NCLAT Clarifies Process for Initiating Insolvency Against Personal Guarantors to Corporate Debtors

 

NCLAT Clarifies Process for Initiating Insolvency Against Personal Guarantors to Corporate Debtors
By Abhishek Jat, Advocate

 

In a significant ruling, the National Company Law Appellate Tribunal (NCLAT) has provided crucial clarity on the procedural requirements for initiating insolvency proceedings against personal guarantors to corporate debtors under Section 95 of the Insolvency and Bankruptcy Code, 2016 (IBC). The judgment, delivered in State Bank of India vs. Deepak Kumar Singhania, underscores the importance of adhering to the contractual terms of the guarantee deed before invoking the insolvency process.

Background of the Case

The case arose from an appeal filed by the State Bank of India (SBI) challenging the rejection of its application under Section 95 of the IBC by the National Company Law Tribunal (NCLT), Allahabad Bench. SBI had sought to initiate insolvency proceedings against Mr. Deepak Kumar Singhania, a personal guarantor to LML Limited, a corporate debtor under liquidation. The bank had issued a demand notice under Rule 7 of the Insolvency and Bankruptcy (Application to Adjudicating Authority for Insolvency Resolution Process for Personal Guarantors to Corporate Debtors) Rules, 2019 (2019 Rules), but had not formally invoked the personal guarantee as per the terms of the guarantee deed.

The NCLT rejected SBI’s application, holding that the bank had failed to satisfy the mandatory prerequisite of invoking the guarantee before filing the application under Section 95. The tribunal emphasized that the statutory demand notice under Rule 7 could not substitute the requirement of invoking the guarantee as per the contractual terms.

Key Legal Issues

The central question before the NCLAT was whether the demand notice issued under Rule 7(1) of the 2019 Rules could be considered as a notice for invoking the guarantee for the purposes of filing an application under Section 95 of the IBC.

NCLAT’s Ruling

The NCLAT, in its judgment, upheld the NCLT’s decision and clarified the following key points:

1. Invocation of Guarantee is Mandatory: The tribunal reiterated that the invocation of a personal guarantee is a contractual obligation that must be fulfilled as per the terms of the guarantee deed. The statutory demand notice under Rule 7(1) cannot be treated as a substitute for the formal invocation of the guarantee.
2. Definition of ‘Guarantor’ Under Rule 3(1)(e): The NCLAT emphasized that the definition of ‘guarantor’ under Rule 3(1)(e) of the 2019 Rules requires two conditions to be met:
• The individual must be a personal guarantor to a corporate debtor.
• The guarantee must have been invoked by the creditor and remain unpaid, either in full or in part.

The tribunal rejected SBI’s argument that the word ‘and’ in Rule 3(1)(e) should be read as ‘or’ to make the provision workable. It held that both conditions must be cumulatively satisfied for an individual to qualify as a guarantor under the IBC framework.

3. Default Must Precede Demand Notice: The NCLAT noted that the issuance of a demand notice under Rule 7(1) presupposes the existence of a default by the guarantor. A default can only arise after the guarantee has been invoked in accordance with the terms of the guarantee deed.
4. Contractual Compliance is Paramount: The tribunal reinforced that the liability of a guarantor is strictly determined by the terms of the guarantee deed. It cited the Supreme Court’s ruling in Syndicate Bank vs. Chamaveerappa Beleri (2006) to emphasize that a guarantor’s liability depends on the specific terms of the contract.

Implications of the Judgment

This ruling serves as a critical reminder for creditors and legal professionals involved in insolvency and debt recovery proceedings. It highlights the importance of complying with the contractual terms of the guarantee deed before initiating insolvency proceedings against personal guarantors.

For lenders, the key takeaway is to ensure that all procedural steps, including the formal invocation of the guarantee, are meticulously followed before filing an application under Section 95 of the IBC. Failure to do so may result in the rejection of the application, as seen in this case.

Conclusion

The NCLAT’s decision in State Bank of India vs. Deepak Kumar Singhania provides much-needed clarity on the procedural requirements for initiating insolvency proceedings against personal guarantors. It underscores the importance of adhering to the contractual terms of the guarantee deed and reinforces the principle that statutory notices cannot override contractual obligations.

This judgment is a valuable addition to the evolving jurisprudence under the IBC and serves as a practical guide for creditors and legal professionals navigating the complexities of insolvency and debt recovery.