Insolvency and bankruptcy of personal guarantors to corporate debtors

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Insolvency and bankruptcy of personal guarantors to corporate debtors

Introduction

The central government, through a notification dated 15 November 2019 (the Notification), appointed 01 December 2019 as the date on which certain provisions of the Insolvency and Bankruptcy Code, 2016 (IBC) relating to personal guarantors to corporate debtors were enforced.

Pursuant to the Notification, the Insolvency and Bankruptcy Board of India (IBBI) notified rules and regulations to separately govern the bankruptcy and insolvency resolution process, in respect of personal guarantors to corporate debtors.

In this update, we have discussed the key takeaways with respect to the Notification and the rules and regulations governing the personal guarantors to corporate debtors.

Overview

The IBC recognizes the following categories of guarantors:

(a) Corporate guarantor: a corporate person who is the surety in a contract of guarantee to a corporate debtor.

(b) Personal guarantor: an individual who is the surety in a contract of guarantee to a corporate debtor.

A guarantor (whether personal or corporate), guarantees to a creditor, the repayment of debt taken by a corporate debtor from the creditor. Prior to the Notification, the IBC only provided for the mechanism for insolvency resolution in respect of corporate guarantors. It was silent on the insolvency resolution or bankruptcy process in case of personal guarantors to corporate debtors. With the objective of bringing about clarity in this regard, the IBC notified the following rules and regulations:

(1) Insolvency resolution

(a) The Insolvency and Bankruptcy (Application to Adjudicating Authority for Insolvency Resolution Process for Personal Guarantors to Corporate Debtors) Rules, 2019 (Insolvency Rules).

(b) The IBBI (Insolvency Resolution Process for Personal Guarantors to Corporate Debtors) Regulations, 2019 (Insolvency Regulations).

(2) Bankruptcy:

(a) The Insolvency and Bankruptcy (Application to Adjudicating Authority for Bankruptcy Process for Personal Guarantors to Corporate Debtors) Rules, 2019 (Bankruptcy Rules).

(b) The IBBI (Bankruptcy Process for Personal Guarantors to Corporate Debtors) Regulations, 2019 (Bankruptcy Regulations).

Note: the Insolvency Rules and Bankruptcy Rules are hereinafter collectively referred to as the Rules, and the Insolvency Regulations and Bankruptcy Regulations are hereinafter collectively referred to as the Regulations.

The IBC, read with the Rules and Regulations provides that, for the insolvency resolution process to be initiated against personal guarantors, (i) the guarantee of personal guarantor must be invoked by the creditor and remain unpaid in full or in part; and (ii) the default should be a minimum of INR1,000.

In case the insolvency resolution application is rejected by the National Company Law Tribunal (NCLT), or the NCLT rejects the repayment plan formulated for the repayment of debt of the personal guarantor, or where the repayment plan comes to a premature end, the debtor/creditor can file for bankruptcy.

It is to be noted that the provisions dealing with the fresh start process of bankruptcy and insolvency against personal guarantors is yet to be enforced.

Key takeaways of the Insolvency Rules and the Insolvency Regulations

The Insolvency Rules and Insolvency Regulations primarily cover the procedural aspects of the insolvency resolution process. They provide for the application forms for initiation of proceedings, withdrawal of applications, public notice, meeting of creditors, repayment plan, etc. The key takeaways of the Insolvency Rules and the Insolvency Regulations are:

Eligibility of a resolution professional (RP): the eligibility criteria, inter alia, states that the RP must be independent of the guarantor, not subject to any disciplinary proceedings, not be a representative of any party in the resolution process and should not have acted as an RP (including interim) or liquidator for the corporate debtor.

Repayment plan: the debtor is required to prepare a repayment plan in consultation with an RP. The repayment plan must, inter alia, provide the term of the plan, its implementation schedule, transfer or sale of all or part of the assets of the guarantor, the mode and manner of such sale, reduction in amount payable to creditors, modification as to the terms of repayment, etc.

The repayment plan must be approved by the creditors, post which it will be binding on the creditors and debtor.

Meeting of creditors: in the event that the RP requires a meeting of creditors be constituted and held, the RP is required to send a notice to all the creditors along with a copy of the repayment plan.

The IBC provides that the repayment plan must be approved by at least 75% in value of the creditors present in person or by proxy and voting on the resolution. In terms of the Insolvency Rules and Insolvency Regulations, any other decision of the committee of creditors requires the approval of 50% or more of creditors who voted. The voting share of each creditor is in proportion to the debt owed to such creditor.

Excluded assets: certain assets of the personal guarantor are to be excluded in the insolvency resolution process. The value of unencumbered personal ornaments to not exceed INR1,00,000, and the value of unencumbered single dwelling unit owned by the debtor to not exceed INR20,00,000 in case of dwelling unit in an urban area, and INR10,00,000, if the dwelling unit is in a rural area.

Discharge order: the repayment plan may provide terms for discharge at a prior time or based on completion of the payment of debts. Based on the terms of the repayment plan, the RP may apply to the Debt Recovery Tribunal (DRT) for passing an order in relation to the discharge.

If the implementation of the plan is successful, the DRT shall pass a discharge order. The discharge order will only be applicable to the debts that have been successfully discharged with respect to the terms of the plan and shall not discharge any other person from any liability in respect of their debt.

Withdrawal of application: the DRT may permit the withdrawal of an insolvency resolution application if (i) the request is made by the applicant before the admission of the application; or (ii) if 90% of the creditors agree to the withdrawal post admission of the application.

Key takeaways of the Bankruptcy Rules and the Bankruptcy Regulations

As in the case of the Insolvency Rules and the Insolvency Regulations, the Bankruptcy Rules and the Bankruptcy Regulations cover the procedural aspects of the bankruptcy process. The key takeaways of the Bankruptcy Rules and the Bankruptcy Regulations are:

Eligibility of a bankruptcy trustee (BT): the eligibility criteria for appointment of a BT under the Bankruptcy Regulations is the same as the eligibility criteria prescribed for the appointment of an RP under the insolvency resolution process.

Meeting of creditors: the meeting of creditors in case of bankruptcy is held in a manner similar to the meeting held in case of insolvency resolution. That is, a meeting of creditors is held if required in the opinion of the BT; a decision of the committee of creditors requires the approval of at least 50% creditors who voted; and the voting share of each creditor is in proportion to the debt owed to such creditor.

Excluded assets: the assets required to be excluded in the case of bankruptcy are the same as the assets required to be excluded in the insolvency resolution process.

Reports by BT: the BT is required to prepare and submit the following reports to the DRT and the committee of creditors:

(1) Preliminary report: this should include, inter alia, a list of assets and liabilities of the bankrupt, the proposed plan of action and timeline, details of assets that are intended to be realized (including value, manner, reasons, expected amount, etc.) and excluded assets.

(2) Progress report(s): this should include, inter alia, appointment details of professionals (if any), statement of progress in the bankruptcy process (including dividends, any material change, distribution of property, creditors, etc.), asset sale report (including realized value, cost of realization, manner and mode, and details of the receiver), other fees and expenses, accounts maintained, etc.

(3) Final report: this should include an account of the completion of the administration and distribution of the estate of the bankrupt including the manner of realization, distribution of dividends, details regarding the discharge of the bankrupt and unclaimed/surplus dividend.

Realization of assets: the BT realizes assets by selling the assets of the bankrupt through an auction or private sale. The Bankruptcy Regulations only permits private sale in certain cases, for example, on grounds that the assets are perishable in nature. Certain persons, as mentioned in the Bankruptcy Regulations, are prohibited from purchasing the assets of the bankrupt without permission of the DRT, such as the BT himself, professional(s) appointed by the BT, creditor or associate of the bankrupt, etc.

Realization of a secured asset may be done by a secured creditor by intimating the BT of the price at which he proposes to realize the asset. Pursuant to this, the BT must find a buyer.

The BT may, if he thinks it necessary, or on the direction of the committee of creditors, appoint a registered valuer to value the assets of the bankrupt.

Proceeds of bankruptcy process and distribution of proceeds: the BT is required to open a separate bank account for the receipt of all amounts due to the bankrupt. Any payments out of the account, in excess of INR5,000 can only be made by cheques or online banking transactions.
The BT is required to apply to the DRT for an order to credit to the Insolvency and Bankruptcy Fund any unclaimed dividends of bankruptcy or undistributed asset(s) or any other balance amount payable to the creditors.

Parallel remedy: personal guarantor and corporate debtor

The IBC permits proceedings against a corporate debtor, and the personal guarantor of the corporate debtor, to be heard simultaneously. The IBC caters to the following circumstances:

(1) Insolvency resolution/liquidation proceedings against a corporate debtor already pending before the NCLT: in such circumstances, the insolvency resolution/bankruptcy proceedings against a personal guarantor to such corporate debtor must also be filed before the same NCLT.

(2) Insolvency resolution/bankruptcy proceedings against a personal guarantor pending before any court or tribunal: in such circumstances, the case against the personal guarantor is transferred to the NCLT dealing with the insolvency resolution/liquidation process against the corporate debtor.

In addition to the above, the IBC allows the personal guarantor’s assets to be attached along with those of the corporate debtor. The objective behind hearing cases against the corporate debtor and personal guarantor together is to increase the creditor’s chances of recovery of amounts due to him.

Prior to the introduction of this provision under the IBC, creditors had to file for recovery of their debt against personal guarantors and corporate debtors separately. This would lead to high costs and multiple litigation in different forums.

To clarify, the above provisions for recovery in case of existing proceedings against a corporate debtor were introduced prior to the notification of the Rules and Regulations. The Rules and Regulations are intended to supplement the procedural aspects of such cases.

Conclusion

The Notification brings about much-needed clarity on the applicability of the provisions of the insolvency resolution and bankruptcy process under the IBC, to personal guarantors. The Rules and Regulations complement the Notification, by comprehensively laying down the process for insolvency/bankruptcy of the personal guarantors.

With the advent of the Notification, Rules and Regulations, creditors may expect faster recovery of their debts. Further, the other aspects relating to personal guarantors, such as the fresh start process, are soon expected to be notified. This is likely to further speed up the process of recovery of debt and boost lenders’ confidence.