Personal Guarantors Now Subject To IBC: A Brief Overview Of The Bankruptcy Process

By a notification dated 15th November 2019, the Central Government has from the 1st of December, 2019 brought into effect Part III of the Insolvency and Bankruptcy Code, 2016 (“the Code“) (save and except provisions dealing with the Fresh Start Process) dealing with the Insolvency and Bankruptcy of Individuals and Partnership Firms in so far as it is applicable to Personal Guarantors of a Corporate Debtor. In pursuance to the aforesaid notification the Central Government has also enacted.

  1. The Insolvency and Bankruptcy (Application to Adjudicating Authority for Bankruptcy Process for Personal Guarantors to Corporate Debtors) Rules, 2019 (“Bankruptcy Rules“); and
  2. The Insolvency and Bankruptcy Board of India (Bankruptcy Process for Personal Guarantors to Corporate Debtors) Regulations, 2019 (“Bankruptcy Regulations“)

In our previous article titled “Personal Guarantors now subject to IBC: A brief overview of the Insolvency Resolution Process” we outlined the Insolvency Resolution Process applicable to an individual who is a Personal Guarantor to a Corporate Debtor (“Guarantor“). In this Article we focus mainly on the broad procedure in relation to the Bankruptcy Process of a Guarantor (“Bankruptcy Process“) contained in the provisions of the Code that have been brought into effect along with the Bankruptcy Rules and Bankruptcy Regulations.

Initiation of Bankruptcy Process

In terms of Section 122 and 123 of the Code, an application for initiating the Bankruptcy Process may be initiated by the Guarantor (i.e., the debtor) or by a creditor, either personally or collectively with other creditors within a period of 3 months from the Adjudicating Authority (“AA“) passing any of the following orders:-

  1. Order rejecting an application for insolvency of the Guarantor in terms of Section 100(4) of the Code in terms of the report submitted by the resolution professional; or
  2. Order rejecting the repayment plan in terms of Section 115(2) of the Code; or
  3. Order that a repayment plan has not been completely implemented in terms of Section 118(3) of the Code.

It may be pertinent to note that in the event the Bankruptcy Process is sought to be initiated by a secured creditor for its secured debt, then in terms of Section 123(2) of the Code, such creditor needs to furnish a statement that he shall, in the event of the Bankruptcy order being made, give up all or part of his security for the benefit of all creditors of the Guarantor.

Interim Moratorium

In terms of Section 124 of the Code, and in a similar manner as Section 96, the Code provides for an “interim moratorium“, which applies to any legal action or legal proceedings against the property of the Guarantor in relation to his debts, as soon as the application for insolvency under Section 122 or Section 123 is filed before the AA. Such interim moratorium shall remain in effect till the bankruptcy commencement date i.e. the date on which the AA passes the order for bankruptcy in terms of Section 126.

Appointment of Trustee

If the bankruptcy application is filed personally by the Guarantor or the creditor, they may recommend an insolvency professional be appointed as the Bankruptcy Trustee (“Bankruptcy Trustee“) for the purposes of Chapter IV and Chapter V of the Code or a new Bankruptcy Trustee be appointed. In both instances, the Bankruptcy Trustee, is appointed by the AA in accordance with Section 125 and 126 of the Code and based on the recommendations or nomination, as the case may be of the Insolvency and Bankruptcy Board of India (“IBBI“).

Order for Bankruptcy of the Guarantor

Section 126 of the Code requires the AA to pass an order for bankruptcy (“Bankruptcy Order“) within 14 days from the appointment of the Bankruptcy Trustee. The Bankruptcy Order shall be valid and continue to have effect till the final discharge of the Guarantor. Upon passing of the Bankruptcy Order, the estate of the Guarantor shall vest with the Bankruptcy Trustee and the same shall be divided among his creditors.

It is further provided that a creditor of the Guarantor indebted in respect of any debt claimed as a bankruptcy debt shall not initiate any action against the property of the Guarantor in respect of such debt or commence any suit or other legal proceedings except with the leave of the AA and on such terms as the AA may impose. However, if a secured creditor has not given up his security, the Bankruptcy Order shall not affect his right to realize or otherwise deal with his security interest in the same manner as he would have been entitled if the Bankruptcy Order had not been passed. Such secured creditor must however take action to enforce his security within 30 days from the bankruptcy commencement date failing which he shall not be entitled to any interest in respect of his debt after the bankruptcy commencement date.

Restrictions and Disqualifications of the Guarantor

In terms of Section 158, any disposition of property made by the Guarantor from the date of filing of the application for bankruptcy till the bankruptcy commencement date shall be void and any transferee of such disposed property shall not be entitled to file a claim or be vested with any right in such property even if such disposition was done in good faith, for good consideration and without notice of filing of the application for bankruptcy. Further, in terms of 158(3), any disposition of property whether or not it forms a part of the Bankruptcy Estate including, the excluded assets of the Guarantor, shall be deemed to be void.

In terms of Section 140 of the Code, the Guarantor, in addition to any other disqualification by virtue of any other law, is further disqualified from the bankruptcy commencement date, from being a trustee to any trust, estate or settlement, from being appointed or acting as a public servant or being elected to any public office or being a sitting or voting member of any local authority. The Guarantor from the bankruptcy commencement date, is also restricted from acting as a director, from promoting, forming or managing a company in any manner and from creating any further charge in relation to the Bankruptcy Estate. The Guarantor is also statutorily required to  inform his business partners and any person he intends to enter into a transaction with (value of which is to be prescribed) that a Bankruptcy Order has been passed against him.

The abovementioned restrictions on the Guarantor however, cease, in the event the Bankruptcy Order is recalled or if a discharge order in terms of Section 138 of the Code is passed by the AA.

Invitation of Claims

Within a period of 10 days from the Bankruptcy Order, the AA is required to issue a public notice inviting claims from creditors as well as send or direct the Bankruptcy Trustee to send notices to all the creditors of the Guarantor as mentioned in the application of bankruptcy or statement of affairs. Thereafter, the Bankruptcy Trustee shall prepare a list of creditors on the basis of the claims received as well as the statement of affairs submitted by the Guarantor or the bankruptcy application.

In addition to claims that stand due and payable on the bankruptcy commencement date, all future claims i.e. claims, which are not due and payable on the bankruptcy commencement date, may also be submitted to the Bankruptcy Trustee. However, unless contracted to the contrary, creditors of such future claims can claim only the principal amount and interest accrued till the bankruptcy commencement date. In any case, rent, interest and such other payments of a periodical nature, can be claimed only for any amounts due and unpaid up to the bankruptcy commencement date.

Meeting of the Creditors

In terms of Section 133 of the Code, the Bankruptcy Trustee shall within 21 days of the bankruptcy commencement date, call a meeting of the creditors (“MoC“). It may be important to note that the Bankruptcy Trustee has the authority to determine the quorum of the MoC. The voting share of each creditor shall be allocated by the Bankruptcy Trustee in proportion to the debt owed to such creditor. However, a creditor shall not be entitled to a vote in respect of any debt arising from an unliquidated amount.

The Bankruptcy Trustee may convene the MoC as and when he considers necessary and shall also convene the MoC on a request by creditors having not less than 33% of the total voting share. Unless otherwise provided in the Code, any decision at the MoC shall require the approval of more than 50% of voting share allocated to the creditors.

It may be pertinent to note that in the case of the repayment plan prepared in terms of Section 105 of the Code, the Guarantor in terms of Section 106 is entitled to veto any modification to the repayment plan, however, on bankruptcy, a Guarantor may attend an MoC only if the Bankruptcy Trustee requires him to, however, his consent is not required for the approval of any matter discussed at the MoC.

Bankruptcy Estate

The estate of the Guarantor, for the purposes of administration of the Bankruptcy Process is contained in Chapter V of Part III of the Code (“Bankruptcy Estate“). The Code in terms of Section 155 excludes certain assets from the Bankruptcy Estate being:

  1. the “excluded assets” listed in Section 79(14) read with Rule 5 which include unencumbered tools, books, vehicles necessary for personal use or for employment, business or vocation, unencumbered furniture, household equipment and provisions, any unencumbered life insurance policy or pension plan taken in the name of debtor or his immediate family or an unencumbered single dwelling unit owned by the Guarantor the value of which does not exceed Rs.20 lakh (in an urban area) or Rs.10 lakh (in a rural area);
  2. any property held by the Guarantor in trust for any other person;
  3. sums due to any workman or employee from the provident fund, the pension fund and the gratuity fund.

The Bankruptcy Trustee is also entitled to claim, in terms of Section 159 of the Code, to any “after-acquired property” which may have been acquired or devolved upon the Guarantor, after the passing of the Bankruptcy Order. Additionally, in terms of Section 160 of the Code, the Bankruptcy Trustee may disclaim any “onerous” property which froms a part of the Bankruptcy Estate, by giving notice to the Guarantor or any person interested in such onerous properties. In this case the term onerous property, includes any unprofitable contract and any other property which is unsaleable or not readily saleable or such property that may give rise to a claim.

Prior transactions

In order to secure the Bankruptcy Estate, the Bankruptcy Trustee may apply to the AA to reverse or set aside or pass necessary orders in relation to the following transactions which have taken place before the bankruptcy commencement date:

  1. Any undervalued transactions as set out in Section 164, entered into in the preceding two years from the date of filing of the application for bankruptcy and which caused the Bankruptcy Process to be triggered.
  2. Any preferential transactions as set out in Section 165, entered into in the preceding two years (with an associate) or preceding six months (with any other person) from the date of filing of the application for bankruptcy and which caused the Bankruptcy Process to be triggered
  3. Extortionate credit transactions as set out in Section 167, entered into in the preceding two years from the bankruptcy commencement date.

Sale of Assets

In terms of Regulation 27 of the Bankruptcy Regulations, the Bankruptcy Trustee may sell the assets of the Guarantor through an auction. A private sale is permitted only if such asset is perishable in nature, or whose value is likely to deteriorate or in the event the selling price of such asset is higher than the reserve price of a failed auction.

Regulation 27 of the Bankruptcy Regulations also disqualifies any person from acquiring any interest in the property of Guarantor, either directly or indirectly, without leave of the AA where such person is the Bankruptcy Trustee, any professional appointed by the Bankruptcy Trustee for the Bankruptcy Process, any creditor or associate of the Guarantor, any company where the Guarantor or a creditor is a promoter or director. Further, the Bankruptcy Trustee is entitled to prevent a sale in the event that he has reason to believe that there is any collusion amongst, the buyers, the Guarantor, the creditors, their associates, the corporate debtor, related party of the corporate debtor, and in such event shall submit a report to the AA for appropriate orders.

In terms of Regulation 31 of the Bankruptcy Regulations, any secured creditor who seeks to realise his security, prior to realising his security needs to intimate to the Bankruptcy Trustee the price at which such security is proposed to be realised and thereafter the Bankruptcy Trustee shall attempt to identify a buyer willing to purchase the security at a higher price. In such an event, the security shall then be sold to the buyer offering the highest price. In the event the amounts realised by the sale of such asset is in excess of the debts owed to the secured creditor then the secured creditor shall tender such excess amounts to the bankruptcy trustee.

Interim Dividend and Final Dividend

In the event that the Bankruptcy Trustee has sufficient funds, the Bankruptcy Trustee may declare and distribute interim dividend among the creditors in respect of the debts which have been proved. Further, in terms of Section 175 of the Code, the Bankruptcy Trustee may, with the approval of the MoC, divide amongst the creditors, according to its estimated value, any property which from its peculiar nature or other special circumstances cannot be readily or advantageously sold.

After the entire Bankruptcy Estate of the Guarantor is realized or so much of it as could be realized in the opinion of the Bankruptcy Trustee, the Bankruptcy Trustee can declare a final dividend after giving notice in the appropriate form, of his intention to do so, thirty days prior to the date specified for the distribution of dividend or if no further dividend is to be issued, give notice of the same. Such notice shall require all claims against the Bankruptcy Estate to be established by a final date specified in the notice which can be extended by the AA on an application being made. After the final date, the Bankruptcy Trustee shall defray the outstanding expenses from the Bankruptcy Estate, and declare and distribute the final dividend among the creditors who have proved their debts, without regard to the claims of any other persons. If a surplus remains after payment in full, with interest to all the creditors of the Guarantor and the payment of the expenses of the Bankruptcy Process, the Guarantor shall be entitled to the surplus.

In terms of Section 177, a creditor who has not proved his debt before the declaration of any dividend may not disturb the disbursement of such dividend but upon proving the debt, he shall be entitled to be paid any dividend or dividends which he has failed to receive, out of any money for the time being available for the payment of any further dividend before such dividend is paid to any other person.

Priority of payment of Debts

The debts of the Guarantor shall in the distribution of the final dividend, in terms of Section 178, be paid to each class of creditors in the following priority, provided that within the same class, each creditor shall be entitled to the same share:

  • Firstly, the costs and expenses as are incurred by the Bankruptcy Trustee during the Bankruptcy Process shall paid off in full.
  • Secondly (i) the workmen’s dues for the preceding twenty-four months to be accounted for from bankruptcy commencement date and (ii) the debts owed to secured creditors; on pari passu basis.
  • Thirdly the wages and pending dues of the employees other than workmen during preceding twelve months to be calculated from the bankruptcy commencement date.
  • Fourthly pending dues if any of the central or state government during a period of two years from the bankruptcy commencement date.
  • Lastly all other dues and debts owed by the Guarantor as well as unsecured debts.

One major distinction here from the priority of payment in liquidation of a corporate debtor as set out in Section 53, is the manner of distribution of balance dues to a secured creditor who has not given up his security for the benefit of all the creditors and has enforced such security  independently for the repayment of his own dues.

In terms of Section 53, if a secured creditor has realised his security interest and the proceeds thereof are inadequate to repay the debts owed to him, the repayment of the balance debts do not rank in  priority over the repayment to unsecured creditors and can be paid out of the liquidation assets only after payments have been made in accordance with Section 53 (1) (a)(b)(c) and (d). On the other hand, Section 178 makes no distinction between the debts due to secured creditors who have relinquished their security to the common pool and the balance debts due to secured creditors who have realised their security separately and the repayment of both of such debts rank prior to that of unsecured debts..

Completion of Administration

In terms of Section 137, on completion of the administration and distribution of the estate of the Guarantor the Bankruptcy Trustee shall convene a MoC. The Bankruptcy Trustee shall furnish to the MoC a report of the administration and distribution of the Bankruptcy Estate. The creditors shall within a period of seven days of the receipt of the report approve the report as submitted by the Bankruptcy Trustee.

Modification/ Recall of Bankruptcy Order

The AA may, on application or suo motto modify or recall the Bankruptcy Order irrespective of the fact as to whether the Guarantor is discharged or not. The modification or calling back of a Bankruptcy Order can only be made in certain circumstances viz.;

  • There exists an error apparent on the face of such Bankruptcy Order; or
  • Where bankruptcy debts as well as the expenses in relation to bankruptcy have either been paid off or are secured as per the satisfaction of the AA.

Where the Bankruptcy Order as passed is modified or recalled by the AA, then any sale or alienation of property or payments made by the Bankruptcy Trustee shall be valid. It is important to note that the property as disposed of post-discharge order shall remain in possession of the person whom AA shall appoint and in case of non-appointment of any person it shall vest back to the Guarantor on such terms as the AA deems fit. The modified order as passed after the passing of the Bankruptcy Order shall be applicable on all the creditors whose debts remain due thereby forming a part of the Bankruptcy Process.

Discharge Order

After the approval by the creditors of the completion of the administration or after a period of one year from the bankruptcy commencement date whichever is earlier, the Bankruptcy Trustee shall approach the AA for seeking a discharge order in terms of Section 138 of the Code. On receipt of the application, the AA shall pass a discharge order and the Guarantor shall be discharged from all bankruptcy debts, subject to the provisions of Section 139 of the Code.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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