IBC: Challenges In Going After Failed Guarantees Of Ambani, Dhoot, Wadhawan...
Anil Ambani, Venugopal Dhoot, E Sudhir Reddy, Kapil Wadhawan, and Sanjay Chhabria are among several business promoters that extended personal guarantees to their companies, defaulted and are now facing insolvency resolution proceedings.
As of March, 116 such insolvency resolution applications were pending at the National Company Law Tribunal. Many for over a year. Now they could get activated thanks to a Supreme Court judgment.
“Serious attempts will be made by lenders to recover amounts in cases where resolution plans have been approved,” Harish Chander, partner at ASA Legal, said.
That said, it’s not going to be easy.
The Insolvency and Bankruptcy Code lays down a two-step process for recovery from personal guarantors.
First, a resolution process in which creditors get 180 days to negotiate a repayment plan. The usual elements—moratorium, resolution professional, creditors’ committee, etc.—come into play at this stage.
If no plan is confirmed in 180 days then a creditor can initiate bankruptcy proceedings against a personal guarantor. Bankruptcy proceedings can, under Section 121, also be triggered.
- If the insolvency tribunal rejects the application for the resolution process.
- Where the repayment plan is rejected by the tribunal.
- If the repayment plan hasn’t been completely implemented.
According to legal experts, bankruptcy proceedings against personal guarantors will be fraught with practical and legal challenges.
On the practical front, recovery will depend on the diligence lenders have carried out on personal guarantors’ assets over the years. It hasn’t been rigorous, experts told BloombergQuint.
Legal challenges will arise if these assets have been alienated by personal guarantors.
Personal guarantee agreements typically come with a statement of net worth and list of assets in the guarantor’s name. And this disclosure needs to be updated on an annual basis. How much due diligence was being done on an ongoing basis varies from lender to lender.Harish Chander, Partner, ASA Legal
It's hasn’t been rigorous, Kumar Saurabh, partner at Khaitan & Co., pointed out. That’s because personal guarantees were treated as good faith agreements and more as a deterrent, he said.
They were never approached as a recovery tool. At best, invocation of guarantee was used as a threat to ensure compliance with the obligations to the lenders by the corporate debtor.Kumar Saurabh, Partner, Khaitan & Co.
So, while these agreements were properly documented, due diligence of assets of the guarantor may not have happened on an ongoing basis to ensure that the personal assets of a promoter will be available when the principal borrower defaults, Saurabh pointed out.
The Legal Hurdles
Prudent lenders might be able to overcome the practical challenges. But, the legal tangles, experts anticipate, are likely to result in lengthy litigation on two fronts: asset tracing and feisty promoters.
Once bankruptcy proceedings are initiated against a personal guarantor, what assets are available to recover the debt is the key challenge. Assets could’ve been attached by enforcement agencies, third party rights could’ve been created, they could’ve been transferred to a trust or as gift.
Historically, Chander pointed out, promoters have ring-fenced assets by gifting them to family members, putting them in a trust, among others. “It’s been very hard to prove that assets were alienated with the intent to defraud creditors.”
The insolvency law allows for alienation of property via gift or trust transfers to be clawed back. But the provisions have a strange requirement.
If property has been alienated as a gift or sold at a significantly low value by a personal guarantor, it can be questioned as a undervalued transaction. The law lays down a two-year look-back window for such transfers from the date when the bankruptcy application has been filed.
But more importantly, the provision says that such a transfer should’ve triggered the bankruptcy process.
Sec164: “The undervalued transaction should have – (a) been entered into during the period of two years ending on the filing of the application for bankruptcy; and (b) caused bankruptcy process to be triggered.”
This makes little sense and detracts from the effectiveness of this provision, Sudipta Routh, partner at Indus Law, said. This is meant to be an asset-clawback provision and not something that in itself caused the personal guarantor to go bankrupt, he said.
Under section 121, bankruptcy can be triggered only under three circumstances conditions, (a) application for insolvency resolution is rejected by tribunal, (b) tribunal rejects repayment plan, (c) repayment plan has not been implemented. So how do you prove that an undervalued transaction, sometime in the past, has triggered the bankruptcy process?Sudipta Routh, Partner, IndusLaw
Further, a creditor cannot seek this relief—this right is conspicuous by its absence. Only the bankruptcy trustee may apply, Routh pointed out.
One way to interpret this statutory requirement that the transaction in question should “cause bankruptcy process to be triggered” is to say that it should’ve been of significant value, Sitesh Mukherjee, an independent lawyer practicing insolvency law, said.
For instance, if the net worth of a personal guarantor got eroded and became less than his liabilities, then any transfers by him in the look-back window can be questioned. So, the value of his overall estate fell below the amount of debt he owes.Sitesh Mukherjee, Independent Counsel
Even if courts take this liberal interpretation, creditors’ issues with asset tracing won’t end here.
IBC says a transaction between a bankrupt guarantor and his associate in the look-back window will per se be categorised as an undervalued transaction. But the definition of “associate” only brings within its fold trust transfers where the beneficiary is the bankrupt himself.
So if personal guarantor ‘X’ has transferred his property to a trust where he himself is the beneficiary, that transaction can be categorised as undervalued and reversed. But if the beneficiary is X’s wife, then it must be proved that the transfer to the trust triggered his bankruptcy.
This implies that if the relatives of the personal guarantor are beneficiaries, those trust transactions won’t qualify as “undervalued” under this deeming fiction. And so in such situations, it’ll need to be proved that this transfer triggered the bankruptcy process.Sudipta Routh, Partner, IndusLaw
The second big worry is litigation by personal guarantors, majority of whom are business promoters.
In its May 21 ruling, the Supreme Court laid down that approval of a resolution plan doesn’t automatically mean the personal guarantor’s liabilities towards creditors stand discharged. Also, in some of its earlier rulings, the apex court has said the personal guarantor’s right, as per contract law, to recover this amount from the principal borrower will be extinguished.
Experts say the situation is ripe for litigation by promoters.
Anshul Jain, partner in the regulatory practice at PwC India, elaborated on this.
Consider a situation where a personal guarantor is charged with the under-recovery basis the creditors’ committee decision. The committee of creditors accepted a plan during corporate debtor’s insolvency process which led to a haircut. And for the residual amount, the lenders go after the personal guarantor.
In order to avoid such scenarios, during the corporate insolvency resolution process the promoters would now come up with all sorts of settlement plans seeking withdrawal of their companies from IBC offering full recovery over a period of time. And if the creditors reject this proposal then the promoters are likely to start blaming the committee of creditors for this under-recovery.Anshul Jain, Partner, PwC India