In a crucial move, the government is preparing individual insolvency regulations under the Insolvency and Bankruptcy Code (IBC) that will provide for debt waiver up to `35,000 to the poorest of the poor, who have borrowed money from not just banks but also informal sources like village money lenders.

Once the regulations are in place, the poor who don’t own houses, earn up to `60,000 a year and have assets up to `20,000 will be eligible to apply for such a relief, according to sources.

While, as per the current proposal, such applications will have to be endorsed by the adjudicating authority (the debt recovery tribunal), given the tiny size of loans and limited ability of debtors to go through any rigorous insolvency process, the government is considering facilitating such a waiver through out-of-court settlements as well. The regulations will be among the first set of measures to be implemented under the new government, whatever its political hue.

A section of the government believes it will be more effective than populist moves like farm loan waivers that involve relief from just bank debt and is mostly exploited by rich farmers; it will also deal a deadly blow to money lenders who charge exorbitantly high interest rates (30-40% a year in many cases) from the poor by taking advantage of their vulnerability and often force them into a debt trap (many farmers have committed suicides due to this).

The sources said the 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.

Unlike in corporate insolvency, the adjudicator here will be the DRT, and not the National Company Law Tribunal (NCLT); similarly, insolvency resolution plans involving the second category of debtors (personal guarantors to stressed firms, proprietary/partnership firms etc) will have to be approved by 75% of lenders, instead of 66%. The minimum default amount to trigger individual insolvency is set at just Rs 1,000 (In case of corporate insolvency, it’s Rs 1 lakh). Bankruptcy proceedings will be allowed only for the second category of debtors, if the resolution plan fails.

The poor will have the option to get rid of their debt under the so-called “fresh start process”. Under this, only the debtors can apply for the discharge of their debt. A resolution professional will examine the application of the debtor and submit a report with the DRT. After considering the report if the DRT admits the case, the creditors will get an opportunity to object on limited grounds. If the adjudicating authority still passes an order for the discharge of the debtor, the debt will be written off, enabling the borrower to start afresh.

Also, at a time when a very large number of promoters of big corporate houses have each defaulted on loans of Rs 30,000-40,000 crore or more, a haircut of Rs 20,000 crore for lenders on ten million underprivileged debtors — assuming an average loan size of Rs 20,000 — appears insignificant. As for informal-sector lenders, the government won’t compensate them for potential losses due to write-offs. While hailing the new regulations, some analysts, however, fear the move, unless implemented properly, could distort credit behaviour of these individuals and may choke credit flow to them in future.

However, since any such relief will be part of their credit history, potentially discouraging lenders to lend them again, these small debtors could also have the flexibility to opt out of the insolvency process and settle with lenders on their own.

As for the insolvency resolution process for personal guarantors to stressed companies, proprietary/partnership firms and others, once the insolvency application of either the debtor or the lender(s) is admitted by the DRT, a public notice will be issued, inviting claims from all creditors. The debtor will then have to firm up a repayment plan in consultation with the resolution professional. This plan has to be approved by creditors with a voting share of 75% before it’s submitted with the DRT for clearance. However, where the resolution process fails or the repayment plan is not implemented, the debtor or creditor will have to again apply for liquidation of the insolvent’s assets.