Insolvency & BankruptcyPersonal Guarantor under Insolvency and Bankruptcy Code 2016

Introduction

The Insolvency and Bankruptcy Code, 2016 (IBC) has radically transformed the corporate debt resolution framework in India by introducing time-bound processes and strengthening creditor rights. While much of the discussion around the IBC revolves around corporate debtors, a crucial aspect is its treatment of personal guarantors to corporate debtors.

A personal guarantor is an individual who undertakes to repay a corporate debtor’s loan if the company defaults. Typically, promoters, directors, and key managerial personnel of companies offer such guarantees to secure corporate borrowings. Under the IBC, personal guarantors face significant and direct exposure when the corporate debtor enters insolvency. The liability of a personal guarantor is a critical risk, as insolvency proceedings can now be initiated against them independently, even while the corporate debtor is undergoing a Corporate Insolvency Resolution Process (CIRP). This represents a significant shift from earlier regimes, where enforcement against guarantors was pursued largely under separate and often lengthy civil recovery proceedings.

Who is Personal Guarantor under the IBC?

The IBC, in Section 5(22), defines a “personal guarantor” as an individual who is the surety in a contract of guarantee to a corporate debtor. This distinguishes them from other categories of individuals, such as partnership firms and other individual debtors, who are treated separately under the Code.A personal guarantor under the IBC is typically:

• A promoter who has guaranteed loans extended to their company.
• A director who has provided a personal guarantee for working capital or term loans.
• A major stakeholder who has executed a guarantee contract with a lender.

Nature and Extent of Liability

A foundational principle of Indian contract law, established in Section 128 of the Indian Contract Act, 1872, is that the liability of a guarantor is co-extensive with that of the principal debtor, unless the contract specifies otherwise. The IBC framework and judicial rulings have consistently upheld this principle.Key aspects of liability under the IBC include:

• Concurrent Proceedings: Creditors can pursue recovery actions against both the corporate debtor (under Part II of the IBC) and the personal guarantor (under Part III of the IBC) simultaneously.

• No Automatic Discharge: The approval of a resolution plan for the corporate debtor does not automatically absolve the personal guarantor of their liability. The guarantor’s obligation stems from an independent contract of guarantee.

• Moratorium Inapplicable: The moratorium under Section 14 of the IBC, which prohibits legal action against the corporate debtor during CIRP, does not extend to the personal guarantor.

Implications and Risks for Personal Guarantors

The initiation of insolvency proceedings against a personal guarantor carries severe consequences:

• Full Debt Exposure: Once the guarantee is invoked, the personal guarantor becomes liable for the entire outstanding debt as per the guarantee agreement, regardless of the corporate debtor’s insolvency status.

• Attachment of Personal Assets: Creditors can move to attach and liquidate the guarantor’s personal assets, including homes, bank accounts, securities, and other investments, to recover the debt.

• Appointment of a Resolution Professional (RP): Insolvency proceedings against the guarantor will lead to the appointment of an RP, who takes control of the guarantor’s financial affairs and assets.

• Restrictions on Asset Transfers: During the insolvency process, the guarantor faces strict legal restrictions on selling, transferring, or otherwise alienating their assets.

• Impact on Credit History: Insolvency proceedings can severely damage the guarantor’s credit score and future borrowing capacity.

• Reputational Risk: As insolvency proceedings are public, they can cause significant harm to a guarantor’s professional reputation and business relationships.

Key Judicial Precedents and Legal Developments

The legal framework governing personal guarantors under the IBC has been progressively clarified and strengthened through key legislative amendments and Supreme Court judgements.

• State Bank of India v. V. Ramakrishnan & Anr. (2018): In this landmark case, the Supreme Court initially held that the moratorium under Section 14 of the IBC would also apply to the personal guarantor. This decision led to a swift legislative response. The government introduced an amendment to the IBC in 2018, adding Section 14(3)(b), which explicitly clarified that the moratorium does not apply to a surety in a contract of guarantee to a corporate debtor. This amendment solidified the creditor’s right to proceed against the guarantor even while the corporate debtor is in CIRP.
• Lalit Kumar Jain v. Union of India (2021): The Central Government issued a notification in 2019 that brought the provisions of Part III of the IBC into force for personal guarantors of corporate debtors. This was challenged on multiple grounds. The Supreme Court, in the Lalit Kumar Jain case, upheld the validity of this notification. The Court’s crucial finding was that the approval of a resolution plan for a corporate debtor does not automatically discharge the personal guarantor’s liability. It affirmed that the contract of guarantee is an independent agreement, and unless it is specifically discharged in the resolution plan, the guarantor remains liable.

• Dilip B. Jiwrajka v. Union of India & Ors. (2023): More recently, the constitutional validity of the procedure for initiating insolvency against personal guarantors (Sections 95 to 100 of the IBC) was challenged. The petitioners argued that the process was unfair as it did not provide for a hearing before the appointment of a Resolution Professional (RP), thus violating the principles of natural justice. In November 2023, the Supreme Court dismissed these challenges, upholding the constitutionality of these provisions. The Court clarified that the role of the RP at this initial stage is not adjudicatory but facilitative; the RP only gathers information and submits a report. The adjudicatory power remains with the National Company Law Tribunal (NCLT), which provides the guarantor a full opportunity to be heard before an insolvency petition is admitted.

These judgements have collectively created a robust and unambiguous legal regime for the enforcement of personal guarantees under the IBC.

Strategic Considerations and Risk Mitigation

Given the significant risks, individuals should adopt proactive strategies before and after providing a personal guarantee:

• Careful Drafting of Guarantee Agreements: Always have the guarantee agreement reviewed by experienced legal counsel. Negotiate to limit the scope of liability to specific debts or a fixed monetary amount, and insert conditions that require lenders to first exhaust all remedies against the corporate debtor.

• Seek Counter-Indemnities: Obtain a contractual indemnity from the corporate debtor, secured by collateral if possible, to recover any amount paid under the guarantee.

• Regular Financial Review: Continuously monitor the contingent liabilities arising from guarantees and the financial health of the corporate debtor.

• Negotiate Release During Restructuring: In any debt restructuring or settlement, prioritize obtaining an explicit and written release from the guarantee obligation from the lenders.

• Pre-Guarantee Due Diligence: Before signing, conduct thorough due diligence on the borrower’s financial stability and understand the full implications of the guarantee under the IBC framework.

Conclusion

The integration of personal guarantor insolvency into the IBC framework has fundamentally altered the risk landscape for promoters, directors, and other individuals connected to corporate borrowers. The liability of a personal guarantor is now direct, independently enforceable, and survives the corporate debtor’s own resolution process. Judicial pronouncements have consistently reinforced the co-extensive nature of this liability, leaving little room to avoid obligations once a guarantee is invoked.

In this stringent environment, approaching guarantee commitments with a full understanding of the legal and financial risks is not just advisable—it is essential for financial survival.

— Team AMLEGALS

Please reach out to us at rohit.lalwani@amlegals.com in case of any query.