Loan guarantors face risks; negotiate cap on liability in loan deed

To protect insurance policies purchased for spouse from recovery proceedings, place it under Married Women's Property Act

The Jammu & Kashmir and Ladakh High Court ruled recently that protection under the Pensions Act, 1871, ends once pension is credited to a pensioner’s bank account. In Chuni Lal vs Jammu & Kashmir Bank Ltd & Ors., a retired government employee challenged the deduction of ₹4 lakh from his pension account, arguing that pension remains exempt from attachment. He had stood guarantor for a loan in which the borrower defaulted.

 

The court held that the pension remains protected only while it is with the employer as a provident fund. Once it is credited to the individual, it is deemed “paid” and can be attached. The court upheld the deduction and dismissed the petition. 

Loans that require a guarantor

 

Guarantors are typically required for unsecured loans. Secured loans, such as car loans or home loans, usually do not require a guarantor. However, lenders may sometimes ask for one based on their risk assessment.

 

“A guarantor is commonly required for first-time borrowers, those with weaker repayment capacity, or loans like personal and education loans that are not backed by assets,” says Raoul Kapoor, co-chief executive officer (CEO), Andromeda Sales and Distribution.

 

Guarantor’s liability

 

If the primary borrower defaults, the guarantor is legally obligated to repay the entire outstanding loan, including interest, penalties, and related charges. Lenders need not first exhaust recovery options against the borrower and may proceed directly against the guarantor.

 

“In prolonged cases of non-repayment, lenders may initiate legal action, possibly leading to attachment of the guarantor’s assets or income. This highlights that a guarantor’s liability is co-extensive with that of the borrower and represents a significant financial and legal obligation,” says Kanwar Bhatia, executive director, Urban Money.

 

“A default by the borrower can also affect the guarantor’s credit profile and future borrowing capacity,” says Kapoor.

 

Protected and attachable assets

 

During recovery, banks can proceed against assets pledged by the guarantor. “These include immovable property, pledged financial instruments, or other assets specifically charged to secure the loan. They may also use funds lying in bank accounts to recover dues,” says Siddartha Karnani, partner, King Stubb & Kasiva, Advocates and Attorneys.

 

Money in a Public Provident Fund (PPF) is protected. “It remains protected under Section 9 of the PPF Act, 1968, and cannot be attached for recovery while it remains within the scheme,” says Vishal Gehrana, partner designate, Karanjawala & Co.

 

Once the tenure ends and the amount is withdrawn and credited to your bank account, that protection may not continue. “The safer view is that it then becomes like any other balance and can be attached by the court. A narrow argument may exist if the funds are kept separate and clearly traceable, but one should not assume continued protection after withdrawal,” says Gehrana.

 

Section 6 of the Married Women’s Property Act, 1874, provides that where an insurance policy is effected by a man on his own life for the benefit of his wife or children, it creates a trust in their favour. “The money payable does not form part of his estate or become subject to his debts,” says Gehrana. Thus, this protection applies only if the policy is taken under Section 6 from inception and the beneficial interest clearly rests in favour of the wife or children.

 

Money lying in savings accounts and investments such as shares, exchange-traded funds (ETFs), or mutual funds is treated as the guarantor’s property and can be attached through a court order.

 

“However, the Code of Civil Procedure, 1908, protects certain assets from attachment, such as basic personal belongings, tools of trade, and, in some cases, pension benefits,” says Karnani.

 

Relief options are limited after default. Banks can proceed against the guarantor’s assets, including funds in bank accounts. “The guarantor can challenge recovery actions mainly on procedural grounds or seek relief from courts if the lender’s actions are fraudulent or violate contractual terms,” says Rahul Sundaram, partner, IndiaLaw LLP.

 

Avoid becoming a guarantor

 

Before becoming a guarantor, assess the borrower’s repayment capacity, financial discipline, and creditworthiness. “Understand the loan terms, including total liability, tenure, and when the guarantor may be required to step in. Also evaluate your own financial ability to handle such a liability,” says Bhatia.

 

Become a guarantor only if it is absolutely necessary and there is a genuine need. Ensure that the borrower is not overleveraged. Track whether equated monthly instalments (EMIs) are being paid on time. Do not agree to become a guarantor based solely on personal relationships.

 

“Negotiate a specific cap on guarantor liability in the deed, and insist on clauses requiring the bank to first exhaust remedies against the principal borrower before invoking the guarantee,” says Sundaram.  The writer is a Delhi-based independent journalist 

Procedure followed against guarantor under SARFAESI Act

• After loan is classified as NPA, demand notice is issued under Section 13(2), with 60 days to clear dues
• Security interest is enforced under Section 13(4) if dues remain unpaid
• This includes possession, appointment of manager for asset, or sale of secured assets for recovery
• Even Supreme Court has held that lenders may initiate recovery proceedings directly against guarantor without first exhausting remedies against borrower