No more 'Mallyas': Banks need strict procedures to avoid bogus loan guarantors

Following the recent blunders by Bank of Baroda in freezing the accounts of Manmohan Singh, an Uttar Pradesh farmer, and Subhash R Gupta, a security guard, for being "guarantors" for Vijay Mallya’s loan, it has become quite evident that there are hardly any strict guidelines and procedures that are taken into account while accepting the guarantee of a person. And if at all they exist, most of the bankers are unaware about it.

In the last few years, Reserve Bank of India (RBI) circulars, High Court and Supreme Court judgments have time and again fixed the responsibility of a guarantor of a bank loan. In September 2014, through a new rule, the RBI allowed banks to take action against guarantors in case of a wilful default on a loan, even without exhausting the remedies available against the principal debtor.

 No more Mallyas: Banks need strict procedures to avoid bogus loan guarantors

Vijay Mallya. Reuters

The 'United Bank of India vs Satyawati Tondon (2010)' and 'Ganga Kishun (2012)' were two important cases in which the apex court fixed the responsibility of the guarantor.

In the Ganga Kishun case, the apex court observed, “There can be no dispute to the settled legal proposition that in view of the provisions of Section 128 of the Indian Contract Act, 1872, the liability of the guarantor/ surety is co-extensive with that of the debtor. Therefore, the creditor has a right to obtain a decree against the surety and the principal debtor.”

The court further ruled that, “The surety has no right to restrain execution of the decree against him until the creditor has exhausted his remedy against the principal debtor for the reason that it is the business of the surety/guarantor to see whether the principal debtor has paid or not”

What this meant was that the guarantor of a loan will now share the same liability as that of the defaulter.

While the apex court judgments and the RBI circular went on to dispel any ambiguity over the liability of the guarantor, the fact remains that the question as to who can be loan guarantor is guided by rules that are quite open ended.

Section 11 of Indian Contract Act, 1872 reads, “Every person is competent to contract who is of the age of majority according to the law to which he is subject, and who is sound mind and is not disqualified from contracting by any law to which he is subject”

As guarantee is also a contract, this provision to a greater extent defines the credential of a loan guarantor. An advocate, who has served as manager (legal) for Allahabad Bank and has handled various cases of loan default, said, “There are no specific provisions or prescribed qualifications that can tell as to who can be accepted as bank guarantor. The qualification is mostly based on the Indian Contract Act, 1872.”

He adds, “Usually the banks accept guarantee of family members and relatives but friends and colleagues can also provide a guarantee. It is expected that banks will ensure that the person standing the guarantee is able to bear that responsibility, and for this, it ought to check the financial position of the guarantor. But then this also hardly happens. Loans are sanctioned on the basis of contacts and other considerations, which is known to everyone.”

A manger working at the Bank of Baroda said, “Ideally the person standing guarantee should be having a financial worth to bear the burden of the default by the person for whom he is standing guarantee. Or else what is purpose of a guarantee?”

He adds, “According to Banking Codes and the Standards Board of India, the bank should tell the guarantor about his liability as a guarantor. He also needs to be informed about the time and circumstances under which he may be called upon to discharge the liability. The bank is also required to keep the guarantor informed of the financial position of the borrower, as it changes with time. But sadly this is again rarely followed. Usually family members and relatives are shown as guarantors who never ask about their liabilities."

RBI in its September 2014 circular went on to clear any confusion about the liabilities of a loan guarantor. The circular read, “In connection with the guarantors, banks have raised queries regarding inclusion of names of guarantors who are either individuals (not being directors of the company) or non-group corporates in the list of wilful defaulters. It is advised that in terms of Section 128 of the Indian Contract Act 1872, the liability of the surety is co-extensive with that of the principal debtor unless it is otherwise provided by the contract.

Therefore, when a default is made in making repayment by the principal debtor, the banker will be able to proceed against the guarantor/surety even without exhausting the remedies against the principal debtor. As such, where a banker has made a claim on the guarantor on account of the default made by the principal debtor, the liability of the guarantor is immediate.

In case the said guarantor refuses to comply with the demand made by the creditor/banker – despite having sufficient means to make payment of the dues – such a guarantor would also be treated as a wilful defaulter. It is clarified that this would apply only prospectively and not to cases where guarantees were taken prior to this circular. Banks/FIs may ensure that this position is made known to all prospective guarantors at the time of accepting guarantees.”

While the new rule is expected to deter people from casually standing in as a guarantor for any one, strict procedures and similarly well-defined rules need to be put into place to ensure that those standing guarantee are in a position to fulfil the liability of a loan guarantor, and that they are doing so willingly.

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Updated Date: Jun 10, 2016 17:20:08 IST