Early evidence from the personal insolvency framework in India

by Karan Gulati, Chitrakshi Jain, and Anjali Sharma.

In 2016, India enacted an insolvency and bankruptcy law, the Insolvency and Bankruptcy Code (IBC), which included corporate and individual insolvency provisions. However, except for a narrow use case, the insolvency of personal guarantors (PG) to corporate debtors, the provisions for personal insolvency are yet to be notified. These provisions for PG insolvency were notified in November 2019 and were upheld as constitutional in November 2023.

PGs represent a unique and narrow category of individual debtors. They are often promoters, key shareholders, or directors of corporate entities and thus provide guarantees for loans taken by these entities. Lenders can invoke these guarantees when the corporate entity defaults, making PGs liable for the loans. The terms of these personal guarantees may allow lenders to seize and liquidate the assets of the PGs to recover their debts. As per the Bankruptcy Law Reforms Committee (BLRC), it is common practice that Indian banks take a personal guarantee from the firm's promoter when they enter into a loan with the firm.

In this article, we examine the data on PG insolvency cases to understand two key issues: (i) can such cases serve as proof of concept for the broader implementation of personal insolvency provisions under the IBC?; and (ii) what feedback loop is emerging for lenders from enforcing personal guarantee contracts through insolvency proceedings? However, we restrict this examination to the outcome of PG insolvency cases (approval of a repayment plan) and exclude the input (the insolvency process itself). Thus, we do not attempt to explain the gap between the applications filed and those admitted or between the applications filed and the appointment of resolution professionals.

Importance of personal guarantees

Limited liability protects a firm's shareholders from personal liability for its debts during distress, allowing them to retain their assets and wealth even during debt recovery or insolvency proceedings. This protection encourages entrepreneurship and risk-taking. Individuals often choose to incorporate to benefit from limited liability. However, when a firm faces distress and the value of its shares falls, two things can happen: (i) limited liability can encourage risky business decisions, and (ii) the firm's promoters may alienate its assets in their favour. One way to balance limited liability with accountability for the firm's promoters is through personal guarantee contracts. If promoters enter into personal guarantee contracts with lenders, lenders can seize the promoters assets if the debts of the incorporated entity remain unpaid. These contracts can moderate risk-taking by making guarantors internalise the costs of default and disincentivise the firms promoters from alienating its assets in their favour.

The interplay between limited liability and personal guarantees affects creditor rights during firm distress. Personal guarantees widen the pool of assets available to lenders when a firms assets are insufficient to cover its debts. In this context, guarantees offer lenders additional collateral for loans to corporate debtors while preserving the principles of limited liability and enhancing the debtors creditworthiness.

Given the role of promoter-owners in managing firms in India, personal guarantees have become a common feature of corporate lending. These guarantees are often used alongside other forms of collateral. RBI guidelines also encourage personal guarantees when lending to closely held or higher-risk firms to enhance loan security and ensure management continuity. Additionally, the RBI has incorporated personal guarantees into its restructuring debt framework. While data on the proportion of corporate loans secured by personal guarantees is unavailable, disclosures by the largest five public-sector and four private-sector banks as of 31 March 2023 suggest that guarantees cover 4% of the advances extended by these banks (authors' calculations).

PG insolvency as a lab for personal insolvency implementation

As per provisions for personal insolvency under the IBC, PGs propose repayment plans based on their ability to honour the guarantee. A resolution professional submits this plan to the committee of creditors, as defined under section 79 (11) of the IBC. Once creditors vote in favour of the repayment plan, it is then approved by the NCLT. Generally, from admission to approval of the repayment plan, this process takes a little over a year.

As of June 2024, 3134 PG insolvency applications involving claims of approximately Rs. 2 trillion have been filed across National Company Law Tribunals (NCLTs) and 50 such applications have been filed before the Debt Recovery Tribunals (DRTs). Of these, 468 applications were admitted, and the NCLT approved repayment plans in 26 cases. Although overall data for the number of corporate debtors that correspond to PG applications is not available, the 26 cases studied in the article correspond to 4 corporate debtors.

In the 26 cases in which the NCLT has approved repayment plans only one featured a joint application for resolution filed by the corporate debtor and its PGs. In the remaining cases, actions against PGs were initiated near or after the conclusion of the corporate debtors insolvency resolution process. In one case, the PG also acted as the resolution applicant in the corporate debtors insolvency process. Table 2 summarises the outcomes of the PG insolvency processes (PGPs) alongside those of the corresponding corporate resolution processes.

Table 2: Outcomes of personal guarantor and the corporate debtor resolution processes
Corporate debtor	No. of PGs	Date of Admission of PGP	Amt. claimed against PGs (Rs. cr.)	Recovery against PGs (%)	Amt. claimed against Corporate Debtor (Rs. cr.)	Date of Liquidation/Resolution (Corporate Debtor)	Outcome of the Corporate Debtor case	Recovery against Corporate Debtor (%)
Bluefern Ventures	2	30-09-2021	30.3	39.6%	38.7	Unclear	Liquidation	NA
Vishwa Infrastructures	12	15-2-2022	1441.6	0.8%	1318.5	14-06-2019	Liquidation	4.3%
Chadalavada Infratech	7	21-09-2022	278.1	24.5%	440.4	11-04-2022	Liquidation	2.4%
Pradip Overseas	5	27-04-2022	3017.5	0.4%	2663.0	14-10-2021	Resolution	4.8%
Total	26	-	4767.5	2.2%	4460.6	-	-	4.1%
Source: IBBI Quarterly Newsletters, NCLT Orders in cases

Personal guarantees are meant to hold promoters accountable. Table 2 shows that, despite variations in the number of guarantors and the amounts claimed, PGPs have yielded an average recovery rate of 2.2%. However, these recovery rates should be viewed in the context of the poor outcomes in the corporate debtor insolvency process and the extent to which these debts have devolved on the PGPs. In three cases, the corporate resolution processes resulted in liquidation. The average recovery rate for the four cases was 4.1%.

The purpose of a personal insolvency framework is to provide the debtor with a way to exit a debt contract. Of the 3184 applications which have been filed, only 468 have been admitted. The tribunals have approved the repayment plans in only 26 out of the 468 admitted cases (till June 2024). These gaps cannot be explained by merely looking at the outcomes in the PGPs which have been completed. The next section underscores how the insolvency process may just be a costly detour, for a substantial number of PGs are unable to honour their obligations under the repayment plan. While the outcomes can only be studied for 26 cases, they are underwhelming and it would be useful to conduct an evaluation of both the process and outcomes in the PGPs before extending the coverage to all classes of individual debtors under the IBC framework.

A feedback loop from PGPs

Since lenders may turn to personal guarantees due to poor value realisation in recovering debts extended to firms, enforcing personal guarantee contracts is important to provide creditors with an efficient means of recovery and to ensure that debtors can discharge their obligations. Before the notification of personal insolvency provisions for PGs to corporate debtors under the IBC, creditors relied on frameworks under the SARFAESI Act, the RDDB and FI Act, and the Indian Contract Act. These frameworks did not allow creditors to collectively enforce their rights.

Most corporate lending in India is secured by collateral, enforceable through the corporate debtor resolution process under the IBC. Enforcing personal guarantees under the IBC offers an additional recovery mechanism. The BLRC also recognised the importance of enforcing these guarantees and recommended establishing a framework to ensure the completeness of the corporate insolvency process. While the IBC extends the recovery process to include personal guarantees and provides a pathway to discharge an individual debtors obligations, it remains to be seen whether the framework is effective and represents an improvement over previous statutory recovery frameworks.

However, early evidence from the outcomes under this framework provides valuable inputs to lenders, helping them to make informed decisions about the value of personal guarantee contracts and their utility as collateral security for credit to firms. In two cases, the repayment plans of PGs resulted in better outcomes 24% and 39.6% compared to nil and 2.4% in the respective corporate processes. However, out of the 468 admitted PGPs, 108 were closed due to the non-submission or rejection of a repayment plan (IBBI Newsletter, Apr-June 2024).

Our analysis of 26 cases in which the NCLT has approved repayment plans reveals that these cases have not yet been marked as disposed of. A closer reading shows that this is because the PGs have failed to fulfil their obligations under the plans. Data on the implementation status of the repayment plans of PGs is available for 19 of the 26 cases (corresponding to two out of corporate resolution processes). Their details are presented in Table 3.

Table 3: Status of implementation of the repayment plans for PGs.
	Vishwa Infrastructures (CD)	Chadalavada Infratech (CD)
No. of PGs	12	7
No. of PGs that have defaulted on plan	7	5
Value of default (in Rs. cr.)	8.0	47.5
No. of PGs discharged	5	2
Value realisation from discharged PGs (Rs. cr.)	3.1	20.6
Total liability devolved on PGs (Rs. cr.)	1441.6	278.1
Recovery rate total	0.8%	24.5%
Recovery rate from discharged PGs	0.2%	7.4%
Average time to default after approval of repayment plan (in days)	274.0	81.4
Average time to discharge after approval of repayment plan(in days)	126	83
Source: Orders of the NCLT, Hyderabad

As of June 2024, of the 12 PGs associated with Vishwa Infrastructures, only 5 have fulfilled their obligations under the repayment plan. The remaining PGs have either been declared bankrupt or are in the process of filing for bankruptcy. Similarly, of the 7 PGs associated with Chadalavada Infratech, only 2 have been discharged from their obligations. The remaining have either been declared bankrupt or have filed for bankruptcy.

Feibelman and Sane (2020) also recognised the challenge of defaults in repayment plans within personal insolvency, noting that adhering to the requirements of the plans might just be a detour for some individual debtors. They recommended standardising repayment plans to identify debtors who should proceed directly to bankruptcy. Our examination of PGPs supports their recommendation.

According to the IBBI, 56 bankruptcy applications for PGs have been filed across DRTs and NCLTs as of June 2024. Completing these bankruptcy proceedings will provide a complete picture of how the IBC operates in personal insolvency cases. However, The low recovery rate and the failure of PGs to submit viable repayment plans suggest that the realisable value from guarantee contracts may be minimal, mirroring the declining fortunes of the corporate debtor. Thus, the likelihood that personal guarantees will cover the shortfall in recovering corporate debts is low. This should prompt lenders to reconsider the role of guarantees in corporate credit contracts.

Conclusion

In 2015, the BLRC had insisted that corporate insolvency provisions are incomplete without a personal insolvency framework. The PGPs that have resulted in approved repayment plans under the IBC have shown limited effectiveness as a value discovery mechanism for lenders and guarantors. Given that many PGs have been unable to fulfil their obligations under the repayment plan and have subsequently filed for bankruptcy, it remains to be seen how extending the coverage of the personal insolvency framework will balance the interests of the debtors and creditors. A careful evaluation of the process of insolvency should be conducted before the IBC framework is extended to all classes of personal debtors.

References

Designing a Personal Insolvency Regime: A Baseline Framework, by Feibelman A and Sane R , 2020, IBBI, Insolvency and Bankruptcy Regime in India - A Narrative.

Velvet Bankruptcy, by Hahn D, 2006, Theoretical Inquiries in Law, Volume 7 Number 2, pp. 523:554.

At the time of writing, the authors Karan Gulati and Anjali Sharma were researchers at TrustBridge. Chitrakshi Jain is currently a researcher at TrustBridge. We are grateful to Adam Feibelman and Renuka Sane for their comments. Views are personal.