Examining the Legal Framework Governing Insolvency of Individuals, Sole Proprietors and Partnership Firms in India

[Namanveer is an Associate, and Aryansh is an intern, at Maheshwari & Co.]

India’s insolvency laws for individuals, sole proprietors, and partnership firms have evolved from a patchwork of century-old statutes to a unified modern code. Since partnerships and sole proprietorships are not separate legal entities, any insolvency would ultimately be of the individual partners or proprietor. Historically, personal insolvency was governed by two colonial-era laws, the Presidency Towns Insolvency Act 1909 (1909 Act) and the Provincial Insolvency Act 1920 (1920 Act), which applied to individuals, including sole proprietors and partnership firms. The enactment of the Insolvency and Bankruptcy Code 2016 (IBC) was a watershed moment that consolidated insolvency regimes for both corporate and non-corporate debtors. IBC introduced a dedicated framework (Part III of the code) for insolvency resolution and bankruptcy of individuals and partnership firms, aiming to replace the fragmented older statutes. The modern insolvency law provides a detailed explanation on how insolvency proceedings can be initiated by and/or against individuals, sole proprietors, and partnership firms. 

Legal Framework Overview

The IBC is a comprehensive code that inter alia governs the insolvency of individuals and partnership firms (Part III, Sections 78–187). The code has specifically stipulated time-bound processes for individual insolvency resolution (repayment plans) and bankruptcy (liquidation of assets), which is supervised by a specialized adjudicatory mechanism. The IBC aimed to repeal the 1909 Act and the 1920 Act​, thus unifying the legal framework. Section 243 of the IBC expressly repeals these old acts​, subject to a savings clause for ongoing proceedings. The intent was that no new insolvency cases would be instituted under those statutes once the corresponding IBC provisions came into effect. However, there was a partial implementation of the IBC’s individual insolvency regime because in 2019 through gazette notification dated 15 November 2019, the government provided the IBC provisions only with respect to personal guarantors to corporate debtors​. This left other individual debtors in a legal limbo because the old laws were ostensibly repealed, and the new law was not operational for them. In order to address this specific issue, a press release dated 28 August 2017 was issued by the Government of India, through the Ministry of Finance, cautioned that Section 243 of the code, which provides for the repeal of the old enactments, has not been notified till date, and further, that the provisions relating to insolvency resolution and bankruptcy for individuals and partnerships as contained in Part III of the code are yet to be notified. 

Thus, the old insolvency law is still operative with respect to other individual debtors which comprise sole proprietors and partnership firms. It is pertinent to mention that new cases under the old statutes may still be filed, and pending cases under them can certainly continue until the Central Government notifies the IBC framework for individuals and partnership firms. The government and the Insolvency and Bankruptcy Board of India have been working on the rules and institutional capacity (particularly of Debt Recovery Tribunals) to extend IBC to all personal insolvencies. Once the Central Government notifies the new laws with respect to individual insolvency, the older laws will be rendered fully obsolete, and only transitional proceedings shall continue by virtue of the savings clause in Section 243​. 

Current Status of Initiation of Insolvency (Individuals and Partnership Firms)

The 1909 Act applied to the erstwhile “presidency towns” (primarily Bombay, Calcutta, and Madras) and the insolvency petitions under this law were entertained by the High Courts in these presidency towns only. The 1909 Act was largely modelled on English bankruptcy law, requiring that a debtor be adjudged an “insolvent” upon proof of certain acts of insolvency. It provided a framework for distributing the insolvent’s assets among creditors and eventually discharging the insolvent from liabilities.  

An individual or partnership residing or doing business in a presidency town (Bombay, Calcutta, or Madras) could file a petition to be adjudicated an insolvent if that individual is unable to pay his debts. The debtor would disclose his assets and liabilities and if the court is satisfied that the debtor could not meet his obligations, then the judge is entitled to declare him an insolvent. Notably, this is a voluntary process wherein a debtor could approach the court and surrender his assets to obtain relief from remaining debts following distribution to creditors. 

A creditor also could file an insolvency petition against a debtor in the High Court, provided certain conditions were met and the same are as follows:

1. The creditor had to show that the debtor owed them a debt of at least a specified minimum amount of INR 500, and; 

2. That the debtor had committed an “act of insolvency” within three months before the petition. 

   
   

The acts of insolvency, as defined in the 1909 Act, included classical bankruptcy events such as: (a) the debtor departing or remaining out of India with intent to defeat or delay creditors, (b) the debtor concealing himself or his property to evade creditors, (c) the debtor transferring property with intent to defraud creditors (d) the debtor’s assets being attached in execution of a decree or (e) the debtor formally admitting inability to pay debts. Proof of any one of these acts entitled a creditor to seek an insolvency adjudication.

It is essential to note that if the Hon’ble High Court found that the petition (by debtor or creditor) satisfies all the parameters / conditions then it may pronounce an “Order of Adjudication” and declare the debtor insolvent. Upon such adjudication, the debtor’s property would then vest with the Official Assignee of the court. The court appointed Official Assignee, is well within its rights to take control of all the insolvent’s assets within the jurisdiction. Subsequently, in the proceedings of liquidation, the Official Assignee would sell the assets and distribute the proceeds among creditors equally (subject to certain priorities, such as secured creditors or governmental dues as per the Act). Moreover, the creditors to substantiate their claims had to file proofs of debt with the Official Assignee. 

The 1909 Act did not provide a reorganization plan akin to the IBC’s repayment plan and was essentially a liquidation regime. However, the insolvent individual could apply to the High Court for a discharge after a specified time or when certain conditions were met. The court had discretion to grant an absolute discharge or a conditional discharge. Upon discharge, the debtor was released from the debts provable in insolvency. Notably, a partnership firm’s insolvency under the statute typically involved the concurrent insolvency of all partners. The law provided that the joint estate of the firm and the separate estates of each partner would be administered together.

The 1909 Act’s reach was geographically limited to debtors within the presidency towns or those carrying on business there. This meant that an individual in Bombay could be subjected to insolvency in the Bombay High Court, but someone in a smaller town would fall under the 1920 Act.  The 1920 Act was enacted to extend a similar insolvency regime to the rest of British India (outside presidency-towns). 

The 1920 Act empowered district courts to handle individual and partnership firm insolvencies in their local jurisdictions which allowed debtors to seek voluntary adjudication as insolvent, and for creditors to file insolvency petitions upon a debtor’s default coupled with an act of insolvency, subject to a minimum debt threshold of INR 500. The catalogue of acts of insolvency in the 1920 Act was largely the same as under the 1909 Act, like absconding or hiding to avoid creditors, fraudulent transfers, attachment of property, admission of inability to pay, etc. On proof of any such act and the debt, the district court was well within its rights to declare the debtor insolvent. The aforesaid acts are so progressive in nature that despite its year of enactment, these acts still continue to be used for individual and partnership insolvencies until the IBC’s individual insolvency provisions are fully operational.

Conclusion

The insolvency framework for individuals, sole proprietors, and partnership firms in India is at a transformative juncture. The IBC promises a streamlined, comprehensive process that balances debtor rehabilitation with creditor recovery, marking a significant improvement over the century-old statutes. The vast majority of individual and partnership firm insolvency provisions of the IBC are still not notified for those who are not guarantors to corporate debt. This leaves a gap where outdated laws are still in play. The uncertainty that still lingers is that when the full framework will be enacted then it may create unpredictability for creditors and debtors. Debtors might prefer the more forgiving discharge under IBC but cannot access it yet and creditors might want the stronger remedies of IBC but have to resort to the old statutes. The success of the personal insolvency regime depends on the significant strengthening of Debt Recovery Tribunals or creating separate benches for insolvency. The experience with personal guarantor cases at National Company Law Tribunals which were themselves busy with corporate cases shows that adding new categories of cases without increasing capacity can cause delays.

Ultimately, the evolution from the old statutes to the IBC signifies India’s progression towards a modern insolvency jurisprudence that aligns with global best practices while catering to the country’s unique socio-economic context. The coming years will be crucial in solidifying this framework and ironing out any ambiguities, to ensure that the insolvency system for individuals and partnerships is as robust and settled as that for companies.