Banks may target family trusts of loan guarantors

The Economic Times | 27th May, 2021

Banks and business promoters are seeking legal opinion to figure out if lenders could recover money and assets parked inside family trusts, following a recent Supreme Court ruling on personal guarantors. The SC ruling said personal guarantors of loans are liable in insolvency cases. This means creditors can initiate proceedings against personal guarantors of corporate debt.

Many of the family trusts created by businesspeople are meant primarily to protect their assets from potential claims related to their companies, such as in bankruptcies. Neither lenders nor agencies such as the Enforcement Directorate or income tax department have been able to penetrate these asset protection trusts.

But now, following the Supreme Court order, lenders are expected to approach courts under the Insolvency and Bankruptcy Code (IBC) to go after assets parked in family trusts, said people dealing with these issues.

“Since there is clarity on liability of guarantors under the IBC, lenders are likely to take an aggressive approach, including looking at family trusts, recourse which many promoters have taken to safeguard their assets,” said Rajesh Narain Gupta, managing partner at law firm SNG & Partners

The trusts are structured in a way where the promoter would not be a trustee and hold only about a 5-10% stake. Lawyers advising banks are essentially basing their argument on two fronts. If creating the family trust to insulate assets was an afterthought or a plan after trouble started brewing on the debt front, lenders should be allowed to go after these structures. If there is an allegation of fraud or siphoning of funds, then also lenders should be able to take on personal guarantors.

“As per IBC law, banks can go after the family trusts formed by promoters or those who have given personal guarantees, provided there is a fraud or siphoning of money involved as per provisions of the IBC,” said Gupta. Legal experts said even now, after the SC ruling many promoters are calling up lawyers and want to create family trusts now.

“If you haven’t created family trust in your good time, then creating it when trouble hits may not be that useful,” said a senior lawyer.