Individual insolvency for the poor on the back burner, focus now on toxic asset resolution

The government has put its plan to implement the so-called “fresh-start process” for indebted poor people under the Insolvency and Bankruptcy Code (IBC) on the back burner, given the complexity of operationalising such a framework at this juncture, sources told FE.

Instead, the government will first focus on further bolstering the IBC architecture to yield quick resolution of toxic assets while preventing unscrupulous elements from gaming the system, and launching the cross-border corporate insolvency framework, said the sources.

The IBC already has provisions for the “fresh-start process” for individual insolvency. It provides for debt waiver up to Rs 35,000 to the poor who don’t own houses, earn up to Rs 60,000 a year and have assets up to Rs 20,000 each. However, since it marks a drastic change in the way insolvency resolution typically takes place (through adjudicating process), the IBC needs to be amended first to enable the operationalisation of the “fresh-start” scheme.

“The idea is to further strengthen the extant insolvency ecosystem first, plug any loopholes and steady the corporate insolvency resolution process (CIRP). The ‘fresh-start process’ will come after that,” said one of the sources.

Moreover, the government apprehends that implementing the “fresh-start” scheme is fraught with risks of inviting a litany of legal tussles, as it could prompt lenders — especially micro-finance institutions and those from the informal sector — to challenge the law, given that the government has no plan to compensate them for write-offs. As such, even the constitutional validity of the IBC itself was challenged earlier and the CIRP in large cases has been inordinately delayed due to litigations. “So, it makes sense to steady the IBC ship first and launch a new chapter after that,” said another source.

As many as 73% of companies, that were undergoing resolution until December 2021, had exceeded the 270-day limit, resulting in an erosion of stressed asset value. In fact, the recovery by financial creditors crashed to a record quarterly low of 13.4% of the admitted claims between October and December 2021.

The IBC’s individual insolvency framework recognises two broad categories of debtors — the poor (who meet the stipulated criteria of income, asset and debt size); and those who have offered personal guarantee to stressed companies, proprietary/partnership firms (not registered under the Companies Act) and everybody else who is not covered under the first category. So far, only individual insolvency proceedings for personal guarantors to corporate debtors have been operationalised.

The “fresh-start” process was envisaged by a panel set up by the Insolvency and Bankruptcy Board of India (IBBI) under Justice Srikrishna. It was later endorsed by the Insolvency Law Committee (ILC), headed by then corporate affairs secretary Injeti Srinivas, which submitted its report with the government in February 2020. Sources said even a draft Ordinance to operationalise the scheme was prepared but it was never adopted in the wake of the Covid outbreak.

Interestingly, under the “fresh-start process”, only the debtors can apply for the discharge of their debt. Unlike in corporate insolvency, the adjudicator in individual insolvency process is the debt recovery tribunal (DRT), and not the National Company Law Tribunal (NCLT). The minimum default amount to trigger individual insolvency is set at just Rs 1,000 (In case of corporate insolvency, it’s Rs 1 crore).

However, given the tiny size of loans and limited ability of the poor to go through a rigorous insolvency process overseen by the DRT, the government was considering a proposal to facilitate such a waiver via out-of-court settlements. Also, the DRTs — already burdened with corporate cases under the SARFAESI Act, etc. — don’t have adequate capacity to adjudicate on a potentially large number of such cases. So, the government was weighing the option of facilitating such a scheme through an administrative process, with the involvement of low-cost professionals (instead of insolvency resolution professionals) and institutions at the panchayat level, under the overall supervision of the IBBI.