by Adam Feibelman.
The Insolvency and Bankruptcy Code has been in force for commercial debtors for over a year, and it has already been employed in over two thousand cases, including some cases that involve large non-performing loans clogging the banking system. These cases have generated numerous important questions of law and policy, and thus the IBC has become a regular and important topic of news, discussion, and commentary within the country.
Meanwhile, there has been hardly any public discussion or commentary about the personal insolvency and bankruptcy provisions of the Code. While the provisions for personal debtors have not gone into effect, the nearly complete lack of attention to portions of the Code covering personal debtors is puzzling. The Insolvency and Bankruptcy Board of India (IBBI) has given clear indications that it is planning to notify those provisions in the relatively new future. Those provisions will introduce a new and complex system of legal tools for citizens across India’s financial spectrum and their lenders, dramatically expanding the global scope of personal bankruptcy and insolvency law by over 1.3 billion people. It is surprising and unsettling that fundamental questions about the purpose and likely impact of these provisions remain largely unaddressed in public discourse.
My working paper, Anticipating the Function and Impact of India’s New Personal Insolvency and Bankruptcy Regime, aims to contribute to discussion of the new personal insolvency and bankruptcy regime by describing it in some detail; analyzing the goals of policymakers who drafted and enacted the regime; assessing the design of the regime in light of those goals; and anticipating the function and impact of the law as enacted.
Provisions of the IBC for Personal Debtors
The Code’s provisions for personal debtors represent a unique combination of approaches from other jurisdictions with some distinct features that harmonize it with the provisions for commercial debtors and others that are designed specifically for the Indian context. The Code provides a “fresh start” chapter for debtors with relatively low income (less than 60,000 rupees), few assets (less than 20,000 “non-excluded” assets), low levels of debt (less than 35,000 rupees), and who do not own their own home. Excluded assets include tools, equipment, books, and vehicles of personal or business use; basic household goods, furniture, and equipment; certain personal ornaments of religious significance; life insurance policies or pension plans; and a dwelling unit up to a value to be determined by the Board. The fresh start chapter simply discharges the debtor’s unsecured debts; it does not require that debtors give up any assets or income to unsecured creditors. Thus, it can be thought of as analogous to a loan waiver regime. It is extremely difficult to anticipate how many individuals in the country who have some debt would be eligible under this chapter, but it could cover significant numbers of borrowers from micro-finance institutions and informal lenders.
Those ineligible for the fresh start chapter will be eligible to file under the Code’s insolvency chapter, which requires debtors to propose a plan of repayment to their creditors and then complete the plan to be entitled to a discharge of their remaining unsecured debt. Unlike the fresh start chapter, creditors can file an application to initiate an involuntary insolvency case for their debtors; they can do so if their debtors default on a payment and fail to timely respond to a demand for payment. In any event, three-fourths of creditors must vote to approve a debtor’s repayment plan, which must provide a minimum budget to the debtor and allow the debtor to retain excluded assets. If creditors fail to approve a debtor’s repayment plan or if the debtor fails to complete an approved plan, the debtor is then eligible for bankruptcy under the Code, which can be initiated by either the debtor or any of the debtor’s creditors. The bankruptcy provisions require the debtor to give unsecured creditors his or her non-excluded assets and then allow for the discharge of the balance of unsecured debts. For the most part, none of the chapters of the Code disrupt secured creditors rights.
There is relatively little in the public record about the precise goals that policymakers had in mind in designing and adopting the personal insolvency and bankruptcy provisions of the Code. An initial interim report of the Bankruptcy Law Reforms Committee that was charged by the Indian Parliament to propose and draft the new Code briefly noted the need for changes to the personal insolvency laws to address the financial distress of micro, small, and medium enterprises, most of which are sole proprietorships or benefit from personal financial guarantees. The Committee did include broadly applicable provisions for personal insolvency and bankruptcy in its draft legislation, but its final report did not explain the underlying motivation for its work in this area or the social or economic need for the new provisions. It noted only "the importance of such borrowers in the economy," and that, under the preexisting framework, creditors often had difficulty recovering from individuals and often resorted to coercive debt collection, which compounded the social costs of indebtedness. It appears that, to the extent that policymakers considered non-business debtors in drafting and enacting the Code, their primary goal was to promote increased consumer lending in the economy and, secondarily, to provide some degree of protection to individuals in financial distress, especially from aggressive debt collection.
Thus, unlike the provisions for corporate debtors under the new Code, the provisions for personal insolvency and bankruptcy do not appear to have been driven by acute economic or financial conditions. This is noteworthy because countries that have adopted or reformed their consumer insolvency regimes in recent decades have tended to do so in the wake of consumer financial crises or dramatically expanding consumer financial markets. Countries across Europe and elsewhere -- including Hong Kong, South Korea, Israel, and Indonesia -- have adopted or reformed their personal insolvency regimes under such circumstances in the last two decades. While the amount of consumer debt in India has increased significantly in recent decades, and instances of household over-indebtedness appear to be growing, it has not reached levels that suggest systemic vulnerability or a looming threat of household financial crisis. Aside from the ongoing financial travails of farmers in certain regions, a spike in financial distress in some sectors due to the recent demonetization, and a generally acknowledged problem of aggressive debt collection practices across the country, there does not appear to be an emerging crisis of intractable over-indebtedness among individuals and households in India.
Anticipating Function and Impact
The IBC appears to represent a rare instance of a country adopting or modernizing a personal insolvency or bankruptcy regime at a relatively early stage in the development of a consumer financial market, before one is acutely necessary. Doing so avoids costs of responding too late, after consumer financial markets have over-heated. It may also have a beneficial effect on the development of those markets in the first place. Especially since the recent global financial crisis of 2008-10, scholars and policymakers around the globe have begun to appreciate that a personal insolvency or bankruptcy regime is an important component of the institutional framework for consumer credit markets. If properly designed and operated, such a regime can help promote a stable market for consumer credit, making creditors more willing to lend and individuals more willing to borrow, disciplining both, reducing the social costs of consumer financial distress and perhaps the amount of household over-indebtedness in the economy as well.
But such potentially beneficial effects likely depend on a system that improves or accelerates creditors’ insolvency state returns, or at least makes their losses relatively predictable, and that effectively insures individuals against the risk of over-indebtedness without creating incentives for them to act opportunistically or recklessly. It is not clear how well the provisions for personal insolvency and bankruptcy under the Code as enacted will serve these functions, and there are some causes for concern. Certain aspects of the institutional design may exacerbate inter-creditor conflicts, for example, by enabling individual creditors to easily initiate a case and by requiring majority votes among creditors to approve repayment plans. The regime’s reliance on negotiated repayment plans may also limit the predictability of outcomes.
While the fresh start process for individuals with low incomes, few assets, and relatively little debt, is designed to provide a robust insurance function, the insolvency provisions that apply to all other debtors provide much more limited protection for individual debtors. To the extent that there is an effort to target fresh start relief to debtors who need it most, i.e., those who genuinely cannot repay a significant amount of their debt, it is done rather bluntly through the narrow eligibility requirements for the fresh start provisions. The insurance function of insolvency or bankruptcy law can be particularly important to debtors, including those with business-related debts, who have income and assets to protect or who have significant amounts of debt, most of whom would ineligible for a fresh start. The bankruptcy chapter of the new Code promises to provide some meaningful debt relief to such debtors, but they must first go through the insolvency process, which requires a plan of repayment subject to creditor approval, during which the debtor is allotted only a minimum budget, and which formally ensures only a minimum level of relief or protection. Added to which, it is likely that large segments of the population of individual debtors covered by the law will not have sufficient information about the law to utilize it, will face logistical challenges even if they do have sufficient information, or will be deterred by stigma or other reputational concerns.
It is possible, therefore, that a significant portion of debtors in financial distress will not voluntarily use the new insolvency and bankruptcy regime and that it will primarily be employed as a debt collection tool for creditors. If so, the scope of the insurance function of the new system may not end up providing sufficient relief to individual debtors who become mired in debt, may not promote risk-taking entrepreneurial activity, and may not provide a meaningful safety valve to developing consumer financial markets.
Time to Plan, Prepare
To be sure, these concerns are highly speculative, and the last year of activity under the new IBC for commercial debtors has shown that it is too easy to make dire predictions about the challenges facing the new law. Yet, the stakeholders of the new personal insolvency and bankruptcy regime have the relative luxury of some time to prepare for the operation of that part of the Code. Hopefully, policymakers have begun to anticipate some of the potential macroeconomic effects of a newly available, robust regime for personal insolvencies and bankruptcies and consumer lenders have begun thinking seriously about how they might be affected by the new law. Ideally, policymakers are also considering how to disseminate information to individuals and households about the personal insolvency and bankruptcy provisions of the Code that will soon become available so that they can make informed decisions about whether, when, and how to employ it.
Adam Feibelman is a Professor of Law at Tulane University, he has been a visiting scholar at National Law School of India University, Bangalore, and the Center for Law and Policy Research.