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Why personal guarantors will now face trouble if their companies can’t repay debt

Personal guarantors have now been brought under Insolvency & Bankruptcy Code, meaning lenders can take them to tribunals alongside their companies.

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New Delhi: Starting last Sunday, personal guarantors to companies facing insolvency proceedings have also been brought under the purview of the Insolvency and Bankruptcy Code (IBC).

The new rules and regulations will allow creditors to simultaneously proceed against the principal borrower, i.e. the company, and the personal guarantor before National Company Law Tribunals.

Up until now, the code only covered insolvency resolution and liquidation of corporate debtors.

The move comes on the heels of the judgment in the Essar Steel case, in which the Supreme Court ruled that lenders can also go after guarantors for debt that hasn’t been settled under the resolution plan.

Experts are hailing the judgment and the central government’s notification, asserting that this would enable creditors to recover a higher amount in a shorter span of time. ThePrint explains.

Also read: How fugitive Sandesaras getting Sterling Biotech back at discount pokes holes in IBC process

Phased implementation

The move forms a part of the government’s efforts to bring in provisions for resolution for individuals under the code in a phased manner.

Section 1(3) of the code allows the central government to notify different provisions of the code at different dates, to allow its implementation bit by bit.

The provisions of the code related to corporate processes — insolvency resolution, fast-track resolution, liquidation and voluntary liquidation — had already been operationalised.

In line with this, the government has now notified certain provisions of the code, making them applicable to corporate debtors’ personal guarantors.

It has notified rules and regulations for insolvency resolution of personal guarantors: The Insolvency and Bankruptcy (Application to Adjudicating Authority for Insolvency Resolution Process for Personal Guarantors to Corporate Debtors) Rules, 2019, and the IBBI (Insolvency Resolution Process for Personal Guarantors to Corporate Debtors) Regulations, 2019.

The government has also notified the rules and regulations for bankruptcy of personal guarantors: Insolvency and Bankruptcy (Application to Adjudicating Authority for Bankruptcy Process for Personal Guarantors to Corporate Debtors) Rules, 2019, (“Bankruptcy Rules”) and the IBBI (Bankruptcy Process for Personal Guarantors to Corporate Debtors) Regulations, 2019 (“Bankruptcy Regulations”).

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.

They state that insolvency proceedings can be initiated against personal guarantors who have committed a default of at least Rs 1,000 on account of a guarantee.

Also read: Modi govt bringing NBFCs under bankruptcy code will clog the tribunal even more

Who is a personal guarantor?

The Bankruptcy Rules define a “guarantor” as “a debtor who is a personal guarantor to a corporate debtor and in respect of whom guarantee has been invoked by the creditor and remains unpaid in full or part”.

In simpler terms, a guarantor is a person or an entity that promises payment of another person’s debt, in case the latter fails to pay it off.

Several promoters had to give personal guarantees on loans for their companies after 2013, when the Reserve Bank of India (RBI) made it mandatory for banks to obtain personal guarantees of promoters in all cases of restructuring.

For instance, Jet Airways founder Naresh Goyal, whose company owes lenders more than Rs 11,000 crore, had given a personal guarantee for some of the loans. So did Amtek Auto’s Arvind Dham and Bhushan Power & Steel chairman Sanjay Singal, who is also facing an Enforcement Directorate inquiry for siphoning off funds.

Up until now, Goyal, Dham or Singal could only be tried in the Debt Recovery Tribunal (DRT) under the old Presidency Towns Insolvency Act, 1902. However, with the amendment, banks will now be able to take recourse against them under the IBC.

It would also increase chances of recovery, as promoter assets could also be attached.

Also read: Common sense wins in Essar Steel bankruptcy case, eases private equity fears

SC set the record straight in Essar Steel case

In the Essar case, Prashant Ruia, Essar Steel’s promoter, had given a personal guarantee for payment of the loan given to Essar. Since Essar had failed to pay off its debts, a few banks had tried to go after Ruia, but only got disappointment from the National Company Law Appellate Tribunal, which ruled that Ruia’s ‘right of subrogation’ became ineffective since Essar Steel’s debt has been cleared under the resolution plan.

The right of subrogation, rooted in the Contract Act, essentially allows the guarantor to step into the shoes of the lenders to recover any amount it has paid to clear the debt, from the corporate borrower — in this case, Essar Steel.

The NCLAT ruling meant that lenders could not go after Ruia for the remaining amount of their debt. So, for instance, if the financial creditors were receiving 90 per cent of their debt under the resolution plan, they could not go after the guarantor for the remaining 10 per cent.

However, the position stands changed after the Supreme Court judgment last month, which allowed lenders to go after guarantors for debt that hasn’t been settled under the resolution plan.

Also read: Why the Essar Steel case pushed Modi govt to give more teeth to bankruptcy code

Parallel remedies

Delhi-based IBC lawyer Deepak Joshi told ThePrint that with this notification, the same mechanism and procedure available under IBC will be applicable for personal guarantors.

“Now the personal guarantors will also have to remain agile, because action would also lie against them. Earlier, under any resolution plan, it was mentioned that any claim against personal guarantors have also been set at naught. Even then, a third party can raise an IBC action against a personal guarantor now,” Joshi said.

He also explained that the remedy against the guarantor would be a parallel one, saying: “Proceedings against the personal guarantor can be initiated before the same bench in which proceedings against the corporate debtor are pending. In that sense, it is a parallel remedy to the lenders. This follows the well settled law that surety/guarantor’s liability is co-extensive with the principal borrower.”

Advocate Aditya Parolia, partner at PSP Legal, also pointed out that earlier, no action could be initiated against personal guarantors, and lenders had to approach regular courts to invoke these guarantees.

“It used to take huge amounts of time and financial resources,” he said. “Right now there is some confusion as to whether the same insolvency resolution professional (IRP) would be appointed. Procedural difficulties still need to be looked into. There is no clarity, but this is a welcome move that would strengthen the Indian economy, by increasing chances of recovery.”

Also read: Supreme Court’s ruling on bankruptcy proceedings gives homebuyers new power


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