Making Bankruptcy Law Implementable in Bhutan

Tandin Wangchuk

Introduction

In the ancient times, creditors took actions against the person of the debtor when actions against his property could not satisfy the debt. However, modern bankruptcy law only permits creditors to take actions against the property of the debtor, not his own person. The reason for this change reflects a compassionate and civilized view that no amount of debt owed can supersede the right of a debtor over his own person.

Unfortunately, in Bhutan, actions against the person of the debtor through his imprisonment in lieu of the debt owed is still in practice. This practice exists not because of the absence of bankruptcy laws but because of its underutilization. The Bankruptcy Act of the Kingdom of Bhutan (“Act”) came into effect in 1999. However, it has rarely been used by distressed individuals or companies. This is evidenced by the lack of foreclosure, liquidation, or reorganization proceedings filed in Bhutan.

The proper utilization of a bankruptcy law is beneficial not only to the debtors but also to the creditors. The creditors are given rights over the insolvent debtor’s property which gives them an opportunity to recover the most legally possible amount by securing equitable division of their insolvent debtor’s property. Additionally, to the benefit of creditors, the bankruptcy law prevents the debtor from conduct detrimental to the creditors’ interests, take for example, transferring their assets.

For honest debtors, bankruptcy law provides protection from the creditors by forgiving the unpaid debt left after pro rata distribution of his property amongst the creditors or by giving him time to reorganize his business. More importantly, it saves him from facing time in prison from a failure to fulfill his contractual obligation.

Failure to fulfill contractual obligation as a ground for imprisonment is prohibited under Article 11 of the International Covenant on Civil and Political Rights 1966 (‘ICCPR’). While Bhutan is not a party to the ICCPR, it is important to highlight that the current practice of imprisoning debtors for being insolvent, does not accord with international standards of human rights.

More than twenty years have passed since the commencement of the Act, and despite its benefits both to the creditors and the debtors, it has been underutilized. Naturally, the question of why the Act has not been used and what is required to make the Act implementable arises. There are two reasons for underutilization of the Act which are first, it is an old Act with many errors and has not kept up with the changing economy and time. Second, the institutions and professionals and regulatory frameworks for them required for implementing the Act have not been established. Accordingly, to make the Acts implementable, the Act must be amended to make it clear, easy to use and fit for the changing time. Also, institutions that are necessary for the implementation of the Act must be established.

The paper is divided into three parts. Part I provides a general background on bankruptcy law and proceedings in Bhutan. Part II will discuss the reasons for underutilization of the Act and the methods to make the Act implementable. Part III will conclude the paper.

General Background

Bankruptcy

Bankruptcy is a legal procedure by which the court declares that a debtor is unable to pay his debt. Bankruptcy is often confused with insolvency. The difference between the two is that an insolvency is a condition of being unable to pay debts as they mature. Whereas, bankruptcy is a statutory procedure by which an insolvent debtor obtains financial relief and undergoes a judicially supervised reorganization or liquidation of the debtor’s asset for the benefit of his creditors. In simpler terms, bankruptcy is a legal procedure whereas insolvency is only a state of being unable to pay.

In a bankruptcy, the distressed debtor can choose to either liquidate or reorganize his business. Where a debtor chooses to liquidate, the court appoints a trustee, who will take control over the property of the debtor, and distribute it proportionately among his creditors. Where a debtor chooses to reorganize his business, the court appoints a receiver, who will take control over the business’ finances, and help the business function and eventually recover debts. In a process of liquidation, after the property is distributed on a pro rata basis, any additional debt due is forgiven. This process of forgiving unpayable debt is called discharge. Liquidation process results in discharge whereas reorganization results in recovery of debts.

Importance of Bankruptcy Law

Bankruptcy laws are important for three reasons. First, it helps creditors secure equitable division of their insolvent debtor’s property. Second, it prevents the debtor from conduct detrimental to the interests of his creditors. Third, it protects an honest debtor from his creditors by means of discharge or by giving him the time to reorganize his business.

Modern bankruptcy laws protect both creditors and debtors. For the creditors, it solves the collective action problem when dealing with an insolvent debtor. Without bankruptcy laws, creditors would race to the courts and multiple petitions would be filed against the debtor. This would not only be a problem to the debtor but also to the creditors who will compete among themselves to satisfy their own debts. This encourages fraudulent agreements between a creditor and the debtor to the detriment of other creditors. In such cases, a debtor satisfies the full debt to one or two creditors but leaves other creditors empty-handed. Having bankruptcy law eliminates this issue as it attempts to bring all the creditors together when dealing with a common insolvent debtor.

Bankruptcy law also gives companies in financial distress an option to reorganize their business rather than winding up and liquidating.  Even though a company suffers from financial distress, more often than not, the company will have more value functioning vis-a-vis winding up. It may make more economic sense for the company to use its assets and its human resources to delay with court’s assistance, the declaration of bankruptcy, and reorganize its business through receivership, and gradually pay off debts.

Finally, bankruptcy law provides a “fresh start” to individual debtors overburdened by debts. Through the means of discharge, even when the assets of an individual cannot satisfy the debts, bankruptcy law deems it waived once the assets have been distributed. Often an individual starts a business, takes risks and implements innovative ideas, however when such a business fails, he ends up with an amount of debt he cannot pay. Bankruptcy laws provide a second chance to such debtors. Bankruptcy law plays an important role in encouraging and incentivizing entrepreneurs to take more risks.

Bankruptcy in Bhutan

The Act was drafted in 1999. As per the Act, when a bankruptcy petition is filed, the court will either issue an order of adjudication or dismiss the case. Bankruptcy petitions can be filed in two ways. First, the debtor can file the petition declaring insolvency. Here, a voluntary proceeding ensues. Second, the creditors can file a petition seeking the court’s request to declare the debtor insolvent. Here, an involuntary proceeding ensues.

The moment the court issues the order of adjudication, an interim trustee is appointed. Trustee is a person authorized by the court to take charge of the debtor’s property (known as “bankruptcy estate”) for the purpose of enforcing lien against the property or administering such property for the benefit of the creditors. Once the interim trustee is appointed, the debtor could seek to either liquidate and distribute the unexempted property or reorganize the business through a scheme of arrangement to pay off debts.

Bankruptcy in the United States

Bankruptcy can be filed under Chapter 7, 11, and 13 of the U.S Bankruptcy Code. Businesses and individuals file for bankruptcy under Chapter 7 of the Bankruptcy Code to dispose of any unsecured debts i.e., debts not backed by collateral. Here, the debtor sells his unexempted assets to pay off his creditors and seeks discharge.

Businesses can also choose to file for bankruptcy under Chapter 11 of the Bankruptcy Code. Here, the debtor uses legal mechanisms to reorganize the business under the supervision of the court. The goal of reorganization is not to seek discharge but to reorganize the business and pay off the debts over time.

Individuals with consistent income can opt to file for bankruptcy under Chapter 13 of US Bankruptcy Code. Bankruptcy under Chapter 13 allows the debtor to create a repayment plan based on the income of the debtor to pay off the debt instead of selling his assets and seeking discharge.

Analysis

The Act is underutilized for two reasons. First, it is an old Act with many errors. The Act has not kept up with the changing time and economy. Second, the institutions and professionals required for the implementation of the Act do not exist. It is time to amend the Act and establish these institutions to make the Act implementable.

The Act is old with many errors and has not kept up with the changing time and economy

The Act was drafted in 1999 and has many errors that do not keep up with time and economy. There are several errors within the Act. In this paper, we will explore four major errors which must be amended:

The Act must be amended to differentiate between individual and corporate bankruptcy

The Act does not differentiate between individual and corporate bankruptcy. In the Act, a debtor can choose to liquidate by filing for an order of discharge or he can choose to reorganize or repay his debts through a scheme of arrangement. The Act combines Chapter 11 and Chapter 13 of the U.S Bankruptcy Code and identifies it under the name, “composition and scheme of arrangement”. Chapter 11 and Chapter 13 are different types of bankruptcy and there is a reason for their separation. Chapter 11 is specifically for businesses and Chapter 13 is specifically for individuals.

The Act when it combines reorganization with repayment plan undermines the importance of both. Bringing the focus on reorganization, bankruptcy laws succeed when there is a high likelihood of successful reorganizations. Bankruptcy laws of many countries were developed with the intent of improving reorganization proceedings, setting time limits on judges to pass reorganization plans and giving priority to loan repayments for companies under reorganization. Such countries include Mexico, Poland, South Africa, Italy, Japan, France, Russia, Estonia, Finland, Belgium, and more. Combining the two chapters into one does not help improve the sections on reorganization.

Moreover, as the economy grows, insolvency among businesses and individuals will increase, and when that happens, an implementable Act must have separate redressal for each. Therefore, it is important to differentiate between individual and corporate bankruptcy.

The Act must amend the Monetary Values

The monetary value within the Act needs to be amended. It has not been updated since 1999. For example, the value of exempted property in religious articles or family heirlooms must not exceed Nu. 5000. To file a bankruptcy petition, debt owed must exceed Nu. 10,000. The value of these currencies in 1999 and today have changed and these currencies are no longer suitable for the current economy. Therefore, the Act must amend the monetary values.

The Act must include a provision on Automatic Stay

In the bankruptcy law of other countries, an important component of bankruptcy is that the filing of a bankruptcy petition automatically stays any civil actions against the debtor’s property in any court. However, in Bhutan, such stay is at the discretion of the court.

Section 53 of the Act states, “Any court in which a suit or other proceeding is pending against the debtor or the property of the debtor shall, on proof that an Order of Adjudication has been made against him under this Act, either stay the proceeding or allow it to continue on such terms as such the court deems proper.” Furthermore, section 54 of the Act states, “The court that entered the Order of Adjudication may at any time after entering such Order stay any civil or other proceeding pending against the debtor or the property of the debtor in another court.” The aforementioned sections grant multiple courts in the same case the discretion to stay proceedings pending against the property of the debtor before it. The problem is not that the discretion is provided to multiple courts, but the very fact that the discretion is provided. Because the logic of “automatic stay” is simply that it is automatic and not a matter of discretion.

An automatic stay which is an important feature of bankruptcy law temporarily suspends creditors, government agencies, and others from pursuing debtor’s property once the bankruptcy petition has been filed. This prevents one creditor from seizing the debtor’s asset before other creditors have the opportunity to do so, hence giving all creditors equal claim over the debtor’s property. It also protects the debtor against multiple court proceedings, foreclosure or enforcing a lien against his property, and attempt to repossess collateral.  Automatic stay is an important part of the bankruptcy proceedings; hence, the amendment should inculcate such intentions adequately and accordingly revoke the discretion provided to the Court under section 53 and 54 of the Act.

The Act must differentiate between Trusteeship and Receivership

The present Act suffers from a definitional confusion of two important concepts. It must be amended to differentiate between “receiver” and “trustee.”

Section 4 (16) of the Act states, “‘receiver’ or ‘trustee’ means a person appointed or authorized by a court of relevant jurisdiction to take charge of the property of the debtor for the purpose of enforcing a lien against such property or for the purpose of administering such property for the benefit of the debtor’s creditors.” Section 4 (16) of the Act gives the same meaning to the terms, “receiver” and “trustee.”. While “trustee” is a term that is also used in the U.S Bankruptcy Code for both liquidation in Chapter 7 and reorganization the company in Chapter 11,  the terms “receiver” and “trustee” are actually used in different contexts.

A “trustee” is any person or an organization who holds the legal title to an asset or group of assets for the benefit of another person (“beneficiary”). This type of legal title is granted to a trustee through a trust, which is an agreement between two consenting parties. A trustee is identified in the process of liquidation. On the other hand, a “receiver” is a person concerned with the process of receivership which is a court appointed tool to assist creditors to recover debts owed by helping the company who owes debts, to restructure its business. A receiver is identified in the process of reorganization.

A trustee and a receiver play different roles. A trustee holds the title of the asset of the debtor in order to distribute it fairly among his creditors. A receiver on the other hand will manage the entire company, its assets, and all financial and operating decisions. Since their roles are different, “trustee” must be the term used concerning liquidation and a “receiver” must be the term used concerning reorganization. A distinction should be made between the meanings of the term, “trustee” and “receiver” within the Act.

Institutions and professionals required for the implementation of the Act does not exist

Establishment of Institutions Training and Regulating Insolvency Practitioners

The receivership and trusteeship are institutions necessary for implementing the Act. It is not enough that a distinction is made between the terms, “trustee” and “receiver.” Institutions that train and regulate these insolvency practitioners must be established. Insolvency practitioners whether an administrator, a receiver, or a trustee are necessary for the liquidation or management of distressed businesses. Bhutan has not established institutions that train and regulate these insolvency practitioners. Many countries recognize the importance of insolvency practitioners and have even launched reforms to ensure adequate capacity building for them. Such countries include Chile, Jamaica, Estonia, Ukraine, Poland, and Lithuania. Bhutan’s first step should be to create these institutions and legislate regulations that incentivizes the insolvency practitioners to expedite the proceedings.

Specialization of Courts

Bankruptcy proceedings should be easy, quick, flexible and efficient. Longer court proceedings are associated with reduction of the company’s value, since ongoing insolvency proceedings makes it difficult to sell the company. Establishing a specialized bankruptcy court is one of the ways to expedite the proceedings.

A specialized bankruptcy court can improve insolvency procedures because specialized judges have better training and more expertise. Specialized judges can make decisions more swiftly. Malaysia established specialized courts in Kuala Lumpur to handle only foreclosure cases which reduced the time span of the proceedings from 2.25 years to 1.5 years. One of the ways Bhutan can make the Act implementable is by gradually establishing a specialized bankruptcy court. Having a specialized court not only expedites cases but also allows both creditors and debtors to be more informed of their rights under the Act.

Conclusion

Imprisoning the debtors in lieu of the debt owed is a practice that Bhutan should gradually abandon. The reason for the existence of this practice is underutilization of the Act. The Act is old and has many errors. It is time to amend the Act. For the Act to be implementable, it is not sufficient that the Act is amended. Institutions that implement the Act must also be established. It is time that we think seriously about bankruptcy laws in order to keep up with the expanding economic transactions.

References

1. Louis E. Levinthal, The Early History of Bankruptcy Law, 66 U. Pa. L. Rev. 223 (1918).
2. Bankruptcy Act of the Kingdom of Bhutan, 1999.
3. International Covenant on Civil and Political Rights, Art. 11, (1966).
4. Black’ Law Dictionary, (11th ed, 2019).
5. David L. Buchbinder, Basic Bankruptcy Law for Paralegals (10th ed. 2017).
6. Todd J. Zywicki, Bankruptcy, Econlib, Bankruptcy-Econlib.
7. Saul Estrin, Tomasz Mickiewicz & Anna Rebmann, Prospect theory and the effects of bankruptcy laws on entrepreneurial aspirations, 48 Small Bus Econ 977 (2017).
8. Nirjhar Nigam & Afef Boughanmi, A survey of Corporate Bankruptcy Reforms: Lessons to be learnt for worldwide good practices, 12, 2016, NNigam-Economix.
9. Julia Kagan, Automatic Stay, Investopedia, Aug. 19, 2020, Automatic Stay-Investopedia.
10. The US Bankruptcy Code, Chapter 7 & 11.
11. Carla Tardi, Receivership, Investopedia, Nov. 28, 2020, Receivership-Investopedia.