Strengthening the Insolvency Framework for Personal Guarantors

Insolvency Framework Latest News

• The Insolvency and Bankruptcy Board of India (IBBI) has proposed four key amendments to the insolvency resolution framework for personal guarantors to corporate debtors. 
• The objective is to strengthen safeguards available to banks and other creditors and bring the process closer to the protections provided under the Corporate Insolvency Resolution Process (CIRP).
• The proposals have gained significance following the controversy surrounding the repayment plan approved in the Subhash Chandra case.
• The case had raised questions over creditor protection, large haircuts and the effectiveness of the Insolvency and Bankruptcy Code (IBC), 2016.

Why the Subhash Chandra Case Matters

• On August 25, a single bench of the National Company Law Tribunal (NCLT) approved a repayment plan involving personal guarantor and Essel Group founder Subhash Chandra.
• Creditors with admitted claims of ₹22,006.57 crore were offered only around ₹6.25 crore.
• Banks alleged that certain non-bank entities involved in the process were associates or related parties of the guarantor.
• They alleged that these entities acted under Chandra’s influence to support a repayment plan involving an exceptionally large haircut. A special NCLT bench subsequently stayed the single-bench order.
• The episode triggered concerns regarding the effectiveness of the IBC, which seeks to facilitate time-bound resolution of insolvency, maximise asset value and improve recovery for creditors.

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Four Key Amendments Proposed by IBBI

• Bar related parties from voting:
  • IBBI proposes that a related-party creditor of the personal guarantor should not have voting rights while approving a repayment plan.
  • Under CIRP, a related party of the corporate debtor is prohibited from voting in the Committee of Creditors (CoC). 
  • However, in personal-guarantor insolvency, the existing restriction applies to an “associate”, whose definition is narrower than “related party”.
  • For example, a company that habitually acts on the guarantor’s advice or instructions may qualify as a related party even if the guarantor does not own shares or formally control its board. 
    • Such an entity may nevertheless fall outside the narrower definition of an associate.
  • Significance: The change seeks to prevent conflict of interest, indirect influence and strategic voting by entities connected with the guarantor.
• Scrutiny of avoidance transactions:
  • IBBI proposes that the resolution professional (RP) should examine, during the resolution process itself, whether the guarantor was involved in –
    • Preferential transactions
    • Undervalued transactions
    • Extortionate credit transactions
  • The RP would have to place the findings before creditors before they vote on the repayment plan and initiate legal proceedings with their approval.
  • At present, unlike CIRP, the personal-guarantor framework does not require the RP to undertake such an examination before the repayment plan is put to vote.
  • Significance: This would help identify possible asset diversion, preferential treatment of creditors and fraudulent or value-diminishing transactions before creditors decide on a repayment proposal.
• Mandatory independent asset valuation:
  • The proposed framework requires the RP to appoint a registered valuer to determine fair value of the guarantor’s assets; and realisable value of those assets.
  • The valuation report would be provided to creditors along with the repayment plan.
  • This would enable creditors to assess – 
    • Adequacy of available security; 
    • Viability of the repayment plan; 
    • Potential recovery from the guarantor’s assets; and 
    • Whether accepting the repayment plan is commercially preferable to initiating bankruptcy proceedings.
• Record creditors’ commercial rationale:

• • Currently, in personal-guarantor cases, resolution professionals primarily record voting tallies, without adequately documenting the reasoning behind creditors’ decisions.
  • IBBI proposes that minutes of creditors’ meetings should capture –
    • Detailed deliberations;
    • Objections and assessments;
    • Reasons for approving or rejecting the repayment plan; and
    • The commercial rationale behind the decision.
  • Where the proposed repayment is substantially lower than either the admitted claims or the estimated realisable value of assets, creditors would specifically have to explain why accepting the plan is preferable to commencing bankruptcy proceedings.

Significance of the Proposal

• The proposals seek to reinforce the core principles of the IBC – Creditor protection → Transparency → Accountability → Value maximisation → Informed commercial decision-making.
• They also seek to reduce the possibility of connected entities influencing insolvency outcomes –
  • Improving due diligence regarding the guarantor’s financial affairs, and 
  • Ensuring that creditors base decisions on objective recovery prospects.

Conclusion

• The proposed amendments can strengthen the credibility of personal-guarantor insolvency proceedings by ensuring that voting is free from conflicts of interest, assets are independently valued, questionable transactions are scrutinised and creditors’ decisions are properly reasoned.
• Overall, the reforms aim to ensure that a repayment plan represents a genuine and commercially justified resolution rather than a mechanism for disproportionately large haircuts at the expense of creditors.

Source: IE