Insolvency Proceedings against Personal Guarantors

News: The Supreme Court has upheld a government moves to allow lenders to initiate insolvency proceedings against personal guarantors, who are usually promoters of big business houses, along with the stressed corporate entities for whom they gave a guarantee.

Background:

  • A personal guarantor is a person or an entity that promises payment of another person’s debt, in case the latter fails to pay it off. Central Government Notification 2019 brought personal guarantors to companies facing insolvency proceedings under the purview of the Insolvency and Bankruptcy Code (IBC).
  • Section 1(3) of the IBC code allows the central government to notify different provisions of the code at different dates, to allow its implementation bit by bit.
  • These rules and regulations lay down the process for initiating insolvency resolution and bankruptcy proceedings against personal guarantors to corporate debtors, inviting claims from creditors, withdrawal of such applications, etc.
  • The new rules and regulations will allow creditors to simultaneously proceed against the principal borrower, i.e. the company, and the personal guarantor before the National Company Law Tribunal (NCLT). Until now, the IBC code only covered insolvency resolution and liquidation of corporate debtors.
  • The Central Government did not have the power to bring in IBC provisions selectively to personal guarantors of corporate debtors. The singling out of guarantors is violative of the fundamental right to equality.

Details of latest Judgement:

  • The judgment has allowed creditors, usually financial institutions and banks, to move against personal guarantors under the Indian Bankruptcy and Insolvency Code (IBC) was “legal and valid”.
  • The November 15, 2019 notification was challenged before several High Courts initially.
  • The apex court said there was an “intrinsic connection” between personal guarantors and their corporate debtors.

Concept of Personal Guarantee:

  • A personal guarantee is most likely to be furnished by a promoter or promoter entity when the banks demand 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.

Significance of the move:

  • The apex court ruling will help banks go after those who have offered guarantees to recover dues in case the resolution amount is short of the claims filed by them in the National Company Law Tribunal.
  • Over the years, many companies have repeatedly defaulted in loan repayment and got banks to restructure the debt, often citing systemic issues.
  • But as part of the clean-up initiated five years ago, the IBC was enacted and banks were told to go after those who were not paying their dues.

Insolvency and Bankruptcy Code, 2016

  • IBC is the bankruptcy law of India that seeks to consolidate the existing framework by creating a single law for insolvency and bankruptcy. It is a one-stop solution for resolving insolvencies which previously was a long process that did not offer an economically viable arrangement. The code aims to protect the interests of small investors and make the process of doing business less cumbersome.

Various institutions to facilitate resolution of insolvency are as follows:

  • Insolvency Professionals:A specialised cadre of licensed professionals is proposed to be created. These professionals will administer the resolution process, manage the assets of the debtor, and provide information for creditors to assist them in decision making.
  • Insolvency Professional Agencies:The insolvency professionals will be registered with insolvency professional agencies. The agencies conduct examinations to certify the insolvency professionals and enforce a code of conduct for their performance.
  • Information Utilities:Creditors will report financial information of the debt owed to them by the debtor. Such information will include records of debt, liabilities and defaults.
  • Adjudicating authorities:The proceedings of the resolution process will be adjudicated by the National Companies Law Tribunal (NCLT), for companies; and the Debt Recovery Tribunal (DRT), for individuals. The duties of the authorities will include approval to initiate the resolution process, appoint the insolvency professional, and approve the final decision of creditors.
  • Insolvency and Bankruptcy Board: The Board will regulate insolvency professionals, insolvency professional agencies and information utilities set up under the Code.  The Board will consist of representatives of Reserve Bank of India, and the Ministries of Finance, Corporate Affairs and Law.