oppn parties Loan Default: Personal Guarantees Can Be Invoked Even If IBC Proceedings Have Begun, Says Supreme Court

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Loan Default: Personal Guarantees Can Be Invoked Even If IBC Proceedings Have Begun, Says Supreme Court

By Sunil Garodia
First publised on 2021-05-22 13:22:08

About the Author

Sunil Garodia Editor-in-Chief of indiacommentary.com. Current Affairs analyst and political commentator.

The Supreme Court has ruled that despite insolvency proceedings starting under the IBC, the personal guarantees of promoters and others, given in availing loans, will stand and creditors will be able to invoke them to recover their dues. The case came up before the court as promoters of several companies that have gone into bankruptcy proceedings challenged the legality of a government circular that allowed banks to invoke their personal guarantees. The court upheld the validity of the said notification. The court order covers guarantors, co-guarantors and co-obligators.

This was necessary for two main reasons. First, when the companies promoted by these entrepreneurs avail loans (sometimes huge amounts just on the basis of a project without corresponding asset value that covers the loan amount), the lenders sanction them such loans on the basis of the promoter's standing, reputation and personal wealth. Hence, when promoters borrows for their company by providing personal guarantees, they are in effect letting the lender know that in case the company fails to repay the loan, they would make it good from their personal assets. That is the level of confidence the promoters have in their project and that is why they are willing to put their personal wealth on line. It needs to be understood that this forms a major part in the calculations of the lenders. Hence when the company goes bust and is unable to repay the loan, regardless of the fact whether IBC proceedings have begun or not, the personal guarantees of the promoters must always be invoked. It is not as if they can avail of the good times and wash their hands off when things go bad.

Secondly, while it is not true of all promoters, it is often seen that the personal wealth of promoters of rogue companies keeps on increasing while the companies promoted by them and recipients of huge public money in the form of bank loans keep sinking. It is very difficult to prove any connection between the two but it is not unheard of for promoters to indulge in all kinds of financial skullduggery to bleed these companies dry. In that case too, promoters who have provided personal guarantees need to be held to account and lenders are entitled to recover their dues from their personal wealth.

This order is likely to have a sobering effect on promoters who provide personal guarantees hoping that they will never be invoked once the IBC proceedings start. This was a grey area in the IBC and the Supreme Court order has now set things right. It will also allow banks to make more informed lending decisions as they now have legal backing to invoke such guarantees even if the companies go bankrupt and the IBC is brought into play by creditors.