Personal guarantees are a standard requirement in Indian commercial lending. Banks and NBFCs routinely require directors and promoters to provide personal guarantees before extending credit facilities to a company. Many directors sign them without fully understanding what they are agreeing to.
This article explains the nature of a personal guarantee under Indian law, what lenders can do if the company defaults, and what directors should seek to negotiate before signing.
What a Personal Guarantee Is
A guarantee under Indian law is governed by Sections 124 to 147 of the Indian Contract Act, 1872. A personal guarantee is a contract by which the guarantor undertakes to perform the promise, or discharge the liability, of a third person in case of their default. When a director signs a personal guarantee for a company's borrowing, they are agreeing that if the company does not repay the loan, the director will.
The critical point is that this is a personal obligation. It is enforceable against the director's personal assets, including their house, investments, and bank accounts. The guarantee is not limited to the director's shareholding in the company. It extends to their entire personal estate.
Continuing Guarantee vs. Specific Guarantee
Most bank guarantees in India are continuing guarantees. A continuing guarantee, as defined under Section 129 of the Contract Act, is a guarantee that extends to a series of transactions. This means that if the company takes multiple drawdowns under a credit facility, the guarantor's liability covers all of them, not just the original advance.
A specific guarantee, by contrast, covers only a single transaction. Guarantors should always check whether the guarantee they are signing is continuing or specific, because the difference has a material impact on their exposure.
Many directors assume that their personal liability is limited to the amount of the loan at the time they sign the guarantee. In practice, under a continuing guarantee, their liability can increase as the company draws further funds under the facility, often without any further notice to or consent from the guarantor.
Enforcement Against Personal Guarantors
The Insolvency and Bankruptcy Code, 2016 introduced a specific mechanism for enforcement against personal guarantors of corporate debtors. Under Part III of the IBC, a creditor can initiate insolvency proceedings against a personal guarantor in the Debt Recovery Tribunal. This is a significant development because it means a guarantor can face formal insolvency proceedings even where the company itself is going through the Corporate Insolvency Resolution Process.
The Supreme Court upheld the validity of these provisions in Lalit Kumar Jain v. Union of India (2021), confirming that the initiation of a CIRP against the corporate debtor does not extinguish the guarantor's liability and that proceedings against the guarantor can proceed simultaneously.
What Directors Should Negotiate
Before signing a personal guarantee, directors should consider negotiating several points. A cap on liability limits personal exposure to a fixed amount rather than the entire outstanding balance. A time limit on the guarantee restricts the period during which the lender can call on it. A right to be notified before the guarantee is called, and a reasonable period to cure the default, can provide some protection.
Directors should also consider whether the guarantee can be released once the company's financial position improves, or once the loan-to-value ratio of security reaches a certain level.
In practice, banks rarely agree to significant departures from their standard forms. But where the borrower has bargaining power, these are worth raising. At a minimum, every director should understand exactly what they are signing and what their maximum exposure is.
Revocation
Section 130 of the Contract Act allows a continuing guarantee to be revoked at any time by the guarantor as to future transactions, by notice to the creditor. This does not affect liability for transactions that have already occurred before the notice. Directors who wish to step back from a guarantee, for example on resignation from the board, should ensure that they formally revoke the guarantee in writing and that the lender acknowledges the revocation.
In many cases, lenders will not accept revocation without a replacement guarantee from another director, but the right to revoke should not be overlooked.
Disclaimer: This article is for informational purposes only and does not constitute legal advice. It does not create a lawyer-client relationship. For advice specific to your situation, please consult a qualified legal professional. LawCite Advocates is a law firm registered in India.