Abstract
The Insolvency and Bankruptcy Code (IBC) of 2016 is a key law in India that affects borrowers and creditors. This paper focuses on Part III of the IBC, which specifically deals with individuals, small businesses (proprietorships), and people who act as personal guarantors for corporate loans. The paper aims to analyze the potential effects of a part of the law called the Fresh Start Process (FSP). Under this process, individuals with minimal assets, low income, and small debts can qualify for relief, which helps them get a fresh financial start. The paper estimates how many people or households might qualify for the FSP by using two important surveys the Consumer Pyramids Household Survey (CPHS) and the All-India Debts and Investments Survey (AIDIS) from 2019. These surveys provide data on household incomes, debts, and financial conditions. By combining this information, the study seeks to understand how the IBC, particularly the FSP, will impact borrowers across India.
The paper also compares the IBC with other similar laws that were previously in place, such as the Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act (2002) and older insolvency laws from the British colonial era. This comparison helps to show how the IBC is different and what improvements it brings. Ultimately, the research helps measure the potential impact of the IBC on various borrower groups in India.
Introduction
The Insolvency and Bankruptcy Code (IBC), introduced in 2016, was designed to address issues faced by lenders, particularly banks, which were struggling with bad loans. The goal of the IBC was to create a faster and more efficient process for resolving insolvencies, which includes reorganizing businesses, recovering debts, and maximizing asset value. It aimed to help businesses, encourage entrepreneurship, and make credit more accessible.
However, after nearly 8 years, the IBC still doesn’t cover all types of debtors. Currently, it is only applicable to corporate debtors (businesses) and individuals who act as guarantors for businesses. Other types of debtors, like partnerships and sole proprietors, are still excluded, mainly because Part III of the IBC, which was supposed to address these groups, has not yet been fully activated.
The reason for this delay is unclear, but it’s likely because of the challenges of applying the law to individual people (natural persons). Unlike companies, individuals have personal lives and ethical considerations, so policymakers have to carefully consider the impact of the law on both the credit market and the individuals involved.
The IBC provides three main processes for individuals to deal with insolvency:
- Insolvency Resolution Process (IRP), which is a process to reorganize debts,
- Bankruptcy Process, which is pursued if the IRP fails, and
- Fresh Start Process (FSP), a unique option for low-income individuals with little debt.
The Fresh Start Process is specifically designed to help people in financial distress who have minimal debt and few assets. It allows them to get a “fresh start” by clearing their debts. This process is intended to support vulnerable borrowers, providing them relief while also addressing ethical concerns about whether individuals should be allowed a fresh start in such circumstances.
Meaning of Fresh Start Process
The “Fresh Start Process” is a way for individuals or small businesses facing financial difficulties to get a clean slate by discharging their debts and starting over without any liability. This process offers an alternative to the regular insolvency and bankruptcy procedures. Many individuals or small partnerships depend on loans to run their businesses, and these loans are often provided by banks or other lenders. While it’s difficult to compare the exact amount of credit given to individuals versus companies, it’s clear that a significant portion of agricultural loans and personal loans are given to individuals. Personal loan growth has been growing steadily, with an increase of 20.4% in February 2023.
However, the Fresh Start Process is still not fully implemented as some rules have not been notified yet. This means that many individuals who are struggling with their debts have not been included in the insolvency and bankruptcy processes. Section 80 of the Insolvency and Bankruptcy Code (IBC) 2016 allows individuals who meet certain criteria, such as having an annual income of no more than Rs. 60,000 and assets worth no more than Rs. 20,000, to apply for the Fresh Start Process. If their application is accepted by the Debt Recovery Tribunal (DRT), they will be relieved from the obligation to pay their qualifying debts, giving them a chance to restart their financial life.
History of Fresh Start Process
For as long as credit has existed, there have been borrowers who couldn’t repay their debts, leading to conflict. In ancient times, debtors could be forced into slavery to repay what they owed, and this practice was based more on customs than formal laws. Between the 1st and 16th centuries, debt slavery was legalized, but some people, especially those of higher social or political status, were protected from this punishment. During the Enlightenment in the 16th century, rational legal principles became more important, and laws were created that offered some protection to debtors, but the state (through the monarchy) could still impose harsh penalties, even the death penalty, on debtors who couldn’t pay their debts.
Over time, the goal of debt-related laws has always been to help creditors recover what they are owed. In the past, both the lender and borrower were typically individuals. However, from the 10th century onward, institutions like churches and monarchies started lending and borrowing money, but the terms were based on agreements between the parties, rather than a formal national law. By the 19th century, corporations became more involved in borrowing and lending money, which marked a shift away from individual borrowers and lenders to businesses being at the center of insolvency and bankruptcy practices.
Corporations are different from individuals because they are not seen as human beings and can be broken apart or liquidated if they fail, unlike individuals who have rights that can’t be taken away. As a result, modern bankruptcy laws now focus on balancing the rights of both debtors and creditors. In India, older laws like the Presidency Towns Insolvency Act (1909) and the Provincial Insolvency Act (1920) tried to achieve this balance, but they were eventually replaced by the Insolvency and Bankruptcy Code (IBC), though many parts of the IBC are still not fully implemented.
The key difference between the old British laws and the IBC is the Fresh Start Process (FSP). The FSP is a low-cost process for people with minimal debt and no major assets, allowing them to completely discharge their debt if they meet certain criteria. This process is similar to bankruptcy but is easier and less expensive, offering a chance for debtors to start fresh without the burden of unpaid debt.
Under the current rules of the Insolvency and Bankruptcy Code (IBC), an individual (debtor) who wants to apply for the Fresh Start Process (FSP) must meet four key financial conditions. These conditions are outlined in sections 80(2)(a) to 80(2)(c) and 80(2)(e) of the IBC. First, the debtor’s income should not exceed ₹60,000 per year. Second, the total value of their assets should be no more than ₹20,000. Third, the individual’s total debt should be less than ₹35,000. Lastly, they should not own a “dwelling unit,” which means no personal home or property. To qualify for the FSP, the debtor must meet all four of these criteria.
However, these criteria are open to interpretation, which confuses. For example, it’s unclear which types of income count under the income rule. For a person running their own business, the revenue from the business is treated as personal income, which could easily exceed the ₹60,000 limit, making them ineligible. Additionally, it’s not clear whether government transfers, like direct benefits to individuals, should be considered as income. If these are counted, it would further reduce the number of people eligible for the FSP.
Because of these unclear points, estimating the effect of the IBC and FSP requires making certain assumptions to fill in the gaps. These assumptions help clarify how to interpret these criteria, allowing for a better understanding of who might be eligible for the FSP under the current rules.
Individual Debtors
The Fresh Start Process (FSP) offers a chance for debtors, especially those severely impacted by the pandemic, to clear their debts and begin anew. While this process can provide much-needed relief to small debtors and businesses struggling with financial difficulties, it also has potential drawbacks. One key issue is that settling a loan through FSP can negatively affect a debtor’s credit report and score, which may limit their future access to credit. This means that while debtors can get a fresh start, it comes with the risk of facing challenges when trying to secure loans in the future.
Another concern is how the FSP might influence India’s corporate culture. Some borrowers might misuse the process, intentionally avoiding repayment even when they have the means to do so, which could lead to the Insolvency and Bankruptcy Code (IBC) stepping in to settle the dispute. This could encourage bad practices, especially in corporate sectors where debtors might not feel the full consequences of not repaying their loans.
Additionally, the Debt Recovery Tribunal (DRT), which is meant to handle debt resolution under Section 179(1) of the IBC, has not been fully effective yet. It faces several issues, including low recovery rates and a heavy caseload of corporate matters, making it less effective for smaller businesses. The DRT often struggles to distinguish between genuine business failures and fraudulent activities, which can undermine its role in resolving disputes.
While India’s laws, such as Section 29A of the IBC, are designed to prevent companies in financial trouble from regaining control of their businesses, some argue that these rules are too harsh. Section 29A, for instance, blocks company management from participating in a resolution plan, potentially denying them a chance to revive their businesses. Critics believe that businesses struggling with debt should have more opportunities to recover, and that a “fresh start” should allow them a real chance at rebirth without being held back by past debts.
Conclusion
The Insolvency and Bankruptcy Code (IBC) was created to help companies that are in financial trouble by giving them a chance to recover and continue operating. The main goal of the IBC is to help corporate debtors (businesses) become “going concerns” again, with liquidation (shutting down) being the last resort. However, this system currently only applies to businesses and not to individual debtors. For individuals who fall into financial distress, the laws that govern insolvency are still based on old statutes, like the Provincial Insolvency Act of 1920 and the Presidency Towns Insolvency Act of 1909, which are outdated and full of gaps. These old laws are slow and inefficient, causing delays and making it difficult for individuals to get a fair chance to resolve their debts.
The government had considered allowing out-of-court settlements for individuals, but this approach is not practical due to the small amounts of debt involved and the challenges individuals face in going through a complicated legal process. Additionally, the Debt Recovery Tribunals (DRTs) are already overwhelmed with cases related to businesses and cannot handle many individual cases. As a result, the government is considering creating a simpler administrative process to help individuals. While the IBC has been a major step forward for businesses, the system needs to be extended to include individual debtors, and clearer rules need to be established. This is especially important in an economy where many small businesses and entrepreneurs, who create jobs and drive growth, could benefit from such a system.