Trials and tribulations of personal insolvency regime in India

Even as India is looking to roll-out its personal insolvency regime, a look at the bankruptcy provisions for personal guarantors to corporate debtors, gives a glimpse of the things to come in the personal bankruptcy space. But while it lays down the basic framework, a lot of questions remain unanswered and a lot of issues remain open-ended.

These issues have been raised by Adam Feibelman, professor of law in Tulane University and Renuka Sane of National Institute of Public Finance and Policy point in an essay in the Insolvency and Bankruptcy Board of India (IBBI’s) annual publication — Insolvency and Bankruptcy Regime in India: A Narrative.

So, as per the laws governing bankruptcy of personal guarantors a default of as low as Rs 1,000 (or $14 on current exchange rates) could land you in insolvency court if you are in India.  The provisions of bankruptcy for personal guarantors lay down three general pathways for personal debtors — fresh start, insolvency, and bankruptcy. The fresh start process is available for debtors with very modest financial profiles who are ‘unable to pay their debt, who do not have more than Rs 60,000 in annual income, Rs 20,000 in assets, Rs 35,000 in qualifying debts and who do not own a dwelling unit.

The Process

The bankruptcy provisions for personal guarantors allow both debtors and creditors to initiate a personal insolvency.  The resolution professional (RPs) is selected by whoever initiates the insolvency proceedings. The role of RP in the personal insolvency process includes assisting debtors in preparing and submitting their repayment plans.

The creditors then vote to approve or reject the plan or modify it with the debtor’s consent. A repayment plan can be approved by three-fourth of votes of creditors. The resolution professional then implements the plan and applies for debtor’s discharge.

However, many other aspects of the implementation of the plan remain unspecified  including whether and how creditors’ claims will be verified, what income a debtor may keep under a plan, and the precise scope of some excluded assets, points out Adam Feibelman and Renuka Sane.

Excluded assets are those which cannot be sold or acquired by the creditors in order to discharge the debtor from his/her liabilities under the bankruptcy laws. Under the bankruptcy provisions of personal guarantors excluded assets include any unencumbered tools, books, vehicles and other equipment as are necessary to the debtor or bankrupt for his personal use or for the purpose of his employment, business or vocation; unencumbered furniture, household equipment and provisions as are necessary for satisfying the basic domestic needs of the bankrupt and his immediate family; any unencumbered personal ornaments of such value, as may be prescribed, of the debtor or his immediate family which cannot be parted with, in accordance with religious usage; any unencumbered life insurance policy or pension plan taken in the name of debtor or his immediate family; and an unencumbered single dwelling unit owned by the debtor of such value as may be prescribed.

The limit for the exemption for unencumbered personal ornaments is Rs 1 lakh and that the limit on the exemption for dwelling units in urban areas is Rs 20 lakh and for dwelling units in rural areas is Rs 10 lakh.

Unanswered questions

However, Adam Feibelman and Renuka Sane in theiressay point out that many questions that remain unanswered in the existing provisions.

Repayment Plan: According to the two, the default approach of code’s personal insolvency regime is to leave the contents of repayment plans that are not specified by the code itself or regulation to negotiation between debtors and their creditors. The code presumably gives the Tribunals authority to review plans for compliance with the relevant rules and regulations, but it is uncertain whether Tribunals have authority to review the terms of repayment plans and police for any egregious substantive unfairness to debtors or dissenting creditors.

“Determining how much a debtor should be required to pay creditors over the life of a repayment plan is probably the most significant question for policymakers designing such a regime. This question often depends on how much income debtors are allowed to retain for their reasonable or necessary expenses, which inevitably raises fraught questions of fairness and about what constitutes adequate baseline support for individuals and families,” they say.

In most countries, the law set pre-determines an amount of income that the debtor must pay to creditors periodically over the life of a plan, while some others require payments to creditors based on the actual income per payment period.

A flexible approach, point out Feibelman and Sane,  may be better matched to a debtor’s actual circumstances, but it may also entail greater costs in monitoring and supervision. “It may also have a negative effect on a debtor’s motivation to earn more income during the term of a repayment plan. Regimes that do not adopt a flexible approach nonetheless often allow modification of repayment plans if a debtor’s circumstance changes significantly. But this imposes monitoring and administrative costs on debtors and creditors alike,” they say.

Duration: Bankruptcy provisions of personal guarantor have not laid down a time line for repayment by the debtors.

Feibelman and Sane point out in their essay that there are two basic approaches towards the timeline for repayment. First approach is to set one or more particular time periods in the law or rules of the regime and second is to allow stakeholders, administrative officials, or judges to determine the length of individual debtors’ plans. For jurisdictions that adopt a rule on duration, there is general tendency to opt for three to five years, tending toward five.

Challenges

Adam Feibelman and Renuka Sane also point outa few challenges that the implementation of personal insolvency law might face.

Over-burdened DRTs: The personal insolvency regime will apply to hundreds of millions of individuals. The DRTs that are the adjudicating authorities for the regime are already taxed with their caseloads. Even if rates of utilization of the Code are low, the absolute numbers could quickly and easily overwhelm the existing capacity of the Tribunals. And even if the capacity of the Tribunals increases, anything that streamlines the process of cases they must adjudicate will likely help improve the timeliness and effectiveness of the regime.

Debtors’ literacy and their information: Debtors’ rates of literacy, social views of indebtedness and government assistance, as well as practical challenges for citizens in navigating physical distances may also pose fundamental challenges to the operation of the regime. Added to which, the availability of relevant information about debtors’ personal and financial affairs and creditors’ claims will be imperfect at best.