Company law and Bankruptcy law share a common trait, i.e. limited liability. While all entities incorporated under the Companies Act get limited liability, it is provided to other entities like individuals and partnerships only on meeting certain conditions. Further, it is a strong prevailing belief that where effective corporate and bankruptcy laws prevail economic growth will flourish as it provides an impetus to entrepreneurship and risk taking which drives private enterprise fueling economic growth.
Given the focus of the governments to promote economic growth, it is no wonder that India is witnessing the enactment of a new Bankruptcy law. If history is anything to go by, we should be aware that this is not going to be a smooth journey. The hiccups we will see are likely to be pronounced with many back and forth movement, before bankruptcy laws are calibrated for smooth functioning.
Looking back at history, bankruptcy laws had an interesting trigger. Prior to the first enactment of this law in England, Lenders could take the defaulting borrower as a bonded worker. What was seen as a deterrent to the borrower soon turned out to be a bigger burden to the lenders in times of acute famine, as they had to feed and maintain the defaulting borrowers.
In response to this predicament, England enacted in 1542 a law that required the defaulting borrower to be sent to a prison. By 1570s, the debtors’ prisons were full, requiring a new bankruptcy law to be enacted that that provided relief to the lenders. This new act provided that
- Only a lender could initiate proceedings
- Only a merchant borrower could be proceeded against
- All the borrowers assets were seized and sold; there was no discharge for the balance amount which could still be recovered
Even as the English bankruptcy laws evolved over the next two centuries, USA the new country tried to emulate it in a short time providing us with interesting learnings, showing the need for calibration.
- In 1800 the first Bankruptcy law was enacted in the US. As prominent speculators benefitted, it was repealed in 1803.
- On the back of a depression that left many defaulting borrowers, 1841 act was passed, which allowed defaulting borrowers to initiate the proceedings. In 1843, the law was repealed as many lenders suffered, which was contrary to the intent.
- In 1867 a revised law was enacted. This too had a short life, being repealed in 1878 as it was expensive and did not benefit the lenders.
- In 1898, another revised law was passed, which with some modifications has stood the test of time, though it was modified in 1938 and 1978.
While it is prudent to expect that learning from history India may not need a hundred years to refine its bankruptcy law, human behaviour suggests caution. If the Indian bankruptcy law is effective, some undeserving will benefit. This will create an uproar to plug the loopholes negating the overall benefits to the economy. On the other hand, if the law is very strict and narrow even the deserving may not get any relief with the status quo prevailing. Should we err on the side of being liberal to progress?