Making IBC work for individuals, too

HS Shylendra | Updated on February 07, 2020 Published on February 07, 2020

The Code’s ‘Fresh Start Process’ criteria for indebted individuals are restrictive and cumbersome. They need to be recast

It is more than three-and-a-half years since the Insolvency and Bankruptcy Code (IBC) 2016 has been in operation. However, not all sections of the Code have been implemented including the one on Fresh Start Process (FSP) for individuals. A phased implementation approach apart, operationalisation challenges have come in the way of full implementation of IBC.

Even as the outcomes of the corporate insolvency resolution have been mixed so far, there are growing concerns over the implementation of the sections on individual insolvency. Apart from the fear of a large number of individual cases choking the adjudication system, there are concerns about the appropriateness of the criteria and procedures suggested for individual insolvency.

Feasible alternative

FSP comes as the first component of the individual insolvency. FSP is meant to give a ‘fresh start’ to low-income individuals who are in a debt trap and unable to move forward. FSP gives an opportunity for those having a debt not exceeding ₹35,000 to seek a discharge. Those concerned with the growing indebtedness of small borrowers — formal or informal — see FSP as a window for addressing chronic debt cases.

FSP can even emerge as a feasible alternative to loan waivers. However, critics view FSP as opening the Pandora’s box, leading to intentional defaults. Though some of the scepticisms seem unwarranted, there is a need for a clear assessment of FSP to have clarity over its working and potential impact.

FSP, in its extant form, faces considerable challenges in its operationalisation. Seeking FSP as per the IBC requires satisfying several eligibility criteria which may prove to be too cumbersome. FSP applies to any unsecured debt up to ₹35,000 incurred three months prior to application.

A debtor is eligible for FSP provided: he has an annual income not exceeding ₹60,000; has maximum assets worth ₹20,000; does not own a dwelling unit; is not a discharged bankrupt, and (e) not having FSP discharge in the last 12 months.

A qualifying debtor may apply for FSP, personally or through a Resolution Professional (RP), to the adjudicating authority which in this case is the Debt Recovery Tribunal (DRT).

In a way, FSP, along with individual insolvency, provides IBC a pro-poor image. However, at the first stage itself, the multiple criteria and the suggested procedure are likely to become the bugbear of FSP implementation. The criteria are very restrictive in terms of inclusion. Apparently, adequate thought does not seem to have been applied at the time of legislation. Unless the eligibility becomes more flexible, FSP itself may become non-workable.

FSP covers only the unsecured debt of a borrower. All secured loans obtained through primary or secondary securities become ineligible. As most formal loans are secured either by primary (like hypothecation and charge) or secondary securities (like collateral and guarantees), they would remain outside the purview of FSP, including those in the microfinance sector.

Only loans of self-help or joint liability groups, provided group guarantee given through inter se agreement is ignored, and those informal personal loans lent by moneylenders, friends, relatives, and traders may get covered under FSP. The eligible loan amount itself may exclude many small borrowers going by the fact that as per All India Debt and Investment Survey, 2013 the average size of debt for households in the first decile itself was ₹49,478 in rural areas and ₹59,808 in urban areas.

Moreover, very small borrowers would be wary of formal procedures not to mention the fact that informal borrowers may feel constrained to reveal their source of debt.

Similarly, what is prescribed as income criterion only matches the rural poverty line income of ₹58,320 for 2011-12. Unless adjusted for current prices, the income criterion may again exclude many borrowers. Another major stumbling block is the criterion of not-owning-a-dwelling-unit.

Given the reality that 91 per cent households in rural and 62 per cent in urban own a dwelling unit, many would be automatically rendered ineligible. Moreover, there is an added trickiness to these criteria. Debt, asset, income, and dwelling unit have been specified at the individual level. There would be a complication to segregate the individual ownership of these resources given their fungible nature.

For example, though the title of a dwelling a unit could be in the name of the head of the household, other members in the family who enjoy its benefit cannot be treated as house-less. Similarly, a SHG female member owing a house given under a scheme may take loan for her husband’s business but both would be ineligible for FSP. The household reality of sharing resources irrespective of ownership is likely to pose difficulty in determining eligibility.

As regards the procedure, a debtor has to approach a DRT and work through an RP both of whom are not easily accessible for a vast section given their current concentration in very limited pockets of the country. Thus, eligibility criteria and limited access may impede the effective implementation of FSP.

Making it workable

For FSP to become workable, a fresh look at its provisions becomes necessary. At the same time, there is a need to clarify to the borrowers through clear information dissemination that FSP is not a typical loan waiver scheme and its applicability rests on a case by case due diligence. FSP may be recast in a feasible way broadly following two approaches.

The first approach is to revise the extant criteria to make them inclusive. A more realistic limit for debt, say ₹50,000, and other criteria reflecting current prices may be prescribed. At least the criterion of owing a dwelling unit needs to be dropped. The network of DRTs and RPs must be expanded which would help even the other individual cases.

The second approach is to more fundamentally change FSP yet retaining its original intent of expeditious discharge of the poor. Here FSP may come as part of individual insolvency and could be applicable to those having debt up to ₹50,000 with the loan size itself serving greatly as a proxy for income and assets. As it is meant for those in acute debt the distinction between secured and unsecured may be given up.

This becomes necessary as with the introduction of FSP lenders, at least on paper, may start securing their loans directly or indirectly to evade FSP. Instead of multiple criteria, the RP should diligently look at the total household situation to assess the distress. At the most, one or two self-evident criteria like paying income tax or a member having job may be prescribed. If found ineligible for FSP, a debtor may be suggested to proceed under the normal insolvency resolution. The period for FSP may be reduced from the current 180 days to 90 days.

Regarding the procedure, given the widespread nature of individual cases, while the expansion of DRT network becomes necessary, alternative mechanisms that help increase the outreach could be explored going beyond DRT. For a certain period, IBBI may bear the cost of RPs or alternate professionals of FSP. Once made operational, institutional lenders need to internalise FSP in their risk-mitigation mechanism so as to deal with it in a normal way.

Only such a fresh recast could make FSP workable. Otherwise, IBC may remain largely as a mere instrument for resolving corporate debt problem.

The writer is with IRMA, and is a member of IBBI’s Working Group on Individual Insolvency. The views are personal.

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Published on February 07, 2020
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