Subhash Chandra case: IBBI to tighten guarantor resolution

Why in the News

The Insolvency and Bankruptcy Board of India (IBBI) has proposed four amendments to the insolvency resolution process for personal guarantors to corporate debtors, extending to banks and creditors safeguards already available under the corporate insolvency resolution process (CIRP) of a company. The proposals follow a special bench of the National Company Law Tribunal (NCLT) staying a single bench order that had approved a repayment plan offering creditors Rs 6.25 crore against admitted claims of Rs 22,006.57 crore. That case led experts to question the efficacy of the Insolvency and Bankruptcy Code, 2016, which was introduced to revive companies under heavy debt and secure repayment to banks. The contested point is that the guarantor track of the Code was built with weaker creditor protections than the corporate track, and a related party of the guarantor can currently vote on the plan that decides what creditors recover.

What is the personal guarantor resolution process?

1. Who a personal guarantor is: An individual, usually a promoter, who personally guarantees a company’s borrowing, so the lender can proceed against that individual’s own estate when the company defaults.
2. How the process runs: A resolution professional is appointed, a repayment plan is prepared for the guarantor, and the plan is put to a vote of the creditors before it goes to the adjudicating authority for approval.
3. How it differs from the corporate track: Under CIRP the plan is decided by a committee of creditors from which a related party of the debtor company is excluded from voting. In a personal guarantor resolution only an associate is barred, and the definition of associate is far narrower.

What triggered the review?

1. The order under stay: On August 25 the NCLT single bench approved a repayment plan involving personal guarantor and Essel Group founder Subhash Chandra, and a special bench has since stayed that order.
2. The recovery on offer: Creditors were offered Rs 6.25 crore against admitted claims of Rs 22,006.57 crore.
3. What the banks alleged: The banks alleged that the non bank entities voting on the plan were associates or related parties of the guarantor and had acted under his influence to push through a plan carrying a very large haircut.
4. The gap the case exposed: The narrower associate test let entities that would fail a related party test vote on the plan. The IBBI’s own illustration is a company that habitually acts on the guarantor’s advice or instructions, without the guarantor holding any shares in it or controlling its board.

What are the four proposed amendments?

1. Voting rights of related parties: Any creditor who is a related party of the guarantor would get no voting right in approving the resolution plan, replacing the narrower associate test.
2. Scrutiny of avoidance transactions: Resolution professionals would have to examine whether the guarantor was party to any avoidance transactions, meaning undervalued transactions, transactions giving preference and extortionate credit transactions, present those findings to creditors before the vote, and initiate legal proceedings with creditor approval.
3. Independent asset valuation: A registered valuer would have to determine the fair value and the realisable value of the guarantor’s assets, and the valuation report would go to creditors along with the repayment plan.
4. Reasoned minutes of creditor meetings: Resolution professionals would have to record creditors’ deliberations and the reasons for their decision in the minutes of creditors’ meetings.

How do these proposals close the gap with the corporate process?

1. Parity on the voting bar: The related party exclusion is the CIRP standard, and applying it to guarantor resolutions removes the mismatch the Chandra case turned on.
2. A duty that does not currently exist: When a guarantor’s repayment plan is put to a vote, the resolution professional is today under no obligation to examine whether an avoidance transaction took place or whether the guarantor made full disclosure of affairs.
3. Informed commercial judgement: The IBBI’s stated purpose for the valuation report is to let creditors assess the adequacy of the proposed security, the viability of the repayment plan and the potential recovery available from the guarantor’s assets.
4. An auditable record: Recording only raw voting tallies leaves no record of commercial reasoning, and reasoned minutes give an appellate forum something to review beyond the arithmetic of the vote.

Challenges to the personal guarantor resolution framework

1. Asset shielding before the filing: A guarantor can move assets into family or trust structures well before insolvency begins, leaving little to value. Eg. Promoter assets held through family trusts have repeatedly fallen outside the estate available to lenders in large default cases.
   The Fix: Extend the look back period for avoidance transactions involving a guarantor’s relatives and require a sworn asset disclosure covering it.
2. Proving a related party connection: The related party test is broader than the associate test and is also harder to establish, since control through habitual instruction leaves no shareholding trail. Eg. The IBBI’s own example is a company acting on the guarantor’s instructions without any shareholding or board control.
   The Fix: Place the burden on the creditor claiming unrelated status to establish it, rather than on the objecting bank to disprove it.
3. Delay in adjudication: The guarantor track sits in the same tribunals already carrying a heavy corporate caseload, so an order and its stay can consume months while asset value erodes. Eg. The stay in this case leaves the approved plan in suspension with no fixed date for a decision.
   The Fix: Fix a statutory outer limit for disposal of a personal guarantor repayment plan and report breaches bench wise.
4. Valuation of illiquid personal assets: Fair value and realisable value diverge sharply for unlisted shareholdings, disputed land and pledged promoter stock. Eg. Pledged promoter shareholdings lose value the moment a lender begins to sell them into the market.
   The Fix: Require two independent registered valuers where the guarantor’s estate is dominated by unlisted or pledged securities.

Conclusion

The guarantor track of the Code was written as a lighter version of the corporate one, and the difference has turned out to matter most in exactly the cases where recovery is largest. The four proposals move that track towards the corporate standard on voting, scrutiny, valuation and record keeping, and each of them constrains the resolution professional rather than the tribunal. The proposals sit in a discussion paper open for public comment, and the special bench’s stay holds until it decides the matter.

Back2Basics: Insolvency and Bankruptcy Board of India

1. What it is: The IBBI is the regulator for insolvency and bankruptcy proceedings in India, established in 2016 under the Insolvency and Bankruptcy Code, 2016.
2. Who it regulates: Insolvency professionals, insolvency professional agencies, registered valuers and information utilities.
3. What makes it unusual: It holds regulatory, executive and quasi judicial functions over the same set of entities, which is rare among Indian regulators.
4. Its rule making role: It frames the regulations that govern both the corporate insolvency resolution process and the resolution of personal guarantors, which is what the present discussion paper proposes to amend.

Matching Previous Year Question

“[2019] What was the purpose of Inter-Creditor Agreement signed by Indian banks and financial institutions recently? (a) To lessen the Government of India’s perennial burden of fiscal deficit nd current account deficit (b) To support the infrastructure projects of Central and State Governments (c) To act as independent regulator in case of applications for loans of Rs. 50 crore or more (d) To aim at faster resolution of stressed assets of Rs. 50 crore or more which are under consortium lending Answer: (d)”