Personal insolvency: Lessons from the UK and Australia

by Renuka Sane.

In India, we have always paid more attention to the restructuring and winding up processes for companies. These include provisions in the I(DR)A Act, 1951, Companies Act (1956 and 2013), the Sick Industrial Companies (Special Provisions) Act, 1985. The 1993 Recovery of Debts Due to Banks and Financial Institutions Act set up Special Tribunals, the DRT, with special powers for adjudication for recovery of loans and enforcement of securities charged with banks and financial institutions. The Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest (SARFAESI) Act, 2002 was put in place to allow banks and financial institutions (FIs) to take possession of securities and sell them.

In contrast, the legal framework for insolvency of individuals is rooted in very old laws. Individuals are geographically divided across the Presidency Towns Insolvency Act, 1909 (PTIA) for Calcutta, Bombay and Madras, and the Provincial Insolvency Act, 1920 (PIA) for the rest of India. A unified version of the existing laws was submitted to the government by the 26th Law Commission in 1964 but not enacted as law.

Individuals do not have a high share of unsecured borrowing from the banking sector. This seems to have been used as a justification for ignoring the substantive and procedural problems in the law governing individual insolvency. But poor recovery practices may be precisely the reason why there is limited lending to individuals leading to financial exclusion and ultimately inhibiting the emergence and growth of small enterprise in the country.

This is not true of other parts of the world. How have other countries designed their personal insolvency system? What lessons can we learn from them? In a recent paper (Ramann, Sane and Thomas, 2015), we motivate the need for a personal bankruptcy law, and study the existing Indian legal framework and contrast it with the UK and Australian experience. This was part of the research that fed into the Indian bankruptcy reforms.

The UK system

In the UK, the Cork Committee undertook a comprehensive review of the insolvency law, publishing its report in 1982 (the "Cork Report"). This led to the enactment of the UK Insolvency Act 1986 (the "UK Insolvency Act"), an omnibus bill which combined the personal and corporate insolvency regimes. Substantial refinements were again made to the UK's insolvency regime by way of the Enterprise Act 2002 (the "UK Enterprise Act") (which amended the UK Insolvency Act) and the Cross-Border Regulations 2006, which adopted the UNCITRAL Model Law on Cross-Border Insolvency into the UK regime. There are three kinds of relief possible for individuals in the UK law:

1. Individual Voluntary Agreement (IVA): which is a private negotiation between debtors and creditors so that debtors avoid the stigma of bankruptcy. While negotiations are outside of the court, they are supported by legal provisions embedded in the law.
   
2. Court initiated bankruptcy: which is process intensive and governed by the rules of the Court.
   
3. Debt Relief Order (DRO): which provides debt relief to low-income households, where the costs of doing an IVA may often be higher than the debts of these households.
   
   

In the first two cases debtors in bankruptcy can be subject to Income Payment Orders, requiring payment of all future income beyond ``reasonable domestic needs'', generally for a term of three years. An important feature of the UK process is that the house or dwelling of bankrupt is excluded from estate available for distribution only after 3 years of adjudication of debtor as insolvent by the Court. Discharge in the UK has also become faster. Debtors are now discharged automatically after one year. As a result they can return to professional and financial life (at least legally) in a year.

The recent institutional changes made in the UK law include the Insolvency Practitioner, the Trustee, the supervisor, the nominee all of whom assist the debtor or the Official Receiver in its role as a mediator between debtor and creditors. The specific provisions in the 2007 amendments on time-lines for completion of negotiations strengthened the hands of creditors and also fixed discharge at the end of one year without an adverse credit history bringing relief to debtors.

The Australian system

The Commonwealth legislation, the Bankruptcy Act 1966, covers personal insolvency, including bankruptcy, Part IX (debt agreements) and Part X (personal insolvency agreements) in Australia. Corporate entities are covered by the Corporations Law administered by the Australian Securities and Investments Commission. There are four forms of relief available in Australia:

1. Declaration of intention (DOI): in which the debtor does not file for either insolvency or bankruptcy. This is just a period of 21 days of relief from unsecured creditor action provided to the debtor to be able to choose the future course of action.
   
2. Debt agreement (DA): a binding agreement between debtors and creditors where creditors agree to accept a sum of money that the debtor can afford. This is similar to the negotiation in the IVA in the UK. Only those below certain specified thresholds are eligible for a DA.
   
3. Personal insolvency agreement (PIA): is also a binding agreement between debtors and creditors, but is more formal than the DA described above. It allows the debtor to come to an agreement with creditors to settle debts without the stigma of bankruptcy.
   
4. Bankruptcy: is a court-led bankruptcy procedure. It may be voluntary (when the debtor presents a petition), or involuntary (when the creditor makes a petition if the debtor fails to pay within 21 days of the creditor serving a notice).
   
   

The Australian system departs from the UK in having a separate institution, knows as the Australian Financial Security Authority (AFSA), responsible for the administration and regulation of the personal insolvency system.

Lessons for India

A sound framework for personal insolvency involves an impartial, efficient and expeditious administration. The trend in the UK and Australia, and in other parts of the world as well, is towards placing administrative proceedings outside of the courts. A negotiated settlement outside of court allows more flexibility in the repayment plans, and the time to execute the plans, that can be acceptable to both parties, as opposed to a court procedure which can constrain the possibilities. Thus the lower the intervention of the court, the better. Recourse to courts should only occur after completion of the negotiation or composition process in the event a party is aggrieved by the order. The record in the credit history of a negotiated settlement should differ, and be lighter from that of bankruptcy. This ensures that individuals will be incentivised to agree on a repayment plan with the creditors.

The process of negotiation, and bankruptcy, is carried out more effectively by an intermediary, instead of an officer of the court. The institution of an insolvency professional (IP) is critical if negotitations between debtors and creditors have to take place outside the court. The same intermediaries can also be entrusted with the task of verifying submissions of debtors, and the claims of creditors. This will assume a lot of importance in India as documentation is weak, and disputes on claims may be large, at least in the early years of the system.

It is important to hold the intermediary accountable, and ensure minimum standards. A regulatory body to monitor the performance of IPs and discipline them as necessary is an important element in the system of personal insolvency. The regulator in Australia plays a larger role in the personal bankruptcy framework than the regulator in the UK, and is a model worth considering, given the problems with the judicial system in India.

A DRO equivalent is worth introducing for India for low-income households. An additional reason to consider this mechanism is that it will lead to formalisation of rules for loan waivers done by the state. Debt-relief has to come at some price, in the form of a record in a credit-registry, which may make it difficult for the person to take future loans. This forces individuals to evaluate the trade-off between relief in the present and expensive credit in the future, thus guarding against misuse of the provision.

These considerations have played an important role in the proposals of the Insolvency and Bankruptcy Code submitted by the Bankruptcy Law Reforms Committee (BLRC).

References

Ramann, S., Renuka Sane and Susan Thomas (2015), Reforming personal insolvency law in India, IGIDR Working Paper.




Renuka Sane is a researcher at the Indian Statistical Institute, New Delhi.