Personal Insolvency Process: A Staggering Need Of The Hour - Part I

The authors are Aditya Singh and Yash Bhatnagar, third year students at Dr. Ram Manohar Lohiya National Law University, Lucknow.

Introduction

The Insolvency and Bankruptcy Code of 2016 was a revolutionary legal regime, enhancing the process of insolvency and bankruptcy vis-a-vis India. However, even after promulgating the concept of a ‘fresh start’, it still hasn’t addressed the substantial concerns regarding personal insolvency procedures, which in some instances, are still conducted through colonial laws. With increasing debt in the informal sector especially after the COVID-19 pandemic, there is a dire need for a robust personal insolvency procedure to fulfill the morals on which the commercial legislation was based. This piece will analyse the cumbersome process of applicable personal insolvency regimes while exploring the scope of comprehensive and effective changes that could take place in the near future.

Current Regime- Analysis and Problems

The two colonial era laws are, namely the Presidency Towns Insolvency Act, 1909 and the Provincial Insolvency Act, 1920-. The content of the laws is similar with the key difference being that the former is applicable to individuals of Calcutta, Bombay, and Madras only, while the latter applies to the rest of India.

Under these laws, a failure to pay a debt exceeding just INR 500, is grounds for a creditor to file an application seeking initiation of insolvency proceedings against the debtor. These regimes provided for creditors to file suits in public fora and did not contain provisions for creditor participation in the debt recovery process which makes this recourse non-preferable to be sought by these entities.

Despite the existence of such inherent flaws in these enactments and writ petitions being filed before High courts of India to repeal these superannuated laws in view of the enactment of the Insolvency and Bankruptcy Code, 2016 (Code), the Finance Ministry still maintains that “stakeholders who intend to pursue their insolvency cases may approach the appropriate authority/court under the existing enactments, instead of approaching Debt Recovery Tribunals (DRTs).”

Problems under IBC

The process of ‘fresh start’ in the ambit of IBC holds its own conundrums. Firstly, the certificate of discharge given by a court to an honest debtor is completely discretionary, leaving a gap for creditors to file for another case even in the situation of proven bankruptcy. Secondly, as there are no guidelines for the debtor’s credit rating or CIBIL score after the successful filing of the bankruptcy, there conversely is no established recourse for a person to enhance their credit rating post-bankruptcy; and a decent CIBIL score is a non-derogative pre-requisite when opening bank accounts and applying for jobs - which would be necessary for the pursuance of a ‘fresh start’.

Moreover, the code treats a corporate entity and an individual in the same manner- as entirely liquidable. This would denote that even the essential elements like a home, owning a car to drive around to work, etc, are up for sale to satiate the creditors. On top of this, even in the best case scenario of obtaining an FSO (Fresh Start Order), this would go on the debtor's permanent credit history, which acts as an obstacle to a true fresh start. In the other scenarios, namely Insolvency Resolution Process (IRP) and bankruptcy- even a successful IRP whilst going on the permanent credit history of the debtor, does not improve the existing CIBIL Score of the debtor. Further, in cases of bankruptcy, while it is a part of the permanent record, this discharge does not release the debtor from any liability in respect of a fine imposed or liability to pay damages from negligence, nuisance, or breach of statutory, contractual, or other duty. 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.

One part where the IBC sorely lacks is grievance redressal for the debts accrued in the informal sector. The practice of unlicensed money lenders and local financial institutions is still prevalent in rural and semi-urban areas. This practice of borrowing in ‘good faith’ albeit subjected to higher interest rates and no recovery mechanism took to new heights in the pandemic era when people found themselves out of jobs, returning to their hometowns, and facing a severe shortage of funds. There is no government agency or institutional set-up which tracks these undocumented loans- to the extent that even the report of BLRC (Bankruptcy Law Reforms Committee), which forms the basis of the IBC, does not contain any data pertaining to the informal sector debt crises or attempts thereof to collect such data. At the very outset, there is a requirement for a dataset on the basis of which regulations need to be formed to try and assist in the debt crises in the informal sector which have been exacerbated by the pandemic.

The code puts too much power in the hands of the RP (Resolution Professionals) as DRTs (Debt Recovery Tribunals) often solely rely on the recommendation of the RPs as they themselves have no guidelines or regulations to adhere to when recording their judgment. On top of this, an IRP/RP is considered an officer of the court and any non-cooperation or non-compliance with the Court’s officer amounts to Contempt of Court.

In cases of individual insolvency, the buying power of the creditor is usually bigger than that of the debtor which provides an opportunity for the RPs to be influenced resulting in providing more creditor-friendly recommendations in the resolution plan. On top of this, the code does not put any fiduciary responsibility on the RP towards the debtor which in itself is flawed for a code that aspires to be debtor friendly.

Risk of Liquidation for an Individual Debtor

The insolvency system requires the parties involved i.e. the Committee of Creditors, to prepare a resolution plan. This is done to mitigate the consequences of the act of insolvency for the corporate debtor and to keep its operations as a going concern. However, not every insolvency proceeding concludes with a successful resolution plan. There are various scenarios in which an individual debtor could also be liquidated due to factors out of their control.

A resolution plan not being submitted in the requisite amount of time could lead to the adjudicating authority ordering liquidation. Even when a resolution plan is submitted in time but the adjudicating authority rejects it, an order of liquidation could be passed against the debtor. Furthermore, if the Committee of Creditors (CoC) does not reach a consensus or attain a majority of 66% in accepting the resolution plan, this failure on the part of the creditors too could lead to an initiation of the liquidation process initiated against the debtor. Lastly, a single violation on part of the debtor of the terms of the Resolution Plan (RP), with no scope for moratorium periods unless leave is expressly granted by the adjudicating authority, would be grounds for any of the creditors to file an application to the adjudicating authority for initiation of liquidation proceedings.

If these scenarios weren’t enough to make this code extremely creditor-friendly, the Supreme Court in Lalit Kumar Jain v. Union of Indiaupheld the notification dated 15 November 2019 (Impugned Notification) issued by the Ministry of Corporate Affairs and the Insolvency and Bankruptcy Rules, 2019 that brought into effect certain provisions of Part III of the Insolvency and Bankruptcy Code, 2016 (IBC) pertaining to the insolvency resolution of personal guarantors to corporate debtors (personal guarantors). While this might make sense for personal guarantors of a corporate debtor, it also inadvertently opens up the opportunity to harass the relatives of an individual debtor who might have provided assurance or guarantee on the debtor’s behalf.

This reality of liquidation is not a once-in -a-blue-moon occurrence but rather the norm. Only 14% of corporate insolvency resolution processes (CIRPs) yielded a resolution plan between December 1, 2016, and March 31, 2022, according to the latest data from the Insolvency and Bankruptcy Board of India (IBBI), and 47%t of CIRPs ended in liquidation during the period. Out of a total of 5,258 corporate insolvency proceedings initiated, 3,406 have been closed.

Conclusion

The conundrum of insolvency still lurks between both colonial and modern regimes of insolvency proceedings in India. Where one completely negates the essence of a debtor-friendly process, the other fails to create a distinction between a corporate debtor and a personal/consumer-based debtor.

One thing is evident that India profoundly needs laws governing personal insolvency, as the current regimes do not contain a holistic understanding of personal insolvency and fail to differentiate it from a Corporate Insolvency Resolution Process (CIRP). This view is also shared by the very committee that formulated the IBC i.e the BLRC Committee Report (which shall be discussed in the following part of this blog). It mentions repealing the colonial era insolvency acts and replacing them with a modern Act. Unfortunately, this hasn’t come to fruition yet as regulations for individual insolvency under the IBC are still being finalised.

Furthermore, the debtor-friendly nature of international regulations in countries like the United States and the leniency towards debtors herein is absconding from the IBC 2016. This too shall be discussed at length in the second part of this blog.