The Supreme Court has upheld a government moves to allow lenders to initiate insolvency proceedings against personal guarantors, who are usually promoters of big business houses, along with the stressed corporate entities for whom they gave a guarantee.

What is the Judgement?

• The judgment has allowed creditors, usually financial institutions and banks, to move against personal guarantors under the Indian Bankruptcy and Insolvency Code (IBC) was “legal and valid”.
• The November 15, 2019 notification was challenged before several High Courts initially.
• The apex court said there was an “intrinsic connection” between personal guarantors and their corporate debtors.

What is a personal guarantee? How do promoters use this route to get funds?

• A personal guarantee is most likely to be furnished by a promoter or promoter entity when the banks demand collateral which equals the risk they are taking by lending to the firm, which may not be doing so well.
• It is different from the collateral that firms give to banks to take loans, as Indian corporate laws say that individuals such as promoters are different from businesses and the two are very separate entities.
• A personal guarantee, therefore, is an assurance from the promoters or promoter group that if the lender allows them the fund, they will be able to turn around the loss-making unit and repay the said loan on time.

Impact of the move

• The apex court ruling will help banks go after those who have offered guarantees to recover dues in case the resolution amount is short of the claims filed by them in the National Company Law Tribunal.
• Over the years, many companies have repeatedly defaulted in loan repayment and got banks to restructure the debt, often citing systemic issues.
• But as part of the clean-up initiated five years ago, the IBC was enacted and banks were told to go after those who were not paying their dues.

About the Insolvency and Bankruptcy Code, 2016

• IBC is the bankruptcy law of India that seeks to consolidate the existing framework by creating a single law for insolvency and bankruptcy.
• It is a one-stop solution for resolving insolvencies which previously was a long process that did not offer an economically viable arrangement.
• The code aims to protect the interests of small investors and make the process of doing business less cumbersome.

Key features of the code

(1) Insolvency Resolution:

• The Code outlines separate insolvency resolution processes for individuals, companies, and partnership firms. The process may be initiated by either the debtor or the creditors.
• A maximum time limit, for completion of the insolvency resolution process, has been set for corporates and individuals.

(2) Insolvency regulator:

• The Code establishes the Insolvency and Bankruptcy Board of India, to oversee the insolvency proceedings in the country and regulate the entities registered under it.
• The Board will have 10 members, including representatives from the Ministries of Finance and Law, and the Reserve Bank of India.

(3) Insolvency professionals:

• The insolvency process will be managed by licensed professionals.
• These professionals will also control the assets of the debtor during the insolvency process.

(4) Bankruptcy and Insolvency Adjudicator:

The Code proposes two separate tribunals to oversee the process of insolvency resolution, for individuals and companies:

1. the National Company Law Tribunal for Companies and Limited Liability Partnership firms; and
2. the Debt Recovery Tribunal for individuals and partnerships

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