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Banks Must Come Out With Clear Cut Policies For Settlement Of Personal Guarantees

Bankers seem to have unlimited leverage over borrowers in the case of a default. Banks are lending with covenants that disbursement and draw-down will happen only if all covenants are complied with. Borrowers tend to yield to pressure as they have timelines to meet in the pursuit of financial closure and project completion

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The recent Supreme Court ruling allowing banks to invoke personal guarantees provided by promoters and KMPs (key managerial personnel) has drawn considerable attention to Indian law and the ease of doing business environment in the country. While banks attempting to recover loans will be tempted to initiate bankruptcy proceedings against promoters against personal guarantees, the issue really has much wider ramifications. 

Invoking personal guarantees has been an extremely contentious issue for a long time, since it is not the general practice in most advanced economies, especially when these guarantees are for projects or collateralised loans. Personal guarantees, however, have been prevalent in the Indian banking system for a long time. Bankers have been taking collateral security including mortgage of fixed assets, lien on stock and debtors, corporate, pledging of shares of promoters and personal guarantees, to secure their exposure. 

The tussle between bankers and borrowers over pledging of shares and personal guarantee persists, since it is natural for bankers and borrowers to be on opposite sides of the spectrum on this issue. Bankers would want to maximise collateral and security, while borrowers on the other hand, would obviously prefer to limit their security to assets of the project. In its last Budget, the Union government announced formation of the DFI (Development Finance Institution) and plans to set up an ARC (Asset Reconstruction Company for managing non-performing assets) to address the issue of large corporate borrowings in stress and of augmenting the financial health of banks. These measures may also give an opportunity to banks to resolve the issue of personal guarantees.

In the ultimate scenario, the law has gone and enabled bankers to have seemingly unlimited leverage over borrowers in the case of a default. Banks are lending with covenants that disbursement and draw-down will happen only if all covenants are complied with.  Borrowers tend to yield to pressure as they have timelines to meet in the pursuit of financial closure and project completion. Both in consortium and multiple lending, there is a tendency to take personal guarantees from promoters. 

The Borrowers’ Dilemma

Borrowers argue that bankers go beyond the company where liability is limited – and that there is always an element of risk in the business and that the company is collateralizing its assets to address this. They argue that at the same time promoters are also infusing equity on a continuous basis. Additionally, promoters argue that while banks charge high interest rates that subsume risk factors to them, the company commonly faces problems like land acquisition, coal and gas allocation, environment clearances, licence cancellation et al, which results in project time and cost overrun, thus jeopardising the viability of the project. Promoters of the borrowers are usually of the view that to avoid stress in the account, group companies augment the borrowers’ cash flow in making interest payments and repayments. There have been numerous cases where projects have become unviable or have had to be shelved owing to external factors that were beyond the control of promoters. 

The Bankers’ Plight

Since banks do take a risk in funding projects, it is understandable that they would in principle, want to ring fence their ability to recover the loans. There have been instances of promoters utilising bank funds for reasons other than those for which they were borrowed. Bankers have faced serious accountability issues in such cases, when it has been impossible to distinguish between genuine lending and mala fide decisions. In such cases, a personal guarantee can be an effective tool. However, bankers observe that the value of personal guarantee changes over the period of the loan, thus making it difficult to assess a specific figure at inception. 

Beyond the value, the enforceability of personal guarantee is also a matter of concern. The concerns of bankers’ stem from the fact that borrowing companies enter into multiple related party transactions. Enforcing personal guarantees, even in DRTs (Debts Recovery Tribunals), have been riddled with complexities owing to family disputes, lessor-lessee litigations, encumbrance by statutory authorities because of their prior rights, etc. The trust deficit between the banker and the borrower is visible. As a way forward, it is essential that promoters show serious intent by bringing in transparency and governance.

The Way Forward

The more serious issue to contend with is ensuring resolution of personal guarantee and the way forward. Banks must come out with clear cut policies for settlement of personal guarantees. Historical data certainly indicates that recovery from corporate guarantee and personal guarantee has not been significant. The recent Supreme Court decision has already prompted banks to take steps for recovery from personal guarantee under the Insolvency and Bankruptcy Code (IBC) process for cases at the National Company Law Tribunal (NCLT), be they in resolution or under liquidation by virtue of amounts which are going to be realised from companies. 

It is imperative that banks frame a clear OTS (one-time-settlement) policy for all borrowers who have provided personal guarantee under the NCLT and recovery process that is systematic, so as to ensure that no arbitrary decisions are taken. This legacy issue which is haunting banks, needs a conclusive resolution. 

Disclaimer: The views expressed in the article above are those of the authors' and do not necessarily represent or reflect the views of this publishing house. Unless otherwise noted, the author is writing in his/her personal capacity. They are not intended and should not be thought to represent official ideas, attitudes, or policies of any agency or institution.

S Ravi

The author is a practising chartered accountant and an independent director on many large public companies whose views and ideas have been instrumental in framing policy

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