Banks must come out with clear policies for settlement of personal guarantees: S Ravi


It is imperative the Banks frame a clear OTS (one time settlement) policy for all borrowers who have provided personal guarantee under NCLT and recovery process that is systematic so as to ensure no arbitrary decisions are taken, said S. Ravi, chartered accountant and independent director in a recent article.

“The more serious issue to contend is to ensure resolution of personal guarantee and the way forward. Banks must come out with clear cut policies for settlement of personal guarantees. Historical data certainly indicates that recovery from corporate guarantee and personal guarantee has not been significant. In cases which are at the NCLT either in resolution or under liquidation by virtue of amounts which are going to be realized from companies, the recent Supreme Court decision has already prompted banks to take steps for recovery from personal guarantee under the IBC process”, Ravi said.

He said that beyond the value, the enforceability of personal guarantee is also a matter of concern. The bankers concern stems from the fact that borrowing companies have entered into multiple related party transactions. Further, enforcing of personal guarantees, even in DRTs, have been riddled with complexities owing to family disputes, lessor-lessee litigations, encumbrance by statutory authorities due to their prior rights, etc.

“The trust deficit between banker and borrower is visible. As a way forward, it is essential that Promoters must show serious intent by bringing in transparency and governance”, he said.

Ravi said borrowers argue that bankers go beyond the company where liability is limited – and that there is always an element of risk in the business and the company is collateralizing its assets to address this. At the same time promoters are also infusing equity on a continuous basis. Additionally, promoters argue that while banks charge high interest rates that subsume risk factors to them, the company commonly faces problems like land acquisition, coal & gas allocation, environment clearances, license cancellation et al, which results in project time and cost overrun thus jeopardizing the viability of the project.

“Further, the promoters of the borrowers also have the view that in order to avoid stress in the account, the group companies augment the borrower’s cash flow in making interest payments/repayments. There have been numerous cases where projects have become unviable or have had to be shelved due to external factors beyond the control of promoters”, Ravi said.

Rishab Shroff, Partner, Cyril Amarchand Mangaldas said, “The giving of personal guarantees was always a very bad idea from the start – and the fallout of this judgement will wake promoters up and show them why. I would be very surprised if any sensible promoter would now even think of giving a personal guarantee, given that the creditors can leave him penniless personally if the business fails”.

Shroff said this recent judgement will have bona fide promoters worried about their legitimate estate planning. Many promoters had in the recent part had undertaken proper planning by moving sizeable assets into trusts (including controlling interests in their family business, cash reserves etc) to streamline succession towards the next generation.

Shroff said unfortunately, this judgement will bring legitimate structures into question and paint every movement of assets into trusts with a bad faith brush.

“People who are the most worried are the ones who had given personal guarantees recently but had not yet moved assets into trusts – for them, it may be very difficult to safely move assets into trusts without exposure to creditor attack”, he added.

The law provides a legal 2 year window to creditors to question any transfers from the creditor’s name into other structures. Even post this window, transfers can be questioned on grounds of bad faith and intent of the transferor – but those grounds are more nebulous. Future movement of assets into trusts are now automatically risky – which is not a good thing as now every promoter will think many times before transferring assets out of his name. The trade-off between control of assets, tax efficient, asset protection, debt fuelled growth of the business etc is now being reset, Shroff said.

He said the additional safeguards to now set up new structures will now come from 2 aspects – one is making sure that any transfer of such assets is done after carefully ensuring that all necessary approvals and consent as needed have been sought and obtained prior to the transfer. This helps negate the risks of challenge from creditors.

He added the 2nd aspect is more important, namely to ensure the whole exercise is properly documented and structured – it would be crucial to demonstrate substance in the exercise, to objectively say the approach is for legitimate succession planning purposes.

Shroff said unfortunately, the boundary between legitimate succession planning and evasion is not a bright line test, and unless done with proper advice, life may become very difficult.

“What is not yet clear, and I suspect it will come in due course, is that is the line between legitimate succession planning (e.g. moving assets into trusts) and evasion – on what actions, intentions, series of steps etc taken by the promoter are permissible (even after having given a personal guarantee) are fine and which are not – this is the clarity that’s needed”, he added.