The National Company Law Tribunal has stayed a Rs 6.25-crore settlement of insolvency proceedings against Essel Group founder Subhash Chandra involving personal guarantees given by him. Rupesh Choudhury explains what the Insolvency and Bankruptcy Code says about the rights and liabilities of personal guarantors.
l What is a personal guarantee?
A GUARANTEE IS a special type of contract under the Indian Contract Act, under which one person undertakes to discharge the obligation of another in case the latter defaults. The person giving the guarantee is the ‘surety’ or ‘guarantor’; the person whose default triggers the guarantee is the ‘principal debtor’, and the person to whom the guarantee is given is the ‘creditor’. When a creditor lends to a company, it may seek security over the borrower’s assets. Where that security is inadequate, a third party may provide additional security or a guarantee. A guarantee is a commitment by the guarantor to meet the borrower’s obligation in the event of default. The guarantor may be a company or an individual; where the guarantor is an individual providing a guarantee to a corporate debtor, the Insolvency and Bankruptcy Code (IBC) refers to him as a ‘personal guarantor’.
l What is the guarantor’s liability?
THE GUARANTOR’S LIABILITY flows from the contract of guarantee. Under Section 128 of the Contract Act, it is, unless the contract provides otherwise, co-extensive with that of the principal debtor. The liability is therefore joint and several: upon default, the creditor may enforce the guaranteed debt against the guarantor, without first exhausting its remedies against the principal debtor.
Under Section 134, a release or discharge of the principal debtor by the creditor can discharge the guarantor. A discharge of the principal debtor by operation of law, however, such as through insolvency or liquidation, does not by itself discharge the guarantor. The Supreme Court has distinguished such involuntary statutory discharge from a release resulting from the creditor’s own act or agreement.
l Isn’t personal guarantee backed by assets?
A PERSONAL GUARANTEE is not asset-backed security in the sense of a mortgage or pledge. It is a personal covenant and a form of credit support.
A promoter’s personal guarantee may provide additional comfort to a lender, create ‘skin in the game’ and deter excessive risk-taking or diversion of funds. But it does not create a second pool of assets equal to the amount of the underlying loan; its recovery value ultimately depends on the guarantor’s resources and the law governing their enforcement.
l What are the options for a creditor to realise its dues against the guarantor?
GIVEN THE CO-EXTENSIVE and joint and several nature of the liability, the creditor may proceed against the principal debtor, the guarantor, or both simultaneously, and may also realise from collateral, subject to recovery being limited to the debt actually due. It need not first proceed against or exhaust its remedies against the principal debtor.
The creditor has remedies against the borrower(s), corporate or personal guarantor(s), and their assets under general recovery laws as well as under the IBC. The IBC, however, is not a debt-recovery mechanism. It provides a statutory process for resolving insolvency through a repayment plan and, where resolution fails, or the plan is not implemented, through bankruptcy. The IBC seeks rehabilitation of the personal guarantor rather than merely recovery from the guarantor’s estate, providing a more structured and objective route to discharge than the earlier Provincial Insolvency Act, 1920.
l What is a typical haircut for a personal guarantor in the IBC process?
THERE IS NO prescribed formula or standard haircut, a concept typically associated with recovery rather than insolvency resolution. The outcome of an insolvency proceeding, whether a resolution plan for a corporate debtor or a repayment plan for a personal guarantor, depends on the resources available, rather than simply on the amount of the underlying loan or guarantee. The relevant question is realisation against face value of the guarantee, but whether creditors would fare better under the available alternatives than under the repayment plan.
This does not mean that a guarantor can escape liability by concealing or diverting assets. Concealment, diversion or fraudulent conduct may attract action under the IBC and other applicable laws, including criminal consequences where the statutory requirements are met. The IBC envisages insolvency resolution of the corporate debtor and its personal guarantors within a coordinated framework under the same Adjudicating Authority, recognising that the guarantor’s liability arises from the same underlying debt. Even where the personal guarantor is proceeded against separately, a repayment plan does not extinguish the creditor’s claim against the underlying borrower; recoveries from the borrower and guarantor are ultimately to be accounted for against the same underlying debt.
The writer is research associate at Dr. Sahoo Regulatory Chambers