Bad loans: SC allows banks to invoke personal guarantees of defaulters

Apex court says approval of resolution plan does not ipso facto discharge a personal guarantor (of a corporate debtor) of his or her liabilities under contract of guarantee

The Supreme Court on Friday upheld a government notification of 2019 to invoke personal guarantees of promoters whose companies defaulted on bank loans.

The court ruling will allow banks to file personal bankruptcies against top Indian promoters whose companies have been sent to the National Company Law Tribunal (NCLT) for debt resolution.

The Insolvency and Bankruptcy Code (IBC) was enacted in 2016 and the government amended the IBC in November 2019 and gave additional powers to lenders to invoke the personal guarantees of defaulters.

Lenders have invoked the personal guarantees of companies including Bhushan Steel, Bhushan Power and Steel, Punj Lloyd, and Reliance Communications, which were sent to the NCLT for defaulting on bank loans.

Some of these promoters have moved high courts across India when banks started invoking their personal guarantees. The Supreme Court later transferred all the cases to itself following petitions from Indian lenders.

In its order the Supreme Court Bench, led by Justice L Nageshwara Rao and Justice S Ravindra Bhat, held that approval of a resolution plan did not ipso facto discharge a personal guarantor (of a corporate debtor) of her or his liabilities under the contract of guarantee.

“As held by this court, the release or discharge of a principal borrower from the debt owed by it to its creditor, by an involuntary process, i.e. by operation of law, or due to liquidation or insolvency proceeding, does not absolve the surety/guarantor of his or her liability, which arises out of an independent contract,” the bench wrote in its order.

The law will be prospective from December 1, 2019, and will be applied to those cases which were invoked after that date.

Lenders said with Friday’s judgment, it would be easier for them to bring erring promoters to cough up their dues.

Swaminathan Janakiraman, managing director (risk management and stressed assets), State Bank of India, said the judgment upheld constitutional validity (on invoking personal guarantees).

“However, it is difficult to put a number to possible upside to recovery as that would vary from case to case, depending upon the net worth of those providing guarantees. This ruling will bring better credit culture, compelling corporate debtors to cooperate for resolution. The promoter’s personal assets are also liable to be put into the IBC process now. The corporate debt resolution process is expected to be a more efficient process now,” he said.

Lawyers said the judgment provided the much-needed teeth to lenders as far as recovery action with respect to personal guarantees was concerned.

“This will enable lenders to pursue simultaneous action against corporate debtors and personal guarantors, thereby ensuring that the promoters, being the provider of personal guarantees, have to deal with their own insolvencies and not become an impediment/roadblock to the insolvency proceedings of the corporate debtor. This will now cause promoters in the capacity of personal guarantors to try and agree on a settlement with the lenders whether under the repayment plan or by way of a one-time settlement under a private treaty basis and also undertake not to be an impediment in the resolution of the corporate debtor,” said Ajay Shaw, partner, DSK Legal.

Misha, partner at Shardul Amarchand Mangaldas & Co, said the Supreme Court had upheld the government notification, bringing into effect the provisions in relation to personal insolvency with respect to personal guarantors to corporate debtors.

“The constitutional validity of notifying such provisions only to one category of individuals, i.e. personal guarantors was challenged before the Supreme Court by way of several writ petitions. The Supreme Court, while pronouncing its decision upholding the validity of the said notification, also held that upon the approval of a resolution plan for a corporate debtor, the liability of the personal guarantor for the balance does not get extinguished. This will help settling the jurisprudence finally on simultaneous initiation and proceeding with insolvency resolution process against principal borrower and guarantors or co-guarantors/co-obligators as well,” she said.

Promoters of several Indian companies had earlier accused their professional managers of fraud and diverting company funds. But lawyers said they would not get any respite from the IBC as lenders will now invoke their personal guarantees.

“This amendment in the long run will prove to be highly beneficial for stakeholders and will also increase the chances of settlement,” said Ruby Singh Ahuja, senior partner, Karanjawala & Company.

With inputs from Abhijit Lele and Ruchika Chitravanshi