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#Needed: A modern bankruptcy law for India’s financial markets

The Budget has an important piece for modernisation of financial markets with a proposed bankruptcy-friendly regime for SMEs.

In the Roman era, bankruptcy law was a species of criminal law and a bankrupt was regarded as a criminal and subjected to cruelty, public flogging, imprisonment or sold as a slave along with family. Bankruptcy codes evolved in medieval Europe to tackle failures in contracts of merchants as they engaged in trade across continents, given the high probability of loss in such business.

Today, the fundamental goal of the US bankruptcy code is to give an honest but unfortunate debtor, a new opportunity in life by releasing a debtor from personal liability of specific debts and prohibit creditors from taking any action to collect those debts. India’s prevailing archaic laws tilt more towards prison for the insolvent than to quick resolution and rehabilitation.

In April 2010, the Calcutta High Court passed an interesting order for investigation into irregularities in insolvency petitions made by individuals, on an application filed by five private sector banks that a racket was in operation to help people declare themselves insolvent.

From 2000 to 2010, total insolvency applications aggregated to 1,427 out of which 1,018 were filed in 2009. The global financial crisis of 2008 led to world-wide recession, loss of jobs and EMI defaults on credit cards, housing mortgages, consumer and personal loans.

Banks and NBFCs recovered loans through muscle men who even resorted to physical assault. Small borrowers faced hard times as they had borrowed to go with the tide of consumerism without being able to predict the disaster. Reports of suicides by defaulters surfaced.

The Reserve Bank of India was forced to intervene and court orders were passed to stop banks from using muscle men. During this period voices for review of the personal insolvency laws surfaced.

The terms insolvency and bankruptcy are not synonymous, though both deal with liabilities exceeding assets — insolvency refers to a ‘financial state’ and bankruptcy to the distinct legal ‘private state’.

The laws regulating insolvency are the Presidency Town Insolvency Act of 1909 covering Kolkata, Chennai and Mumbai and the Provincial Insolvency Act, 1920 for the rest of India. Bankruptcy and insolvency is specified in Entry 9 of the Concurrent List of the Seventh Schedule, under Article 246 of the Constitution. The statutes have been amended infrequently by a few states with the last visible amendment being in 1979.

The trigger for a creditor to file an insolvency petition in court are defined acts of insolvency by a debtor, including when he is unable to pay debts of Rs 500 or more after receiving a notice for its repayment.

As can be expected, these relics from the colonial era Acts are copied from bankruptcy Acts of the UK and though the UK Act was overhauled in 1986, lawmakers in India are yet to awaken to the new realities and requirements of participants in the financial markets.

A settlement-based bankruptcy regime that does not consign debtors to prison at the whims of the court or creditor is a necessity for financial markets in India to come of age and integrate globally. Debtors cannot be viewed through a criminal lens and the RBI’s guidelines in 2005 restraining banks from resorting to threats of physical assault in cases of delinquency was a much welcome step for restoring a balance between creditors and debtors; but it is not the law.

The Acts apply to individuals and partnerships but Sections 107 and 8 of the two Acts respectively, exempt corporations from its ambit. In the complete absence of a separate Act for corporate insolvency, we fall back on the Companies Act, that states “a company shall be deemed to be unable to pay its debts if a creditor to whom the company is indebted in a sum exceeding five hundred rupees (it is not a misprint) neglects to take action in three weeks from the date of notice received”. The Companies Act 2013 has raised this threshold to Rs 1 lakh. The 2013 Act gives life to still-born provisions of the amendments of 2002 while explicitly addressing ‘insolvency’ under Section 269 on “Rehabilitation and Insolvency Fund”. This deals with rehabilitation, revival and liquidation of sick companies based on a balance sheet threshold, as it integrates provisions of SICA, 1985 into the Companies Act.

Separately, secured creditors alone have been privileged with a series of enactments under RDDB 1993, SARFAESI 2002 and CDR guidelines of 2008 that significantly secure their interests. It is well acknowledged in global surveys of competitiveness that court procedures in India can take decades.

Unfortunately, we may have a bankruptcy ‘in’ our legal framework. If borrowers in India could benefit from credit through NBFCs, thereby reducing dependence on costly bank loans, an appropriate law for efficient bankruptcy and revival arrangements between unsecured creditors and debtors is a pre-requisite. No less than our current RBI Governor had called for this five years ago.

Largely unheralded, but Budget 2014-15 has an important piece for modernisation of financial markets with a proposed bankruptcy-friendly regime for SMEs. The legal form of more than 7 lakh SMEs in India could vary from proprietorship, partnership association of persons or company. This is an excellent starting point to modernise the legal framework and bring all laws under a common umbrella of bankruptcy.

The author is a civil servant with the CAG and a former Executive Director, Sebi

First Published on: July 21, 2014 4:42 am