(Representative image. Source: ShutterStock)
Permitting banks to invoke personal guarantees can speed up the recovery of dues besides preventing related-party transactions by defaulting companies, experts said.
This could mean a reduction in the amount that lenders forego, seven legal and banking experts told Moneycontrol on May 11. Banks typically sacrifice a portion of their loans during the resolution process of a stressed borrower.
The Supreme Court
, in a written order dated May 6, said creditors can invoke personal guarantees for the recovery of corporate loans, even if the insolvency process hasn’t been initiated against a corporate debtor or stressed borrower. A personal guarantee is an agreement between a person – the promoter or owner of an institution – and a lender. The individual guarantor is responsible for paying back a loan if the business defaults.
The National Company Law Appellate Tribunal (NCLAT) passed an order in January that initiation of corporate insolvency was not mandatory to start the insolvency process against the personal guarantor of a corporate loan. This order was challenged in the Supreme Court in the State Bank of India versus Mahendra Kumar Jajodia case.
The Supreme Court, in its latest order, observed that there was no “cogent reason to entertain the appeals.” The NCLAT’s judgement does not warrant any interference, the court said. This means that financial creditors, mostly banks, need not wait for the bankruptcy process to be initiated against a company before invoking a personal guarantee.
This is the second time the Supreme Court has ruled in favour of lenders invoking personal guarantees to recover loans. In 2019, the government had enabled financial institutions to proceed with insolvency against promoters who were the personal guarantors of loans taken by defaulting companies. The top court had said that lenders could invoke personal guarantees in case the debt was not repaid under the resolution plan.
Boon for creditors
According to experts, the judgment assumes significance for lenders and will allow them to simultaneously invoke personal guarantees even as bankruptcy proceedings against defaulting companies are pending. This would speed up the process of recovering dues.
The ruling also assumes relevance as promoters may not be able to indulge in strategies to strip the company of its valuable assets or erode its value by indulging in related-party transactions, which may deter prospective bidders, according to Abhishek Swaroop, a partner at Saraf & Partners.
According to data from the Insolvency and Bankruptcy Board of India, applications invoking personal guarantees against corporate debtors filed by creditors surged to 637 as of March 2022 from 191 in FY21 and 16 applications in FY20. The total amount of debt currently stands at Rs 95,656.59 crore, while the guaranteed amount is Rs 71,672.65 crore, the data showed.
“If a case is currently under the corporate resolution process under the Insolvency and Bankruptcy Code, then lenders were anyways free to proceed with invoking personal guarantee(s) before the same National Company Law Tribunal,” said Nirav Shah, a partner at DSK Legal. “With this move, lenders now have the freedom to proceed against the personal guarantor before the NCLT having territorial jurisdiction directly.”
In the case of Essar Steel, former promoters Prashant Ruia and Ravi Ruia had given personal guarantees that were to be assigned to lenders only upon approval of ArcelorMittal’s resolution plan. The current ruling allows banks to pursue the promoters for additional recovery of debt before the insolvency process is initiated.
Bankers said the ruling will have a direct impact on personal insolvency proceedings in high-profile cases involving people such as Anil Ambani, the former promoter of debt-laden Reliance Communications and Reliance Capital. Banks could also invoke personal guarantees by Atul Punj, one of the promoters of Punj Lloyd, and Dheeraj Wadhawan, former promoter of Dewan Housing Finance, among others.
“The ruling has cleared doubts on discharge of debt,” said an official in the stressed assets department at a leading state-run bank, requesting anonymity.
“Prior to this judgment, there was a lot of back and forth when it came to invoking personal guarantee and a lot of legal appeals in multiple courts complicated and delayed the whole recovery process. This should now be done away with,” another official with a state-run bank added.
According to Rohit Singhal, chief executive of Masin Projects, a claims and arbitration advisory firm, the Supreme Court’s ruling will ensure that the promoters and directors are more cautious in giving personal guarantees now “and will not take such assurances lightly.”
However, the flip side is that it may affect the confidence of the business fraternity and genuine business failures will not be appreciated, Singhal added.
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