PERSONAL GUARANTORS UNDER IBC:INCREASED RISKS FOR BUSINESS OWNERS

– Shreya Shree Singh, Associate

The Insolvency and Bankruptcy Code, 2016 (‘IBC’), has significantly changed the landscape of corporate debt resolution in India. While the code primarily aims to streamline the insolvency process for corporate entities, it has also placed substantial liabilities on personal guarantors, often business owners or promoters. The increased risks for such individuals have been reinforced through judicial interpretations and legislative amendments.

Legal Framework for Personal Guarantors

The IBC was amended in 2019 to bring personal guarantors under its ambit, allowing creditors to initiate insolvency proceedings against them independently of corporate debtors. Key provisions relevant to personal guarantors include:

1. Section 5(22): Defines a “personal guarantor” as an individual who provides a guarantee for a corporate debtor’s liability.
2. Section 60(2): Establishes that proceedings against personal guarantors will be conducted before the National Company Law Tribunal (NCLT) where
   the corporate debtor’s insolvency case is pending.
3. Section 95 to 101: Outline the process for initiating and resolving personal insolvency, including the appointment of a resolution professional and the consequences of default.
4. Section 128 of the Indian Contract Act, 1872: Establishes the principle of coextensive liability, holding that a creditor can recover from either the principal debtor or the guarantor, depending on which offers a more viable recovery route.
5. Section 140 and 145 of the Indian Contract Act, 1872: Provide that a guarantor who pays on behalf of the debtor has a right to seek reimbursement from the debtor. However, under IBC, once a resolution plan is approved, the right to recover from the corporate debtor may be extinguished, putting guarantors in a precarious position.

Increased Risks for Business Owners

The inclusion of personal guarantors under the IBC framework has heightened
financial risks for business owners. Some of the primary risks include:

1. Immediate Financial Liability- Personal guarantors are now directly liable for a corporate debtor’s unpaid dues. Creditors can proceed against them without exhausting remedies against the corporate debtor first. This means that even if the corporate entity has not yet defaulted on repayments or is in the process of resolution, creditors can still target the guarantor’s assets to recover dues.
2. Impact of NCLT Rulings- Since NCLT has jurisdiction over personal guarantors in connection with corporate debtors, adverse rulings in corporate insolvency cases can directly impact personal assets. In many cases, tribunals have held that personal guarantees remain enforceable even when the corporate debtor undergoes resolution, exposing personal guarantors to continued legal and financial challenges.
3. Loss of Personal Assets- Under IBC, if a personal guarantor fails to repay debts, their assets—including bank accounts, properties, and investments— can be liquidated to meet obligations. Unlike corporate debtors who benefit from the resolution process, personal guarantors do not have the same protective mechanisms, leading to potential financial ruin.
4. Restriction on Future Business Activities- Once insolvency proceedings are initiated against a personal guarantor, their creditworthiness and ability to conduct business may be severely affected, restricting future entrepreneurial endeavors. Banks and financial institutions may be hesitant to provide loans or credit facilities to individuals who have previously been subjected to insolvency proceedings.
5. Legal Proceedings and Mental Strain- The process of defending against insolvency proceedings can be stressful, time-consuming, and financially draining. Business owners facing insolvency as personal guarantors often have to engage in lengthy litigation, which can be both emotionally and professionally taxing.

Comparative Analysis: Personal Guarantors in Other Jurisdictions

The treatment of personal guarantors under insolvency law varies across jurisdictions:

• United States (Chapter 7 and Chapter 11 of Bankruptcy Code): Personal guarantors may file for bankruptcy protection, limiting their liabilities through structured repayment plans or complete discharge of debts.
• United Kingdom (Insolvency Act, 1986): Personal guarantees are enforced strictly, but debtors have options such as Individual Voluntary Arrangements (IVAs) to settle liabilities without full liquidation.
• Singapore (Insolvency, Restructuring and Dissolution Act, 2018): Offers personal guarantors structured resolution options, similar to corporate restructuring mechanisms.

India’s approach under IBC appears to be more stringent compared to these jurisdictions, with fewer protective measures for personal guarantors.

Mitigation Strategies for Business Owners

While personal guarantees are often unavoidable in corporate finance, business owners can adopt several strategies to mitigate risks:

• Negotiating Limited Guarantees: Restricting the guarantee to specific amounts or time periods can help limit exposure.
• Seeking Collateral Substitution: Offering alternative security in place of personal guarantees can reduce personal financial risk.
• Asset Protection Planning: Structuring personal assets in a way that shields them from insolvency risks can provide financial security. This may include transferring assets to trusts, creating separate legal entities, or strategic investments in exempted assets.
• Diversifying Credit Sources: Avoiding excessive reliance on personal guarantees and seeking diversified credit options can help spread financial risk.
• Seeking Professional Advice: Engaging legal and financial experts can help navigate the complexities of IBC and protect individual interests.

Conclusion

The inclusion of personal guarantors under IBC has heightened risks for business owners, making them personally accountable for corporate debts. Given the evolving legal landscape, business owners must adopt proactive measures to safeguard their financial interests and navigate the challenges posed by insolvency proceedings. Understanding the implications of personal guarantees and seeking expert guidance can help mitigate potential financial setbacks. As judicial interpretations continue to evolve, individuals providing personal guarantees must remain vigilant and well-informed about their rights and liabilities under IBC.