GUARANTEE ENFORCEMENT UNDER IBC

Introduction

To understand guarantee enforcement under IBC, we must first understand the background of IBC (Insolvency and bankruptcy code). This code deals with creditors and debtors who declare themselves bankrupt or insolvent. This board was set up in 2016, under the Companies Act 2013. This code deals with two categories, the first being individual and partnerships, which are dealt with by the Debt Recovery Tribunal (DRT). The second is companies and limited liability partnerships. 

Both individuals and companies are capable of applying for bankruptcy. The reason for the classification of both is that in the case of individuals, it shall be referred to as bankruptcy, on the other hand in the case of companies it is referred to as corporate insolvency.

 Firstly, let us discuss the meaning of the terms Insolvency and bankruptcy. Insolvency means an individual or a company that is in a state where they are unable to pay debts on time, defaults on payments are made because of insufficient funds: Whereas bankruptcy is the legal declaration of an individual or company’s inability to pay debts.

India being a developing country, has a lot of businesses that are run by individuals and companies. A lot of companies go insolvent and then declare themselves bankrupt, which creates NPAs (Non-Performing assets), these NPAs further on are a huge load on the economy, so to ease and solve the situation this law was deemed necessary. Henceforth in 2015, the final draft was submitted and on 1st June 2016, the Act was passed.

Overview of Personal Guarantees

What is a personal guarantee? Let us understand this, a promise binding by law to repay credit towards the respective business.  A personal guarantee is an extra layer of protection to the creditor regarding the reimbursement, in the circumstances where the undertaking fails to fulfil its promise. There is an individual(guarantor) and primary borrower (corporate debtor) who borrows.

These types of guarantees are often given for obtaining credit or funding from creditors, it reflects their commitment and confidence in the ability of a business to repay the debt. The guarantor’s assets may be ceased if he fails to comply with the obligations. This exposes the guarantor to inherent risks. But if the borrower defaults on the payment then the creditor under section 128 of the Indian Contract Act can initiate proceedings against both, the guarantor and primary borrower subsequently.

The liability of personal guarantors is known as co-extensive liability, which means that the liability incurred by the personal guarantor is equal to the liability of the principal debtor. This is because when the primary debtor fails and defaults on his payment, then the guarantor has to step in and cover the debt. The liability here is not sequential rather it is simultaneous and equal.

Let us understand this with an example, let the primary debtor be A, the guarantor be B, and the creditor be C. Here C lends A an amount of 1Cr, where A gives a personal guarantee with his guarantor being B. The amount was to be returned before the end of the month, but A failed and defaulted on the payment due to lack of funds to C. 

Here regardless of whether C starts insolvency proceedings against A or not, A has to pay the amount to C, if A fails to do so B has to step in and pay the amount of 1Cr.

Now let’s take a glance at the rights of the creditors and guarantors.

Rights of creditors in enforcing guarantees

1. Right to demand payment
2. Right to sue
3. Right to seize collateral
4. Right to insolvency proceedings
5. Right to information

Rights and defences available to guarantors

1. Right to indemnity
2. Right to seek contribution
3. Right to information
4. Right to limited liability
5. Right to release
6. Right to avoid payment
7. Right to demand action against the principal debtor

Process of guarantee enforcement under IBC

Now, let us understand once a legally binding promise is made, the primary borrower is unable to repay. Then what is the further procedure to protect the rights of creditors and enforce IBC,

• Initiation of insolvency proceedings 

When a creditor applies with the NCLT(National Company Law Tribunal), the insolvency proceedings are said to have begun against the personal guarantor, when the creditor along with the application filed provides evidence regarding the debt and personal guarantee invocation. After submitting this the NCLT goes through this and if satisfied, admits it and the proceedings begin.

• Interim Moratorium

Moving ahead Sec 96 of the IBC is applied, which states interim moratorium(suspends debt payments). What the moratorium does is suspend all activities regarding debt or assets of creditors being used to pay off the debt, or any suits regarding it. This is done to conduct the negotiations for resolving the debt without external pressure on the guarantor.

• Resolution professional

A committee of creditors is formed(all the people who were creditors and lost their money) these people appoint a person named resolution professional who must assess and evaluate the assets of the debtor. He is also responsible for preparing a resolution plan and negotiating with the creditors.

• NCLT Proceedings

The whole process is overseen by NCLT, by following IBC. NCLT will further review the Resolution plan proposed by the RP and decide whether or not to approve it. The plan is of very high importance here as if the plan is passed it will be binding on all the stakeholders and the guarantor, whereas if the plan is rejected by the committee then the assets of the guarantor will be liquidated.

While exercising these rights and the duration of the proceedings, there are certain practical challenges faced in guarantee enforcement. They are as follows-

1. Identification of assets:- when the assets of the guarantor are spread across different jurisdiction, it becomes difficult to evaluate them all.
2. Legal hurdles:- different jurisdictions have different laws and procedures for enforcing guarantees, which makes the process complicated.
3. Time and cost incurring:- these processes usually take a lot of time and administrative resources.
4. Resistance from debtors:- the debtors may resist and dive into legal battles.

Conclusion

When the primary debtor fails to meet their financial obligations, personal liability management under the Insolvency and Bankruptcy Code (IBC) is an important tool for         Lenders to recover outstanding debts. This system introduces the principle of joint liability,  where the guarantor is equally liable for the debts of the primary creditor. More importantly, when the debtor is illegal, creditors can go after not only the debtor but also the personal assets of the guarantor, thereby expanding the resources available for recovery of the debt.    The personal liability process is fraught with problems that can hinder recovery. Determining the assets of the guarantor is an important issue. More often than not, the guarantor will have to divide or transfer his assets to other entities, making it difficult for creditors to determine what they can claim. This issue is further complicated by the need for due diligence, which can be time-consuming and costly.

An IBC is usually headquartered in India, but many sponsors may have capital or reside in other countries. This requires knowledge of international laws and regulations, which may or may not be the same as the IBC regulations. Addressing these legal issues can lead to legal disputes that lead to delays in recovery. The guarantor may challenge the validity of the guarantee or the performance of the guarantee, which may lead to a dispute that must be resolved through litigation. Debtors may also use various strategies to avoid repayment, such as declaring themselves bankrupt or hiding their assets. This attack can increase the recovery time and increase administrative costs. The difficulty of identifying assets, the complexity of various legal arrangements, and the potential for debt protection complicate and prolong debt collection. Resolving these issues requires a comprehensive approach that includes strengthening the legal system, increasing participation in decision-making processes, strengthening the search for inheritance, and strengthening the recovery process.

Author(s) Name: Sangram Vaishali Dolas (SPPU ILS law college, Pune)