Improving judgment enforcement: Let judgment creditors file insolvency resolution applications

by Karan Gulati and Anjali Sharma.

Judgments form the basis of a sound legal system. However, the mere issuance of judgments, without ensuring their prompt enforcement, takes away the incentive to turn to the courts. It also reduces trust in contracts and property rights, the bedrock of economic activity. This discourages investment, curbs entrepreneurial enthusiasm, and impedes national development (World Bank 2003; Chemin 2007; Rao 2020). Beyond economic consequences, a delay or failure in enforcing judgments diminishes public confidence in the judiciary (Salzman and Ramsey 2013).

In India, enforcing monetary judgments is particularly challenging, as evidenced by its low ranking on the World Bank’s ‘Enforcing Contracts’ indicator and data from the National Judicial Data Grid (NJDG). To ensure and expedite the enforcement of such awards, we propose that judgment creditors – holders of a judgment by a court or tribunal – should be allowed to initiate insolvency resolution proceedings against judgment debtors. Due to the severe consequences under the Insolvency and Bankruptcy Code (IBC), such proceedings will deter non-compliant debtors from evading their obligations.

The problem

Enforcing judgments with monetary components is an especially difficult problem. In 2020, India ranked 163rd out of 190 countries on the World Bank’s Doing Business indicator for ‘Enforcing Contracts’. This metric measures the time and cost of enforcing a standard contract in a civil court. In India, once a dispute is initiated, it takes 1,445 days till enforcement, costing 31% of the claim value. In addition to the time already spent securing a judgment, enforcement takes 305 days. As per the NJDG, while approximately 4.5 lakh new execution petitions are instituted each year, only 3.9 lakh are disposed. Even then, less than 15% result in an award or decree.

This poor track record on court-led enforcement also dilutes alternate dispute resolution mechanisms, which operate in the shadow of the law. When parties understand that enforcing settlement agreements is likely to be prolonged, often with poor outcomes, their incentives change. Consequently, such mechanisms are used not to resolve disputes but to avoid payments and cause delays. In fact, poor performance on contract enforcement may be why Indian and international businesses often include international arbitration clauses in contracts when dealing with cross-border transactions.

At present, enforcement of civil judgments is governed by the Code of Civil Procedure 1908 (CPC). To ensure enforcement, a court can attach a judgment debtor’s (a person against whom a judgment capable of execution has been passed) assets, imprison them, or appoint an individual to manage their property. Once attached, the debtor cannot dispose of or transfer the property. If they fail to fulfil the judgment claim, the attached property can be auctioned off. While the CPC comprises intricate and complex procedures, which may be necessary to deal with the myriad of matters adjudicated by the civil court system (for example, specific performance, partition trusts, inheritance rights, etc.), there are no provisions to determine the true value of the debtor’s assets or reverse undervalued or preferential transactions. This allows assets to be unduly siphoned off. Due to the non-specificity of provisions regarding monetary awards, judgment debtors can also exploit procedural gaps and employ dilatory tactics to delay or frustrate the enforcement of such awards.

A proposed solution

The IBC already recognises judgment creditors as ‘creditors’ (Section 3 (10)) with legitimate ‘claims’ (Section 3 (6)) against a debtor. However, because they have not been explicitly recognised as financial or operational creditors, they cannot initiate insolvency resolution proceedings. Instead, they must wait for a financial or operational creditor or the corporate debtor to set the ball rolling on insolvency proceedings and, even then, only file their claims during the process without any participatory rights. This inability to initiate insolvency takes away a potent lever to ensure compliance with judgments.

We propose that judgment creditors be allowed to initiate insolvency resolution proceedings under the IBC. Such a move will pose a significant threat to non-compliant debtors. This is because the IBC creates two significant deterrents against wilful non-payment of claims: (i) the displacement of the promoter when the insolvency resolution proceedings commence, and (ii) a possibility of liquidation of the company if the resolution fails. Given these grave consequences, the judgment debtor’s incentive will be to voluntarily fulfil the judgment claim. This change should be prospective, allowing all creditors to adjust to evolving dynamics.

In fact, when allowed, admission of an insolvency application filed by a judgment creditor should be made simpler than one filed by other creditors. This is because the IBC requires that four factors be considered before admitting an insolvency resolution application: (i) whether there is a claim of a certain threshold, (ii) whether it is undisputed, (iii) whether it has become time-barred, and (iv) whether it has come to the correct bench of the tribunal. In the case of judgment claims, the first three are validated by a court or a tribunal; hence, there are no ambiguities that may delay the admission proceedings.

This is not a novel solution. Judgment creditors can initiate insolvency proceedings in both the United Kingdom and the United States of America.

• United Kingdom: Judgment creditors have specific rights to push a debtor into administration or winding up (analogous to insolvency resolution and liquidation proceedings in India, respectively). Under paragraph 11 of schedule B1, read with Section 123, of the Insolvency Act 1986, a creditor may file an administration application if an order of any court in their favour is returned unsatisfied. Under Section 122, a creditor can file a winding-up application on the same grounds. When it comes to individuals, the process is slightly different. Section 267 of the Insolvency Act allows a creditor to present a bankruptcy petition if the individual owes a judgment debt of £5,000 or more.

• United States of America: Judgment creditors possess distinct rights to push a debtor into involuntary bankruptcy proceedings. Under 11 USC § 303 of the US Bankruptcy Code, upon satisfying the prerequisites, creditors can file an involuntary bankruptcy petition against a debtor. If the court determines the involuntary petition is valid, it will issue an “order for relief,” initiating the bankruptcy process. For individual debtors, this often translates to a Chapter 7 liquidation or a Chapter 13 repayment plan.

To enable this in India, the IBC must be amended to recognise judgment creditors of a monetary award as financial creditors holding financial debt under Sections 5 (7) and 5 (8), respectively. This is because the award includes interest, penalties, or costs, and aligns with the time-value-of-money considerations intrinsic to financial debts. As loans accrue interest over time, judgment awards accumulate interest until settled, mirroring the financial obligations of the judgment debtor. Once a court has passed a monetary award, the claim is rooted in the judgment award, not the original transaction. Hence, even when the underlying dispute is related to the provision of goods or services, the judgment award should be understood to represent a financial debt. This view has been endorsed by the Supreme Court of India and should be legislatively incorporated. The Court, in Kotak Mahindra Bank Limited v A Balakrishnan (2022 INSC 630), has noted that:

Taking into consideration the object and purpose of the IBC, the legislature could never have intended to keep a debt, which is crystallised in the form of a decree, outside the ambit of clause (8) of Section 5 [financial debt] of the IBC.

Classifying judgment creditors as financial creditors during the insolvency process would also ensure that they have an influential participatory role, commensurate with the significance of court-sanctioned monetary awards.

Allowing judgment creditors the power to initiate insolvency proceedings will generate strong monitoring and compliance effects in the pre-insolvency world. Other financial creditors of the debtor will factor current and potential adverse judgment claims into their credit decisions. This, in turn, will generate strong incentives to avoid adverse judgments and to comply with judgment claims when they arise. Conversely, businesses would be compelled to take a proactive stance in settling disputes, knowing the ramifications are not just reputational but could also threaten their solvency and control over the enterprise. It will signal to the market that judgments are not just moral proclamations but actionable financial commitments.

An illustration

To better understand how this will play out, let us consider an arbitration proceeding between X Co and Y Co concerning a contract violation, where the arbitrator awards Rs. 2,00,00,000 to Y. X will likely challenge such the award under Section 34 of the Arbitration and Conciliation Act 1996 (Arbitration Act). Since the grounds for challenge under Section 34 are procedural, courts generally uphold arbitral awards.

Traditionally, Y would have been forced to then rely on the procedure set out under the CPC. However, as mentioned, enforcement under the CPC is notorious for delays. The award would remain stuck in court procedures, and Y may face a cash crunch. The money they rightfully won, tied up in legal battles, would not be accessible for business needs, growth, or reinvestment. At the same time, X would remain operational, benefiting from the liquidity that it has withheld (Gulati and Roy 2020).

However, things may be different if Y is allowed to initiate an insolvency resolution proceeding. Although X may prefer an appeal under Section 37 of the Arbitration Act, the confirmation of the award under Section 34 will convert it into a claim under the IBC (a right to payment reduced to judgment). The initiation of the insolvency proceeding will immediately shift the dynamics. Under IBC, X’s promoters could be displaced, and there may be a potential change in the company’s ownership. Thus, it will attempt to clear the dues and settle its dispute with Y. In essence, the IBC will be the much-needed lifeline for Y, ensuring it doesn’t remain stuck in the quagmire of the CPC and can promptly access its rightful claim.

Concerns

One potential concern regarding the proposal might be the risk of overburdening the insolvency resolution process and, consequently, the NCLT. While the IBC recognises that time is of the essence, it is already struggling with capacity challenges and mounting delays. Overloading this system could create an environment reminiscent of the current civil court enforcement mechanism, fraught with delays and backlogs. This would counteract the benefits and efficiencies the proposed change aims to introduce.

However, this concern does not acknowledge the strong deterrents to frivolous insolvency proceedings built into the IBC. Judgment debtors will need to comply with the minimum default value requirement of Rs. 1,00,00,000. Further, the filing of the insolvency application is understood to aid negotiations between the filing creditor and debtor, often resulting in a settlement between parties outside the purview of the NCLT. As per the Insolvency and Bankruptcy Board of India, 28% of the insolvency resolution matters are settled or withdrawn. These figures do not account for the negotiations in the shadow due to the mere threat of an insolvency application being filed. Thus, the actual strain on the NCLT might be lower than anticipated. 

Similarly, there may be concerns about whether insolvency proceedings can take away the judgment creditor’s right to prefer an appeal against the underlying judgment. These concerns can be alleviated by deferring to good design principles. One way of doing this is to only allow judgment creditors to initiate insolvency proceedings when the judgment debtor has exhausted all statutory remedies (e.g., an appeal under Section 37 of the Arbitration Act by X in our example). As an alternative, it may be recognised that even under the IBC, there is a 14-day period within which an admission application is to be decided. The judgment debtor may file a statutorily permitted appeal against the underlying judgment within this period. In practice, the time between filing an insolvency application and its admission is far more than 14 days. This gives the judgment debtor ample opportunity to prefer statutorily permitted appeals. In such cases, the judgment claim will be viewed as disputed until the appeal is decided, resulting in non-admission of insolvency proceedings. The path to be taken between the two alternatives is a procedural policy decision independent of the merits of the core proposal of allowing judgment creditors to initiate insolvency proceedings.

Conclusion

The efficacy of a legal system not only lies in the issuance of judgments and their timely enforcement. For India, where enforcing monetary judgments remains a daunting challenge, it is pivotal to usher in mechanisms that effectively bridge this gap. Allowing creditors to initiate insolvency resolution applications presents a powerful tool that can drastically transform the landscape of judgment enforcement.

Not only will this proposal push judgment debtors to be more compliant, but it will also signify a broader shift in the perception of judgments. Such reforms, emphasising actionable financial commitments, will help restore public faith in the judiciary, boost investment, and stimulate economic growth. By embracing this change, India can pave the way for a more robust and efficient legal system, thus fostering a climate of trust, accountability, and development.

References

Doing Business: 2020, The World Bank, 2020.

Judging the judiciary: Understanding public confidence in Latin American courts, Ryan Salzman and Adam Ramsey, 2013, Latin American Politics and Society, Volume 55, Issue 1, pp 73-95.

India’s low interest rate regime in litigation, Karan Gulati and Shubho Roy, 11 March 2020, Leap Blog.

Institutional Factors of Credit Allocation: Examining the Role of Judicial Capacity and Bankruptcy Reforms, Manaswini Rao, 2020, JusticeHub.

The Impact of the Judiciary on Economic Activity: Evidence from India, Matthieu Chemin, 2007, Cahier de recherche / Working Paper.

World Development Report 2004: Making Services Work for Poor People, The World Bank, 2003.

The authors are a research fellow and the research director at the TrustBridge Rule of Law Foundation. We are thankful to Madhav Goel and Renuka Sane for their insightful comments. Views are personal.