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.

The size of personal bank credit in India

by Renuka Sane and Anjali Sharma.

In May, 2016, the Insolvency and Bankruptcy Code, 2016 (IBC) law was passed by Parliament and received Presidential assent. The law consists of provisions for both corporate and personal insolvency. However, only the corporate insolvency provisions of the law have been notified and are being implemented. The rapid implementation of the corporate insolvency provisions is largely a response to the policy discourse on the non-performing asset (NPA) problem of the banking sector.

In this article, we turn our attention to personal credit extended by banks, with a view to informing policy actions on the personal insolvency provisions of the IBC. While banks are just one source of personal credit amidst a variety of institutional and non-institutional sources, they are the largest "formal" source of credit, and therefore, the first likely users of the insolvency provisions. Understanding the nature and composition of personal credit extended by banks has implications for effectively designing the procedural aspects of of insolvency resolution under the Code, as well as the institutions that enable the resolution. The decisions surrounding personal insolvency can help lay the foundations for a healthy market for individual credit.

Bank credit to the HH sector

We use the data from the Quarterly BSR-1: Outstanding Credit of Scheduled Commercial Banks released by the RBI. This is a quarterly data series, from March, 2014 till September, 2016, which provides the composition of bank lending by organisation, occupation, loan size, interest rate bands and regions. RBI classifies household (HH) sector credit into three categories. These are credit to: (1) individual borrowers, (2) proprietary concerns, joint families and unregistered partnerships, and (3) joint liability groups (JLG), NGOs and trusts. The data gives us the following details on the size and composition of lending to this sector:

1. HH sector credit is large, both in terms of value and accounts.

   In September, 2016, credit to the HH sector was Rs. 32.2 trillion, 44.3% of the total credit given by banks. In terms of number of loan accounts, HH sector accounts were 98% of the total accounts of the banking system (Table 1). Within the HH sector, credit to single individual borrowers was the largest component, both in terms of value and in terms of accounts.

Table 1: Household sector credit in India

	Loan accounts	Loan value
Categories	(million)	(Rs. trillion)
Total bank credit	143.7	72.7
O/w credit to HH sector	140.2	32.2
- Individuals	134.3	25.2
- Proprietors/ partnerships	3.0	6.3
- JLGs, NGO, Trusts	2.9	0.7
Source: RBI, Quarterly BSR I, Table 1.6

2. Bank credit to HH sector is growing at a faster rate than credit to the corporate sector.

   In the last six quarters, from Q1 2015 to Q2 2016, bank credit to the HH sector has seen an average quarter-on-quarter (Q-o-Q) growth of 3%. By contrast, in the same period, bank credit to non-HH sectors has only seen an average Q-o-Q growth of 0.3%.

3. Bulk of HH sector credit is given as agri loans and personal loans.

   Personal loans (mostly in the form of secured housing and vehicle loans) and agri loans account for Rs. 22 trillion or 67% of the total bank credit to the HH sector. Average loan sizes are relatively small, Rs. 1.2 lakhs per loan for agriculture and Rs. 2.6 lakhs per loan for personal loans.

   The remaining 33% is spread mainly across three sectors: industries (12%), trade and transport (13%) and professional services (6%). These loans are in the nature of business loans. Within industries, most loans are given to proprietors and partnerships, and at an average of Rs. 9.3 lakhs loan size, are relatively large. In trade, transport and services, average loan size is between Rs. 3.5 to Rs. 5 lakhs per loan.

4. Southern and western regions account for more than 60% of agri and personal loans, by value and by accounts.

   38% of agri and personal loans by value, and 46% of the loan accounts, are in the southern region. 24% of loan value and 19% of loan accounts are in the western region. Two states: Tamil Nadu and Maharashtra account for 40% of the loan accounts and 30% of the loan value.

5. Agri loans are given mainly in rural and semi-urban centers while personal loans are given mainly in urban and metropolitan centers.

   Around 85% of agri loan accounts and 72% of the loans by value are given in rural and semi-urban centers. These are places with population less than 0.1 mn. In case of personal loans, 58% of loan accounts and 51% of loans by value are given in metropolitan areas. These are centers with population of 1 mn or more.

6. Agri credit is largely short tenure whereas personal loans are medium to long tenure.

   70% of agri credit is given in the form of cash credit or as demand loans. In contrast, more than 80% of personal loans are medium to long tenure loans.

7. The interest rate distribution of agri and personal loans suggests that, at an aggregate level, there is limited margin for NPAs

   Table 2 shows the distribution of agri and personal loans by interest rate ranges. A comparison of the lending rates with the marginal cost of lending rate (MCLR) for State Bank of India from September, 2016 shows that the margin available for NPAs is limited. The short term MCLR, relevant for agri loans, is 9.05%. Around 56% of agri loans, are in the 6 - 11% lending rate category, suggesting a less than 2% room for NPAs. Similarly, the MCLR relevant for personal loans is 9.25%. 67% of personal loans are in the 6 - 11% lending rate category, suggesting a less than 1.75% room for NPAs.




Table 2: Agri and personal loan lending rates

Lending rate	% agri-loans	% personal loans
Less than 9%	25%	5%
9% - less than 11%	31%	62%
11% - less than 13%	32%	16%
Above 13%	12%	17%
Source: RBI, Quarterly BSR I, Table 3.3

8. Banks have limited mechanisms for enforcement.

   Currently, banks can avail of SARFAESI for resolving secured loans. However, for individual debtors it is used more as a deterrent than an actual enforcement mechanism. DRTs, with their threshold of Rs. 10 lakhs, are available only to the 6-7% of personal credit loan accounts which meet the threshold. For the remaining segments of personal credit, the only mechanism available is the slow and costly Civil Court system. Some banks use the provisions of the Arbitration and Conciliation Act, 1996 for recovery. However, the enforcement of arbitration awards relies on the Civil Court system. There is no collective resolution process available to deal with an individual with a portfolio of loans. Each lender has to pursue its recovery action separately. This proves to be inefficient and costly.

In summary, the data tells us four important facts about personal credit given by banks. First that it is diverse, in terms of borrower profile, loan profile, and geographical spread. Second, it is growing at a faster rate than overall bank credit, given the slowdown in corporate credit and banks increased focus on extending personal credit. Third, the difference between lending rates and marginal cost of lending for this segment is narrow, leaving a limited margin for NPAs. Any deterioration in credit quality of these loans will spell trouble for the banks. Fourth, the mechanisms for recovery are inadequate.

Implications for IBC implementation

The size, and nature of personal credit extended by banks implications for:

The design of IBC resolution procedures:

Most personal loans are secured loans, and banks might continue to use SARFAESI for recovery action on them. IBC may be used mostly in cases where a debtor has multiple unsecured loans, or where the debtor wishes to file for protection under the Code.

A large proportion of agricultural loans are given to low income households. It is possible that many of them will qualify for the fresh start. As most of these loans are in rural and semi-urban areas, design of access will be important for these households to be able to apply for such a waiver.

For those loans that do come to the IBC, the IRP needs to be aligned with the borrowers' profile. A resolution procedure for an individual borrower with low value loans, needs to be simple, low cost and time effective. A simple form-based resolution mechanism, that requires little or no adjudication, may be desirable here. In contrast, resolution procedure for a large borrower or a proprietor may be closer in design to the process for a small company.

On reach, procedure, cost structure and role of the DRTs:

The size of the loans, their complexity, and their geographical spread will need to shape resourcing decisions of the DRTs. This will, in turn, decide their effectiveness as the adjudicating authority for personal insolvency cases. Today DRTs are designed to deal with bank loans above Rs. 10 lakhs. There are only 65 lakh loan accounts in this size threshold in the entire banking system. In contrast, there are 14 crore HH loan accounts, and their average size is Rs. 2.3 lakhs. To effectively deal with resolution of such loans, the DRT rules of procedure, reach, infrastructure, as well as their use of technology for case management, will require a comprehensive re-think.

On how the market for RPs may develop:

The role of RPs, as well as how the RP profession evolves for personal insolvency cases, will be critical. It is likely that, for high value loans, a market for private RPs, concentrated in urban and metropolitan centers, will develop organically. However, for small sized loans, which are geographically dispersed, the question of who will be the RPs and what role they will perform will require assessment, and perhaps even policy action. Further, even when RPs are identified, the process for their licensing, training and monitoring will need to be carefully formulated.

On design of IUs, their accessibility and cost
structures:

The institution of Information Utilities (IUs) is a core component of IBC design. The IUs are expected to facilitate the digitisation of credit transactions, and give such digital records sanctity as evidence in courts of law. Information in an IU can be used for establishing default, and initiating insolvency resolution processes. The structure of IUs, their mechanisms for accepting personal credit related information, and their standards of service will need to be aligned with the need to digitise a large number of small valued loan accounts given to individuals.

On the role of the Insolvency and Bankruptcy Board of India (IBBI):

For personal insolvency, one of the biggest challenges for the IBBI, will be dealing with consumer protection issues. Individual debtors will be vulnerable to biased advice on whether to file for insolvency, the process guiding the filing, and the process for resolution. The IBBI will have to step up to the challenge of protecting customer interests from misaligned incentives that stem from high powered sales practices that have plagued other sectors of the retail financial market.

Conclusion

The design of personal insolvency systems is a complex problem, with challenges that are completely different from those faced by corporate insolvency systems. This article has discussed only the market for bank credit. There will be a larger category of lenders, including money-lenders and friends and family, that may at some point wish to use the provisions under the IBC. Given the size and complexity of the personal credit market, and the paucity of effective recovery mechanisms, there is need for carefully planning and implementing the personal insolvency law sections of the IBC. This is unlike the approach followed for implementing corporate insolvency provisions where speed of implementation has been prioritised.

 

Renuka Sane is a researcher at the Indian Statistical Institute, Delhi and Anjali Sharma is a researcher at the Finance Research Group at IGIDR, Mumbai.