Reforming India's personal insolvency framework for economic stability and growth

The Insolvency and Bankruptcy Code (IBC) has transformed corporate resolutions, its application to individuals remains underdeveloped.

By Manish Lalwani 

India's financial ecosystem is witnessing a significant evolution. The rise in retail credit, surpassing ₹50 lakh crore, has democratised aspirations, empowering individuals and businesses alike. However, this credit surge has also exposed gaps in the country's ability to address financial distress, particularly personal insolvency. While the Insolvency and Bankruptcy Code (IBC) has transformed corporate resolutions, its application to individuals remains underdeveloped. The current scenario is in critical need of reforms, drawing insights from global practices and proposing a roadmap for India's personal insolvency framework.

A Snapshot of India's Current Framework

The IBC, introduced in 2016, revolutionised corporate insolvency resolution in India. For individuals and partnership firms, it provides a pathway through the Insolvency Resolution Process (IRP), involving a Resolution Professional (RP), repayment plans, and Debt Recovery Tribunal (DRT) approvals. Personal guarantors of corporate debtors are adjudicated by the National Company Law Tribunal (NCLT) to align resolutions with corporate insolvencies.

Yet, the practical use of these provisions remains limited. Lack of awareness, limited accessibility to insolvency professionals, and systemic delays hinder their effectiveness. These challenges become more pronounced for entrepreneurs and small business owners, whose personal and business liabilities are often intertwined.

The Case for Reform

A robust personal insolvency framework is not only a legal necessity but a critical component of economic stability. This is particularly relevant in India, where interlinked financial risks mean that corporate failures often cascade into personal insolvency, especially for entrepreneurs. Conversely, widespread personal financial distress can dampen consumer demand, negatively impacting businesses. Furthermore, personal insolvencies contribute to rising non-performing assets (NPAs), straining financial institutions. Structured resolutions under an effective personal insolvency framework can help reduce these pressures and strengthen financial institutions. This framework also offers economic resilience by providing individuals with a second chance, enabling them to recover financially and contribute positively to the economy. Moreover, a clear and predictable insolvency mechanism enhances credit discipline by encouraging responsible borrowing and lending practices, essential for a healthy economic environment in India.

Learning from Global Models

To design a robust personal insolvency framework, India can draw valuable lessons from mature systems worldwide while adapting to local socio-economic realities.

In Title 11 of the United States, personal insolvency is managed through Chapter 7, which involves asset liquidation to pay off debts, and Chapter 13, allowing individuals with regular income to reorganise their debts and create a repayment plan. The proposed Chapter 10 aims to unify these frameworks by simplifying the process and offering a more flexible approach, combining elements of both liquidation and debt restructuring. This would reduce administrative burdens and legal costs, providing a faster, more accessible pathway for debtors to regain financial stability.

The United Kingdom's Individual Voluntary Arrangements (IVAs) offer another model, allowing individuals to repay a portion of their debt over a set period without the need for bankruptcy, thus retaining their assets and making affordable payments. IVAs balance the interests of both debtors and creditors, enabling debt management without long-term bankruptcy consequences.

Similarly, Australia's debt agreements and Canada's consumer proposals focus on negotiated settlements that avoid bankruptcy by agreeing to repay a portion of the debt over time, protecting essential assets like homes and tools of trade. These frameworks provide structured repayment plans, allowing individuals to recover financially without severe bankruptcy consequences. While these models are inspirational, India must tailor its approach to address local socio-economic factors, including the prevalence of informal credit and culturally ingrained stigmas around insolvency. Integrating these lessons within India's legal framework can help create an effective and inclusive personal insolvency system.

Challenges to Implementation

While the need for reform in India's personal insolvency framework is clear, several significant challenges must be addressed to establish a comprehensive system. Judicial capacity is a crucial issue, as India's tribunals will require additional resources and streamlined processes to manage personal insolvency cases effectively. Furthermore, developing a robust cadre of trained insolvency professionals is essential to ensure fair and efficient resolutions. Public awareness campaigns are necessary to educate individuals, creditors, and institutions about the available insolvency options and their benefits. Additionally, societal stigmas surrounding insolvency as a moral failing must be addressed to drive broader acceptance and encourage individuals to seek the help they need without fear of judgement. Overcoming these challenges is vital for creating a strong and effective personal insolvency framework in India.

A Roadmap to Reform

A multi-faceted approach is essential to reform India's personal insolvency framework, requiring segmented solutions tailored to salaried individuals, entrepreneurs, and small business owners due to India's diverse socio-economic landscape. Technological integration via digital platforms streamlining filing, enabling real-time tracking, and ensuring transparency is crucial for efficiency and accessibility. Simultaneously, strengthening institutional capacity by expanding DRT and NCLT capabilities and investing in insolvency professional development is necessary for long-term sustainability. Furthermore, policy clarity is critical, achievable through integrating personal insolvency provisions within the IBC for consistency and execution flexibility, or by enacting a standalone law. This legal clarity and operational efficiency will support the effective resolution of personal insolvencies and foster a healthier economic environment.

A robust and inclusive financial system is vital for India's economic aspirations, and a well-crafted personal insolvency framework acts as a crucial safety net, preventing individual financial crises from becoming systemic risks. By adopting and adapting global best practices, India can empower individuals, strengthen institutions, and ensure sustainable economic growth. This framework is not merely about debt resolution; it's about creating an ecosystem of trust, resilience, and opportunity, enabling individuals to recover, rebuild, and thrive.

Manish Lalwani, MD & CEO, Omkara ARC.

Views are personal and do not represent the stand of this publication.