Businessmen like Mallya may no longer be able to game banks. Here's why

On Friday, the Supreme Court (SC) upheld the validity of a notification issued by the Centre, saying banks can take action against personal guarantors to recover loans given to a company.

The Centre had issued the notification on November 15, 2019, under the Insolvency and Bankruptcy Code (IBC), and several petitioners had challenged the order. Guarantors are often the promoters of a company offering guarantees in their personal capacity.

In its Friday verdict, the Supreme Court Bench of justices L Nageswara Rao and S Ravindra Bhat upheld the government notification and said lenders to a stressed company agree upon a resolution plan for it, but that does not mean personal guarantors cease to hold any liability. They do have a liability and the banks can proceed against them to recover the dues.

What does the ruling mean for different stakeholders in the corporate ecosystem?

Definitive hurrah for banks

The Supreme Court ruling offers a big breather for banks — both private and public sector — that have been struggling to recover bad loans. Their non-performing assets (NPAs) have been mounting over the years, and the introduction of the IBC in 2016, while offering a legal redress, has not really done much to help recovery.

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The ruling lets them take steps to recover dues from bad loans’ personal guarantors even as the debtors face bankruptcy proceedings. Such concurrent insolvency proceedings are bound to expedite loan recovery. A personal guarantee even allows lenders to claim the promoter guarantor’s personal assets in case the corporate debt goes bad.

Breather for stressed companies

For stressed companies facing insolvency resolution process, the Supreme Court ruling offers a breather. The continued liability of promoter guarantors will, at least to an extent, take some burden off their backs.

There will be a positive impact on the company’s balance-sheet to the extent of the debt burden the guarantor bears .

Also, a strict implementation of the IBC clause may, in future, deter promoters from taking vastly excessive loans for their companies on the strength of their personal guarantees. This, in turn, may help companies keep debt in check and maintain a healthier balance-sheet.

Setback for promoter guarantors

The Supreme Court ruling is a setback for personal guarantors to corporate groups. Often, promoters convince banks to lend to their companies on the back of their own credit worthiness, personal wealth, political influence or societal stature.

However, once the loan goes bad, the promoters tend to transfer the burden of recovery on to the lenders through the IBC process, while they themselves go mostly unscathed.

This immediately brings to mind the Vijay Mallya case. Banks gave his company, Kingfisher Airlines, loans of over ₹9,000 crore as he offered a personal guarantee and some collaterals, too. But, today, the airline is defunct and the banks are staring at a massive NPA while Mallya eludes regulatory action after having fled to the United Kingdom. Indian courts have declared him a fugitive.

Other examples of promoter guarantors who have spelt trouble for banks are Anil Ambani (Reliance Group), Sanjay Singhal (Bhushan Power and Steel), Venugopal Dhoot (Videocon) and Kapil Wadhawan (Dewan Housing Finance Ltd, or DHFL).

While the Supreme Court verdict is not likely to immediately open the debt recovery floodgates for lenders, it certainly scales up the liability of promoters, making them more accountable for the resolution process.