CLPR Monthly Talk Series
The Promises And Perils Of India’s New Personal Insolvency And Bankruptcy Law
By Professor Adam Feibelman
The Parliament passed the Insolvency and Bankruptcy Code on 28th May 2016, drafted by a specially constituted ‘Bankruptcy Law Reforms Committee’ under the Ministry of Finance, recognising that reforms in the bankruptcy and insolvency regime are critical for improving the business environment and alleviating distressed credit markets.The new personal insolvency and bankruptcy law will at least be a modest improvement over the previous regime. It could meaningfully expand protections for a significant segment of individual debtors in India from the debilitating costs and harms of financial distress and would therefore contribute to the development of a healthy consumer financial system. The objective of this talk was to present possible promises and prospective perils of the new regime.
Prof. Fiebelman described personal insolvency and bankruptcy laws to be a form of “social insurance”. The objective of such laws is usually to provide protection of the consumer at the transactional stage and provide protection against financial distress. The questions addressed in the talk were whether the new Code promises to increase or improve the social insurance function of personal insolvency law in India and,if so, what will determine whether that promise is realized and how much impact it will have. Other questions pertained to the protection of borrowers against the risk of financial distress, and the employment of the new regime as intended.
Prof. Fiebelman started with a description the old regime of insolvency laws under the Presidential and Provincial Towns Insolvency Act 1909 and the Provincial Insolvency Act 1920 which was slow and mostly used by creditors or debtors facing incarceration or aggressive debt collections. Debtors and creditors could file, upon an “act of insolvency”, and there was heavy court involvement. Furthermore, Stay of debt collection was at the courts’ discretion.
In the new regime, a three-tiered scheme is provided in the act, for three situations of indebtedness: Insolvency as a primary situation, followed by Bankruptcy as the secondary situation, and lastly, the “Fresh Start”situation, for low income and asset debtors.
Under the insolvency tier, the debtor or creditors can initiate a case if the debtor has committed a default;Whoever files can pick a Resolution Professional(RP), creditors approve of the repayment plan, the DRT decides whether to approve or reject the plan or require modifications. However, there are no standards prescribed in the Code for the DRT’s determination.
The Bankruptcy tier is initiated on rejection of debtor’s application by the DRT due to debtor’s intention to defraud the creditor, or rejection of the repayment plan; or if the repayment plan ends before completion.Once the DRT passes a bankruptcy order, creditors must file claims, the RP can call a meeting of creditors and create a creditor committee if needed; the RP administers the estate.
The conditions to file under fresh start are that the income of the debtor must be less than Rs. 60,000/-, assets must be worth less than Rs. 20,000/- and the total debt value must be less than Rs. 30,000/-.
The positives of this new regime are that there are precise and lucid eligibility criteria and relief provisions. The role of the courts is smaller, and automatic moratoriums and non-discriminatory discharge would speed things up. On the downside, there currently a lot of unsecured debt and the Code would not discharge a significant amount. The Code excludes a number of people as potential beneficiaries of the law. Additionally, there is stigma attached, and practical hurdles such as costs, lack of information and lack of judicial infrastructure. This may also be primarily a creditor’s remedy, and may reduce the cost of credit. The time limits to file and complete procedures are rigid and short and there are technical ambiguities, such as majority requirement in a creditors’ vote. The new system of RPs would also need to be evolved.
The new regime, interestingly, was not brought into the legal scenario as a “reaction” to any economic or financial occurrence in the country. Professor Feibelman states that in theory this is ideal because the social insurance function will be built into the financial system that emerges and, hopefully, this will cause consumer credit to expand with protections in place to limit the negative effects of over-indebtedness and financial distress and to price those protections accordingly.
The first question was whether the new regime would be used opportunistically; water-tight moratorium period, lack of confidence RPs could further facilitate irregular usage. However, the regime may not be completely debtor friendly, but statistically, few people use laws like this opportunistically, but stricter and more effective credit-rating system might be a disciplining factor.The social insurance function may not be a benefit of the new regime, as this is effective only if debt collection is diligent. Under the new regime, the RPs do not require any legal qualifications.The relationship between the new regime and the existing SARFAESI Act and RDB Act was discussed. The regime does not at all talk about cross border insolvency, therefore creating a legal vacuum.The debtor or creditor in order to come under Bankruptcy has to go through the entire process of insolvency. Creditors over-securing their loans, proves the law ineffective. There may as well be an inverse relationship between over-securing and credit-rating sophistication.