Former Rajya Sabha MP Subhash Chandra is in the news again. This time, for a CBI enquiry into fraud allegations concerning his misrepresented net worth. The spotlight is back on the fragility of personal guarantees under the Insolvency and Bankruptcy Code, or the IBC.
The case has once again exposed the severe challenges of asset recovery post-default. It also highlights systemic failures in how lenders initially evaluate and accept these guarantees. Fixing this broken framework requires a dual approach: overhauling banking regulations to tighten origination standards, and amending bankruptcy laws to ensure swift enforcement.
The borrowing process generally follows a set path: a promoter sets up a company, puts in equity, and goes to a bank for the rest. The bank conducts its appraisal and offers a loan based on its assessment of the business plan, expected cash flows, the balance sheet, and the collateral offered by the company.
This is the standard limited liability structure — the company is a separate legal person, and its debts have nothing to do with the personal wealth of the promoter. However, more often than not, the bank demands more. It asks another company belonging to the same promoter for a “corporate’ guarantee or the promoter to sign a personal guarantee: a promise to repay from her own pocket if the company cannot.
Personal guarantors were brought within the ambit of the IBC in 2019. The company may go into insolvency; however, a corporate resolution plan does not automatically extinguish the guarantor’s liability. The guarantee survives the company’s insolvency, and the lender can pursue the individual separately. However, recoveries from personal guarantors have not been promising, with creditors realising roughly 1 per cent of admitted claims.
Part of the problem is that the IBC has not been able to tackle “avoidance transactions”. In such cases, guarantors’ assets get transferred to family members, offshore structures or through other means before the code can reach them.
By the time insolvency proceedings begin, the guarantors’ estate is often severely depleted. By the time a repayment plan is voted on, there is frequently very little left to distribute. The law does provide for clawing back diverted assets. However, these get stuck in the inability to conduct complex forensic tracing and protracted litigation.
Why do personal guarantees persist?
A personal guarantee is a peculiar feature of Indian credit markets. In more developed markets, personal guarantees are a feature of small-business lending, where the borrower and the owner are genuinely indistinguishable, and there is no meaningful balance sheet to appraise. They are largely absent from mid-market and large corporate credit.
One way to ask why personal guarantees persist is to think about the conditions under which the practice of personal guarantees would be a thing of the past.
First, there would need to be a clear and genuine separation between the promoter and the firm. That means dispersed shareholding, professional boards with real authority, and group structures transparent enough that a lender can see where the money actually goes. If one family controls the entity, and it is hard to observe how capital moves between related parties, then asking for a personal guarantee from the top of the food chain seems reasonable.
Second, banks would need to be able to price and absorb credit losses openly. This means the existence of credit appraisal capacity that can underwrite a business on its own merits. Further, it requires an institutional culture where a loan going bad is seen as a commercial failing, and not a personal one, with the thread of vigilance hanging around one’s neck. A personal guarantee is easy protection from this threat.
Third, banks would need a robust recovery process that ensures security can be enforced against the company, or a bankruptcy process that solves the collective action problem with other creditors. If there is little faith in this process, personal guarantees are seen as a way to ensure that the promoter remains at the negotiating table.
The IBC was supposed to make personal guarantees unnecessary. Corporate default was to be resolved through a time-bound process against the company’s assets. A decade on, the guarantee is asked for as routinely as ever. Resolutions run well past their statutory timelines, haircuts remain steep, and outcomes stay hard to predict at the sanction stage. Meanwhile, the deeper conditions have shifted very gradually. Promoter-led firms remain the norm and appraisal capacity remains thin, each slowing the other in turn.
Also read: Subhash Chandra repayment case isn’t the scandal everyone is making it out to be
Reforming the system
Given that personal guarantees are here to stay at least for the foreseeable future, how might we reform the system? The answer lies in fixing both how guarantees are given and how avoidance transactions are handled. On the banking side, personal guarantees often rely on a static net-worth certificate provided only at the time of loan sanction.
For most promoters, a significant portion of their net worth would be in their ownership of the borrowing companies. If these companies go into insolvency, the net worth would, obviously, nosedive. Banks must assess net worth independent of the value of the promoter’s ownership interest in the company they are lending to. Lenders must also transition to dynamic, continuous monitoring, potentially mandating quarterly or semi-annual filings of the guarantor’s global assets, tax returns, and liabilities, certified by a statutory auditor.
On the IBC, the government should consider specialised benches dedicated exclusively to avoidance transactions. If a personal guarantor transfers assets to a related party, within a defined look-back period (for example, three to five years before default), the burden of proof must rest with the guarantor to prove legitimate commercial justification, transferring assets back to the available pool when such justification fails to materialise.
While the Subhash Chandra episode raises a range of reactions — from outrage to perplexity — we should not lose sight of important lessons it holds for how banks should assess and monitor credit and how IBC can be made more effective.
Renuka Sane is managing director at TrustBridge, which works on improving the rule of law for better economic outcomes for India. She tweets @resanering. Harsh Vardhan is a management consultant and researcher based in Mumbai.
Views are personal.
(Edited by Saptak Datta)