SC ruling on personal guarantors could be a wake-up call for Indian promoters

This ruling, a blow to many promoters, is significant – more so because it again signals a shift in favour of Indian lenders- bolstering their ability to enforce guarantees without long legal battles besides leading to faster recoveries. It comes at a time when banks and institutional lenders dampened by earlier court rulings are increasingly taking recourse to other avenues for recovery other than the IBC route. 

It should hopefully end the gaming of the legal system by many promoters who have stymied the efforts of many banks to enforce personal and corporate guarantees against their loans on which there have been defaults. And an attitudinal change when it comes to fulfilling debt obligations.

Interestingly, the Supreme Court has this time dismissed the case built up by some promoters that some of the provisions of the bankruptcy law on personal insolvency cases violated the principles of natural justice and that due process was not followed. In an earlier ruling on wilful defaulters, banks were told to provide an opportunity of hearing to wilful defaulters before enforcing the rights of lenders. This ruling in a way levels the field for both ordinary or retail borrowers and big promoters who have the ability to stave off legal proceedings and drag the process for long, frustrating lenders. Indeed, Indian newspapers are full of public e-auction notices issued by banks on sell-off of properties, and assets of individual borrowers.

For long, Indian companies and promoters have been offering corporate and personal guarantees knowing well the obligations it entails and the implications of a default. These guarantees are over and above the cover of fixed assets and cash flows to offer comfort to lenders. Many such guarantees have been provided during a period when assets are being created or during completion of a project. It is also a cover for lenders when the credit rating of a company drops. But unlike in the case of small borrowers where banks have been quick to seize upon their assets when there is a default, banks have for long struggled to invoke personal guarantees provided by many promoters. The lengthy time for resolution under the bankruptcy law over the past few years may also have emboldened many of these promoters to legally contest the attempts of lenders to enforce their rights. The Supreme Court ruling could well be a wake-up call for them.

The Supreme Court’s ruling on personal guarantors offers an opportunity for Indian firms and promoters to have a complete relook at the practice of offering such guarantees. The Tata group for long is known to have refused to provide corporate guarantees. In an earlier era, when avenues for borrowing were limited as also centralised information on borrowers and when risk management practices had not been refined, it was perhaps natural to seek the comfort of such personal or corporate guarantees. That is no longer the case with a centralised information system in place and better monitoring of borrowers and sharing of information by banks.

Indian banks and many firms too have recognised this. Banks are now looking much more at cash flows. There are enough promoters and companies who now decline to offer personal or corporate guarantees when the assets are well secured. It is also an opportune time for banks and companies to review the practice of providing guarantees to subsidiaries of listed firms.

What is more heartening is that overall the courts have backed a relatively new law such as the IBC and many of its provisions over the past few years. But the challenge of speedy resolution of insolvency cases remains. It is for the courts, the government, regulators and banks to address this quickly.