The wider implications of sending debtors to jail

In August 2018, the Supreme Court approved a Rs 550 crore settlement between RCom and Ericsson to be paid on or before September 30,2018. The court also allowed RCom to sell spectrum, fiber, telecom towers and certain real estate assets to Reliance Jio for some Rs 2,500 crore. This deal ran into regulatory hurdles and the Department of Telecom (DoT) blocked the sale. Jio refused to comply with DoT’s regulatory conditions and RCom ran out of options.

This is when Ericsson threw up its hands and initiated contempt proceedings. RCom pleaded helplessness. The company had agreed to pay Ericsson provided it could raise the money. In any case, RCom was a listed company with thousands of owners and directors could not be victimised for the debt owed by many. The implications of the situation were all too plain.

Should the Supreme Court allow these three players to act out this charade and deny a legitimate creditor its dues despite a painful haircut? On February 21, the Supreme Court directed Anil Ambani to either pay the remaining Rs 453 crore debt to Ericsson within four weeks or prepare to go to jail.

As jurisprudential milestones go, this is a truly momentous development. Imprisonment for insolvency has been largely rejected in the developed world in the last 150 years. Historically, debtors were seen as ‘bonded’ to their creditors and bankruptcy was a crime. The indigent were incarcerated until they worked off their debt either through labour or secured outside funds through family members.

A great many never secured their release. Harsh working conditions shortened the life of many, which did nothing for the creditors. Once society caught on to the fundamental flaw in this recovery procedure, the necessary jurisprudence followed.

The law now allowed debtors to be discharged once all their assets had been disclosed, seized, sold and the proceeds paid to the creditors. As the global situation now stands, Article 1, Protocol 4 of the European Convention on Human Rights prohibited the imprisonment of people for breach of contract.

This historic period of European history also saw the rise of the limited liability company. All business entails risk. If risk can be shared under the shelter of the corporate personality, many more will assume greater risk to the extent of their contribution to the share capital.

Companies were given an independent legal existence. If the business failed, the company was dissolved, the proceeds paid to the creditors and that was the end of it.

The Indian legal position has been no different. Section 51 of the Civil Procedure Code, 1908 provides that a decree for payment of money may be executed by detention in prison if (a) the judgement debtor is likely to abscond, (b) has dishonestly transferred, concealed or removed property, (c) has the means to pay but deliberately refuses to pay the creditor, and (d) the decree is for a sum for which the judgement-debtor was bound in a fiduciary capacity.

The prison term was limited to a maximum of 3 months. Traditionally, the Indian judiciary has always been sympathetic to debtors. Courts have always been reluctant to resort to arrest and detention unless there is a manifest attempt to defeat the decree.

To be clear, it is with Section 51(c) in mind that the Supreme Court has threatened to send Ambani to jail. That said, wider forces have conspired to undermine the fundamental scheme of Indian jurisprudence on this point as became obvious in the Sahara case. Back in 2012, the Supreme Court had ordered Sahara to refund Rs 25,000 crore of illegally raised money through one-time fully convertible debentures from nearly 3 crore investors. Sahara failed to do so. In March 2014, the court send Sahara chief Subroto Roy to jail eventually leading to a recovery of some 11,000 Crores over a period of two years. Since the balance was not forthcoming, the Supreme Court was compelled to order the Official Liquidator of the Bombay High Court to steer the auction and sale of Sahara’s flagship property Aamby Valley.

It has not worked as there are no buyers. It is possible to cite a succession of reasons but in the main, there are grave issues around title: no buyer wants to pay premium prices for a project that is bound to deliver a lifetime of perpetual post-acquisition litigation. There are issues around funding too. Banks simply don’t fund real estate projects anymore and even if they did, how would you securitise assets that don’t have clear title?

To put it bluntly, India’s jugari culture of creating unorthodox title transfers through ‘Power of Attorney Sales’ and such likes designed to circumvent crippling land use laws and transaction taxes has created a web of illegality which the highest court in the land finds difficult to penetrate.

The Supreme Court wants to deliver justice to a creditor. How does it do so when the legislative and administrative structure over which it discharges its constitutional obligations has created an inextricable web of documentary deceit designed to circumvent Kafkaesque regulation and administrative discretion in search of extortion opportunities?

Seen thus, one can only empathise with this well-meaning attempt to see justice done. Still, there is great cause for circumspection because of the enormous risk of collateral damage. If a director can be thrown in jail every time a company defaults, no one will have either the courage or the inclination to become an entrepreneur. As certain as the knowledge that the sun will rise in the east tomorrow, this kind of law will bring an end to our developmental ambitions.