A recent order of the Ahmedabad bench of Debt Recovery Tribunal (DRT) dismissing SBI’s plea for invoking a personal guarantee extended by Essar Steel (ESIL) promoters has dealt a severe blow to the lenders. The order was on the grounds that secured creditors cannot trigger personal guarantees in the absence of any subsisting underlying debt due from the company.
Banks feel they now need to go back to the drawing board while approving any resolution plan vis-à-vis the provisions relating to personal guarantees of promoters of the debt-laden firms under insolvency.
ArcelorMittal and Nippon Steel had acquired ESIL in December 2017 for Rs 42,000 crore in one of the largest stressed-asset deals in the country.
Legal experts feel that the DRT has followed the principle that the guarantor’s liability cannot be divorced from the liability of the principal debtor, and thus rightly held that the personal guarantee cannot be invoked without an underlying debt. “Therefore, the DRT has affirmed the position that the benefit of the guarantee and security cannot be retained by the creditors if the underlying debt has been assigned. However, there is a need to resolve this dispute as the debt would still remain outstanding in the books of the assignee,” a corporate lawyer, who appears for various lenders in insolvency cases, said.
Affirming the DRT ruling, PDS Legal, managing partner, Tarun Gulati, said once the creditor’s claim gets extinguished by the resolution plan, the creditor cannot maintain a claim against the guarantor. “This is for the reason that once the primary liability gets extinguished, there is no question of a default of such primary liability. Consequently, the question of discharging the primary liability by the guarantor won’t arise,” he added.
SC lawyer Balaji Srinivasan has similar views. “The DRT judgment appears to be legally sound for the simple reason that the clock cannot be set back. This is because the resolution applicant has invested money, made business sustainable and now no debt remains,” he said, adding “the SBI should have exercised the commercial wisdom than when they were part of the CoC,” he said.
“If the underlying debt has been assigned pursuant to the IBC proceedings to the successful bidder then obviously personal guarantees cannot be invoked against erstwhile promoters. The debt they guaranteed is no more debt in the books of the original borrower. This judgement is a good development in the law relating to guarantees,” SC advocate-on-record Roohina Dua said.
The judgment will result in a paradigm shift in the outlook of the lenders as they would need to revisit how personal guarantee contracts are drafted.
According to SC lawyer Amar Dave, the implication which may arise from this ruling on various banks and FIs would undoubtedly be huge. The specific details of the resolution plan passed as far as the corporate debtor is concerned would need to be carefully perused in future under the scheme of IBC to ascertain the exact treatment of the original debts under the said scheme and whether any exclusions have been preserved under the said scheme, he said.
Moving forward, even the independent guarantee agreements would need to be structured being conscious of the latent/implicit implications arising under the scheme of IBC, he added.
The DRT’s view in respect of the liability of personal guarantors should apply to situations where a loan is assigned for consideration to a successful resolution applicant and the terms provide that on receipt of purchase consideration in full, the borrower would have no liability towards any assignor, according to SC senior lawyer Siddharth Bhatnagar. This is so because, in such a situation, there would be no existing debt that can be enforced against the personal guarantors, he said.
As a corollary, there should be no proceedings under Chapter III, Part III of the IBC against such guarantors (insolvency against individuals). At present, under Chapter III, an interim moratorium commences immediately on merely applying and before admission (unlike in Part II, where for corporate persons, the moratorium commences after admission of the Application). “This can lead to highly inequitable and prejudicial situations for an individual who may otherwise have no liability. Thus, this is an aspect of the IBC that may require a legislative re-look,” Bhatnagar said.