M J Antony: Damocles' sword over guarantors

OUT OF COURT

The SC is yet to determine the liability of directors of sick units who stood as sureties.

The Sick Industrial Companies (Special Provisions) Act 1985 has proved to be a bad remedy to revive ailing units. Several defects in the law have come to light in the last two decades, like excessive protection to sick industries, providing for automatic stay of all proceedings, the necessity of consensus among secured creditors before finalising a revival scheme, lack of monitoring of sanctioned revival schemes and delays in winding up. A legislation intended to repeal the law and dissolve the BIFR and AAIFR was not implemented.

It is a measure of the poor drafting of the law and the resulting confusion in the judiciary that a crucial question involving the status of guarantors is still unresolved. Two Supreme Court judgements of recent years have given contrary interpretations regarding the role of guarantors of sick units which are under BIFR protection. A new bench of the court recently discovered this anomaly in the appeal, Zenith Steel Tubes & Industries vs Sicom Ltd, and referred the question to a larger bench for a definitive answer.

Very often, directors of companies stand personal guarantee for loans advanced to the companies. When the companies go under, the creditors proceed against the companies as well as the guarantors, whether they be directors or others. This multiplies proceedings and obstructs the BIFR's efforts to revive sick units. Therefore, this question should have been finally answered long ago. But it is still in a limbo, giving nightmares to the directors.

In the Zenith Steel case, the company defaulted in its payment of loans to the state finance corporation in 1998. Later it was declared sick and given over to the BIFR for rehabilitation. The creditor nevertheless moved against the company as well as the director who stood guarantee. In view of this situation, one of the directors who stood guarantee moved the Bombay high court and asserted that he could not be proceeded against in view of the bar on suits imposed by Section 22 of the Sick Industries Act. The high court rejected his plea and insisted that the liability of the guarantor was independent of that of the principal debtor and, therefore, the amount could be recovered from the guarantor.

There have been two views so far in the Supreme Court. In Kailash Nath Agrawal vs Pradeshiya Industrial & Investment Corporation (2003), the directors did not get total immunity from debt recovery proceedings. Though a suit against the company is barred by the Act, a proceeding for the recovery of money against a guarantor stood outside the protective net of Section 22.

However, in a more recent judgment, Paramjit Singh Patheja vs ICDS Ltd (2006), another bench of the same court ruled that any proceeding adopted to realise the debt would be prohibited under the above provision. The court stated in that judgment that the objective of Section 22 in protecting guarantors from legal proceedings was to ensure that a rehabilitation scheme should not be defeated by isolated proceedings against guarantors. It is this "anomalous situation" which is now attempted to be cured.

The controversy in the present case is a decade old, and an amendment to the Act on this point did not make the matter clearer. The judiciary also added its bit to the inconsistency in law. Whether the answer would come from the court before the law itself is repealed in a moot question.

Meanwhile, there is a move to transfer the role of the tribunals under the Sick Industries Act to the machinery set up under the Companies Act, like the Company Law Board or the National Company Law Tribunal. The government had earlier introduced the Sick Industrial Companies Repeal Act of 2003 to wind up the BIFR and replace it with the National Company Law Tribunal. However, the fate of the proposed tribunal itself is hanging in the balance as the SC is seized of its constitutional validity. Like the Competition Commission and other quasi-judicial tribunals, this tribunal has also hit a hurdle over the constitutional principles of the separation of powers and independence of judiciary.

Even so, the BIFR is valiantly moving onward, despite rumours of its imminent winding up. Set up in 1987, the number of companies knocking at its doors has constantly grown. The overwhelming majority were private companies. This has led to severe criticism of the mechanism set up under the Act. A former Central Vigilance Commissioner identified the Act as a source of corruption. He remarked that in our country, industries become sick, but not the industrialists. Despite such overwhelming evidence, tribunals are surviving on borrowed time.