SC ruling on creditors invoking personal guarantees
24/05/2021

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Context:

  • Recently, the Supreme Court has ruledthat creditors can proceed against promoters of defaulting companies to recover debt if such promoters have given personal guarantees to secure funds.
  • The top court has also said that lenders can also proceed against the promoters of a defaulting company even when the corporate insolvency resolution process of the firm itself has not been completed.

SCstand on personal insolvency under IBC:

  • Mere approval of a resolution plan for a debt-laden company does not automatically discharge a promoter from their liability in lieu of the personal guarantee they had given to secure the funding for the company.
  • Since personal guarantees from promoters are a kind of assurance to lenders that the monies being borrowed will be returned, the apex court has said that under the contract of guarantee, the liability of the promoter will be over and above the liabilities of the company. This ruling allows them to pursue promoters for additional recovery of debt.

About personal guarantee:

  • A personal guarantee is most likely to be furnished by a promoter or promoter entity when the banks demand for collateral which equals the risk they are taking by lending to the firm, which may not be doing so well.
  • It is different from the collateral that firms give to banks to take loans, as Indian corporate laws say that individuals such as promoters are different from businesses and the two are very separate entities.
  • A personal guarantee, therefore, is an assurance from the promoters or promoter group that if the lender allows them the fund, they will be able to turn around the loss-making unit and repay the said loan on time.

Stand of government

  • Bad loans have been a major problem for banks and financial creditors over the past decade. Promoters had been able to secure funds from banks without the due diligence in most cases because of their past transaction history.
  • Government, in December 2019, introduced the provision which gave banks the power to move application for initiation of insolvency against personal guarantors to corporate debtors.
  • Finance ministry nudged banks to also pursue personal insolvency cases against promoters who had furnished personal guarantees for the loans taken by their firms, which later was not re-payed as per the agreed schedule.
  • Both these steps were taken to make promoters more liable for their actions and to check the practice of securing monies for a particular project but then diverting it to other projects or works.

Impact on promoters:

  • In December 2019, when the government came out with the notification on personal insolvency, the provisions were challenged initially by as many as 19 promoters before different high courts.
  • They claimed that it was always a management board that ran the company and therefore the promoters alone should not be held liable for the default on debt repayment.
  • By the time the Supreme Court transferred all the cases to itself in December 2020, as many as 75 promoters and guarantors had challenged the personal insolvency provisions.
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