Law and Economics of the Bankruptcy Code of India: A Comparative Analysis with US Law

 

The Insolvency and Bankruptcy Code (IBC), 2016, of India, stands as a transformative reform aimed at streamlining and expediting insolvency resolution. Its introduction marked a significant shift from a "debtor-in-possession" to a "creditor-in-control" regime, with a paramount focus on maximizing asset value and fostering responsible credit behavior. This note delves into the economic underpinnings of the IBC, drawing insights from Cooter and Ulen's principles of law and economics, and offers a comparative perspective with US bankruptcy law, highlighting recent judicial developments in both jurisdictions.

Economic Foundations of the IBC, 2016: Efficiency and Pareto Improvements

The IBC is deeply rooted in principles of economic efficiency, seeking to address the fragmentation and inefficiencies that plagued India's pre-IBC insolvency regime. Cooter and Ulen's framework of efficiency (maximizing societal welfare from scarce resources) and distribution (how benefits and burdens are allocated) provides valuable lenses for analysis. While pure Pareto improvements (making someone better off without making anyone worse off) are challenging in bankruptcy, the IBC aims for a constrained Pareto efficiency or Kaldor-Hicks improvements, where collective gains outweigh losses, allowing for hypothetical compensation.

Key economic objectives pursued by the IBC include:

• Minimizing Costs of Financial Distress: Prolonged insolvency proceedings inflict both direct (legal fees, administrative costs) and indirect (loss of customer confidence, employee morale, supplier credit) costs, leading to significant value erosion. The IBC directly tackles this by mandating a time-bound resolution process (Section 12). Initially set at 180 days (extendable by 90), though subject to judicial interpretation for genuine reasons (e.g., Committee of Creditors of Essar Steel India Ltd. v. Satish Kumar Gupta & Ors. (2019) extending the outer limit), the core principle remains to prevent the dissipation of value through delays. This aligns with Cooter and Ulen's emphasis on reducing transaction costs associated with private bargaining in distressed situations.
• Creditor-Driven Process and Efficient Asset Transfer: The Code empowers financial creditors, who form the Committee of Creditors (CoC) under Section 21. This aligns with the economic theory that creditors, having a direct stake in recovery, are best positioned to make rational decisions about the distressed company's future. The CoC's power to approve or reject a resolution plan (Section 30) or opt for liquidation (Section 33) facilitates the allocation of assets to their "highest-value user," often a resolution applicant capable of reviving the corporate debtor as a going concern. This echoes the Coasean principle, where, by overcoming high transaction costs inherent in bankruptcy, efficient outcomes can be achieved.
• Maximization of Asset Value: The IBC's explicit objective is the "maximisation of value of assets of such persons." This economic goal is pursued through the resolution process, which prioritizes revival over immediate liquidation, as a going concern generally yields higher value. This creates a larger "pie" for distribution among stakeholders, moving towards a Kaldor-Hicks improvement.
• Reduction of Information Asymmetry: Information asymmetry between debtors and creditors can lead to inefficient decisions. The establishment of Information Utilities (IUs) under Part IV, Chapter V (Sections 209-216), along with the role of the Insolvency Professional (IP) (Section 18), aims to provide verified financial data, reducing search costs and facilitating more informed decision-making by creditors. This mitigates adverse selection and moral hazard problems in credit markets, driving greater efficiency.
• Promoting Entrepreneurship and Credit Availability: By providing a clear and time-bound exit mechanism for failed businesses, the IBC encourages entrepreneurship by mitigating the fear of perpetual debt. It also enhances creditor confidence, leading to improved credit availability, as lenders have a robust framework for recovery.

Key Sections of the IBC, 2016:

• Part II: Insolvency Resolution and Liquidation for Corporate Persons:
  • Chapter II (Sections 6-32): Corporate Insolvency Resolution Process (CIRP):
    • Section 7, 9, 10: Initiation of CIRP by financial, operational, or corporate creditors.
    • Section 13: Declaration of moratorium, halting actions against the corporate debtor.
    • Section 18: Duties of the Interim Resolution Professional (IRP), who manages the debtor's assets.
    • Section 21: Constitution of the Committee of Creditors (CoC).
    • Section 29A: Eligibility criteria for resolution applicants, preventing errant promoters from regaining control.
    • Section 30: Submission and approval of resolution plan by the CoC.
    • Section 31: Approval of resolution plan by the Adjudicating Authority (National Company Law Tribunal - NCLT).
  • Chapter III (Sections 33-54): Liquidation Process:
    • Section 53: Defines the "waterfall mechanism" for asset distribution, prioritizing resolution costs, secured creditors, and workmen's dues.
• Part III: Insolvency Resolution and Bankruptcy for Individuals and Partnership Firms (gradual implementation).
• Part IV (Sections 188-223): Regulation of Insolvency Professionals, Agencies, and Information Utilities, establishing the Insolvency and Bankruptcy Board of India (IBBI) as the regulator.

Comparison with US Bankruptcy Law (Chapter 11)

The US Bankruptcy Code, particularly Chapter 11, presents a contrasting philosophy to the IBC.

| Feature | IBC, 2016 (India) The Law and Economics of the Indian Bankruptcy Code: A Comparative Analysis with US Law

The Insolvency and Bankruptcy Code (IBC), 2016, of India, represents a monumental reform aimed at streamlining and expediting insolvency resolution. It ushered in a paradigm shift from a "debtor-in-possession" to a "creditor-in-control" regime, with a paramount focus on maximizing the value of assets and promoting a culture of responsible credit. This note delves into the economic underpinnings of the IBC, drawing insights from Robert Cooter and Thomas Ulen's seminal work in law and economics, and offers a comparative perspective with US bankruptcy law, incorporating the latest judicial developments in both jurisdictions up to June 2025.

Economic Foundations of the IBC, 2016: Efficiency and Pareto Improvements

The IBC is deeply rooted in principles of economic efficiency, seeking to address the fragmentation and inefficiencies that plagued India's pre-IBC insolvency regime. Cooter and Ulen's framework of efficiency (achieving the greatest good from scarce resources) and distribution (how the benefits and burdens are shared) provides valuable lenses for analysis. While pure Pareto improvements (making someone better off without making anyone worse off) are rarely achievable in bankruptcy due to inherent losses, the IBC strives for a constrained Pareto efficiency or Kaldor-Hicks improvements. This means aiming for changes where the gains to the winners outweigh the losses to the losers, allowing for hypothetical compensation, thereby maximizing the collective welfare of stakeholders.

Key economic objectives pursued by the IBC include:

• Minimizing Costs of Financial Distress: Prolonged insolvency proceedings incur significant direct (legal fees, administrative costs) and indirect costs (loss of customer confidence, employee morale, supplier credit), leading to substantial value erosion. The IBC directly tackles this by mandating a time-bound resolution process (Section 12). Initially set at 180 days (extendable by 90), though subject to judicial interpretation for genuine reasons (e.g., the Supreme Court in Committee of Creditors of Essar Steel India Ltd. v. Satish Kumar Gupta & Ors. (2019) pragmatically allowed extensions in exceptional cases to facilitate successful resolution), the core principle remains to prevent the dissipation of value through delays. This aligns with Cooter and Ulen's emphasis on reducing transaction costs associated with private bargaining in distressed situations, which are often amplified by collective action problems.
• Creditor-Driven Process and Efficient Asset Transfer: The Code empowers financial creditors, who form the Committee of Creditors (CoC) under Section 21. This model aligns with the economic theory that creditors, having a direct financial stake in the recovery, are best positioned to make rational decisions about the distressed company's future. The CoC's power to approve or reject a resolution plan (Section 30) or opt for liquidation (Section 33) facilitates the allocation of assets to their "highest-value user" – often a resolution applicant who proposes the most viable plan for revival. This embodies a practical application of the Coase Theorem, aiming to overcome the high transaction costs inherent in bankruptcy and achieve an efficient outcome even when perfect private bargaining is impossible.
• Maximization of Asset Value: The IBC's explicit objective, as stated in its preamble, is the "maximisation of value of assets of such persons." This economic goal is pursued through the resolution process, which prioritizes reviving the corporate debtor as a going concern, rather than immediately resorting to liquidation, which typically yields lower recovery values. Achieving a higher aggregate value for the entity moves towards a Kaldor-Hicks improvement for all stakeholders.
• Reduction of Information Asymmetry: Information asymmetry between debtors and creditors can lead to inefficient decisions and adverse selection. The role of the Insolvency Professional (IP) (Section 18) in gathering and verifying financial information, and the establishment of Information Utilities (IUs) under Part IV, Chapter V (Sections 209-216), are crucial in addressing this. By providing reliable, authenticated financial data, the IBC reduces the costs of due diligence for potential resolution applicants and creditors, mitigating moral hazard and promoting more informed, efficient decision-making.
• Promoting Entrepreneurship and Credit Availability: By providing a clear and time-bound exit mechanism for failed businesses, the IBC encourages entrepreneurship by reducing the fear of perpetual debt. It also enhances creditor confidence, as they have a more robust framework for recovery of dues, thereby improving credit availability and discipline in the economy.

Key Sections of the IBC, 2016:

• Part II: Insolvency Resolution and Liquidation for Corporate Persons:
  • Chapter II (Sections 6-32): Corporate Insolvency Resolution Process (CIRP): This is the core of the corporate insolvency framework.
    • Section 7: Initiation of CIRP by financial creditor.
    • Section 9: Initiation of CIRP by operational creditor.
    • Section 10: Initiation of CIRP by corporate applicant (debtor).
    • Section 13: Declaration of moratorium, prohibiting certain actions against the debtor during CIRP.
    • Section 18: Duties of the Interim Resolution Professional (IRP), who takes control of the debtor's assets.
    • Section 21: Constitution of the Committee of Creditors (CoC).
    • Section 29A: Eligibility criteria for resolution applicants, preventing errant promoters from regaining control.
    • Section 30: Submission and approval of resolution plan by the CoC.
    • Section 31: Approval of resolution plan by the Adjudicating Authority (National Company Law Tribunal - NCLT).
  • Chapter III (Sections 33-54): Liquidation Process: Outlines the process if a resolution plan is not approved or fails.
    • Section 53: Defines the order of priority for distribution of assets during liquidation (waterfall mechanism), prioritizing resolution costs, secured creditors, and workmen's dues.
• Part III: Insolvency Resolution and Bankruptcy for Individuals and Partnership Firms: While provisions exist, full implementation for individuals and partnership firms is still evolving.
• Part IV (Sections 188-223): Regulation of Insolvency Professionals, Agencies and Information Utilities: Establishes the institutional framework, including the Insolvency and Bankruptcy Board of India (IBBI) as the regulator.

Comparison with US Bankruptcy Law (Chapter 11)

The US Bankruptcy Code, particularly Chapter 11, offers a contrasting philosophy, primarily characterized by a "debtor-in-possession" (DIP) model.

Feature	IBC, 2016 (India)	US Bankruptcy Code (Chapter 11)
Philosophy/Control	Creditor-in-Control: Focus on creditor empowerment; Board of Directors is suspended, and an Insolvency Professional (IP) manages the company.	Debtor-in-Possession (DIP): Existing management usually retains control of operations during restructuring.
Timelines	Strict, time-bound process (initially 180+90 days, now generally 330 days, with judicial discretion).	More flexible, often lengthy process, taking several years for complex cases.
Resolution Plan	Creditors (CoC) primarily drive and approve the resolution plan.	Debtor typically has the exclusive right to propose a reorganization plan for a set period.
Primary Objective	Maximization of asset value, often through resolution as a going concern, or liquidation if resolution fails.	Reorganization and rehabilitation of the debtor as a going concern; liquidation is a last resort.

Recent Case Laws: India (IBC, 2016)

The Indian Supreme Court and the National Company Law Appellate Tribunal (NCLAT) continue to interpret and refine the IBC, addressing practical challenges and reinforcing its core objectives.

1. Mandatory CCI Approval for Resolution Plans: Recent trends indicate the Supreme Court's emphasis on strict adherence to statutory provisions, including mandatory approval from the Competition Commission of India (CCI) for certain resolution plans involving significant market share acquisitions. From a Cooter & Ulen perspective, this ensures that the resolution process, while aiming for efficiency in debt recovery, does not lead to anti-competitive market structures. The law balances the efficiency of quick resolution with the broader economic goal of fostering fair competition, preventing a perceived "Pareto improvement" in bankruptcy from leading to a "Pareto sub-optimal" outcome for the wider market by creating monopolies.
2. Scope of Moratorium and Personal Guarantors: The Supreme Court has consistently held that the moratorium under Section 14 of the IBC protects the corporate debtor, not the personal guarantors of the corporate debtor. Proceedings against personal guarantors can continue simultaneously. This aligns with the economic principle of creditor protection and deterrence of moral hazard. It ensures the promise of a personal guarantee holds, enhancing credit discipline and availability by maximizing creditor recovery from all available avenues, thereby contributing to overall economic efficiency in debt recovery.
3. Appellate Review of CoC's Commercial Wisdom: Building on judgments like Essar Steel, the Supreme Court continues to emphasize the limited scope of judicial review over the "commercial wisdom" of the CoC. If the CoC, comprising financial creditors, has made a decision regarding a resolution plan after due deliberation and in good faith, the NCLT or NCLAT should generally not interfere unless there's a clear legal violation. This reinforces the principle of decentralized decision-making and expertise, minimizing ex-post review costs and promoting faster, more efficient resolutions by trusting the CoC's commercial judgment for a Kaldor-Hicks improvement for the creditor body.
4. Treatment of Operational Creditors: While the IBC prioritizes financial creditors in the CoC, the Supreme Court has clarified the rights and fair treatment of operational creditors. This often involves ensuring that resolution plans make a "fair and equitable" provision for them, especially those critical for the debtor's continued operation. This attempts to balance the efficiency of a creditor-driven process with equitable distribution among different creditor classes. Ensuring fair treatment for operational creditors (suppliers, employees) contributes to the long-term viability and the going concern value of the company, thereby creating a larger pie for distribution and fostering broader economic stability.

Recent Case Laws: USA (Chapter 11 Bankruptcy)

US bankruptcy law continues to evolve, with recent cases often focusing on the limits of reorganization powers, especially concerning non-debtor releases and the role of specialized bankruptcy courts.

1. Nonconsensual Third-Party Releases in Chapter 11: The US Supreme Court's ruling in Harrington v. Purdue Pharma L.P. (June 27, 2024), held that the Bankruptcy Code generally does not authorize nonconsensual third-party releases in Chapter 11 plans. This means a bankruptcy court cannot extinguish claims against non-debtors (like the Sackler family in the Purdue case) without the claimants' consent.
   • Economic Impact: This decision profoundly impacts the "global settlement" model in complex Chapter 11 cases, particularly mass torts. From a Cooter & Ulen perspective, while nonconsensual releases could be seen as an attempt to achieve an "efficient" global settlement by resolving all claims in one forum, the Supreme Court prioritized the individual property rights of claimants to pursue their claims against non-debtors. This may increase transaction costs for future complex reorganizations, potentially making global settlements more difficult to achieve, thus prioritizing a distributional concern (individual rights) over perceived transactional efficiency.
2. Authority to File Bankruptcy: Recent US Bankruptcy Court decisions (e.g., early 2025 rulings) have emphasized strict adherence to corporate governance requirements for filing Chapter 11 petitions, especially for LLCs where operating agreements may require specific consents (e.g., from an "independent manager"). Courts have dismissed cases lacking proper corporate authority.
   • Economic Impact: This reinforces the importance of contractual clarity and adherence to corporate governance. These rulings protect creditor expectations and the efficiency of lending markets by reducing the "moral hazard" where a debtor might unilaterally seek bankruptcy protection against the express terms of their financing agreements, thereby promoting predictability in credit relationships.
3. Increased Bankruptcy Filings and Subchapter V: Recent data (e.g., March 2025 statistics from the Administrative Office of the U.S. Courts) show a significant increase in business and non-business bankruptcy filings, signaling a broader economic adjustment. The "Subchapter V" of Chapter 11, designed for small business debtors with streamlined processes, continues to be utilized, and its eligibility thresholds were adjusted upwards for inflation on April 1, 2025.
   • Economic Impact: The rise in filings reflects macroeconomic pressures. The continued use and adjustment of Subchapter V highlight a commitment to tailoring efficiency mechanisms for different scales of businesses. Small businesses often face higher per-unit transaction costs in traditional bankruptcy. Subchapter V aims to reduce these costs, making reorganization a more feasible and efficient option for smaller entities, thus promoting a more robust entrepreneurial ecosystem by offering a less burdensome path to a fresh start and contributing to potential Pareto improvements at the small business level.

Conclusion

The IBC, 2016, represents a crucial legislative piece that has fundamentally reshaped India's insolvency landscape. Its legal framework, informed by Cooter and Ulen's economic principles, aims to create a more efficient, transparent, and creditor-friendly environment for resolving financial distress. It seeks to achieve constrained Pareto efficiency by minimizing value destruction, reducing transaction costs, improving information flow, and providing a robust mechanism for collective decision-making to maximize the overall value of the estate. While no bankruptcy system can achieve pure Pareto efficiency, the IBC's focus on maximizing the "pie" before distribution, and its time-bound creditor-in-control approach, clearly align with principles of Kaldor-Hicks efficiency.

The ongoing judicial interpretations in India, particularly from the Supreme Court, continually refine the IBC's application, often balancing efficiency goals with broader economic and social considerations. Similarly, recent US bankruptcy jurisprudence, as exemplified by cases like Purdue Pharma, demonstrates a continuous evolution, grappling with the limits of bankruptcy court powers and balancing competing interests of efficiency and individual rights. Both jurisdictions, in their distinct ways, underscore the dynamic nature of bankruptcy law, constantly adapting to economic realities and societal values in the complex endeavor of managing financial distress.