This move by banks follows the recent landmark Supreme Court order that upheld the constitutional validity of recovery provisions against personal guarantors under the Insolvency and Bankruptcy Code (IBC). In practice, lenders insist on personal guarantees from promoters of small and medium companies while large borrowers, leveraging their heft, have stopped providing these guarantees long ago.
“Going forward, we expect banks will exercise even more vigilance about the assets of promoters who provide personal guarantees for their companies availing loans,” said Bikash Jhawar, senior partner at law firm Saraf and Partners.
“They may introduce loan covenants that allow them to create a negative lien on the assets underlying the personal guarantees given by promoters. Lenders will also track the assets owned by borrowers and guarantors regularly to ensure assets do not dissipate.” By creating a negative lien, the borrower commits not to dispose of the asset or create encumbrance on it without consent of the lender.
Underlying Assets Not Pledged
Provisions of the IBC empower lenders to initiate personal insolvency against promoters to recover shortfalls after the creditors have sold assets of the defaulting company. There are 2,289 applications before several tribunals claiming Rs 1.63 lakh crore in aggregate in individual insolvency cases as of September 30, data from the Insolvency and Bankruptcy Board of India (IBBI) showed.
Typically, when a company avails a loan, the promoter provides a list of assets s/he owns, or those in which s/he has a beneficiary interest. At that time, the company’s assets, such as the collateralised manufacturing unit, are pledged while the promoters’ underlying personal assets are not pledged even if they provide a personal guarantee.Thus, as loan covenants currently stand, the promoter is within her/his right to sell or even transfer these assets to a special trust, legal experts say.
‘Overvalued Net Worth’
“Most of them (guarantors) would have transferred or sold most of the assets in their personal names,” said Sujit Varma, former deputy managing director at State Bank of India (SBI) and currently director of Tata Cleantech Capital and L&T Metro Rail. “Hence, there will be a huge difference between their net worth as per banks’ records and the actual net worth today.”
Personal assets, at present, are pledged only if there is a shortfall in the security cover for corporate loans.
“The problem is in monitoring the assets of personal guarantors. Unlike borrower companies, where the lenders monitor the sale of assets, there is no mechanism that lenders use to monitor personal assets,” said Anshul Jain, Partner, PwC India. “By the time personal insolvencies are invoked, the promoter would have no meaningful asset left, thereby leading to negligible recoveries for lenders.”
Following the Supreme Court order, promoters are seeking legal advice on ways to transfer their assets to a special trust that is legally impenetrable.
