Followers of the progress of the Insolvency and Bankruptcy Code were recently subjected to two decisions, one poorly reasoned and the other completely unreasoned. The NCLT, Chennai and the NCLAT (in appeal), in the case of Veesons Energy Systems, held that personal guarantees given for the payment of debts incurred by companies undergoing insolvency proceedings would be ineffective during the Code-mandated “moratorium period” (when all suits and other proceedings against the embattled company are suspended).
To start with, the NCLT read the Code to exempt personal guarantees from recovery proceedings based on statutory provisions which do not in any way support its interpretation. According to the NCLT, if the guarantor of a company actually paid off the company’s debt, the guarantor would itself become a creditor of the company, as Section 140 of the Contract Act mandates that a guarantor who repays a creditor succeeds to all of the creditor’s rights against the debtor. Allowing a guarantor to step into the shoes of a creditor during the moratorium period, the NCLT opined, was against the purpose and object of the moratorium, and would violate Section 14(1)(b) of the Code, which prohibits the transferring of any of the assets of a company, or any legal right or beneficial interest in such assets, during the moratorium period.
Presumably, the NCLT was under the impression that a company cannot sprout new creditors during the moratorium period. However, the mere fact that Section 14(1)(b) puts a bar on the transfer of the assets of a company does not support such an interpretation in any way. In fact, Section 20 expressly contemplates raising of “interim finance” by the company during the moratorium. With the raising of finance come creditors. The NCLT’s fears of new creditors being created with the payment of guarantees during the moratorium period, in breach of the provisions of the Code, are therefore thoroughly unfounded, and the provisions of the Code do not support its conclusions.
The NCLAT decision is notable in its lack of any reasoning to justify reaching the same conclusion as the NCLT – not even an endorsement of the NCLT’s logic. The NCLAT (chaired by Justice SJ Mukhopadhyaya) simply reproduced Sections 14 and 31 of the Code, and held that “in view of the aforesaid provisions”, the moratorium would also protect guarantors. Strangely, the NCLAT did not notice two of its prior judgments, in Alpha & Omega Diagnostics and Schweitzer Systemtek, both of which also featured Justice Mukhopadhyaya as Chairperson, which held that guarantors had no protection during the moratorium period.
Neither of the two Veesons judgments referred to above engaged with the earlier law on this subject, laid down by the Supreme Court before the Code was enacted, which declares that merely because a principal debtor’s obligation to pay a debt is absolved by the law of bankruptcy, a guarantor of that same debt would not be relieved of its liability.
It is clear that no part of the Code supports the view that guarantors are also entitled to the same protections that insolvent companies are during the insolvency resolution process. Yet if the draftsmen of the Code would have been asked their view on this point, they might have agreed with the two Tribunals’ conclusion.
The Bankruptcy Law Reforms Committee, which designed the Insolvency and Bankruptcy Code, envisioned a “calm period”, when the debt-ridden enterprise would be made statutorily immune from debt recovery actions against it. This “calm period” is what the Code calls “the moratorium”. The purpose of such a breather, the Committee said, would be to allow the enterprise’s owners to negotiate with creditors without having to simultaneously juggle time-consuming recovery actions. Based on the intent of the Code’s draftsmen, therefore, it can be argued that it would make sense to protect the promoters of a company, who give personal guarantees for the payment of loans taken by it, from the heat of proceedings taken out during the insolvency process, so they could avail of the opportunity to negotiate that the Code intended to give them during the moratorium.
However, there is a wrinkle.
After the first version of the Code was legislated, Parliament amended it to insert Section 29A, which denies the promoters of a company the right to once again take over. Thus, the “calm period” negotiations that the Bankruptcy Law Reforms Committee had contemplated, between the owners and its creditors, can no longer happen. The shielding of personal guarantors, who are often the promoters of the company, during the moratorium would therefore achieve nothing.
In sum, there is nothing in the Code that protects personal guarantors from recovery actions during the moratorium period, and it is difficult to understand why the NCLT and NCLAT thought any different.
From news reports, it appears that the Committee constituted to review the Insolvency and Bankruptcy Code is proposing an amendment to expressly state that guarantors’ assets are fair game during insolvency proceedings under the Code. A much-needed amendment, in the light of the Tribunals’ contradictory views.
