Escaping The Debt Trap: Understanding Individual Insolvency

Introduction

An Overview of Indian Insolvency

The situation of personal insolvency in India is characterized by a stagnant system that is both inefficient and ineffective. The report points out the frequent delays within the Indian framework and the insufficient incentives for both debtors and creditors to pursue legal action. Accessibility is a significant concern, and the high costs deter many individuals from seeking help. Additionally, the current legal framework, with its broad court powers and complex adjudication, requires a more streamlined approach. For instance, a moratorium, which is essential to halt individual enforcement rights, cannot be enacted until a court has officially declared insolvency.

The existence of several forums, including as the National Company Law Tribunal (NCLT), Debt Recovery Tribunal (DRT), Board for Industrial and Financial Reconstruction (BIFR), and their separate Appellate Tribunals, further prolonged the insolvency process. Because the previous regime's insolvency framework lacked an effective and efficient mechanism for the timely completion of the insolvency resolution, it generated uncertainty in meeting the stakeholders' final claim. Even the availability of multiple adjudicating forums made the entire process of winding up a company useless.

Personal Insolvency in India under the IBC

The IBC is a groundbreaking piece of legislation that represents a significant shift in India's financial system. Even though the corporate insolvency resolution process, or "CIRP," has gotten a lot of attention, the IBC also includes measures for personal insolvency, with the aim of giving individual debtors a structured and time-bound resolution. This page provides a detailed explanation of the IBC's personal insolvency framework, processes, and consequences.

Part III of the IBC addresses personal insolvency, which affects both people and partnership firms. The IBC categorizes individuals into three classes for the purposes of insolvency and bankruptcy.

• Partnership firms and proprietorship firms;
• Other individuals;
• Personal guarantors ('PGs') to corporate debtors ('CDs').

At first, corporate insolvency was the main emphasis of the IBC. After the Report of the Reconstituted Working Group on Individual Insolvency ('RWG')¹ made suggestions, the insolvency resolution procedure for PGs was later implemented. The RWG stressed that Part III should be implemented gradually in order to account for the various market dynamics, stakeholders, transactions, and procedural types.

Personal Insolvency Framework

According to the IBC, personal insolvency is divided into two primary categories:

• The Fresh Start Procedure (or "FSP")
• Process for Insolvency Resolution (or "IRP")

The Fresh Start Procedure (or "FSP")

An individual debtor can dismiss their qualified debts through the FSP. It is designed to let those with low incomes and assets start over without having to worry about crippling debt.

A debtor who is unable to pay their debt and meets the requirements listed below may apply for a fresh start in order to discharge their qualifying debt under Part III Chapter II, as per Section 80 of the IBC.

FSP eligibility requirements include having a gross yearly income of no more than Rs. 60,000.

• The total asset worth shouldn't be more than Rs. 20,000.
• The total amount of all eligible debts cannot be more than Rs. 35,000.
• The debtor shouldn't be a home owner.
• The debtor must not be a bankrupt person who has not been discharged.
• The debtor must not be a bankrupt person who has not been discharged.
• During the previous 12 months, the debtor has not been admitted for a fresh start procedure.

Process

Navigating Personal Insolvency:

Application: Through a resolution specialist, the debtor submits an application to the Debt Recovery Tribunal (or "DRT") in order to navigate personal insolvency.

Interim Moratorium: After the application is filed, a period of interim moratorium is imposed, which prevents the debtor from being sued for any debts covered by the application.

Examining the application, the resolution professional ('RP') reports back to the DRT with their findings².

Decision: After reviewing the report, the DRT issues an order either accepting or rejecting the application. If accepted, a discharge order for qualified obligations is given to the debtor, and the moratorium is maintained.

Discharge: The debtor is released from qualifying debts after completing the program successfully.

Insolvency Resolution Process ('IRP')

The IRP applies to individuals and partnership firms who have debts over the government-set threshold, that is currently set at Rs. 1,000³. In this more structured approach, a resolution specialist is appointed to supervise the resolution.

Initiation

Launching

The IRP can be started by the debtor or creditor by submitting an application to the DRT in accordance with IBC Sections 94 and 95.

The National Company Law Tribunal receives applications for PGs to CDs ('NCLT').

How to Proceed with an Application for Personal Insolvency: Details of debts, assets, and financial matters are included in the application, which is submitted by the debtor or creditor.

Similar to FSP, an interim moratorium begins at the time of filing.

RP Appointment: A resolution professional is chosen by the DRT to oversee the debtor's assets and affairs⁴.

Public Notice: In order to solicit claims from creditors, the RP publishes a public notice⁵.

Claims Submission: The RP verifies the claims made by creditors⁶.

• Repayment Plan Preparation: The debtor creates a repayment plan after consulting with the RP.
• Meeting of Creditors: The RP calls a meeting of creditors to discuss and decide on the repayment plan.
• Approval: The repayment plan (or "Plan") is sent to the DRT for approval if the majority of creditors accept it.
• Implementation: The Plan is carried out under the RP's supervision after DRT gives its approval.
• Discharge: If implementation is successful, the debtor is released from any outstanding obligations.

RP's role

In the FSP and IRP, the RP is essential. Among the duties of the RP⁷ are:

• Helping the debtor with the application and payback schedule.
• Confirming the claims of creditors.
• Overseeing the repayment plan's implementation.
• Ensuring adherence to the IBC's rules and safeguarding each stakeholder's interests.

Effect on PGs

According to the IBC, PGs to CDs have a special place. Their insolvency procedure is inextricably related to the corporate debtor they have guaranteed bankruptcy resolution procedure. A coordinated resolution process is ensured by the NCLT's authority over PG-related cases.

According to the IBC, the DRT is the adjudicating authority for personal and partnership firm insolvency, and the NCLT is the adjudicating authority for corporate insolvency. The IBC did, however, cross jurisdictions, particularly with regard to PGs.

According to Section 60 of the IBC, the NCLT has sole authority over PGs in the following situations:

1. The start of PGs' insolvency and resolution procedures.
2. While the corporate debtor's CIRP is still unresolved.
3. Applications pertaining to PGs are transferred to the NCLT while CIRP is still pending against the corporate debtor.
4. The NCLT assumes powers ordinarily vested in the DRT for PG matters.

Legal Consequences

It is possible to pursue PGs and the CD at the same time. Provisions for handling the PG's liabilities may be included in the CD Plan. This connection guarantees a thorough resolution and stops guarantors from avoiding their responsibilities.

The Judicial and Legal Environment

The IBC has been interpreted differently by judges, particularly when it comes to PGs. In several rulings, the Hon'ble Supreme Court of India ('SC') upheld the IBC's provisions, emphasizing the comprehensive approach to resolution and the PGs' non-exclusivity from the CDs' insolvency process. In Lalit Kumar Jain v. Union of India⁸, a significant disagreement between CD, PGs, and the IBC provisions that allow creditors to declare bankruptcy against PGs was resolved by the Supreme Court.

This ruling makes it abundantly evident that individuals who personally guarantee corporate loans are held accountable in the event that the corporate debtor defaults. Consequently, the IBC now clearly covers PGs, including directors and promoters, ensuring that they will be held accountable for the debts of the businesses they finance.

In a similar vein, the Supreme Court ruled in State Bank of India v. V. Ramakrishnan and Ors.⁹ that PGs, including company directors, are not exempt from their independent and coextensive duty to pay back the whole amount owed under the IBC. In the case of Committee of Creditors of Essar Steel India Limited v. Satish Gupta Kumar Gupta & Ors.¹⁰, the Supreme Court recognized that in order to start anew, resolution applicants must take over a corporate debtor's firm. Additionally, the SC maintained the legality of the 2019 notification, which guaranteed PGs' concurrent culpability with CDs by applying IBC requirements to them. The SC clarified that the rights of subrogation and indemnity that are typically granted to guarantors under the Indian Contract Act, 1872, may be terminated under the IBC if expressly stated in the resolution plan. This ensures that the ability of new management to perform won't be impacted by legacy commitments.

Analysis

The IBC represents a paradigm shift in India's insolvency framework by introducing a structured mechanism for individual insolvency. While the FSP and IRP aim to balance debtor relief and creditor rights, the regime exhibits both progressive elements and systematic challenges.

The FSP is a noteworthy initiative but suffers from restrictive eligibility criteria, that is, income cap and asset limit. These thresholds may exclude economically vulnerable debtors, defeating the provision's rehabilitative intent. On the contrary, the IRP provides a robust framework for larger debts but is marred by procedural delays, overlapping jurisdictions between DRTs and NCLT, and inadequate judicial capacity. Although Section 60 of the IBC provides for a coordinated resolution, the dual adjudicatory system for PGs leads to jurisdictional issues and makes enforcement more difficult.

PG's liability has been upheld by judicial intervention, particularly in Lalit Kumar Jain v. Union of India and SBI v. V. Ramakrishnan, the lack of clarity and extinguishment of the guarantor's right under approved resolution plans runs the risk of unfairly burdening PGs without appropriate safeguards. Legislative caution is reflected in the 2019 Notification's staggered implementation. However, it is unclear what the threshold is, which may exclude small debtors. India's system does not address socioeconomic inequities in access to insolvency remedies and lacks flexibility in debt restructuring. Therefore, in order to achieve the IBC's goals of financial stability and economic fairness, a balanced strategy that balances creditor demands with fair debtor relief is essential.

Conclusion

The IBC's definition of personal insolvency is a revolutionary development in Indian finance, offering those in financial hardship a fair and organised framework. Even though there are still issues, the developing body of law and possible changes point to a strong system that strikes a balance between the rights of creditors and debtors, encouraging a responsible lending and borrowing culture. As knowledge grows and processes become more effective, the IBC's personal insolvency system is poised to offer significant relief to individuals and promote the overall financial stability of the economy.

Footnotes

1. Report of the Working Group on Individual Insolvency (Regarding strategy and approach for implementation of the provisions of the Insolvency and Bankruptcy Code, 2016 in respect of Personal Guarantors to Corporate Debtors; Partnership Firms and Proprietorship Firms; and Other Individuals), October 2018

2. Insolvency and Bankruptcy Code 2016, Section 96: Interim moratorium

3. Ministry of Corporate Affairs (MCA) Notification – S.O. 1207(E) dated 24.03.2021, which increased the threshold to ₹1,000 crore

4. Insolvency and Bankruptcy Code 2016, Section 82: Appointment of resolution professional

5. Insolvency and Bankruptcy Code 2016, Section 102: Public notice and claims from creditors

6. Insolvency and Bankruptcy Code 2016, Section: 105-119

7. Insolvency and Bankruptcy Code 2016, Section 25: Duties of resolution professional

8. (2021) 9 SCC 321: 2021 SCC OnLine SC 396

9. (2018) 17 SCC (Civ) 458

10. Civil Appeal No(s). 878/2019

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.