SC empowers banks to chase defaulting promoters invoking personal guarantees: 5 questions answered

In an important development, the Supreme Court (SC) on May 21 dismissed pleas by various promoter guarantors against lenders launching insolvency proceedings against promoter guarantors.

With this ruling, the SC has affirmed the November 2019 notification issued by the Government under the Insolvency and Bankruptcy Code (IBC) that permitted lenders to invoke personal insolvency proceedings against promoter guarantors of companies facing Corporate Insolvency Resolution Process (CIRP). The judgment decided on 75 petitions that challenged the notification.

What is the significance of this ruling?

Although the Government notification enabled banks to proceed against the defaulting corporate promoters invoking their personal guarantees, banks have been finding it tough to move against powerful promoters as many challenged this legally. In October, 2020, all the petitions challenging the notification were transferred from high courts to the SC and the apex court reserved its judgment in the matter in March 2021. With the SC now dismissing the petitions against the lenders, banks are now more empowered to chase  defaulting corporate debtors invoking the personal guarantees.

What are personal guarantees? How does it work?

When a loan is drawn by a company, certain assets are marked as collateral against the loan so that banks can recover the money selling those assets if the loan is defaulted. A loan is defaulted if there is no repayment of the interest amount of principal in 90 days. Banks need to set aside more money (provisions) to cover such loans. Personal guarantees are beyond the normal collaterals. As the name suggest, a personal guarantee by promoter is a promise to the banks that the guarantor promoter will repay the money if the company fails to do so. This enables banks to claim even the personal assets of the guarantor promoter if the firm fails to pay back the money. This is essentially the purpose of the personal guarantee.

Do banks use this provision?

Earlier, banks were hesitant to use personal guarantees. But with a spike in corporate NPAs and in the backdrop of the Government notification in 2019, more banks have started invoking personal guarantees to recover money from defaulting promoters. But, lenders have not been very successful in recovering money as promoters dragged lenders to courts against using this provision.

Who gets impacted with the SC ruling?

The move can be a setback for promoter guarantors such as Anil Ambani, Sanjay Singhal, Venugopal Dhoot and Kapil Wadhawan who had challenged the invocation of the IBC against promoter guarantors. Even in cases like Kingfisher, which are not in IBC Court, banks can now more aggressively chase defaulting promoters. One big example is the Kingfisher-Vijay Mallya case. Banks have invoked the personal guarantee furnished by Mallya later as there was nothing much to recover from other collaterals submitted by Mallya such as Kingfisher brand and certain real estate assets. There are many other cases like this where personal guarantees against the promoters have been invoked. The SC move is expected to make promoters more accountable for the loans drawn by their companies.

What are the legal experts saying on SC ruling?

According to Misha, a partner at Shardul Amarchand Mangaldas & Co, the Supreme Court while pronouncing its decision upholding the validity of the the notification has clearly held that upon 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-obligors as well." In simple words, the SC has affirmed that corporate guarantor cannot escape the responsibility of balance repayment even post resolution if there is a personal guarantee.