Beware of guarantors: On loans to business creditors

Entrepreneurs who sign guarantees must be certain that their company will not fail.Personal loan

The Supreme Court decision protecting creditors’ ability to seek personal guarantors for loans given by them to a corporate borrower removes doubt over the degree to which banks and other financial lenders would pursue not only the corporate debtor but also the persons that provided personal guarantees to allow the flow of credit to the business for which they had stood surety. This should have a considerable impact on the financial system, which is already burdened by a pile of bad loans, by hastening the resolution of such strained assets. The two-judge Bench deliberated on a slew of petitions questioning the government’s 2019 notification that designated personal guarantors as a distinct category of persons who could be pursued under the Insolvency and Bankruptcy Code as part of insolvency proceedings instituted by lenders against defaulting corporate entities. In rejecting the petitions, the judges stated unequivocally that the government was correct in “carving out personal guarantors as a distinct species of persons,” owing to the “intimate relationship between those individuals and corporate bodies to which they stood pledge.”Banks now have a real risk of recovering significantly more from the settlement of a troubled business company. In most circumstances, the comparatively wealthy sponsors have served as individual personal guarantors for the personal loans lent to the companies they sponsored.

Several company leaders are affected. The sponsors of many of the defaulting companies on trial under the IBC had collateralised billions of rupees on loans that were used by the companies they ran. Apex Court, which served notices of lawsuits totalling more than Rs 39,000 on persons who had signed up to guarantee the credit granted to companies. The judges also cleared the air on another issue that will undoubtedly strengthen the position of creditors in the future and even closed the bankruptcy proceedings. The court ruled that approving a resolution plan for the corporate debtor did not nullify the liability of the personal guarantor, which “results from a separate contract”. Lenders can now take action against guarantors to improve the recovery as most banks agree to “haircuts” by negotiating a wind-up plan with a new sponsor for the criminal enterprise. The only downside is that once the wind-up plan becomes legally binding, the surety loses the borrower’s recourse if the creditor calls on the personal guarantee. Business owners now need to think twice before signing a personal guarantee unless they can be confident that the company they are found will not fail.

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