Individual Insolvency: A New Regime

[By Akash Mukherjee]

The author is a third-year undergraduate student at National Law University, Jodhpur

Introduction

The Insolvency and Bankruptcy Code, 2016 (hereinafter “the Code”) was enacted on 28^th May, 2016. It has been in force for over three years, successfully operationalizing a mechanism for corporate insolvency resolution. The objective of the enactment was to provide an effective legal framework for the development of the credit market and entrepreneurship. The Code has been able to fulfill these objectives, so far, with respect to the corporate sector. However, corporate insolvency resolution is not the only means to attain the aforementioned objectives. Individual Insolvency, enshrined in Part III of the Code, aims to reach the same destination. Although, it has not been notified yet and is still in its nascent stages, the regime for individual insolvency portends major impact on the Indian credit market. This article would focus upon the need for the introduction of individual insolvency in the Code, the inadequacy of the current laws for recovery of individual debts, the mechanisms put in place for facilitating individual insolvency resolution and the issues with the proposed mechanisms.

The need for Individual Insolvency Resolution

Proprietorship and Partnership firms account for a substantial share in the income and employment sector in India. The Government initiatives like Start-Up India, under the aegis of Make in India programme, have identified their significance in the Indian economy and are aimed at providing a much-needed boost to them. Individual Insolvency Resolution framework, enshrined in the Code, must be pursuant to this goal. It should protect the interests of the debtor by preventing the creditors from causing detriment to him by putting in place a resolution process and isolating minimum assets for his subsistence. It must shield the individual against honest business failure and, thereby, promote entrepreneurship.[i] Meanwhile, it should also ensure increased returns to the creditors which would promote credit availability. Furthermore, the proposed framework would provide a resolution process for personal guarantors which is not in place currently. This would bridge the gap between corporate guarantors, for whom the resolution process is already in place, and personal guarantors.

The Current Legal Framework is fragile

The laws with respect to personal insolvency, currently in force, were enacted during the British Raj. The Presidency Towns Insolvency Act, 1909 for Madras, Bombay and Calcutta and the Provincial Insolvency Act, 1920 for the rest of India provide for the existing legal framework in India for individual insolvency. However, these laws have been a rare recourse for resolution of individual insolvency. Instead the Negotiable Instruments Act, 1881 and the Securitization and Reconstruction of Financial Assets and Enforcement of Security Act, 2002 (hereinafter “SARFAESI Act”) have been used to initiate the process of formal recovery.

Section 138 of the Negotiable Instruments Act has been a vital device for credit recovery since its introduction in 1988. It criminalized dishonor of a cheque which served as a deterrent for the borrower against default. This provision was used increasingly by the lenders in the home mortgage market since its introduction due to lack of any other viable alternative.[ii] Non-Banking Financial Corporations giving loans to individuals still actively resort to this section for recovery. The SARFAESI Act, 2002 provided the banks and financial institutions with the power to take possession of collateral security without any intervention from the Court. It was a tool of recovery against non-performing loans.

The increased use of Section 138 has over-burdened the Courts which has led to inefficient and delayed disposal of matters regarding property and mortgages.[iii] Also, SARFAESI Act is available only to banks and financial institutions. Its effectiveness has diminished since its inception. The recovery rate under SARFAESI Act was 61% in 2008 which fell to 22% in 2013.[iv] Thus, both these alternatives have become obsolete in the present scenario.

The resolution process under Part III of the Code

Part III of the Code stipulates three procedures for resolution of personal insolvency on default of a threshold amount:

Fresh Start Process[v]: The Code provides for a complete waiver of debt for a debtor with the annual income of less than Rs.60,000, assets less than Rs.20,000, debts not amounting to Rs.35,000 and no dwelling unit.[vi] The process can be initiated only by the debtor. The debtor must not be an undischarged bankrupt and must not own a dwelling unit.[vii] There should not be a fresh start process subsisting against the debtor or a fresh start order issued in relation to him twelve months prior to the date of application.[viii] The application is examined by a Resolution Professional (hereinafter “RP”). The RP submits a report to the Adjudicating Authority (hereinafter “AA”) recommending acceptance or rejection of the application by the debtor.[ix] The AA, after due consideration, either admits or rejects the application.[x] On admission, a moratorium period becomes applicable for six months on all creditors.[xi] The creditors can object to the process only on limited grounds.[xii] By the end of the moratorium period the AA shall pass a discharge order writing off all debts of the applicant subject to an entry in the credit history.
Insolvency Resolution Process[xiii]: This provides for a mechanism for negotiation of a repayment plan between the debtor and the creditors under the guidance of the RP. This process can be initiated by either the debtor or the creditor.[xiv] On admission of the application by the AA, a public notice is issued inviting all the claims.[xv] Then, a repayment plan is formulated by the debtor under the supervision of the RP. If the plan is approved by 75% of the creditors,[xvi] and thereafter by the AA, it is implemented by the RP. On the successful execution of the plan, the AA passes an order discharging the debtor from his liability under the plan. The debtor, therefore, gets an ‘earned start’.[xvii]

Bankruptcy Process[xviii]: On failure of the resolution process or non-implementation of the repayment plan, the debtor or creditor could initiate bankruptcy proceedings.[xix] If the application is approved the AA issues a bankruptcy order and appoints a bankruptcy trustee.[xx] The estate of the bankrupt shall be vested with the trustee who shall undertake the function of investigating the affairs of the bankrupt, regulating all the claims, realizing the estate of the bankrupt and administering the claims in the order of priority provided in the Code.[xxi]

Issues with the Resolution model under the code

The criteria for eligibility for applying for a fresh start process has been fixed and hard-coded into the Code. The relevance of the given threshold must be scrutinized as it shall determine the accessibility of the process to the debtors. The proposed threshold would cover only a limited section of the debtors in need for a fresh start. For instance, the fresh start process could help resolve the crisis farmer debts by providing a systematic mechanism for waivers instead of the present farmer loan waiver mechanism which provide relief for the farmers only with regard to formal sources of credit such as banks. Moreover, farm loan waivers only benefit 10-15% of the farmers as the remaining do not have access to institutional sources of credit.[xxii] The present threshold would limit the access to the fresh start process for these farmers. Therefore, it is vital for the threshold to be linked to some index for it to remain in sync with the GDP growth and inflation encompassing the debtors who would be left out from receiving the assistance through the fresh start process under the stipulated threshold.[xxiii]

The definition of assets and income to be included in the insolvency or bankruptcy process has not been clarified. This leaves no scope for setting aside a portion of the debtor’s assets like a share of property or some tools of trade which are essential for a minimum standard of subsistence for him. A clear definition on the income or the assets to be exempted which are “reasonably necessary” for the debtor is essential. The aim of the law must be to safeguard the necessary interests of the debtor for an ideal resolution process.

Unlike the Bankruptcy process, the Code does not provide for any priorities in the Insolvency Resolution Process. Here, the Code has underestimated inter-creditor tensions and adverse interests among them.[xxiv] The inconsistency in priorities could lead to counter-productive effects like the creditors subverting the interests of the individual debtor for personal gains. For instance, if the creditors with an effective veto believe that their returns would be prioritized against some other creditors in the bankruptcy process instead of the insolvency stage, the creditors would push for the bankruptcy stage. This could lead to an adverse consequence for a small firm which could have had some value as a going concern.

Conclusion

The individual insolvency law enshrined in the Code is a necessary endeavor to regulate the credit market for individuals and small concerns. Its implementation would mark the eventual step for the Code to further strengthen India’s credit availability and promote proprietorship by providing a systematic framework for insolvency resolution. The fresh start process attempts to preserve the interests of the humblest debtors. The insolvency process allows the debtor to chart a way to settle his debts under professional guidance and the bankruptcy process guarantees returns to the creditors. However, the proposed law is ambiguous in certain respects like the eligibility criteria for the fresh start process, the definition of the assets and income to be exempted and the priorities in the insolvency resolution process. This could result in a law which appears to be debtor-friendly but in reality works in favour of the creditors. Such a regime would fall short of the goal of helping individual debtors to recover from financial distress and exacerbate systemic over-indebtedness.

[i] MS Sahoo, ‘Individual Insolvency: The Next Big Thing’, (Insolvency and Bankruptcy Board of India)< https://ibbi.gov.in/webadmin/pdf/whatsnew/2019/Apr/NewsLeter%20Jan-%20March.,%202019_2019-04-27%2017:47:25.pdf>accessed 1 June 2019

[ii] Vikramaditya S. Khanna, ‘Law , Institutions and Economic Development: Examining the Development of the Home Mortgage Market in India – Can two wrongs make a right?’ (2017)< https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3032632>accessed 1 June 2019

[iii] Vikramaditya S. Khanna, ‘Law , Institutions and Economic Development: Examining the Development of the Home Mortgage Market in India – Can two wrongs make a right?’ (2017)< https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3032632>accessed 1 June 2019

[iv] Renuka Sane, ‘The way forward for personal insolvency in the Indian Insolvency and Bankruptcy Code’ (NIPFP, 24 January 2019) < https://www.nipfp.org.in/media/medialibrary/2019/02/WP_251_2019.pdf>accessed 1 June 2019

[v] Insolvency and Bankruptcy Code 2016, s 80.

[vi] Id.

[vii] Id.

[viii] Id.

[ix] Insolvency and Bankruptcy Code 2016, s 83.

[x] Insolvency and Bankruptcy Code 2016, s 84.

[xi] Insolvency and Bankruptcy Code 2016, s 84.

[xii] Insolvency and Bankruptcy Code 2016, s 86.

[xiii] Insolvency and Bankruptcy Code 2016, s 94.

[xiv] Insolvency and Bankruptcy Code 2016, s 94, 95.

[xv] Insolvency and Bankruptcy Code 2016, s 102, 103, 104.

[xvi] Insolvency and Bankruptcy Code 2016, s 111.

[xvii] MS Sahoo, ‘Individual Insolvency: The Next Big Thing’, (Insolvency and Bankruptcy Board of India)< https://ibbi.gov.in/webadmin/pdf/whatsnew/2019/Apr/NewsLeter%20Jan-%20March.,%202019_2019-04-27%2017:47:25.pdf>accessed 1 June 2019

[xviii] Insolvency and Bankruptcy Code 2016, s 121.

[xix] Id.

[xx] Insolvency and Bankruptcy Code 2016, s 125.

[xxi] MS Sahoo, ‘Individual Insolvency: The Next Big Thing’, (Insolvency and Bankruptcy Board of India)< https://ibbi.gov.in/webadmin/pdf/whatsnew/2019/Apr/NewsLeter%20Jan-%20March.,%202019_2019-04-27%2017:47:25.pdf>accessed 1 June 2019

[xxii] Aishwarya Satija, ‘How Bankruptcy Code can help fix India’s agrarian crisis’, (The Economic Times, 5 March 2019)< https://economictimes.indiatimes.com/news/economy/policy/how-bankruptcy-code-can-help-fix-indias-agri-crisis/articleshow/68260995.cms >accessed 12 June 2019

[xxiii] Renuka Sane, ‘The way forward for personal insolvency in the Indian Insolvency and Bankruptcy Code’ (NIPFP, 24 January 2019) < https://www.nipfp.org.in/media/medialibrary/2019/02/WP_251_2019.pdf>accessed 1 June 2019

[xxiv] Adam Feibelman, ‘Legal Shock or False Start? The Uncertain Future of India’s New Consumer Insolvency and Bankruptcy Regime’ <https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3092042>accessed 1 June 2019