Early evidence from the personal insolvency framework in India

by Karan Gulati, Chitrakshi Jain, and Anjali Sharma.

In 2016, India enacted an insolvency and bankruptcy law, the Insolvency and Bankruptcy Code (IBC), which included corporate and individual insolvency provisions. However, except for a narrow use case, the insolvency of personal guarantors (PG) to corporate debtors, the provisions for personal insolvency are yet to be notified. These provisions for PG insolvency were notified in November 2019 and were upheld as constitutional in November 2023.

PGs represent a unique and narrow category of individual debtors. They are often promoters, key shareholders, or directors of corporate entities and thus provide guarantees for loans taken by these entities. Lenders can invoke these guarantees when the corporate entity defaults, making PGs liable for the loans. The terms of these personal guarantees may allow lenders to seize and liquidate the assets of the PGs to recover their debts. As per the Bankruptcy Law Reforms Committee (BLRC), it is common practice that Indian banks take a personal guarantee from the firm's promoter when they enter into a loan with the firm.

In this article, we examine the data on PG insolvency cases to understand two key issues: (i) can such cases serve as proof of concept for the broader implementation of personal insolvency provisions under the IBC?; and (ii) what feedback loop is emerging for lenders from enforcing personal guarantee contracts through insolvency proceedings? However, we restrict this examination to the outcome of PG insolvency cases (approval of a repayment plan) and exclude the input (the insolvency process itself). Thus, we do not attempt to explain the gap between the applications filed and those admitted or between the applications filed and the appointment of resolution professionals.

Importance of personal guarantees

Limited liability protects a firm's shareholders from personal liability for its debts during distress, allowing them to retain their assets and wealth even during debt recovery or insolvency proceedings. This protection encourages entrepreneurship and risk-taking. Individuals often choose to incorporate to benefit from limited liability. However, when a firm faces distress and the value of its shares falls, two things can happen: (i) limited liability can encourage risky business decisions, and (ii) the firm's promoters may alienate its assets in their favour. One way to balance limited liability with accountability for the firm's promoters is through personal guarantee contracts. If promoters enter into personal guarantee contracts with lenders, lenders can seize the promoters assets if the debts of the incorporated entity remain unpaid. These contracts can moderate risk-taking by making guarantors internalise the costs of default and disincentivise the firms promoters from alienating its assets in their favour.

The interplay between limited liability and personal guarantees affects creditor rights during firm distress. Personal guarantees widen the pool of assets available to lenders when a firms assets are insufficient to cover its debts. In this context, guarantees offer lenders additional collateral for loans to corporate debtors while preserving the principles of limited liability and enhancing the debtors creditworthiness.

Given the role of promoter-owners in managing firms in India, personal guarantees have become a common feature of corporate lending. These guarantees are often used alongside other forms of collateral. RBI guidelines also encourage personal guarantees when lending to closely held or higher-risk firms to enhance loan security and ensure management continuity. Additionally, the RBI has incorporated personal guarantees into its restructuring debt framework. While data on the proportion of corporate loans secured by personal guarantees is unavailable, disclosures by the largest five public-sector and four private-sector banks as of 31 March 2023 suggest that guarantees cover 4% of the advances extended by these banks (authors' calculations).

PG insolvency as a lab for personal insolvency implementation

As per provisions for personal insolvency under the IBC, PGs propose repayment plans based on their ability to honour the guarantee. A resolution professional submits this plan to the committee of creditors, as defined under section 79 (11) of the IBC. Once creditors vote in favour of the repayment plan, it is then approved by the NCLT. Generally, from admission to approval of the repayment plan, this process takes a little over a year.

As of June 2024, 3134 PG insolvency applications involving claims of approximately Rs. 2 trillion have been filed across National Company Law Tribunals (NCLTs) and 50 such applications have been filed before the Debt Recovery Tribunals (DRTs). Of these, 468 applications were admitted, and the NCLT approved repayment plans in 26 cases. Although overall data for the number of corporate debtors that correspond to PG applications is not available, the 26 cases studied in the article correspond to 4 corporate debtors.

In the 26 cases in which the NCLT has approved repayment plans only one featured a joint application for resolution filed by the corporate debtor and its PGs. In the remaining cases, actions against PGs were initiated near or after the conclusion of the corporate debtors insolvency resolution process. In one case, the PG also acted as the resolution applicant in the corporate debtors insolvency process. Table 2 summarises the outcomes of the PG insolvency processes (PGPs) alongside those of the corresponding corporate resolution processes.

Table 2: Outcomes of personal guarantor and the corporate debtor resolution processes
Corporate debtor	No. of PGs	Date of Admission of PGP	Amt. claimed against PGs (Rs. cr.)	Recovery against PGs (%)	Amt. claimed against Corporate Debtor (Rs. cr.)	Date of Liquidation/Resolution (Corporate Debtor)	Outcome of the Corporate Debtor case	Recovery against Corporate Debtor (%)
Bluefern Ventures	2	30-09-2021	30.3	39.6%	38.7	Unclear	Liquidation	NA
Vishwa Infrastructures	12	15-2-2022	1441.6	0.8%	1318.5	14-06-2019	Liquidation	4.3%
Chadalavada Infratech	7	21-09-2022	278.1	24.5%	440.4	11-04-2022	Liquidation	2.4%
Pradip Overseas	5	27-04-2022	3017.5	0.4%	2663.0	14-10-2021	Resolution	4.8%
Total	26	-	4767.5	2.2%	4460.6	-	-	4.1%
Source: IBBI Quarterly Newsletters, NCLT Orders in cases

Personal guarantees are meant to hold promoters accountable. Table 2 shows that, despite variations in the number of guarantors and the amounts claimed, PGPs have yielded an average recovery rate of 2.2%. However, these recovery rates should be viewed in the context of the poor outcomes in the corporate debtor insolvency process and the extent to which these debts have devolved on the PGPs. In three cases, the corporate resolution processes resulted in liquidation. The average recovery rate for the four cases was 4.1%.

The purpose of a personal insolvency framework is to provide the debtor with a way to exit a debt contract. Of the 3184 applications which have been filed, only 468 have been admitted. The tribunals have approved the repayment plans in only 26 out of the 468 admitted cases (till June 2024). These gaps cannot be explained by merely looking at the outcomes in the PGPs which have been completed. The next section underscores how the insolvency process may just be a costly detour, for a substantial number of PGs are unable to honour their obligations under the repayment plan. While the outcomes can only be studied for 26 cases, they are underwhelming and it would be useful to conduct an evaluation of both the process and outcomes in the PGPs before extending the coverage to all classes of individual debtors under the IBC framework.

A feedback loop from PGPs

Since lenders may turn to personal guarantees due to poor value realisation in recovering debts extended to firms, enforcing personal guarantee contracts is important to provide creditors with an efficient means of recovery and to ensure that debtors can discharge their obligations. Before the notification of personal insolvency provisions for PGs to corporate debtors under the IBC, creditors relied on frameworks under the SARFAESI Act, the RDDB and FI Act, and the Indian Contract Act. These frameworks did not allow creditors to collectively enforce their rights.

Most corporate lending in India is secured by collateral, enforceable through the corporate debtor resolution process under the IBC. Enforcing personal guarantees under the IBC offers an additional recovery mechanism. The BLRC also recognised the importance of enforcing these guarantees and recommended establishing a framework to ensure the completeness of the corporate insolvency process. While the IBC extends the recovery process to include personal guarantees and provides a pathway to discharge an individual debtors obligations, it remains to be seen whether the framework is effective and represents an improvement over previous statutory recovery frameworks.

However, early evidence from the outcomes under this framework provides valuable inputs to lenders, helping them to make informed decisions about the value of personal guarantee contracts and their utility as collateral security for credit to firms. In two cases, the repayment plans of PGs resulted in better outcomes 24% and 39.6% compared to nil and 2.4% in the respective corporate processes. However, out of the 468 admitted PGPs, 108 were closed due to the non-submission or rejection of a repayment plan (IBBI Newsletter, Apr-June 2024).

Our analysis of 26 cases in which the NCLT has approved repayment plans reveals that these cases have not yet been marked as disposed of. A closer reading shows that this is because the PGs have failed to fulfil their obligations under the plans. Data on the implementation status of the repayment plans of PGs is available for 19 of the 26 cases (corresponding to two out of corporate resolution processes). Their details are presented in Table 3.

Table 3: Status of implementation of the repayment plans for PGs.
	Vishwa Infrastructures (CD)	Chadalavada Infratech (CD)
No. of PGs	12	7
No. of PGs that have defaulted on plan	7	5
Value of default (in Rs. cr.)	8.0	47.5
No. of PGs discharged	5	2
Value realisation from discharged PGs (Rs. cr.)	3.1	20.6
Total liability devolved on PGs (Rs. cr.)	1441.6	278.1
Recovery rate total	0.8%	24.5%
Recovery rate from discharged PGs	0.2%	7.4%
Average time to default after approval of repayment plan (in days)	274.0	81.4
Average time to discharge after approval of repayment plan(in days)	126	83
Source: Orders of the NCLT, Hyderabad

As of June 2024, of the 12 PGs associated with Vishwa Infrastructures, only 5 have fulfilled their obligations under the repayment plan. The remaining PGs have either been declared bankrupt or are in the process of filing for bankruptcy. Similarly, of the 7 PGs associated with Chadalavada Infratech, only 2 have been discharged from their obligations. The remaining have either been declared bankrupt or have filed for bankruptcy.

Feibelman and Sane (2020) also recognised the challenge of defaults in repayment plans within personal insolvency, noting that adhering to the requirements of the plans might just be a detour for some individual debtors. They recommended standardising repayment plans to identify debtors who should proceed directly to bankruptcy. Our examination of PGPs supports their recommendation.

According to the IBBI, 56 bankruptcy applications for PGs have been filed across DRTs and NCLTs as of June 2024. Completing these bankruptcy proceedings will provide a complete picture of how the IBC operates in personal insolvency cases. However, The low recovery rate and the failure of PGs to submit viable repayment plans suggest that the realisable value from guarantee contracts may be minimal, mirroring the declining fortunes of the corporate debtor. Thus, the likelihood that personal guarantees will cover the shortfall in recovering corporate debts is low. This should prompt lenders to reconsider the role of guarantees in corporate credit contracts.

Conclusion

In 2015, the BLRC had insisted that corporate insolvency provisions are incomplete without a personal insolvency framework. The PGPs that have resulted in approved repayment plans under the IBC have shown limited effectiveness as a value discovery mechanism for lenders and guarantors. Given that many PGs have been unable to fulfil their obligations under the repayment plan and have subsequently filed for bankruptcy, it remains to be seen how extending the coverage of the personal insolvency framework will balance the interests of the debtors and creditors. A careful evaluation of the process of insolvency should be conducted before the IBC framework is extended to all classes of personal debtors.

References

Designing a Personal Insolvency Regime: A Baseline Framework, by Feibelman A and Sane R , 2020, IBBI, Insolvency and Bankruptcy Regime in India - A Narrative.

Velvet Bankruptcy, by Hahn D, 2006, Theoretical Inquiries in Law, Volume 7 Number 2, pp. 523:554.

At the time of writing, the authors Karan Gulati and Anjali Sharma were researchers at TrustBridge. Chitrakshi Jain is currently a researcher at TrustBridge. We are grateful to Adam Feibelman and Renuka Sane for their comments. Views are personal.

Do court vacations matter: evidence from the Bombay High Court

by Tushar Anand, Pavithra Manivannan, and Bhargavi Zaveri-Shah.

Introduction

Court vacations are often invoked as a problematic feature of the Indian judiciary. The discourse on this includes blaming court vacations for case delays, petitions to reduce the length of court vacations, and substituting them with staggered leave for judges. This discourse is characterised by the classic divide that cuts across most Indian discourse on court reforms. Lawyers and judges emphasize the importance of court vacations for overall judge productivity. Often, they perceive the criticism of court vacations as being politically motivated or as an attack on judicial integrity. Other stakeholders underscore the problems of delays and pendency, and compare the courts' calendar with that of other public organisations. In the event, neither side is able to support their argument by demonstrating the extent of delays attributable to court vacations. The puzzle on how much do court vacations actually affect case durations and disposal continues to remain unanswered. This article presents some first estimates on the impact of court vacations on these outputs.

During the vacation period, courts function with minimal capacity. This allows us to compare the functioning of a court during its vacation and non-vacation periods. Using a dataset of civil and commercial cases filed over about six years at the Bombay High Court, we evaluate the extent to which vacations at the court affected its productivity, measured in terms of case disposal rates and the lifecycle of cases.

Unsurprisingly, we find that there is a significant drop in the daily number of cases filed and disposed by the Bombay High Court during vacations, compared to the non-vacation periods of the year. However, this gap shrinks over time. Second, the fact that a case is filed during the vacation period affects its initial phases, but does not affect the duration within which it will get disposed of. In sum, while court vacations affect the initial phase of a case schedule, dispensing with court vacations will not make a significant difference to the disposal rates or the disposal duration of cases at the Bombay High Court.

Court vacations

Indian courts, such as the supreme court, high courts and district courts, and most tribunals, are scheduled to take three vacations - summer, festive, winter - each year. The summer vacation lasts for a little more than a month and the festive and winter vacations last for a little more than week. While the concept of court vacations is traceable to the colonial origins of the Indian judicial system, they eventually became a part of the rules governing the functioning of the Supreme Court and High Courts. The practice is not unique to India and is followed in several developed countries, such as the United States, Australia and Singapore.

During vacations, Indian courts function with vacation benches of judges to hear urgent matters that come up during this time, and a lower staff at the court registry. A comparison of the sitting list of judges for the Bombay High Court shows that, on a non-vacation day, 27 courtrooms are functional. On the other hand, on vacation days, not more than four courtrooms are functional. A reduced number of judges will likely affect the scheduling and eventual disposal of cases filed during vacations. A reduced registry capacity will likely affect the filing of new cases and scheduling of proceedings for existing cases. To be sure, court vacations affect not only the working hours of courts, but also the entire ecosystem around it. For instance, it is generally hard to find lawyers to appear for litigants before vacation benches during this time, further slowing down proceedings. Since these changes are endogeneous to court vacations, it is hard to isolate the impact of lower judges from that of the absence of lawyers willing to work during the vacation period, on the lifecycle of a case. Finally, what cases are construed as 'urgent' varies across judges' interpretation of urgency.

In this institutional setting, we ask the following questions to evaluate the impact of court vacations on overall case durations at the Bombay High Court:

1. Do case filings and disposals drop during vacation periods?
2. Do cases filed during court vacations take longer to get their first hearing?
3. Do cases filed during court vacations take longer to get disposed of?

Data and Methodology

We collect and analyse the data of cases involving all civil suits and commercial suits, which were filed at the Bombay High Court during the seven year period from January 2017 to December 2023 (Study Period). For each of these cases, our dataset captures information on the entire life-cycle of the case available on the respective courts' websites. This includes the date of filing, the dates on which hearings were conducted, and the date of disposal. Table 1 shows the total number of cases in our dataset and their status, that is, whether the cases were pending or disposed, at the time of data collection. We then count the number of days on which these courts were on vacation during our Study Period, using the vacation dates published on their websites. On an average, the Bombay High Court has 52 days of vacation per year and the average number of working days is 235.

Table 1: Data description

Cases
Disposed	1379
Pending	2529
Total	3908

One caveat. Our results account for select case-types (civil suits and commercial suits), as our dataset comprises such cases. Given that criminal cases or writ petitions, particularly those pertaining to questions of liberty or reliefs pre-empting State actions, have a higher element of urgency, it is possible that the findings for these case types will differ from our findings for civil and commercial cases.

Impact of court vacations on case filing and disposal

We begin by comparing the daily average number of cases filed and disposed before the Bombay High Court during the vacation and non-vacation period (Table 2). At the Bombay High Court, on an average, the number of cases filed during non-vacation days is thrice the number of cases filed during vacation days. Further, the Bombay High Court is able to dispose four times the number of cases on non-vacation days, compared to the vacation days.

Table 2: Average number of cases filed and disposed per day

	Vacation days	Non-vacation days
Cases filed	0.67	2.23
Cases disposed of	0.21	0.88

We examine whether the difference between the number of cases filed during vacation and non-vacation periods or between the number of cases disposed of during these two periods, is statistically significant. The standard t-test and z-test used for determining statistical significance assume a normal distribution of the underlying data. However, our data is not amenable to this test for two reasons. One, the number of observed cases in non-vacation period is five times than that in the vacation period. Second, the distribution of the per day number of cases filed and disposed of is right-biased, with a long tail. We used a two-sample Kolmogorov-Smirnov test to confirm that the two samples come from different distributions. In the absence of the standard tests (t-test and z-test), we use a bootstrapped sampling method to estimate the statistical significance of the difference in means of the two sets (vacation and non-vacation) of our data. This method allows us to create a normal distribution of the data by repeatedly drawing random samples from each of the two sets. This approach shows that the difference in means for the number of cases filed and disposed during vacation and non-vacation days is statistically significant at the five percent level.

At first glance, these findings might suggest that had the court not been on vacation, case disposals would have increased by a factor of four. However, this disposal rate is likely not linear. For instance, a quarter-wise analysis of cases filed and disposed of shows that these differences reduce (Table 3). That is, the difference in the number of filings and disposals in Quarters 2 and 4 that are affected by vacation days (Apr-Jun and Oct-Dec) and Quarters 1 and 3 that are not affected by vacation days (Jan-Mar and Jul-Sep), are much smaller.

Table 3: Quarter-wise average of cases filed and disposed

	Q1	Q2*	Q3	Q4*
Cases filed	162.57	128.29	134.86	132.58
Cases disposed of	51.29	38.71	58.43	46.00

^{*Denotes quarters affected by vacation days.}

Impact of vacations on case timelines

The analysis in the previous section would reflect the impact of court vacation on the overall productivity of the court. However, what is the impact of court vacations for an individual litigant? In this section, we examine whether the timelines for important milestones in a case vary for a litigant who filed her case during the vacation period, compared to a litigant who filed her case during the non-vacation days.

We estimate the time taken for cases to be scheduled for its first hearing and time taken for them to be disposed of. These estimations are made using the survival analysis approach used by Manivannan et al, 2023. This approach is a useful measure of individual case life cycles. It shows the likelihood of a case awaiting an important milestone, such as a first hearing or disposal, at different points in time.

Table 4: Probability of first hearing

	Vacation days	Non-vacation days
1 month	6.47%	7.24%
3 months	25.10%	23.35%
6 months	49.39%	47.20%

Table 4 shows the probability of a case getting its first hearing within one month, three months and six months of filing. The table compares these probabilities for cases filed during vacation days and non-vacation days. The probability of a case filed during the non-vacation period getting its first hearing within one month of filing is only slightly higher than the corresponding probability of a case filed during the non-vacation period. As time progresses, this difference disappears. In fact, after the first month of filing, cases filed during the vacation period have a marginally higher probability of getting their first hearing than cases filed during the non-vacation period. In sum, our analysis suggests that the "vacation effect" on case scheduling persists for not more than a month.

Similarly, we estimate the probability of a case getting disposed of within one to two years of its filing. Table 5 compares these probabilities for cases filed during vacation days and non-vacation days. At the Bombay High Court, there is about 5-6% higher disposal probability for cases filed during the non-vacation days. Overall, the "vacation effect" is marginal and temporary, and does not seem to affect the case duration for a litigant.

Table 5: Probability of disposal

	Cases filed on
	Vacation days	Non-vacation days
6 months	6.95%	11.03%
1 year	11.62%	17.95%
2 years	22.59%	27.11%

Conclusion

Our analysis provides the first estimates on the impact of Indian court vacations on some measurable elements of a court's functioning. Historical data from the Bombay High Court for civil and commercial cases shows that court vacations have a statistically significant impact on the number of cases filed and disposed of on a daily basis. While this finding is perhaps unsurprising, these differences disappear over time. Further, they do not substantially affect the overall duration of the case, even as they have a small effect on the initial phases of cases filed during court vacations.

A key limitation of our analysis is that it does not account for the impact, if any, of court vacations on a judge at the individual level. That is, it does not capture the possible intangible productivity gains that accrue from a holiday. It is possible, for instance, that when a judge goes on a vacation, she writes more judgements, reads more jurisprudence or returns with boosted productivity. The data available in the public domain does not allow us to measure these impacts on judge productivity. Besides, if there were such impacts on a judge, they are not a powerful explanation for a court vacation where all the judges go on vacation simultaneously. These benefits would accrue even where judges take leave as per their own convenience during the calendar year. Therefore, while measuring such impacts is important for its own sake, it does not add to the vacation-related discourse which our analysis speaks to.

Finally, several scholars have started adopting the empirical approach in evaluating Indian courts and tribunals, using a variety of tools ranging from simple summary statistics to more advanced analyses grounded in statistics, and using the tools of natural language processing and artificial intelligence. We provide yet another demonstration that questions pertaining to the impact of interventions in the Indian court system are amenable to empirical research. Expanding such analyses to other courts will strengthen the discourse on court vacations by shifting from pure normative perspectives to empirically grounded questions on whether vacations actually increase the productivity of a court.

References

Pavithra Manivannan, Susan Thomas and Bhargavi Zaveri-Shah (2023), Helping litigants make informed choices in resolving debt disputes, The Leap Blog, 15 June 2023.

Law Commission of India (2009), Reforms in the Judiciary: Some suggestions, Report No. 230, August 2009.

Alex Tsun (2020), Chapter 9, Applications to Computing, Probability & Statistics with Applications to Computing, 2020.

Tushar Anand and Pavithra Manivannan are researchers at XKDR Forum and Bhargavi Zaveri-Shah is a doctoral candidate at the National University of Singapore. The authors thank Susan Thomas and Geetika Palta for useful discussions.

Who is "innovative"? Unpacking the process of tax exemption grants to startups

by Aneesha Chitgupi, Karthik Suresh, and Diya Uday.

When private individuals spend resources on innovation, the ideas and benefits that arise spread to society at large. An underspend on innovation results in the market failure of "positive externalities". The state has an important role to play in solving this market failure by encouraging spending on activities that generate innovation (Mashelkar et al., 2024). In India, the government did so by: (i) building research organisations like CSIR and ISRO and hiring career scientists, and (ii) providing tax exemptions. The Income Tax Act, since its inception in 1961, has exempted expenditures on scientific research. Since 1996-97, goods used for R & D have been exempt from customs and excise duties.

In the last ten years, both the Union and various state governments have perceived "startups" as major drivers of innovation. A host of incentives have been put in place for them. These include: (i) reduced fees and priority in processing patent and design applications; (ii) full exemptions on income tax for the startup following approval from an Inter-ministerial Board (IMB); (iii) priority during public procurement, etc. However, in a previous article (Chitgupi et al., 2023), we analysed Indian patent filings and grants and found that, despite enjoying government incentives, the overall share of startups in patent filings and grants --- a proxy for innovation --- remains small. Moreover, only a few startups receive income tax exemptions aimed at spurring innovation (see Table 1).

Table 1: Overview of the landscape of startups

Startups	2023	2024
Total (registered and unregistered)	2,49,107	3,14,492
Registered as startups by DPIIT*	90,939 (36.5)	1,31,191 (41.7)
Granted tax exemptions by the IMB**	1,100 (1.2)	2,976 (2.3)

Table notes: * fraction of total startups;
** fraction of DPIIT registered startups.
Source: Authors' compilation and analysis

The income tax exemption for startups

Section 80-IAC of the Income Tax Act allows a one hundred per cent tax deduction for eligible startups. The aim is to reduce the tax and compliance burden in the initial years of incorporation. A startup is eligible if (i) it is a new business incorporated after 1 April 2016 and is not a reorganisation of an old business with old machinery; (ii) its total turnover does not exceed INR 100 crores; and (iii) it is "engaged in innovation, development or improvement of products or processes or services or a scalable business model with a high potential of employment generation or wealth creation". The body tasked with determining the eligibility of a startup is the IMB. It was set up by the DPIIT in April 2016 with three members, and it is an executive body with delegated powers.

In this article, we study the institutional design and functioning of the IMB under Section 80-IAC. Our findings suggest that the IMB's process is not optimised to deliver the statutory intent of tax exemptions to startups. We identify the bottlenecks that must be targeted for change and question the current incentive structure for startups to innovate.

Methodology

There is a perception that staffing an organisation with technocrats will solve the problems of the organisation. This is not a recipe for lasting success (Kelkar and Shah, 2022). It is instead important to draft rules and procedures that work within and beyond the administrative system and that provide the right incentives to bolster the purpose of the organisation, i.e., promoting innovation. We view the IMB as an executive body tasked with an executive function --- to determine whether a startup is eligible for an exemption under Section 80-IAC. We rely on principles of administrative law while examining the processes and workings of the IMB. In particular, we focus on (i) institutional design, (ii) transparency, (iii) administrative discretion, and (iv) accountability (see Table 2).

We integrate this framework with Adam Smith's Canons of Taxation which sets out design principles for efficient tax administration. These are: (i) the maxim of equality, i.e., the tax must be collected with equality before the law; (ii) the maxim of certainty, i.e., the time, manner, and amount of tax to be paid ought to be clear and plain to the taxpayer, (iii) the maxim of convenience, i.e., the tax ought to be levied at the time and in the manner in which it is most likely to be convenient for the taxpayer and (iv) the maxim of economy, i.e., the tax ought to be so contrived that it takes from the taxpayer as little as possible. Smith's canons are routinely used by Indian courts to test the constitutionality of actions by tax administrations. For example, in South Indian Bank Ltd. vs. CIT AIR 2021 SC 4266, the Supreme Court applied Adam Smith's canons to examine the tax exemption to income arising from interest paid by banks.

Table 2: Our framework for analysing the process of tax exemptions to startups

Parameter	Administrative principle	Smith's canons
Institution design	Clarity of purpose and process	Equality, certainty, convenience.
	Composition of the board
	Reporting of conflicts of interest
Process transparency	Publication of rules and processes	Certainty
Administrative discretion	Issue of reasoned orders	Equality, certainty
Administrative accountability	Procedure for appeals from orders	Equality, certainty
	Audit oversight mechanism

We hand-collected and evaluated a sample of the minutes of the IMB meetings published on the Startup India portal to determine the eligibility of startups for tax exemptions. Our dataset comprises 52 decision documents out of the 72 available on the portal from 2016 to 2023, with the most recent document being from February 2023. There have been no additions to the IMB decisions since February 2023. Table 3 summarises our sample and provides insights into the total number of cases heard and the corresponding board decisions, forming the foundation of our study. Of the 72 IMB decisions published on the IMB website from May 2016 to February 2023, we have hand-collected data from 52 of these meetings, covering a total of 2,102 cases (72.2 per cent) each representing a startup.

Table 3: Overview of the sample data of IMB meetings

Year	No. of meetings*		No. of startup applications
		Granted	Rejected	Deferred	Total
2016	6	9	265	35	309
2017	3	21	201	141	363
2018	3	6	126	17	149
2019	8	109	1	57	167
2020	8	73	10	15	98
2021	10	80	13	9	102
2022	13	651	97	52	800
2023	1	112	2	0	114
Total	52	1061	715	326	2102

Table notes: *No of meetings from which data was used for this article.
Source: Authors' compilation from the Startup India website.

Results

Institution design

Clarity of purpose and process: The IMB has to decide whether a startup is eligible for the tax exemption. We find that the substance of the criteria to be applied by the IMB to determine eligibility for startup tax exemptions overlaps with the DPIIT criteria to register a startup. The need for a body like the IMB to reassess a startup on the same criteria is unclear. Despite this, only a small percentage of firms that have qualified the DPIIT's criteria meet the IMB's criteria. This violates Smith's canons of certainty and convenience because of the uncertainty of receiving the exemption despite having met the DPIIT's criteria. Table 4 compares the criteria for the IMB and the DPIIT to determine the eligibility of a startup for registration and grant of tax exemption. The criteria are substantially the same.

Table 4: Mandate of the IMB compared with the mandate of DPIIT for startups

	IMB (for startup tax exemption)	DPIIT (for startup registration)
Criteria 1	The entity's business involves innovation, development, deployment or commercialisation of new products, processes or services driven by technology or intellectual property	Entity is working towards innovation, development or improvement of products or processes or services, or if it is a scalable business model with a high potential of employment generation or wealth creation.
Criteria 2	The entity was incorporated on or after 1 April 2016 but before 1 April 2025.	Upto a period of ten years from the date of incorporation/ registration, if it is incorporated as a private limited company (as defined in the Companies Act, 2013) or registered as a partnership firm (registered under Section 59 of the Partnership Act, 1932) or a limited liability partnership (under the Limited Liability Partnership Act, 2008) in India.
Criteria 3	The entity's turnover does not exceed one hundred crore rupees.	Turnover of the entity for any of the financial years since incorporation/ registration has not exceeded one hundred crore rupees.
Criteria 4	The entity has not been formed by splitting up, or the reconstruction, or using more than 20% by value of machinery, of a business already in existence.	The entity shall not be formed by the splitting up or the reconstruction of an existing business

Source: DPIIT notification dated 19 February 2019 and Section 80 IAC of the Income Tax Act 1961

This is further highlighted through our analysis of the reasons for rejection of exemption claims. We map the reasons that are recorded in the minutes of IMB's meetings to the eligibility criteria set out in Table 4. We find that in 65 per cent of cases, a startup fails to get an IT exemption from IMB despite having met the same criteria for the DPIIT's requirement. Table 5 presents the percentage of exemption applications rejected based on previously assessed criteria. Further, 51 per cent of cases were rejected because the IMB determined that the startup was incorporated before 1st April 2016. At the outset, this is an objective criterion that the DPIIT and IMB should be able to agree on. Further, the cases in the Others category, which make up nearly 15 per cent of rejections, comprise criteria not specified under the law, such as shareholding patterns or other reasons said to be privately communicated to the startup.

Table 5: Overview of the reasons for rejection of applications for the IT exemption

	Reasons for rejection	No. of rejections	Rejections as a fraction of total rejections (where reasons are given) (%)
Criteria 1	Lack of innovation, scope of scalability, and wealth generation	91	12.7
Criteria 2	Incorporated before April 2016	366	51.2
Criteria 3	Turnover exceeds hundred crore rupees	0	0
Criteria 4	Reconstruction of existing business	12	1.7
	Others*	105	14.7
	Rejection without reasons	141	19.7
	Total	715	100

Table notes: * "Others" includes reasons not part of Criteria 1 to 4 in Table 4 above.
Source: Authors' compilation and analysis

Composition of the board: It is not apparent how the composition of the IMB is relevant for the purpose of the IMB. Since its constitution, the IMB has had a Joint Secretary from the Department for Promotion of Industry and Internal Trade (DPIIT), a scientist from the Department of Science and Technology, and a scientist from the Department of Biotechnology. For a year, between 2018 and 2019, the IMB also included representatives from SEBI, RBI, the Ministry of Corporate Affairs, the Ministry of Electronics and IT, and the Central Board of Direct Taxes. The IMB also has a "technical consultant". This consultant is an employee of the National Research Development Corporation (NRDC), a public sector undertaking owned by the Government of India. We are unable to find documentation that highlights the selection process and requisite qualifications of these members. All of them are ex-officio members. The role of the NRDC consultant has also not been clearly defined.

Process transparency

Publication of rules and processes: The rules or guidelines on the IMB's processes are not available in the public domain. For example, there are no guidelines on the basis of which the most important phrase in section 80-IAC, "innovation, development, deployment or commercialisation of new products, processes or services driven by technology or intellectual property" is determined. The lack of guidelines also violates Smith's canons of certainty and convenience. Guidelines are necessary for predictability for firms and greater accountability from the government. Other departments of the Indian government that carry out similar certification processes, such as the Department of Scientific and Industrial Research which certifies whether an applicant qualifies for tax exemptions for scientific research and R & D under Section 35(2AB) of the IT Act, have prescribed guidelines that companies can use to evaluate their chances of success.

Administrative discretion

Issue of reasoned orders: A central tenet of administrative law is that an order that carries negative consequences for an assessment should be well-reasoned. Unfortunately, non-speaking orders are frequently issued by Indian tax administrations (example, example). We do not have access to the text of the orders that are issued to individual applicants, so it is unclear whether detailed reasons are provided by the IMB while rejecting applications. However, from the minutes of the IMB meetings, we note that many companies are not provided with adequate and specific reasons for why their applications were rejected. This violates Smith's canons of certainty and equality. All deferred or rejected cases must be provided with reasons for their deferment or rejection. Published decisions help other startups better understand and comply with the eligibility criteria.

Figure 1 demonstrates whether the IMB communicated the reasons for the decisions taken on granting or rejecting the IT exemption for startups. We find that not all decisions are published with reasons. Even where applications are rejected, we do not see reasons being provided in every case. Of the 715 startups that were rejected, 19.7 per cent (141 startups) were not given reasons for rejection by the IMB. We further find that of the total 2,102 cases (Table 3) in our sample, deferred cases accounted for 15.5 per cent of them. Nearly 38.7 per cent of such cases were deferred without providing any reasons. Among the 1,061 startups granted the tax exemption, 67.9 per cent were granted without reasons being published. This creates ambiguity. In 15 per cent of cases, the IMB rejected applications for reasons other than those stated in the law (Tables 4 and 5).

Figure 1: Reason provided by application status across IMB decisions as a share of total cases

Figure 2, presents the share of cases where reasons were published across the decisions taken (whether granted, rejected, or deferred) by IMB from 2016 to 2023 across 52 decision documents. Since its inception, the IMB has published reasons for the majority of its decisions --- 67.3 per cent, 61.2 per cent and 73.2 per cent for 2016, 2017, and 2018, respectively. Across the years 2019, 2020, and 2021, IMB published reasons for all of its decisions. However, in 2022 and 2023, IMB published reasons for only 25.7 per cent and 1.8 per cent of decisions, respectively.

Figure 2: Reasons provided by year as a share of total cases

One may argue that since 2019, the IMB decision in favour of grants has increased from 65 per cent in 2019 to 98 per cent by 2023 and that the lack of reasons provided for the grant of IT exemption is not a major administrative challenge. We believe this has happened as the scheme gained maturity and there was a rise in the number of startups incorporated after 2016 that are applying for exemption under Section 80-IAC. It is important to note here that the cases brought to the IMB are recognised as startups by DPIIT, which follow similar criteria for establishing an entity as a startup with differences in the incorporation date, which is restricted to 'after April 2016' for IMB classification. This has been the major reason for rejections in the early years of the scheme (Table 5).

Administrative accountability

Procedure for appeals from orders: The right to appeal is another core tenet of administrative law. Judicial review of an administrative action ensures the lack of arbitrariness and improves administrative accountability. The IMB does not appear to have an appellate or review mechanism. It is unclear whether the decision of the IMB, not being one taken by the Income Tax Department, is appealable under the Income Tax Act. Moreover, this contravenes Smith's canon of equality. Startups that are aggrieved with the IMB's decision have to directly approach the High Court under a writ petition (example from Delhi HC). A case should lie before the High Court only if it involves a substantial question of law (Datta et al., 2017). This is because it is inefficient and costly to bring routine cases such as challenges to IMB's exemption decisions that do not involve a substantial question of law. This only adds further strain on the high courts' already burdened docket.

Audit oversight mechanism: The IMB is subject to audits by the CAG. However, no such audit of its functions has been carried out so far.

Discussion

Our findings indicate that the 80 IAC tax exemption is not working as desired. There are some core challenges in both the design of the exemption and its implementation.

Substantive challenges: The eligibility criteria to become a startup recognised by DPIIT and the eligibility criteria to be granted a tax exemption by the IMB are substantially the same (Table 4). However, startups are being granted recognition by the DPIIT but are being rejected for the tax exemption on the very same criteria by the IMB. If the criteria are substantially the same, a registered startup must automatically gain a tax exemption grant by virtue of qualifying as a startup by DPIIT. It is unclear why a separate application must be made involving both cost and time. Further, conversations with startup founders revealed that the 80-IAC exemption is not the impetus they need to spur innovation.

Implementation challenges: A key challenge is that rules and process guidelines on the grant of the IT exemptions are not available in the public domain. This has two drawbacks: (i) a startup applying for the exemption will not have a full picture of the process, and (ii) it allows room for administrative discretion, reducing the predictability of the outcomes of the applications. Further, the IMB does not publish reasons for rejection of applications consistently. This is imperative, as it will bring about transparency in the working of the IMB and also give potential applicants a sense of the reasons for rejection, acceptance, or deferment. The IMB process must also have a published procedure for appeals. Lastly, the composition of the IMB must be commensurate with its purpose. It is unclear why, for example, SEBI and RBI officers were part of the panel to determine "innovation". Our findings are in line with the recent observations of the Parliamentary Standing Committee on Commerce on the lack of clarity in the process for granting these exemptions. In response, DPITT has proposed to take steps to make the process of granting tax exemptions more "transparent" and "user-friendly".

Alternative strategies to encourage innovation

Building better supply-side incentives: Supply-side incentives are effective strategies to encourage spending on innovation. Tax exemptions could be one way forward, but not in their current form. We compared the Indian scenario to other countries to get some guidance. We find that while tax incentives are common for startups in many countries, and are the recommended way forward, the mechanism by which they are granted is different from the IMB. In the United Kingdom, "knowledge-intensive" companies can avail of tax benefits. Whether a company is knowledge-intensive or not is determined by HM Treasury under Section 252A of the Finance (No. 2) Act, 2015. The provision defines a "knowledge-intensive" company as one that: (i) spent at least 15 per cent of OpEx on research and development or innovation in at least one of the previous 3 years, or spent 10 per cent of OpEx in each of the previous 3 years, and (ii) is either likely to exploit intellectual property that it has created in the previous 3 years, or at least 20 per cent of the company's full-time employees (FTEs) are engaged in research and development or innovation. These FTEs must have at least a masters' degree. In Ireland, under Section 496 of the Taxes Consolidation Act, 1997 there is a negative list of industrial sectors and companies that do not qualify for the Startup Relief for Entrepreneurs (SURE) scheme if their main activities of business are in the specified sectors. Companies self-certify their applicability for the scheme, and there are stiff penalties in case they misinform the Revenue department. In Germany, the INVEST scheme of the Federal Ministry of Economic Affairs and Climate Action mentions that companies must (i) either hold a patent issued to them in any of the EU member states in the previous 15 years, or (ii) must be "innovative". "Innovation" is proved in a manner opposite of the Irish method, i.e. the company demonstrates that it is in fact working in the specified sector. The German Federal Tax Office may carry out random checks on whether a company is "innovative" by hiring an audit firm to independently assess whether it is truly generating output in its stated sector.

In all these countries, the government does not enter into the question of which firm is "innovative". The main reason for this is the difficulty in determining who is "innovative". Instead, countries identify priority sectors and grant incentives to all startups within the sector. That aside, in the Indian context, given the significant overlaps between the eligibility criteria for being a registered startup vis-a-vis the eligibility criteria for tax exemptions by registered startups, the government may consider a single window clearance system in which an eligible startup is registered and then is automatically given a tax-exempt status on account of being registered with the DPIIT. In doing so, the state will free up valuable state resources and capacity, which may be deployed for other purposes aligned with the intention of promoting innovation among startups.

Demand-side interventions through government contracting: As an alternative, some literature suggests that demand side strategies through public procurement will encourage innovation (Rothwell et al. 1981).

While the creation of the IMB and the government's focus on startups appears to be in response to a market failure, the design of the intervention has flaws. We note that "startups" are not necessarily major drivers of innovation in India. Firm size has no role to play in how innovative it can be. Therefore, tax exemptions for startups, even if they are "innovative", have little measurable effect on innovation in Indian society as a whole. Mashelkar et al (2024) recommend that the government "buy" i.e. contract out more research and innovation functions to firms in the private sector. The spillovers this can generate would be substantive and would have a multiplier effect. We already have many examples of the government choosing to do so e.g. the New Millennium Indian Technology Leadership Initiative (NMITLI) program of the Council for Scientific and Industrial Research (CSIR), Department of Space's (DoS) contracting with companies like L & T and Tata Elxsi to build rocket engines and recovery modules for the all-important Chandrayaan and Gaganyaan missions. These kinds of contracts should be done more often and frequently with all kinds of companies to build innovation and production capacity. Our recommendation in all cases is to pursue innovation by contracting out.

References

1. Adam Smith, The wealth of nations, Fingerprint Classics, 2024.
2. Aneesha Chitgupi, Karthik Suresh and Diya Uday, Are startups engaging in innovation in India?, The Leap Blog, 25 April 2023.
3. Pratik Datta, Surya Prakash B.S., and Renuka Sane, Understanding judicial delay at the Income Tax Appellate Tribunal in India, Working Paper, National Institute of Public Finance and Policy, 13 October 2017.
4. Ramesh Mashelkar, Ajay Shah and Susan Thomas, Rethinking innovation policy in India: Amplifying spillovers through contracting-out, Working Paper, XKDR Forum, 21 March 2024.
5. Vijay Kelkar and Ajay Shah, In Service of the Republic: The Art and Science of Economic Policy, Penguin, 2022.
6. R Rothwell and W Zegweld. Industrial Innovation and Public Policy: Preparing for the 1980s and the 1990s. In: London: Francis Pinter Publications (1981).

Aneesha Chitgupi, Diya Uday and Karthik Suresh are researchers at XKDR Forum. The authors thank Ajay Shah and two anonymous referees for their comments and inputs.

Who lends to the Indian state?

by Aneesha Chitgupi, Ajay Shah, Manish Singh, Susan Thomas and Harsh Vardhan.

Public finance researchers in India have paid great attention to debt and deficits. By now, the main messages of the field have started sinking into common knowledge: that it is good to run primary deficits in most years, so as to create space to surge the deficit once in a while when faced with a crisis. There is an adjacent field of public debt management that is equally important. Here, the strategic question is: How should the government borrow? From whom? Debt management strategy has not received the required level of interest.

Strategic thinking in debt management

A sound public debt management strategy must cater to three objectives:

• The mechanism for borrowing must not induce economic distortions upon the domestic economy.
• It must create strategic depth of being able to borrow on a very large scale when faced with great challenges, once every few decades.
• It must induce sustainable mechanisms for reasonably low cost borrowing, at reasonably predictable rates, for the long term.

There are four main pathways to choose from in debt issuance:

1. Monetisation of the deficit. Here, the central bank distorts the monetary base with `fiscal dominance’ where it buys the bonds issued by the government.
2. Coerced borrowing from financial firms. These are typically regulated firms, who are coerced using the tools of financial regulation.
3. Borrowing from voluntary participants (domestic or foreign). This is done through local currency bonds issued domestically, possibly nominal and possibly inflation indexed.
4. Borrowing abroad using foreign currency denominated bonds. As an example, this could involve Yen denominated bonds issued in London.

As with many other countries, we started out in India with the first method (monetisation of the deficit). This induces an economic distortion: the loss of monetary policy autonomy. A long journey of monetary policy reform took place, from the Ways and means agreement of 1993, to the Monetary policy framework agreement in 2015 that ushered in inflation targeting. This freed up monetary policy from the limitations imposed by debt management. In 2015, there was an attempt at institutional reform, in the form of the establishment of the Public Debt Management Agency (freeing up the Reserve Bank of India of the responsibility of issuing public debt), but this did not come to pass.

From 1993 onward, the main strategy for public debt management in India has involved method 2 in the list: a system of `financial repression’ where the government borrows from coerced financial firms. This is a tax upon financial intermediation. The interest rates discovered through government borrowing are important prices that impinge upon the economy. But these rates are distorted owing to the presence of coerced buyers of government debt. The lack of voluntary lenders creates the lack of strategic depth. The government is limited in how it can expand its borrowing when faced with special situations.

From the late 1990s onwards, economists and thinkers have sought to enhance fiscal prudence in India through the mechanism of fiscal responsibility law. It is increasingly clear that this does not work. In recent work, Datta et. al. 2023 show that the Indian constitutional arrangements frustrate the possibility of Parliamentary law imposing fiscal discipline upon the union government. Once this idea is internalised, there is one main path towards fiscal responsibility: market discipline. This requires removing the system of financial repression.

Who lends to the Indian state?

In this context, the question Who lends to the Indian state? attains importance. A recent paper by Aneesha Chitgupi, Ajay Shah, Manish Singh, Susan Thomas and Harsh Vardhan examines this question. For a period of 10 years, we assemble information from multiple sources, which were all available in the public domain, to examine the nature of lenders to the Indian state. Some discoveries that we make are:

• The SLR went down in the last decade. This meant that the extent of bank funds mandated for the government decreased. However, the actual investments by banks in government debt securities was higher than what was mandated.
• Simultaneously, there was major growth in the role of insurance and pension funds lending to the government. While de jure financial repression of banks declined, there has been no such retreat with pensions and insurance.
• All the three groups of financial firms bought a lot more government bonds as compared with the de jure requirements. Excess ownership went from about 0 in 2011 to Rs.30 trillion in 2021.
• How did the government increase borrowing over the last decade, while simultaneously elongating the maturity profile? The answer lies in (a) Strong growth in insurance and pensions industries, and (b) Excess ownership of government bonds by coerced industries.
• The voluntary lenders are the private firms, MFs and FIIs, who are 4.8% of investors in the government debt market for 2021. India (along with China) remains an outlier in having very low borrowing from international debt markets.

Important questions for the future

This field is target rich with interesting questions, some of which are:

1. Why do financial firms lend so much to the government?
2. What will the structure of lenders to the government look like, 10 years out into the future?
3. If a big surge in borrowing is required, where will it come from?
4. How are households and firms changing their behaviour in response to the financial repression tax?
5. What is the path to fiscal responsibility?

Conclusion

The field of public finance in India has studied deficits and debt. There has been work on the institutional arrangements for debt management (i.e. the establishment of the Public Debt Management Agency). There has been relatively little work on the economic reasoning, the strategic thinking for debt management. In this paper, we offer novel insights and facts for this journey. More research is required, at the interfaces between public finance, finance and public administration, to grow knowledge on the important field of debt management strategy.

Announcements

Positions for researchers in the field of working of courts

XKDR Forum is looking for two researchers to work on a project on the working of courts in India.

About XKDR Forum

XKDR Forum is a Mumbai-based inter-disciplinary group of researchers working in the fields of courts, household and firm finance, public finance management and land. In these fields, the group engages in academic and policy oriented research, and advocacy. The new recruits will come into an active research program in the field of working of courts.

Researchers at XKDR Forum have been working in the field of legal systems development for the last decade. Their work in this field includes developing unique case-level datasets from public sources; statistical analyses to establish stylised empirical facts; and studying institutional arrangements of the judicial branch. The work published by their researchers in this field can be found here.

As a research associate at XKDR Forum, you will work on project deliverables under the supervision of a senior researcher. You will be expected to work in person at the office premises in Mumbai.

Eligibility

The project involves building and/ or working with large databases of court data. The eligibility requirements for these two positions are:

1. Masters in Public Policy or Economics, along with skills or an interest in the coding languages of R and Python; or
2. Masters or bachelors in Data Science, along with an interest in questions of public policy or public administration.

Candidates with work experience of 1-2 years are preferred, but if you have a Masters degreee, the absence of this attribute is not a barrier to applying for these positions. They must be comfortable working in an inter-disciplinary research environment with people from varying backgrounds such as economics, public policy and law. They must be curious and passionate about research and must be willing to work on independent outputs as well as in teams.

The remuneration offered will be commensurate with your skill and experience and will be comparable with what is found in other research institutions.

Interested candidates must fill in the application form by 31st August, 2024.

The exercise of discretionary powers: The case of debarment and restraint from capital markets

by Natasha Aggarwal, Bhavin Patel, and Renuka Sane.

Introduction

Financial market regulators, such as the Securities and Exchange Board of India (SEBI), can impose monetary penalties and other sanctions, including debarment from capital markets and restraint from dealing in particular securities. Enforcement action by the state, such as a market regulator, is a double-edged sword. On the one hand, empowering the state to impose sanctions ensures that violators face consequences. Enforcement actions potentially serve as a deterrent against future violations and restore society's (and the market's) trust in the system's fairness. However, if the procedure established by law is not followed while imposing sanctions or if the sanctions are unpredictable or disproportionate to the offence, the process can be seen as unjust and lose its legitimacy. Such actions would damage markets instead of protecting them. Research suggests little clarity exists about the basis for determining penalty amounts in insider trading cases ( Asthana, Sane, and Vivek, 2021) and that there is no discernible pattern on how SEBI applies debarment provisions (Damle and Zaveri, 2022).

Debarment and restraint have enormous business, reputational, and career consequences on whom they are imposed. Section 11(4) of the Securities and Exchange Board of India Act, 1992 (SEBI Act) requires that SEBI provide written reasons when ordering debarment or restraint in final and interim orders. Such reasons must explain why a sanction is necessary in the interests of investors or the market. SEBI has ordered debarment in 575 instances and debarment with disgorgement in 111 instances (SEBI Annual Report (2022-23)) across all violations. This article investigates SEBI's process for applying debarment and restraint sanctions. It focuses on the following questions:

1. Whether SEBI specifies reasons for ordering debarment and/or restraint?
2. What reasons are specified?
3. Are these reasons special to the instances where debarment or restraint is ordered?
4. Is there a correlation between the amount of quantified gain or advantage and the period of debarment or restraint ordered?
5. If the answers to the above questions are negative, are there constitutional grounds of arbitrariness and non-application of mind on which such orders can be challenged?

Our analysis suggests that SEBI often does not provide reasons for imposing debarment and/ or restraint. When it does give some reasons, it does not indicate why debarment and/ or restraint are imposed rather than other sanctions, such as penalties. In such instances, SEBI uses near-identical language in its orders when imposing debarment and/ or restraint as it does when imposing penalties. We also find little correlation between the quantified gain or advantage resulting from the violation and the period of debarment or restraint. Our reading of the law suggests that SEBI's processes expose its orders to challenge on constitutional grounds of non-application of mind and arbitrariness.

Data and methods

Our data consists of SEBI orders on insider trading, which has become an important issue for SEBI in recent years. During 2022-23, SEBI took up 85 insider trading investigations and imposed penalties worth Rs. 3 crore (SEBI Annual Report (2022-23)). There has also been a rise in the percentage of appeals in insider trading cases allowed at the Securities Appellate Tribunal (SAT), from 9% in 2021-2022 to 44% in 2022-2023. The increasing numbers of insider trading matters investigated, penalties, debarment and restraint imposed, and appeals allowed by SAT raise questions about whether SEBI has exercised its administrative discretion in consistently, rationally, and predictably determining sanctions.

We collected a set of insider trading orders passed by SEBI between September 2009 and July 2023. We then created a dataset of orders which matched the following set of keyword searches relating to insider trading: a single instance of 'insider' AND a single instance of 'UPSI' OR 'unpublished' OR 'prevention' OR 'insider trading' (case-insensitive). This gave us 913 observations (599 by Adjudication Officers (AOs) and 314 by Whole-Time Members (WTMs)). AOs do not have the power to impose debarment and restraint as sanctions. We, therefore, focus on the subset of observations related to WTMs. Table 1 presents the summary of our dataset.

Table 1: Summary of our data

Total number of observations	913
Number of observations from WTMs	314
Debarment	188
Restraint from capital markets	71
Both	57
Average period of debarment (in years)	2.9
Average period of restraint (in years)	1.8

There are 188 instances where WTMs have ordered debarment from capital markets and 71 instances of restraint from dealing in securities of the relevant company. In 57 cases, debarment and restraint have both been ordered. We observed no qualitative difference between these 57 cases and the remaining cases where only debarment or restraint was ordered. The average debarment period is about three years, and the average period of restraint is two years.

As described earlier, the SEBI Act requires SEBI to give reasons for imposing debarment or restraint. We use this as the basis of our analysis. From each order, we extracted information on whether SEBI explicitly provided reasons for imposing debarment or restraint, what the reasons were, and whether the order noted the amount gained or loss avoided by the violator. We then used the 'Free online text compare tool' from GoTranscript to compare SEBI's reasons for imposing penalties with reasons for ordering debarment and restraint. This helps us understand if the reasons provided by SEBI are generic or specific. We also studied whether the number of years of debarment or restraint was correlated with the amount gained or loss avoided. This provides one measure of determining proportionality in such orders.

Results

Has SEBI specified reasons?

Table 2: How often does SEBI provide reasons for its actions?

Sanction	Number of instances	Reasons provided	Reasons not provided
Debarment	188	153 (81.4%)	35 (18.6%)
Restraint	71	20 (28.2%)	51 (71.8%)

Table 2 shows SEBI orders do not provide a rationale in ~19% of cases where debarment has been sanctioned and ~72% of cases where restraint has been ordered.

What reasons has it specified?

Where SEBI does provide reasons, they are similar to non-statutory factors it provides when imposing penalties higher than the minimum prescribed under the SEBI Act. The reasons include:

1. Ensuring a level playing field and minimising information asymmetry.
2. Protecting the investors' interests.
3. Regulating and developing the market.
4. Upholding standards of transparency, good governance and ethical behaviour.
5. Upholding the integrity, orderly development and fairness of the market.
6. The seriousness of the violation.
7. Insider trading is behaviour that undermines confidence in the securities market.
8. Discouraging and curbing future instances of insider trading.
9. The role and extent of involvement of an alleged violator.

Are these reasons special to the instances where debarment or restraint is ordered?

The reasons are broad and do not indicate anything special that justifies the imposition of debarment and/or restraint rather than another sanction, such as a penalty. The reasons also do not clarify how the period of debarment or restraint was determined in these instances.

Our analysis from the GoTranscript tool indicates a 99% similarity between the reasons for imposing penalties and ordering debarment and an 86% similarity between the reasons for imposing penalties and ordering restraint. This indicates that the reasons for imposing debarment or restraint are the same as those for imposing penalties. Moreover, the language used to describe these reasons is nearly identical. Application of mind in the exercise of administrative discretion implies that the regulator provides reasons for imposing a sanction and clarifies why it has decided to impose one type of sanction (such as debarment or restraint) rather than another (such as penalty). The fact that SEBI uses near-identical language suggests that SEBI does not consider the proportionality of the sanction to the specific nature and extent of the violation in recording its reasons for imposing certain sanctions or calculating the quantum of penalty or the periods of debarment and restraint. This also suggests that its orders in such instances suffer from procedural lapses and a lack of application of mind and are open to challenge.

Is there any correlation between the amount of quantified gain and the period of debarment or restraint ordered?

Table 3 provides the number of instances in which SEBI established the amount gained or loss avoided before imposing a sanction and the average period of debarment and restraint.

Table 3: Amount loss/gained and the average period of debarment

	Number of instances	Average period (years)	Cases with "Till further orders"
Debarment: Amount gain/loss established
Yes	120/188	3.51	2
No	68/188	1.76	4
Restraint: Amount gain/loss established
Yes	40/71	2.05	2
No	31/71	1.47	12

The table points to three observations.

• First, in 36% of cases where debarment was imposed, SEBI did not identify the amount gained or loss avoided. This is higher in the case of restraint at 40%.
• Second, the average sanction period is higher when the amount of gain/loss avoided is established.
• Third, SEBI imposes debarment and restraint without an end date more often in cases where it has not established the amount gained or loss avoided.

Figure 1 shows the correlation between the amount gained/loss avoided and the years of debarment and sanction in more detail.

Figure 1: Amount loss/gained and the periods of debarment and restraint

Figure 1 does not include two instances in which SEBI quantified the amount of gain and ordered both debarment and restraint 'Till further orders'. The amounts gained in these two instances were Rs. 2,79,51,000 and Rs. 26,82,000.

There is no correlation between the period of debarment ordered and the quantified gain or advantage. There appears to be an inverse relation between the period of restraint ordered and the quantified gain or advantage. We, therefore, infer that the quantified gains or advantages have not been a consistent factor in determining the debarment or restraint period. Moreover, of the 188 instances where SEBI has imposed debarment, it could not quantify the gain in 158 instances (i.e., approximately 84%).

Constitutional safeguards on administrative discretion

One reason for SEBI's non-application of mind when imposing debarment and restraint may be that the SEBI Act provides no guidelines. However, the Indian Constitution and case law in the Supreme Court suggest that this is not a valid excuse.

The Constitution of India imposes restrictions against the exercise of arbitrary power by the State against its citizens. Such arbitrary exercise of power violates Article 14 of the Constitution. This principle has been reiterated by the Supreme Court (Bachan Singh v. State of Punjab, (1982) 3 SCC 24; East Coast Railway v. Mahadev Appa Rao, (2010) 7 SCC 678; Trustees of H.C. Dhanda Trust v. State of Madhya Pradesh, (2020) 9 SCC 510) where it has said:

Whenever a statute transfers discretion to an authority, the discretion is to be exercised in furtherance of the objects of the enactment. The discretion is to be exercised not on whims or fancies rather, the discretion is to be exercised on a rational basis in a fair manner.

Further, the Court has also said:

Every order should demonstrate "due and proper application of mind by the person making the order" and clearly set out the reasons for the order. --East Coast Railway v. Mahadev Appa Rao, (2010) 7 SCC 678.

The Court has also held that there must be consistency in decision-making involving the exercise of administrative discretion.

[I]t is important to emphasize that the absence of arbitrary power is the first essential of the rule of law upon which our whole constitutional system is based. In a system governed by the rule of law, discretion must be confined within clearly defined limits when conferred upon executive authorities. The rule of law, from this point of view, means that decisions should be made by the application of known principles and rules and, in general, such decisions should be predictable and the citizen should know where he is. If a decision is taken without any principle or without any rule it is unpredictable and such a decision is the antithesis of a decision taken in accordance with the rule of law. -- S.G. Jaisinghani v. Union of India, AIR 1967 SC 1427.

One can expect the constitutional guardrails to apply to SEBI actions, whether for penalties or debarment. Consequently, SEBI must provide clear reasons for imposing debarment or restraint, the period of such debarment and restraint, and what is special in the instances where such debarment or restraint is ordered, making it different from instances where it is not.

Conclusion

The absence of justifiable exercise of its discretionary power by SEBI when imposing debarment and restraint in a reasonable number of cases is demonstrated by the fact that there are many instances where no reasons are provided when imposing such sanctions. Where reasons are provided, they do not indicate anything special in these particular instances that distinguishes it from instances where such sanctions are not ordered and are largely the same as those provided for imposing penalties. Finally, little correlation exists between the quantified gain or advantage and the debarment or restraint imposed.

It is particularly important to examine whether SEBI provides reasons when imposing debarment or restraint, how it determines the duration of such sanctions, and what these reasons and methods are because the SEBI Act does not specify what these factors should be, unlike in the case of penalties. These reasons and methods must be described in its orders so that they are available to the persons directly affected and the general public. This is required by the rule of law principles of reasoned decisions and knowability and predictability of the law. It is not sufficient to describe such reasons and methods in internal, unpublished documents or decisions, such as those determining whether an Adjudicating Officer or a Whole-Time Member should adjudicate a matter. If SEBI fails to provide good reasons or does not clarify its methods, its orders are open to challenge on constitutional grounds of arbitrariness.

We recommend developing more precise, appropriate, and usable guidelines in the legal framework to guide and constrain SEBI's discretion in imposing sanctions. The amount gained or loss avoided in insider trading cases may be difficult to quantify. Given this, the 15J factors must be modified to indicate how the debarment period can be calculated in such instances. The Competition Commission of India (Determination of Monetary Penalty) Guidelines, 2024 may be a good reference point for designing such guidelines. Having a clear set of guidelines that SEBI follows in its orders will help satisfy the requirements of consistency, non-arbitrariness, and predictability. This will also help address the high (44%) overturn rate at the SAT, which SEBI self-reports for its insider trading cases. This is perhaps attributable to the frequency with which the SAT modifies sanctions imposed by SEBI.

The Report of the High-Level Committee under the Chairmanship of Justice Anil R. Dave on the Measures for Strengthening the Enforcement Mechanism of the Board and Incidental Issues stated that debarment may serve as an ineffective deterrent mechanism. This, coupled with the lack of specific reasons in SEBI's orders, suggests a need to review the use of debarment and restraint as sanctions in SEBI's enforcement proceedings and to develop more implementable guidelines to guardrail the regulator's actions in imposing such sanctions.

References

Asthana, Sane, and Vivek, An analysis of the SEBI WhatsApp Orders: Some observations on regulation-making and adjudication, Leap Blog, 27 May 2021.

Damle, Devendra and Zaveri, Bhargavi, Enforcement of Securities Laws in India: An Empirical Overview, 24 August 2022.

Securities and Exchange Board of India, Report of the High-Level Committee under the Chairmanship of Justice Anil R. Dave on the Measures for Strengthening the Enforcement Mechanism of the Board and Incidental Issues, 2020.

Securities and Exchange Board of India, Annual Report, 2022-2023

The authors are researchers at TrustBridge. The data cited here was collected by a team at TrustBridge comprising Madhav Goel, Karan Gulati, Amol Kulkarni, Sonam Patel, Praduta Singh, and the authors. We thank Sonam Patel for her assistance in data analysis and creating graphs and tables. We also thank the three anonymous referees who read an earlier draft and provided their comments and suggestions.