Personal Guarantors Liable for Corporate Debt

• 22 May 2021

Why in News

The Supreme Court of India has upheld the Central Government 2019 notification that allows lenders to initiate insolvency proceedings against personal guarantors.

• It will allow the lenders to recover their remaining debt from personal guarantors following the conclusion of the Corporate Insolvency Resolution Process (CIRP).
• The CIRP is a recovery mechanism made available to creditors as under the Insolvency and Bankruptcy Code, 2016 (IBC).

Key Points

• Background:
  
  • Definition: A personal guarantor is a person or an entity that promises payment of another person’s debt, in case the latter fails to pay it off.
  • Central Government Notification 2019: It brought personal guarantors to companies facing insolvency proceedings under the purview of the Insolvency and Bankruptcy Code (IBC).
    
    • Section 1(3) of the IBC code allows the central government to notify different provisions of the code at different dates, to allow its implementation bit by bit.
    • 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.
  • Simultaneously Proceedings: The new rules and regulations will allow creditors to simultaneously proceed against the principal borrower, i.e. the company, and the personal guarantor before the National Company Law Tribunal (NCLT).
    
    • Until now, the IBC code only covered insolvency resolution and liquidation of corporate debtors.
  • Counter Argument: The Central Government did not have the power to bring in IBC provisions selectively to personal guarantors of corporate debtors.
    
    • The singling out of guarantors is violative of the fundamental right to equality.
• Supreme Court Verdict:
  
  • Intrinsic Connection: There was an “intrinsic connection” between personal guarantors and their corporate debtors.
    
    • Section 60(2) of the IBC Code had required the bankruptcy proceedings of corporate debtors and their personal guarantors to be held before a common forum, the NCLT.
  • Adjudicating Authority: The adjudicating authority for personal guarantors will be the NCLT if a parallel resolution process is pending in respect of a corporate debtor for whom the guarantee is given.
    
    • The side by side bankruptcy proceedings before the same forum for both the corporate debtors and their personal guarantors would help the NCLT consider the whole picture.
• Concept of Guarantee: The concept of ‘guarantee’ is derived from Section 126 of the Indian Contracts Act, 1872.
  
  • A contract of guarantee is made among the debtor, creditor and the guarantor.
  • If the debtor fails to repay the debt to the creditor, the burden falls on the guarantor to pay the amount.
  • The creditor reserves the right to begin insolvency proceedings against the personal guarantor if the latter does not pay.
• Possible Benefits:
  
  • By initiating the insolvency proceedings against personal guarantors, there is a greater likelihood that they would “arrange” for the payment of the debt to the creditor bank in order to obtain a quick discharge.
  • The creditor bank would be prepared to take a haircut or forego the interest amounts so as to enable an equitable settlement of the corporate debt, as well as that of the personal guarantor.
  • It would result in maximising the value of assets and promoting entrepreneurship.

Note

• Insolvency: It is a situation where individuals or companies are unable to repay their outstanding debt.
• Bankruptcy: It is a situation whereby a court of competent jurisdiction has declared a person or other entity insolvent, having passed appropriate orders to resolve it and protect the rights of the creditors. It is a legal declaration of one’s inability to pay off debts.

Source: TH