Explained: What is the Supreme Court ruling on creditors invoking personal guarantees?
Six months after transferring all personal insolvency matters to itself, the Supreme Court ruled that creditors can sue promoters of failing businesses to collect their debts whether these promoters have given personal guarantees to obtain funds. The higher court also said that lenders can also sue promoters of a defaulting company even when the insolvency resolution process of the company itself is not complete.
What did the Supreme Court say about personal insolvency under IBC?
One of the most important things the SC has said is that the mere approval of a resolution plan for an indebted company does not automatically relieve a sponsor of their liability instead of the personal guarantee they had given to guarantee. the financing of the company. .
Since the promoters’ personal guarantees are a kind of assurance for the lenders that the borrowed money will be repaid, the Supreme Court said that under the guarantee contract, the promoter’s liability will exceed the responsibilities of the company.
Since lenders are, in most cases, forced to reduce their outstanding dues when a resolution plan is approved for an indebted company, the Supreme Court ruling allows them to sue promoters for further recovery of the debt. the debt.
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What is a personal guarantee? How do promoters use this channel to obtain funds?
Personal collateral is most likely to be provided by a promoter or promoter entity when banks require collateral equal to the risk they take in lending to the business, which may not be as good.
This is different from the guarantee that companies give to banks to take out loans because Indian corporate laws say that individuals such as promoters are different from companies and the two are very different entities. A personal guarantee is therefore an assurance of the promoters or group of promoters that if the lender allows them the fund, they will be able to reverse the deficit unit and repay said loan on time.
Why does the government want developers to be more responsible for the funds they borrow?
Bad debts have been a major problem for banks and financial creditors over the past decade. Add to that, the promoters had been able to obtain funds from banks without due diligence in most cases due to their trading history.
To put an end to it, the government introduced in December 2019 the provision that gave banks the power to transfer the insolvency request against personal guarantors to debtor companies.
In addition, the Ministry of Finance urged banks to also pursue personal insolvency cases against promoters who had provided personal guarantees for loans taken by their companies, which were subsequently not repaid on schedule. agreed.
These two measures were taken to make developers more accountable for their actions and to verify the practice of obtaining funds for a particular project and then diverting them to other projects or works.
On which promoters will the Supreme Court decision have an impact in the near future?
In December 2019, when the government issued the personal insolvency notice, the provisions were initially challenged by as many as 19 developers in different high courts who claimed that it was still a board of directors that ran the business and that, therefore, the promoters alone should not be held responsible for the default of debt repayment. By the time the Supreme Court handed over all cases to itself in December 2020, as many as 75 promoters and guarantors had challenged the personal insolvency provisions.
Among the biggest names likely to be affected by the judgment are former promoters of Bhushan Steel and Power Sanjay Singhal and his wife Aarti Singhal had provided personal guarantees worth up to Rs 24,550 crore to take out loans. with a bank consortium led by the State Bank. of India (SBI).
Likewise, banks are now likely to go ahead with a personal insolvency plea against Venugopal Dhoot and other members of the Dhoot family who were in the capacity of promoter of Videocon and had provided personal guarantees to obtain funds.
Former Reliance Communications promoter Anil Ambani is also one of the biggest names banks are likely to move quickly to collect as many dues as possible.