Analyzing the Obstacles to Addressing Personal Guarantors Insolvency Under IBC

Along with announcing Part III of the Insolvency and Bankruptcy Code, 2016 (IBC) for insolvency proceedings against personal guarantors, the Indian government announced the provisions for starting insolvency proceedings against personal guarantors under IBC as a separate class other than individuals in 2019. 

On November 15, 2019, the Supreme Court affirmed the notice, ruling that personal guarantors—despite being a part of a larger group of  individuals—were to be treated differently due to their close ties to corporate debtors. The court also found that a personal guarantor is nevertheless liable for liabilities under the individual guarantee contract even if a resolution plan is approved and the borrower is released from debt through an involuntary process, that is the operation of law in bankruptcy proceedings.

Although a considerable increase of personal guarantor under IBC insolvencies was anticipated after the Supreme Court determined the notification’s legality, the rate is still modest due to the many ambiguities in the developing sphere of the Insolvency and Bankruptcy Laws.

Discharge of Corporate Debt

Personal guarantors attempt to be released from liability in light of the responsibilities of both the debtor and the personal guarantor under IBC by claiming that the corporate debtor’s resolution plan resulted in the discharge of the total debt. In a recent ruling, the Debt Collection Tribunal (DRT), Ahmedabad rejected an application for debt recovery against the personal guarantor because the settlement plan had entirely discharged the borrower’s underlying debt.

While debt discharge by the legal process does not necessarily prevent the creditor’s rights to undertake against the personal guarantee. However, if a debt assignment under the resolution plan and transactions results in repayment of the underlying borrowing in cash or kind (such as capitalization) to the assignee. In that case, therefore, the capacity to pursue the guarantor may be at risk due to the primary debt being discharged. 

Judicial Authoritative Challenges

Whereas the National Company Law Tribunal has the authority to decide on the insolvency resolution and liquidation of debtors as well as personal guarantors. The Laws of the IBC require applications for the personal guarantor’s insolvency resolution to be submitted to the NCLT while a corporate insolvency resolution or corporate debtor’s liquidation proceeding is ongoing. Many personal guarantors rely on the NCLT as the ideal for personal guarantors’ insolvency resolution since the corporate insolvency resolution procedure or liquidation has yet to start or be completed. 

A judgment passed by the Supreme Court directed that NCLT is the proper adjudicating authority for the initiation of all insolvency proceedings against personal guarantors, even if there is no active corporate insolvency resolution process or liquidation against the corporate debtor. Although the NCLAT only required limited notice requirements at the stage of enrolment of insolvency and did not address orders of interim moratorium and the appoint of the resolution professional, a recent writ filed before Supreme Court raises a constitutional concern on the grounds of a violation of principles of natural justice, requesting the right of the personal guarantor under IBC to be heard before the appointment of resolution professional, creating another ground for personal guarantors to seek stay against the admission into insolvency.

Conundrum Over Personal Guarantor’s Assets

Even though such remedies exist for corporate debtors and in the case of bankruptcy of individuals, the structure for the insolvency resolution process against personal guarantors under IBC does not allow for clawback in the event of avoidance or fraud transactions. Before the resolution professional takes possession of the personal guarantor’s assets, there are issues related to asset diversion. Without a plan to recover them, the personal guarantor’s assets would be reduced by the diverted or siphoned off.

Conclusion

Creditors should include suitable safeguards in corporate debtors’ resolution plans to guarantee that the unpaid debt remains due to the assignee till the personal guarantor’s insolvency proceedings conclude. Initiating insolvency procedures against corporate debtors and personal guarantors simultaneously time will enhance efficiency and synergise efforts to maximise value. The IBC should be amended as necessary to enable the clawback of diverted assets.

If you’re a creditor struggling with filing an insolvency resolution process against a personal guarantor or a personal guarantor who’s looking for a way-out from the debt liability, reach out to expert professionals at Ancoraa Resolution. 

Providing personalized legal solutions for all your debt concerns, the insolvency professionals at Ancoraa help you understand the complexities of the insolvency and bankruptcy process while nudging you towards a debt-free financial chapter.