the Legislative Guide on Insolvency Law of the UN Commission on International Trade Law and it was noted that the insolvency mechanism “must strike a balance not only between the different interests of these stakeholders, but also between these interests and the relevant social, political and other policy considerations that have an impact on the economic and legal goals of insolvency proceedings”.

The decision in V Ramakrishnan on the face of it furthers this object and purpose by denying the guarantors of corporate debtors the option of immunizing themselves from recovery proceedings such as provided under the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002, through cleverly resorting to a section 10 application under the IBC.

In doing so V Ramakrishnan provides valuable guidance on the rules of interpretation of the IBC, arguably aiming to achieve consistency in resolution of similarly placed disputes and contextual arguments. The most important rule is that of employment of literal construction in interpreting section 14 of the IBC. In respect of the impugned NCLAT order the court made reference to the observations of the Insolvency Law Committee, which noted that a broader meaning of the moratorium incorporating the personal guarantor is not in the scheme of the IBC.

The interpretation of the court is further in line with another golden rule of interpretation – the doctrine of mischief as propounded in the landmark Heydon’s Case (1584).

The Supreme Court’s interpretation has kept the very design and essence of the IBC intact as the reason it’s called a “code” and not an “act” lies in the understanding that it is a consolidated statute for insolvency proceedings, which makes it all the more essential for its purposes to interpret each of its provisions in harmony with the whole statute and in accordance with the general scope and the mischief that it is intended to remedy.

The decision in V Ramakrishnan not only sets the record straight in the context of the controversy but also reinstates the faith of lenders in guarantee provisions. It respects the essence of the IBC and ensures that the guarantors will be held liable for their inactions or incorrect decisions driving the corporate debtor to the brink of insolvency and the banks and financial institutions to piles of non-performing assets.

Shweta Bharti is a senior partner and Sukrit Kapoor is a senior associate at Hammurabi & Solomon.

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