‘SC ruling to hold personal guarantor liable in insolvency cases to strengthen MSMEs’ credit discipline’

Stress within the MSME sector could have a cascading impact on the Indian economic system and therefore a dynamic insolvency decision framework is crucial within the context of MSMEs.

By Madhav Kanoria

The Insolvency and Chapter Code, 2016 (IBC) launched a creditor-in-control, decision professional-managed insolvency regime for Indian firms. Importantly, the IBC course of as a basic rule excludes the promoters of any entity in IBC from retaining management of the corporate or regaining management of the corporate by means of the IBC course of. This basically modified the equation between promoters and collectors, bringing a few paradigm shift within the insolvency decision course of in India. Since its inception, massive legacy NPAs have been resolved below the IBC.

Whereas the IBC initially solely permitted collectors to proceed in opposition to company debtors or firms, the provisions permitting collectors to proceed in opposition to private guarantors for company debtors turned efficient on and from December 1, 2019. A number of creditors-initiated insolvency proceedings in opposition to private guarantors. A number of proceedings have been additionally instituted earlier than totally different Excessive Courts to problem the notification extending the IBC provisions to the non-public guarantors. All of those have been transferred to the Supreme Court docket as they concerned interpretation of frequent questions of regulation pertaining to provisions of IBC. The Supreme Court docket, in its judgment of Could 21, 2021, in Lalit Kumar Jain vs. Union of India, upheld the constitutionality of the notification extending the IBC provisions to private guarantors.

Grounds for Problem

The first floor for the problem of the IBC extension to private guarantors was that it selectively made the IBC efficient for just one class of people (i.e. private guarantors) with out making it efficient for particular person debtors typically. The Supreme Court docket held that this was not discriminatory, since private guarantors have an “intrinsic connection” to company debtors. The method for debt decision needs to be earlier than a standard authority, being the Nationwide Firm Regulation Tribunal or NCLT. Another mechanism would give rise to uncertainty of final result for the collectors. By having a standard adjudicatory authority, the collectors would additionally be capable to approve real looking decision plans, holding in thoughts the prospect of realizing some a part of the collectors’ dues from private guarantors.

Private guarantors argued that when a decision plan for a company debtor is authorized, their assure is routinely discharged below the regulation. In addition they contended that collectors would have a chance to unjustly enrich themselves by recovering quantities from the company debtor in addition to the guarantors. Disagreeing with their contentions, the Supreme Court docket held that the discharge of a company debtor’s liabilities by an involuntary means of regulation (akin to insolvency/liquidation) doesn’t discharge a guarantor of their legal responsibility, which arises out of an unbiased contract.

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This judgment is a major milestone within the subject of insolvency legal guidelines. It would assist in making certain a complete decision of the company debtor and all its liabilities by means of a consolidated type of insolvency decision/ chapter of the company debtor together with the non-public guarantor. The judgment additionally places to relaxation contentions raised by guarantors as properly in a number of proceedings below the IBC relating to their liabilities after completion of a decision continuing below IBC.

Implications on Decision of MSMEs

Micro, Small, and Medium Enterprises (MSMEs) are the bedrock of the Indian economic system. The Indian MSME sector contributes about 29 per cent to the GDP. Stress within the MSME sector could have a cascading impact on the Indian economic system and therefore a dynamic insolvency decision framework is crucial within the context of MSMEs. A particular characteristic of credit score prolonged to MSMEs is that it’s typically backed by private ensures supplied by promoters.

Parliament has acknowledged the peculiarities of MSMEs within the IBC course of. The pre-packaged insolvency decision course of for MSMEs (or “pre-packs”) have additionally been launched for dealing successfully with careworn property within the MSME sector. The underlying premise of those modifications is that there’s advantage in allowing present promoters to take part within the decision course of for MSMEs.

The Supreme Court docket has now clarified that the legal responsibility of private guarantors will proceed to outlive even after the approval of a decision plan. For present circumstances, this may encourage promoters of MSMEs to discover a decision that’s acceptable to the collectors and on the similar time, stop them from being topic to insolvency proceedings, which can have social and enterprise ramifications. Going ahead, for the reason that default of the MSME might result in insolvency of the promoter, MSME promoters will calibrate leverage to property and money movement of the corporate. Promoters will probably be acutely aware that assure obligations may be enforced and should lead to insolvency and accordingly, is not going to assume commitments that can not be honoured. This judgment may also encourage the promoters to make use of the pre-pack regime for MSMEs to search out resolutions acceptable to the collectors and strengthen credit score self-discipline throughout the debt market.

Madhav Kanoria is the Companion on the regulation agency Cyril Amarchand Mangaldas. Views expressed are the writer’s personal.