Supreme Court ruling on creditors invoking personal guarantees

Context

Supreme Court has ruled that creditors can proceed against promoters of defaulting companies to recover debt if such promoters have given personal guarantees to secure funds even when the corporate insolvency resolution process of the firm itself has not been completed.

What is a personal guarantee?

• A personal guarantee is furnished by a promoter or promoter entity when the banks demand for collateral which equals the risk they are taking by lending to the firm, which are at risk of default.
• It is an assurance from the promoters or promoter group which they will be able to turn around the loss-making unit and repay the said loan on time.
• It is different from the collateral that firms give to banks to take loans.
• Promoters are different from businesses and the two are separate entities.

What was the government stand on this?

• Promoters had been able to secure funds from banks because of their past transaction history, which may lead to Bad loans accumulation.
• To put a stop to this, the government had in December 2019 introduced the provision that gave banks the power to move application for initiation of insolvency against personal guarantors to corporate debtors.
• Additionally, the finance ministry nudged banks to also pursue personal insolvency cases against promoters who had furnished personal guarantees for the loans taken by their firms, which later was not re-payed as per the agreed schedule.
• Both these steps made promoters more liable for their actions and to check the practice of diverting money to other projects or works.

What did the Supreme Court say about personal insolvency under IBC?

• SC said that mere approval of a resolution plan for a debt-laden company does not automatically discharge a promoter from their liability in lieu of the personal guarantee they had given to secure the funding for the company.
• Since personal guarantees from promoters are a kind of assurance to lenders that the monies being borrowed will be returned, the liability of the promoter will be over and above the liabilities of the company.
• Since lenders are forced to take a haircut on their pending dues when a resolution plan is approved for a debt-laden company, the ruling by the Supreme Court allows them to pursue promoters for additional recovery of debt.