The Next Wave – Personal Guarantors under the Insolvency and Bankruptcy Code, 2016

By Niloufer Lam and Zarir Bharucha

1. Introduction

The Insolvency and Bankruptcy Code, 2016 (“Code”) is one of the most prolific legislative changes in the last few years, spurring furious litigation, multiple legal interpretations, regular amendments and is ever evolving to deal with the non-performing assets of various financial institutions in India. India as a country of entrepreneurs has a large percentage of companies (whether listed or unlisted) that are owner run (“Promoters”). Historically banks giving loans would always require personal guarantees to be given from Promoters to ensure their “skin in the game”. Now that the over-leverage has come back to bite, the lack of an effective forum to enforce the personal guarantees that very much go hand in hand with the insolvency of the company for which the guarantee has been given, has led legislators to enact provisions relating to personal guarantees.

Prior to the Code, the Presidency Towns Insolvency Act, 1909 (for individuals in 3 erstwhile Presidency towns of Chennai, Kolkata and Mumbai) and the Provincial Insolvency Act 1920 (for individuals in areas other than the Presidency towns) governed insolvency and bankruptcy of individuals. There were multiple issues with the working of erstwhile individual insolvency laws including lack of a professional like resolution professional to conduct the insolvency process[1], no time bound mechanism, and above all the entire process was debtor driven with little role of creditors. A major drawback of the erstwhile individual insolvency laws was lack of pre-bankruptcy insolvency resolution process which has been introduced by the Code along with the fresh start process- which allows an individual to fresh start his life.

The Code now enables rehabilitation and bankruptcy proceedings against personal guarantors, provided the corporate debtor is subject to pending insolvency or liquidation proceedings before the National Company Law Tribunal (“NCLT”) (“Personal Guarantor”). The Ministry of Corporate Affairs (“MCA”) and Insolvency and Bankruptcy Board of India (“IBBI”) have also notified insolvency rules and regulations which came into effect on 1 December 2019.

2. Mechanism to Trigger? 

The insolvency process can be triggered either by a Personal Guarantor itself or by any creditor. A creditor can only petition for bankruptcy of a Personal Guarantor, if it has invoked a guarantee provided in its favour and the Personal Guarantor has failed to pay the debt within 14 days of such notice. A resolution professional is appointed by the NCLT (“RP”).

A resolution professional submits a report to the NCLT within 10 days of his appointment recommending either approval or rejection of the application. Within 14 days from the date of submission of report by the RP, the NCLT has to either admit or reject the application filed by a creditor or a Personal Guarantor.

3. What is the process for rehabilitation or repayment plan of a Personal Guarantor?

After admission of the application by NCLT, a Personal Guarantor submits his repayment plan for restructuring debts in consultation with the RP (who determines it complies with laws and is reasonable). This has to be approved by the creditor committee or if the RP decides that a meeting of creditors is not required it will need to justify this to NCLT. A creditor committee approves or modifies a repayment plan by 75% in value of the creditors present in person or by proxy and voting on a repayment plan. The NCLT can either approve or reject the repayment plan, provide directions for implementation of the repayment plan, or may direct the RP to re-convene meeting of creditors to reconsider or amend the repayment plan. Ultimately, if a repayment plan is not approved then the Personal Guarantor goes into bankruptcy.

The cost of the resolution process is recovered from the funds repaid by the Personal Guarantor under the repayment plan. The legislation makes no provision for recovery of resolution costs where the repayment plan is rejected. Logically, the applicant should bear such cost. This omission will inevitably result in litigation.

4. What is the priority of payments between creditors in the event of bankruptcy of a Personal Guarantor?

The waterfall mechanism for distribution of final dividend pursuant to the administration and distribution of estate of a Personal Guarantor is similar to that provided in Section 53 of the Code that governs the liquidation of a corporate debtor. Accordingly, costs and expenses incurred during the bankruptcy process are paid first followed by payments to secured creditors and the workmen dues for the period of 24 months, in priority to all other debts.

All other debts including unsecured debts are placed at the bottom of waterfall mechanism and are subordinated to wages and any unpaid employee dues (other than workmen) for the period of 12 months preceding the bankruptcy commencement date[2] and government dues[3].

5. What are the rights of a lender during insolvency/bankruptcy of a Personal Guarantor?

A secured creditor, during insolvency process, may relinquish his right to enforce the security during the period of the repayment plan. However, if a secured creditor decides to enforce its security, the voting right of such secured creditor shall be limited to the extent of unsecured debt owed by a Personal Guarantor[4]. During bankruptcy process, a secured creditor may realise his security and produce proof of balance debt due to such secured creditor or it may choose to surrender its security to the bankruptcy trustee for general benefit of creditors[5].

6. Will the CIRP of a corporate debtor and insolvency of its personal guarantor run simultaneously?

Yes, the CIRP of a corporate debtor and insolvency and bankruptcy of a Personal Guarantor to such corporate debtor can run simultaneously.

However please note the National Company Law Appellate Tribunal in Dr. Vishnu Kumar Aggarwal v. Piramal Enterprises Limited (Company Appeal (AT) (Insolvency) No. 346 of 2018) held it is not necessary to initiate corporate insolvency resolution process against the principal borrower before initiating corporate insolvency resolution process against the corporate guarantors – a financial creditor can commence insolvency against both the corporate debtor and the guarantor in respect of the same debt and default. However, in the event of admission of any one application, the other application will not be admitted. This judgement is problematical as the whole idea of a guarantee is the co-extensive nature of the obligation and independent remedy. Of course, there should be no double dipping for the same debt, but applying this issue in the context of Personal Guarantor, we envisage this will lead to some confusion and timing related issues. It could also be that the same RP will be appointed for the corporate debtor and the Personal Guarantor – similar to cases like Videocon where insolvency proceedings of various companies have been clubbed.

7. Does the insolvency of a Personal Guarantor cover all its debts or merely the amounts owed to the Personal Guarantor as surety for the corporate debtor?

Yes, the insolvency and bankruptcy of a Personal Guarantor covers all its debts. The NCLT, during insolvency process, invites claims from all creditors by way of a public notice within 7 days of passing an order of admission of a Personal Guarantor. All creditors have 21 days from the date of public notice to submit their claim. In bankruptcy, the NCLT invites claims from all creditors within 10 days of the bankruptcy commencement date.

8. Should a creditor file an application initiating insolvency against Personal Guarantors under the Code when he can enforce the security interest under the Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act 2002 (SARFAESI) or by filing a summary suit?

Insolvency and bankruptcy of a Personal Guarantor under the Code can be a preferred mode for lenders for following reasons:

i. Time bound: The insolvency of a Personal Guarantor to be completed within a period of 180 days from admission by NCLT. Even assuming it is linked with a corporate insolvency and may be extended to 333 days, none of the other recovery laws provides any time bound resolution – delaying tactics and multiple adjournments are therefore rampant.

ii. Moratorium: Interim moratorium[6] and moratorium under the Code provides a calm period preventing a Personal Guarantor from transferring his assets outside the recovery proceedings. In contrast, if a lender initiates summary proceedings or SARFAESI action against a Personal Guarantor, it is possible that a Personal Guarantor may subsequently seek the protection of a moratorium by filing for insolvency under the Code. Therefore, a lender will always run the risk of moratorium under the Code while proceeding under SARFAESI or CPC[7]. However, a Personal Guarantor may be able to seek protection of moratorium under the Code only if the corporate debtor is undergoing insolvency or liquidation proceedings under the Code.

iii. Identification of assets of a Personal Guarantor: The insolvency proceedings under the Code is driven by a third party RP: (i) repayment plan is prepared by the debtor as Personal Guarantor in consultation with the RP and (ii) repayment plan is monitored by the RP. This may assist in identification of assets of a Personal Guarantor and result in better realization for lenders as against summary proceedings or SARFAESI actions that are not driven by third party professionals and lenders are dependent on debtors to disclose their assets. This is more crucial for unsecured debts. We also envisage an increase in white-collar crimes and tracing actions being required in connection with identification of a Personal Guarantor’s assets.

iv. Restrictions on a bankrupt: Once a Personal Guarantor is declared bankrupt[8], several restrictions are imposed on the bankrupt including restriction on being appointed as a director of a company, prohibition on availing any further loan without the permission of the bankruptcy trustee, restriction on travelling overseas without the permission of NCLT[9]. These restrictions may incentivize recalcitrant Personal Guarantors to settle legitimate dues.

However, if a secured asset can be sold smoothly without any opposition from the mortgagor/owner of such property, a lender may prefer to use SARFAESI action against such property.

9. What happens in Bankruptcy?

An application for bankruptcy of a Personal Guarantor can be filed either by a creditor or by a Personal Guarantor itself if: (a) the NCLT rejects an application for initiation of insolvency against a Personal Guarantor; or (b) the NCLT rejects a repayment plan or it is not implemented fully. The NCLT passes a bankruptcy order against a Personal Guarantor within 14 days of receiving confirmation or nomination of a bankruptcy trustee. A bankruptcy trustee appointed by the NCLT is primarily responsible to investigate the affairs, and distribute the assets of a bankrupt. He submits a report to the committee of creditors of a Personal Guarantor after completing the distribution of assets. A bankrupt is discharged on either 1 year from bankruptcy commencement date or earlier if the committee of creditors so approve. The discharge order releases a bankrupt from all debt except court fines, damages for negligence, nuisance maintenance liability, student loans and any debt incurred by fraud or breach of trust.

10. What if a Personal Guarantor tries to dispose of assets?

Any disposition of property by a bankrupt between the date of filing of bankruptcy application and bankruptcy commencement date will be void even if such property was acquired by a person before bankruptcy commencement date in good faith, for value and without notice of bankruptcy application. A bankruptcy trustee may also disclaim any unprofitable contract or any property which is unsaleable or not readily saleable. They can approach the NCLT for orders for (a) an undervalued transaction entered into by a bankrupt in the previous 2 years ending on the bankruptcy commencement date and if such transaction triggers bankruptcy process of the bankrupt; or (b) any preferential transaction entered into with any associate in the previous 2 years ending on the bankruptcy commencement date or the prior 6 months in any other case and if such transaction triggers bankruptcy process; or (c) exorbitant payments made in respect of a credit to the bankrupt or if a transaction is unconscionable and entered into by the bankrupt in the previous 2 years ending on the bankruptcy commencement date.

11. Conclusion

The rules and regulations on insolvency and bankruptcy of a Personal Guarantor is a first step towards operationalizing personal insolvency under the Code and for holding promoters accountable for the debt pile up. There are several benefits; (i) it ensures that creditors do not have to go to multiple forums to recover their debt; (ii) it will yield better and more time bound results for lenders; (iii) the fear of bankrupt promoters not being able to travel abroad without prior permission together with the many disqualifications, is intended to inculcate a repayment culture and discipline amongst borrowers. Having said we envisage the practicalities of the issues that will arise will no doubt yield to multiple future amendments as well as burden the already over-worked NCLTs with an even higher case load. It is hoped that the impact and result of the new regime on promoter borrowers becomes visible soon.

[1] The estate of the insolvent was sold by a court appointed assignee or receiver under the Presidency Towns Insolvency Act, 1909 and the Provincial Insolvency Act 1920.

[2] Bankruptcy commencement date means the date on which a bankruptcy order is passed by the NCLT.

[3] Section 178 of the Code.

[4] Section 110 of the Code.

[5] Section 172 of the Code.

[6] Section 96 of the Code.

[7] IBC has overriding jurisdiction over other laws.

[8] Section 126 of the Code.

[9] Section 141 of the Code.