The Cheat Sheet

Why personal guarantors under IBC are a worried lot

KR Srivats | Updated on September 30, 2020 Published on September 30, 2020

Top industrialists are now facing the music with personal guarantors being brought under the Insolvency and Bankruptcy Code in November 2019. Also, banks have been directed by the Finance Ministry to set up a monitoring mechanism to pursue personal insolvency proceedings against all those promoters who had furnished personal guarantees for borrowing by their companies and that later turned bad. Put simply, this has opened a can of worms.

Should the Finance Ministry not deserve a pat for bringing personal guarantees under the IBC?

Certainly, but most of the credit should go to the Supreme Court. The apex court, in July showed the mirror to the Finance Ministry and asked why banks are not invoking the new remedy in law. Some ₹1.8-lakh-crore worth of guarantees are now at stake.

So, has Finance Ministry now gone on overdrive?

Not really, but it has certainly nudged banks to use this remedy. By putting out an advisory, the FinMin has clearly put the ball in banks’ court.

Well, IBC has been suspended from March 25 due to Covid. Why then fret about insolvency proceedings against personal guarantors?

There is a catch. The IBC suspension — which will be valid till December 25 — is only for initiation against corporate debt default arising on or after March 25. It does not disallow action against the personal guarantor of corporate debtor.

Is it going to be easy for lenders to get back their money?

No no, don’t count the chickens before they are hatched. Promoters — the big boys — who are at the receiving end have already challenged before the Supreme Court and the High Court the very vires of the provisions relating to personal guarantors. It is difficult to say which way the law will evolve on this front.

So is it going to be party time (more fees) for lawyers handling such cases for promoters?

The lawyers are certainly going to burn the midnight oil to bring out the current lacuna and lack of clarity in the law around insolvency proceedings against personal guarantors.

What could be the issues of clarity or lacuna?

There are several — there’s no clarity on double dipping; extinguishment of liability of personal guarantors due to a successful resolution process of the corporate debtor; the maintainability of parallel proceedings against the corporate debtor and the personal guarantors ; and right of subrogation for the guarantor.

Did you say double-dipping?

Yes. For the same set of debt, filing a claim by the same financial creditor in two separate Corporate Insolvency Resolution Process (CIRP) will tantamount to a “double-dip”. NCLAT is of the view that once a CIRP is initiated against one of the corporate debtors (either the principal debtor or the corporate guarantor), on the basis of the claim of a financial creditor, the same creditor cannot file a second application for initiating CIRP against other corporate debtors for the same set of claim and default. The Supreme Court has to clarify, as there’s an appeal before it on this matter.

What’s this subrogation issue?

Under contract law, if the guarantor pays the debt — either partially or in full — owed by a corporate debtor, then the guarantor will have the right to recover the amount from the borrower. The apex court had, in the Essar Steel case, moved away from the settled principles under the Contract Act and clarified that guarantors are not entitled to right of subrogation, if the resolution plan states so. Thus a guarantor’s remedy against the borrower is eroded. Now, this may put the personal guarantor — who is most often the promoter — in a fix.

What then is the way out?

Well, all eyes are now on the Delhi High Court and the Supreme Court to show the way forward. This is only going to play out as a Test match and not as T20 match.

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Published on September 30, 2020
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