The ongoing pandemic and the related economic downturn have affected most citizens of the country and distressed the finances of even the best financial planners amongst us. Despite the moratorium offered by banks, the successive lockdowns in different parts of the country and the continued suspended functioning of markets have caused several businesses to struggle to make ends meet. The high unemployment rate, saturated demand in many sectors, and low GDP growth rate has rendered many persons unable to meet their debts.

The question of how to escape the above predicament may very well find its answer in personal bankruptcy or personal insolvency laws, which enable debtors to approach courts to either restructure their debts or to avail a discharge from the obligation to repay their debts after liquidating their assets and distributing the value to creditors.

Applicable Regime – Costly, Cumbersome, and Ineffective

Though the Indian economy has flourished, colonial-era laws continue to apply to insolvency procedures of individuals and partnership firms. These laws are - the Presidency Towns Insolvency Act, 1909 and the Provincial Insolvency Act, 1920, which are similar in their provisions and substantial content but differ in respect of their territorial jurisdiction i.e. - Presidency Towns Insolvency Act, 1909 applies in presidency towns namely, Kolkata, Mumbai and Chennai while the Provincial Insolvency Act, 1920 applies to all provinces of India (Earlier Regime).

Under the Earlier Regime, a creditor could file an application seeking initiation of insolvency proceedings against a debtor for failure to pay any debt exceeding INR 500[1]. In order to prove that “an act of insolvency” had been committed, a creditor had to prove that the debtor had either[2],

1. alienated his/her property to a third person generally for the benefit of his/her creditors; or
2. alienated his/her property to a third person in order to defeat or delay his/her creditors; oralienated his/her property to a third person in a manner which would be voidable if insolvency proceedings were to be initiated against him/her; or
3. disappeared from his/her place of business/residence so as to prevent his/her creditors from communicating with him/her; or
4. had a property sold in execution of the decree of any court for the payment of money,

within three months[3] of the presentation of the petition seeking initiation of insolvency.

The Earlier Regime was costly, made the procedure under Code of Civil Procedure, 1908 applicable to the insolvency proceedings, thereby providing for undue recourse to courts, and also lacked provisions for creditor participation in the debt resolution process. Accordingly, the aforesaid enactments lacked effectiveness in aiding resolution of debts and were seldom resorted to by creditors.

New Regime – Does it solve the problem?

As a result of the aforesaid lacunae, the Insolvency and Bankruptcy Code, 2016 (Code) was introduced. The Code reconceptualised the framework for debt resolution in India, the provisions pertaining to personal insolvency have not yet been notified, except for the provisions applicable to personal guarantors of corporate debtors. As per the objectives enshrined in the Bankruptcy Law Reforms Committee Report, the provisions of the Code were aimed at providing (i) a fair and orderly process for dealing with the financial affairs of insolvent individuals; (ii) effective relief or release from the financial liabilities and obligations of the insolvent; and (iii) the correct ex-ante incentives.[4]

The eligibility threshold for initiating personal insolvency under the Code has been raised from INR 500 under the Earlier Regime to INR 1,000, which can be raised to a maximum of INR 1,00,000 by the government[5]. The corporate insolvency resolution proceedings (CIRP) under the Code can be initiated either by a debtor (an individual or partnership firm) or the creditor, which includes a financial, operational, secured, unsecured creditor as well as a decree holder. The debt excluded from the ambit of such personal insolvency proceedings include - liabilities for court or tribunal fines, maintenance of any person required by law, student loans, negligence, nuisance or breach of statutory contractual or other legal obligations[6].

Under the Code, insolvency proceedings against an individual can be initiated by way of the ‘bankruptcy’ route or the ‘fresh start’ route. The procedure involved under each route, along with its drawbacks, is as below:

1. Bankruptcy Route – Under the bankruptcy route, an application seeking initiation of CIRP can be filed by a debtor or its creditors at the relevant Debt Recovery Tribunal (DRT), which application shall be examined by a Resolution Professional (RP) who is responsible for making a recommendation of acceptance or rejection thereof to the DRT[7]. Upon acceptance of the application, a six-month moratorium commences on all debt collection actions against the debtor, and a public notice calling for claims is issued by the RP[8]. The debtor then has to suggest a repayment plan, which must meet the approval of at least three-fourths of his/her creditors, and ratified by the DRT, in order to be implemented[9]. Thereafter, a discharge order is granted to the debtor, in the manner provided for in the resolution plan. In the event that, (i) the debtor’s application to initiate insolvency proceedings is rejected as an attempt to defraud creditors or RP; or (ii) the creditors and debtor fail to agree on a resolution plan; or (iii) the debtor fails to implement the repayment plan, bankruptcy proceedings may be initiated by the debtor himself/herself or by his/her creditor(s) by way of an application to the DRT[10]. If the DRT admits the application, the debtor will be declared “bankrupt”, and his/her entire estate will vest in the bankruptcy trustee appointed by the DRT[11].
2. Fresh Start Process – The Code attempts to draw a distinction between small loan and significantly larger exposures by proposing a “Fresh Start Process” for those with gross annual income of less than INR 60,000, assets less than INR 20,000, “qualifying debts” of less than INR 35,000, and no homeownership. Qualifying Debts are debts incurred three months prior to applying for a fresh start and do not include (i) court or tribunal fines; or (ii) damages for negligence, nuisance or breach of a statutory, contractual or other legal obligation; or (iii) maintenance payable as per law; or (iv) student loans[12]. The application may be made by the debtor himself or through an RP, upon admission whereof, a moratorium of six months would commence, at the end of which a discharge order for the qualifying debts will be issued by DRT[13]. The benefit of the Fresh Start Process is the reduction in the transaction costs of the IRP-bankruptcy route, which would often be larger than the debt at stake for low-income, low-asset debtors.

One of the drawbacks of the bankruptcy provisions under the Code is the lack of any bankruptcy exemptions allowing the debtor to keep certain property or assets even after insolvency proceedings have commenced, thereby not ensuring provision of any minimum living standard for the debtor in the resolution plan. The only saving grace for the debtor is the existence of a veto right in the event that creditors suggest any modifications to the resolution plan[14]. The Code also fails to clarify the impact of discharged debts on the debtor’s credit ratings. The Code also fails to solve the problem of excessive judicial involvement in personal insolvency, which was the complication plaguing the Earlier Regime. The law does not provide any guidance on what the DRT should base its judgment on, and whether it should solely rely on the recommendations of the RP.

It is likely that the aforesaid drawbacks would be resolved once the New Regime is operationalised, by way of Regulations and timely amendments, as has been the case with the corporate insolvency resolution process. In the absence of such timely intervention, the provisions under the New Regime will also continue to languish untested in the statute books for the next 100 years, with little to no respite to individual defaulters and their creditors.

Authored by:

Ms. Shilpa Gamnani, Senior Associate, TMT Law Practice

[1] Section 9 of the Provincial Insolvency Act, 1920 and Section 12 of the Presidential Insolvency Act, 1909

[2] Section 6 of the Provincial Insolvency Act, 1920 and Section 9 of the Presidential Insolvency Act, 1909

[3] Ibid at 1

[4] The Report of the Bankruptcy Law Reforms Committee Volume I: Rationale and Design, November 2015

[5] Section 78 of the Insolvency and Bankruptcy Code, 2016

[6] Section 79(15) of the Insolvency and Bankruptcy Code, 2016

[7] Section 99 of the Insolvency and Bankruptcy Code, 2016

[8] Section 101 to 104 of the Insolvency and Bankruptcy Code, 2016

[9] Section 111 & 114 of the Insolvency and Bankruptcy Code, 2016

[10] Section 121 of the Insolvency and Bankruptcy Code, 2016

[11] Section 125, 126 & 114 of the Insolvency and Bankruptcy Code, 2016

[12] Section 79(15) & (19) of the Insolvency and Bankruptcy Code, 2016

[13] Section 82 to 92 of Insolvency and Bankruptcy Code, 2016

[14] Section 108(3) of the Insolvency and Bankruptcy Code, 2016