What about limited liability, your honour? – The Economic Times

Clipped from: https://economictimes.indiatimes.com/opinion/et-editorial/what-about-limited-liability-your-honour/articleshow/82917958.cmsSynopsis

Limited liability played a vital role in advancing entrepreneurial risk-taking and capitalism’s creative destruction. If a person’s entire worth was at stake every time he or she ventured into a new project, fewer projects would be undertaken. If only the capital that has been infused in a company is at risk in case the company fails, and the rest of the entrepreneur’s assets are safe, she would be encouraged to keep trying till she met with success.

The Supreme Court ruled last week, upholding the validity of an official notification that allowed banks to enforce the personal guarantees offered by promoters even in cases where default on the loans so guaranteed had led to insolvency resolution proceedings. This is a double-edged sword. Beyond upholding the obvious sanctity of a legal agreement by associates of the borrower to hand over personal assets in case the borrowing entity defaulted on loan repayment, the court ruling breaches the sanctity of limited liability.

Limited liability played a vital role in advancing entrepreneurial risk-taking and capitalism’s creative destruction. If a person’s entire worth was at stake every time he or she ventured into a new project, fewer projects would be undertaken. If only the capital that has been infused in a company is at risk in case the company fails, and the rest of the entrepreneur’s assets are safe, she would be encouraged to keep trying till she met with success. Personal guarantees by directors and promoters of a company for the debt incurred by the company violates the principle of limited liability. Ideally, banks should lend on the strength of the company’s strength and prospects, not on the strength of the promoter’s assets. However, the world of credit in India is far from ideal. The problem is not just that banks insist on personal guarantees. Promoters often inflate project costs and borrow far more than what the project can realistically sustain, endangering the project itself. Bankers sanction such loans prodded by hidden persuaders in the neta-babu nexus. And, in several cases, the promoter’s interest in the company is limited to running it in a manner that would not disqualify her for another loan. In this non-ideal world, personal guarantees offer some form of accountability.

Rather than continuing with personal guarantees, because the Supreme Court has approved it, the effort must be to change corporate and lending culture to honour the sanctity of limited liability. This is vital for India’s economic progress.

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