Personal guarantors have no guarantee!

The Apex Court had cleared the ambiguity and concerns over the partial notification of the provisions in Part III of the Insolvency and Bankruptcy Code to enable the creditors to invoke the Personal Guarantee of the promoters of Corporate Debtor and affirmed the legal validity of the partial notification by the legislature. While deciding on writ petitions, pulled out from various High Courts in different part of the Country, the Supreme Court had clarified that the Personal Guarantors, though are individuals, are a separate class and, as sureties of the loans availed by the Corporate Debtor, they cannot shy away from the guarantees they had given to the financial institutions for the loans availed by the Corporate Debtor.


The scheme of the Code

When a Corporate Person(Company /LLP) is unable to meet its debt obligations, the creditors can approach the Adjudicating Authority, the National Company Law Tribunal(NCLT), for invoking the Corporate Insolvency Resolution Process (CIRP) against it. If satisfied with the contents of the application submitted by the Creditor, the NCLT shall admit the application and initiate the CIRP against the Corporate Debtor. On its initiation, the Resolution Professional shall step into the shoes of the promoters of the Corporate Debtor and strives to operate it as a going concern with the help of Committee of Creditors. The Resolution Professional , with the assistance and advice of Committee of Creditors, invites the interested buyers to take over the defaulting company along with its debts. The interested parties can submit the plan for takeover the corporate debtor before the Resolution Professional and Committee of Creditors for its consideration. The price and value of the (assets) corporate debtor is being arrived through a proper price discovery mechanism as envisaged in the Insolvency and Bankruptcy Code(IBC). In practical sense, a buyer who is agreeing to takeover a distressed asset shall look for a better price and he will negotiate with Committee to have a better deal in all aspects. During the negotiation and plan approval process, the Committee of Creditors, which consist only of financial institutions, may approve the best plan which is meeting all the specific parameters of the law. Once the Committee approves a plan, then the same shall be forwarded to the NCLT for its approval. NCLT after getting satisfied with the compliance of the plan with the law, approve the same. On approval of the plan, the same shall be binding on the corporate debtor and its employees, members including the Central Government, any State Government or any local authority to whom a debt in respect of the payment of dues arising under any law for the time being in force, such as authorities to whom statutory dues are owed, guarantors and other stakeholders involved in the resolution plan.


In most of the cases, the amount quoted by the buyer may not be sufficient to meet the entire debt obligations of the Corporate Debtor, considering various aspects such as valuation , economic conditions, cost for revival of the corporate debtor etc. As the scheme of the code is to ‘revive the corporate debtor and thereby rejuvenate the credit eco system’ , the recovery of the debt of the creditors is not the first priority. Due to that reason the creditors may have to forgo their money, either in part or in full, and make some compromises during the negotiation process. Once a plan is approved by the NCLT, then the Corporate Debtor is getting a fresh start in a clean slate and the creditors including its employees, members including the Central Government, any State Government or any local authority have to be satisfied with the allocation given to them in the Resolution Plan. The Corporate Debtor is fully relieved from its debt obligations and it is no more responsible for its previous debts.


Consequent to the approval of the plan, the old promoters are also getting relieved from all the liabilities and they can carry on with their life further. But, interestingly, due to the partial invocation of the provisions of the Part III of the Code, they are not getting relieved from the debt nets if they had given their personal guarantee to the creditors!


A free fall from top.

The banks , who are the lenders to the companies, shall always insists for personal guarantees of its promoters as well as the directors, as a pre-condition to extend the loan facilities. The said guarantee is to nullify the protection given to the promoters under the ‘limited liability clause’ of a company and to make them personally ‘unlimitedly liable’ for the debts of the company, in case of any default. A personal guarantor is a surety to the bank as he guarantees the bank to repay the debts in case the company is making default in repayment of its loan. While determining the fate of the Personal Guarantors, the Apex Court underlines that, the release or discharge of the principal borrower(Corporate Debtor) from the debt owed by its creditor, by an involuntary process ie by operation of law, or due to liquidation or insolvency proceedings, does not absolve the surety/guarantor of his or her liability, which arises out of an independent contract and also observed that the same logic applies to personal grantors of corporate debtors. While dismissing the petitions, the Court observed thus:


111. In view of the above discussion, it is held that approval of a resolution plan does not ipso facto discharge a personal guarantor (of a corporate debtor) of her or his liabilities under the contract of guarantee. As held by this court, the release or discharge of a principal borrower from the debt owed by it to its creditor, by an involuntary process, i.e. by operation of law, or due to liquidation or insolvency proceeding, does not absolve the surety/guarantor of his or her liability, which arises out of an independent contract.

112. For the foregoing reasons, it is held that the impugned notification is legal and valid. It is also held that approval of a resolution plan relating to a corporate debtor does not operate so as to discharge the liabilities of personal guarantors (to corporate debtors).


The question of finality of the resolution plan.

The Court while clarifying the finality aspect of the approved resolution plan observed that , though on approval of the resolution plan by the NCLT the debts of the corporate debtor is getting extinguished, it is not restraining the creditors from proceeding against the personal grantors separately for the recovery of the balance due amounts, which was not recovered from the resolution plan. In this regard, the Supreme Court observed :


"The rationale for allowing directors to participate in meetings of the CoC is that the directors' liability as personal guarantors persists against the creditors and an approved resolution plan can only lead to a revision of amount or exposure for the entire amount. Any recourse under Section 133 of the Contract Act to discharge the liability of the surety on account of variance in terms of the contract, without her or his consent, stands negated by this court, in V. Ramakrishnan where it was observed that the language of Section 31 makes it clear that the approved plan is binding on the guarantor, to avoid any attempt to escape liability under the provisions of the Contract Act".


Conclusion

As the resolution plan shall attain its finality on its approval and the lenders are getting empowered to recover the balance debts from the personal assets of the promoters who are the personal guarantors, the Personal Guarantors of the Corporate Debtor shall be at great loss. Furthermore , in case of invocation of the guarantee by the banks , the personal guarantors will not be able to claim the said amount from the Corporate Debtor as it got the immunity under the Code due to the plan approval. So, a piece of advice that can be given to all the entrepreneurs is to think twice or thrice before you sign the documentation for personal guarantee for your company and sign it only if you are fully convinced about the prospects and future of its business. Under the changed business and legal scenario, be intelligent enough to keep away from signing a personal guarantee document of a company, if you are not fully convinced about and involved in the affairs it, as the same is equivalent to an undated and open signed cheque leaf.


Bijoy P Pulipra


Picture courtesy : Internet images

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