Legal Shock or False Start? The Uncertain Future of India's New Consumer Insolvency and Bankruptcy Regime.

• Author: Feibelman, Adam

Abstract

In May of 2016, India adopted a regime for personal insolvencies and bankruptcies as part of a comprehensive new Insolvency and Bankruptcy Code. The Code's provisions for individual debtors have not yet gone into force, and it is not clear when, or even if, this will happen or whether significant changes might be made to the regime before it does. The regime, as enacted, represents a dramatic change in the legal framework affecting consumer debtors in India, providing previously unavailable tools to both creditors and debtors. Assuming it comes into force in its current form, it will be a legal shock to financial markets and social systems in that country. It is not clear, however, how that legal shock will be absorbed by Indian society and its economy. The function and impact of the regime will be determined by how it is implemented and how it is utilized by stakeholders.

This Article describes India's new personal insolvency and bankruptcy regime in some detail and anticipates the function and impact of the regime as enacted. The regime was something of an afterthought for policymakers, who were primarily motivated to reform the restructuring and liquidation schemes for corporate debtors. Perhaps as a result, it strifes an uncertain balance of various policy goals. On paper, it significantly expands the availability of relief and protection available to individuals and households, especially for those poorest debtors who qualify for its fresh start process, essentially a loan waiver program. Yet, it also gives creditors the power to force all other debtors into a relatively burdensome insolvency process. Furthermore, there are reasons to be concerned that many debtors who might benefit from the regime will not utilize it. This Article proposes that the regime will, at least initially, function primarily as a creditor's remedy and provide suboptimal insurance for individual and household debtors. If so, then it might fall short of its potential for helping individual debtors, including entrepreneurs, recover from financial distress and would exacerbate some of the social costs of consumer over-indebtedness. It might also distort the development of consumer financial markets in India by promoting the expansion of lending without effectively insuring against systemic household indebtedness.

INTRODUCTION

In 2016, India adopted a regime for personal insolvencies and bankruptcies as part of a comprehensive new Insolvency and Bankruptcy Code. (1) The Code's provisions for business debtors were "notified" (2) and came into force in August of that year and have received a significant amount of attention within India and abroad. The personal insolvency and bankruptcy provisions under the Code, on the other hand, have not gone into effect, and there has been little public discussion and commentary within India or elsewhere about these provisions. (3) The chairperson of the newly created Insolvency and Bankruptcy Board, described below, has consistently stated since October of 2017 that one of the institution's primary current goals was to "operationalise the individual insolvency regime in respect of guarantors to the corporates and the individuals having proprietary business." (4) The Board issued draft regulations for the personal insolvency regime at that time, seeking public comments and issued draft regulations for bankruptcy proceedings for personal guarantors to corporate debtors in April of 2019. (5) Given the long delay in notifying these provisions, however, the future of India's personal insolvency and bankruptcy regime remains profoundly uncertain. The regime may be notified in the relatively near future for a narrow set of individuals or for all individuals; it may be notified after some significant delay or with significant amendments; or it may not be notified and never go into force.

As designed, the new regime for personal insolvency and bankruptcy would represent a shock to the legal framework governing consumer credit relationships in India, one that will potentially affect over 1.2 billion individuals. (6) It not only alters the substantive relationships between consumer debtors and their lenders but also introduces an institutionally unfamiliar process for individuals seeking to employ those substantive rights. The practical significance of this legal shock (7) will be determined by how it is absorbed by Indian society--how it operates, what function it serves, and what impact it has.

This Article describes the new regime in detail and then considers the potential function and impact it might have if notified and implemented as designed. The regime as enacted significantly expands substantive protections for individual debtors who cannot repay their debts while also providing their creditors a powerful new tool for attempting to enforce and collect their claims. In light of various institutional, social, and economic factors that would affect how the new regime functions, this Article concludes that the regime would, on balance, prove more useful to consumer creditors than to their debtors, which may effectively limit the beneficial effects of the new regime on consumer financial markets.

The challenge of anticipating the function and impact of the new regime is exacerbated by the fact that it was not enacted in response to acute precipitating economic or social conditions in India. This is noteworthy because countries that have adopted or reformed their consumer insolvency regimes in recent decades have tended to do so in the wake of consumer financial crises or dramatically expanding consumer financial markets. (8) While the amount of consumer debt in India has increased significantly in recent decades, and instances of household over-indebtedness appear to be growing, it has not reached levels that suggest systemic vulnerability or a looming threat of a household financial crisis. (9) To be sure, there are ongoing financial travails of farmers in certain regions, a spike in financial distress in some sectors due in part to the recent demonetization, (10) and a generally acknowledged problem of aggressive debt collection practices across the country. Yet there does not appear to be an emerging crisis of intractable over-indebtedness among individuals and households in India. It seems very unlikely that the Indian parliament would have tried to reform the country's personal insolvency laws if it were not otherwise overhauling the insolvency system for commercial debtors.

The new Indian Insolvency and Bankruptcy Code thus appears to represent a rare instance of a country adopting or modernizing a personal insolvency or bankruptcy regime at the relatively early stages of the development of a consumer financial market, before one is acutely necessary. Doing so avoids costs and difficulties of responding too late, after consumer financial markets have overheated, when politicians must allocate substantial actual losses. It may also have a beneficial effect on the development of those markets in the first place. In the wake of the recent global financial crisis of 2008-10, there is an emerging consensus that a personal insolvency or bankruptcy regime is "a significant market institution and ground rule for credit markets." (11) If properly designed and operated, such a regime can help pro' mote a stable market for consumer credit. Ideally, it can make creditors more willing to lend and individuals more willing to borrow, discipline both, and reduce the social costs of consumer financial distress and perhaps the amount of household over-indebtedness in the economy as well. (12)

But such beneficial effects depend on a system that improves or accelerates creditors' insolvency state returns, or at least makes their losses relatively predictable, and that effectively insures individuals against the risk of over-indebtedness without creating incentives for them to act opportunistically or recklessly. It is not clear how well the provisions for personal insolvency and bankruptcy under the Code as enacted would serve these functions, and there are some causes for concern. Certain aspects of the institutional design may exacerbate inter-creditor conflicts, for example, by enabling individual creditors to easily initiate a case and by requiring majority votes among creditors to approve repayment plans. The regime relies heavily on negotiated repayment plans, which may also limit the predictability of outcomes.

The Code's "fresh start" process for individuals with low incomes, few assets, and relatively little debt is designed to provide a robust insurance function. (13) But it is not clear how many individual debtors in India will fall within its eligibility requirements, and many of those eligible may be unaware of the relief it affords or unwilling or unable to obtain such relief. The insolvency provisions that apply to all other individual debtors provide much more limited protection to individual debtors. Depending on how it operates, the insolvency process for individuals may give creditors significant power to determine the scope of relief available to debtors and may require debtors to adhere to an onerous budget for the duration of a repayment plan. The bankruptcy chapter of the new Code would presumably provide more debt relief to debtors, because it ensures a discharge of certain debts that are not repaid from available assets. But to obtain such relief under the bankruptcy provisions, debtors must first effectively fail under the insolvency process.

It is possible, therefore, that a significant portion of debtors in financial distress may not voluntarily use the new insolvency and bankruptcy regime and that it will primarily be employed as a debt collection tool for creditors, either directly or indirectly by threat. If so, the scope of the insurance function of the new system may fail to: (1) provide sufficient relief to individual debtors who become mired in debt, (2)...