Ending guarantors' impunity

Wake-up call for errant promoter-guarantors

The Insolvency and Bankruptcy Board of India (IBBI) is reportedly working on rules to ensure that those who have offered guarantees to stressed companies will also be subject to recoveries by creditors. This is a welcome move, as it has been observed that many company promoters in India have borrowed money from banks under the cover of personal guarantees, which then the banks have struggled to recover if the companies went belly-up. The idea is that if creditors fail to recover their dues from the sick companies in the current bankruptcy process, they will be able to move against the guarantors of the companies as well. This will apply, presumably, to both individuals and holding companies if it is to be properly effective. 

The legal distance between companies and promoter-shareholders is carefully maintained by much current regulation but is reduced to a fiction in practice, especially when it comes to borrowing money. When a guarantor is also a promoter, surely the principle of limited liability fails to apply in full. There have been many well-reported cases of individuals who continue to live lavish lifestyles even after providing sizeable personal guarantees to companies that are going through the bankruptcy process and from which creditors are struggling to recover their dues. This dichotomy cannot last forever, and it is good news, therefore, that the insolvency regulator is seeking to rationalise the rules. It should be seen as part of a larger effort by the government to clean up promoter culture in India. Other instances of such an effort include the search for shell companies, which are used to strip assets or to evade taxes by unscrupulous promoters. Within the insolvency and bankruptcy process itself, there was the attempt by the government to prevent promoters whose companies have taken on loans that were subsequently classified as non-performing assets from bidding in the auctions for other sick companies. The logic in that instance was if the promoters had those resources to spare, surely they should be investing in their own companies. It is also logical to assume that promoters could have used the insolvency process under the Insolvency and Bankruptcy Code (IBC) as a method of marking down their debt while retaining control. Such bad behaviour should be dis-incentivised, and cutting down on the misuse of guarantees is another route to that end. 

There are additional questions that need to be sorted out regarding the insolvency and bankruptcy process for guarantors. For example, what happens when both a group company and the holding company that guaranteed the group company’s debt enter the insolvency process? What is the status of the creditors in this case, especially those who have lent to both the group company and the holding company? Questions about individual bankruptcy will also need to be worked out going forward now that personal guarantees are being brought within the IBC process. Then there are concerns over whether banks, which demand personal guarantees for corporate loans, are taking the easy way out and abdicating their responsibility for better risk management. Although there is still considerable work to be done by the regulator, it has made a good start in cleaning up the culture of impunity surrounding promoters in India.