Dealing with promoters’ guarantees
Banks in India have traditionally placed tremendous faith on promoters and personal guarantees provided by them, on par with if not higher than the intrinsic creditworthiness of the proposal itself (i.e. borrower, project/business, industry, etc.).
The relationship between promoters and banks in India has been considered a long-term marriage as hitherto banks never had access to a credible and effective legal framework to take control away from the errant promoters. The banks, therefore, did the next best thing, i.e. to seek more accountability from promoters in the form of guarantees.
During difficult times, banks further perpetuated reliance on the promoters by restructuring loans and seeking more comforts viz. pledge of shares, undertaking to infuse funds, more guarantees, etc. The regulators also recognize this reality by stipulating prudential lending norms at the group level, mandatory requirement of personal guarantees for restructuring under corporate debt restructuring (CDR), etc.
As things were, the majority of promoters also did not think twice before extending guarantees as long as banks kept sanctioning more and more loans, aggregating to several times over the net worth of the guarantor. And here we are, while most of the stressed companies are crumbling under the weight of excessive leverage, the promoters are carrying even higher leverage at personal level vis-à-vis their net worth, which has fallen drastically due to lower market capitalization and reduction in shareholding, sometimes due to pledge enforcement.
The newly enacted Insolvency & Bankruptcy Code, 2016 (IBC), has given renewed hopes to the debt resolution drive. But how well does IBC articulate the likely role of personal guarantors in the upcoming resolutions? This issue assumes even greater significance against the backdrop that in majority of the cases, lenders would seek to pursue change of control away from the promoters and in favour of new buyers or investors.
Ambiguity in current regulations
While IBC covers personal guarantee in its scope, it does so in a very limited manner. Presently, IBC provides for transfer of insolvency proceedings of a guarantor before the same National Company Law Tribunal (NCLT) where a corporate insolvency resolution process (CIRP) or liquidation of a corporate debtor is pending. However, ambiguity exists whether moratorium prescribed by IBC extends to proceedings against the guarantors or security provided by them. Two contradictory judgments have only added to the confusion.
NCLT, in the CIRP matter of Schweitzer Systemtek India Pvt. Ltd, judged that Phoenix ARC can continue enforcement against collaterals provided by the personal guarantors. At the other end, the Allahabad high court, in the CIRP matter of Lohia Machines Ltd, directed debt recovery tribunal, Mumbai, to stay all proceedings against personal guarantors pending finalization of CIRP. Further, IBC does not provide clarity on discharge or release of personal guarantees as part of CIRP.
The road ahead
In the current framework, two distinct trends are likely to emerge. First, a change of control at the corporate debtor level or sale of businesses/assets. Second, banks would be required to take large write-downs but questions remain whether banks post corporate resolution will continue waging war with errant promoters on the personal guarantees front or let them move on, case in point being Kingfisher Airlines which ticked both these boxes. Clues could also be deciphered from the ministry of corporate affairs order requiring 63 Moons Technologies Ltd (erstwhile Financial Technologies Ltd), a profitable listed company, to merge National Spot Exchange Ltd, a defaulting wholly-owned subsidiary, with itself even in the absence of a guarantee from 63 Moons.
In debt resolutions wherein a new buyer is inducted into the corporate debtor accompanied by settlement or restructuring of debt, personal guarantee would be arguably extinguished along with debt settlement or restructuring. However, a sizeable number of corporate debtors are likely to end up in liquidation.
Further, there would be hybrid resolutions where debt is only partially satisfied by selling assets or businesses and ‘residual’ corporate debtor with large unsustainable debt is despatched for liquidation. While obligations under guarantees may survive liquidation of the corporate debtor, in the absence of any known valuable assets owned by the personal guarantor, a meaningful recovery would be elusive and banks may end up clogging their and courts’ bandwidth for an indefinite period.
The bankruptcy code for individual debtors, expected to be notified soon, would hopefully synchronize well with IBC and provide for a way to deal with personal guarantees in a time-bound manner. IBC could potentially transform credit culture in India wherein banks, armed with this new-found ability to drive out errant promoters, would refocus their underwriting lens more towards inherent credit parameters of the proposal and not personal guarantees. The promoters, aware of power of IBC, are expected to show more respect towards their guarantees. The new law has the power to make personal guarantees redundant in the Indian credit system.
Anand Bhageria is a partner with Singhi Advisors. A veteran banker, he is responsible for deal origination and execution across sectors.
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