Insolvency refers to the circumstances when a company or an individual cannot meet financial obligations or repay any outstanding financial loan owed to lenders. The company or individual may prevent insolvency proceedings from being initiated against them by arranging for alternate repayment arrangements or make any informal arrangement with the creditors for alternative payment arrangements. If the insolvency situation remains unresolved, legal action may be undertaken against the company or individual. This may lead to liquidation by the order of the Court to make payment of the outstanding debts.
Although insolvency is often confused with bankruptcy, they are indeed two different concepts although both refer to such circumstances where the individual or company becomes incapable of paying a debt incurred. While insolvency refers to such a state where an individual or company lacks sufficient assets to meet liabilities, insolvency will lead to liquidation for a corporate entity and bankruptcy for a non-corporate entity. Insolvency arises due to the inability to dispose of debts due to lack of assets, bankruptcy is when an application is made to an authority declaring insolvency requesting itself to be declared bankrupt. Essentially, bankruptcy is a conclusion to the state of insolvency.
Factors that lead to Insolvency
Some of the most common reasons that lead to insolvency on part of a company or individual are as follows:
The company or individual is unable to return the money borrowed relying upon a future revenue is the most common reason for insolvency.
The company or individual has been unable to carry out proper financial management.
The company or individual has a business venture that is of a very high risk or impractical.
The company or individual has a business venture that faces excessive competition in the market.
The company or individual has a lack of expertise in commercial operations leading to an increase in risks.
The company or individual has a lack of knowledge of business practices leading to an increase in risks.
The company or individual has a lack of resources to cover the amount necessary to make their business a viable business.
The company or individual has spent excessively in the process of trying to make the business viable leading instead to losses.
The company or individual is owed money from clients who have failed to make payments or to follow through with business projects.
The Insolvency and Bankruptcy Code, 2016
The Insolvency and Bankruptcy Code (IBC), 2016 has been laid down in India to consolidate the laws regarding insolvency and bankruptcy in the country. It was brought about with the intention to strike a balance between creditors and borrowers with regard to their rights and liabilities. It was also brought into place to strengthen the position of creditors in the system as it was often seen that the existing legal regime before the IBC tended to give a long recovery process to the defaulters, hence, favouring them over the creditors. The most important aspect of the IBC is to ensure that the resolution and revival should be in a time-bound manner so as to ensure that the defaulter’s assets are at maximum valuation. IBC also makes provision for coming to the aid of sick companies so as to ensure that they are either wound up or revived at the earliest, essentially protecting the interests of the investors to the maximum possible extent.
Key Features of the Insolvency and Bankruptcy Code, 2016
Some of the most essential features of the Code are as follows:
Insolvency and Bankruptcy Board of India
The IBC establishes the Board to regulate all registered entities and to oversee all insolvency proceedings thereunder. The Board has 10 members including representatives from the Reserve Bank of India and the Ministries of Law & Finance.
The IBC prescribes separate procedures for insolvency resolution for companies, individuals and partnership firms which may be initiated by the creditors or the debtors themselves. The IBC further prescribes for a time limit of 180 days for the resolution of proceedings. This time period may be extended by an additional 90 days if a majority of the creditors agree to the same. In such circumstances where proceedings have been initiated by small companies, Startups or other companies with assets valued at less than Rs. 1 crore, the same should be resolved within 90 days with a possible extension of up to 45 days.
Insolvency and Bankruptcy Adjudicator Authority
The IBC provides for the establishment of the Debt Recovery Tribunal to act as an adjudicating authority for partnership firms and individuals and any appeals from this body shall lie in the Debt Recovery Appellate Tribunal. The National Company Law Tribunal has similar authority over companies and other LLPs and any appeals from this body shall be referred to the National Company Law Appellate Tribunal.
The IBC provides that insolvency proceedings are to be managed by licensed professionals and professional agencies. Such professionals are to handle the assets of the company or individual during the pendency of the insolvency proceedings.
Insolvency Information Utilities
The IBC provides for the establishment of information utilities that must undertake the collection, collation, authentication and dissemination of financial information of the registered companies and their operational and financial creditors.
The IBC makes provision for grant of Moratorium during which the actions of the creditor may be stayed. This may be granted by the Adjudicating Authority at the recommendation of the Resolution Professional.
The IBC provides that Corporate Liquidation may take place on the recommendation of the resolution plan, due to the failure to submit a resolution plan within the required time period and dependent upon majority opinion of the creditors through voting.
The IBC provides for certain debts to have to disposed on a priority basis such as insolvency resolution cost & liquidation cost, debts to secured creditors & dues of secured workmen, unpaid dues of employees, etc.
Procedure for Insolvency Proceedings
The IBC further provides for a step by step procedure for the resolution of insolvency proceedings which leaves the onus on the creditor as well as the debtors to initiate the insolvency proceedings rather. Where the default amount exceeds Rs. 1 lakh, the creditor has the right to initiate insolvency proceedings as per the IBC. The creditors may do so by assessing the viability of the debtor’s business and coming up with suggestions regarding business models that may be adopted to prevent further losses. In case of failure of the same, the creditors may take a unanimous decision to liquidate the business, i.e., decide that the business should be wound up and all assets should be sold for the recovery of dues.
The process of resolution of a Corporate Insolvency proceeding before the NCLT is as follows:
The insolvency proceedings may be initiated by a corporate or financial creditor or a corporate debtor through any authorized member or corporate applicant.
If an operational creditor is initiating the proceedings, a demand notice giving 10 days time must first be given to the corporate debtor must be sent before an application to this effect must be made to the National Company Law Tribunal (may approach directly if the debtor fails to repay the outstanding dues).
The claims are then frozen for a 6 months period during which the NCLT deliberates upon the means of reviving the debtor and decides upon the future course of action.
No legal claim may be sought against the debtor in any other forum unless a liquidation process is initiated or a resolution plan is framed.
After the insolvency application has been accepted, the NCLT must appoint an Insolvency Professional within 14 days who takes up the responsibilities of the properties and functioning of the corporate debtor. Such professional is appointed for 30 days and must collect all relevant information within that time.
The Insolvency Professional must further collect and collate all information regarding the financial condition of the corporate debtor.
Further, a public announcement must be made regarding the corporate insolvency process so as to collect information from other creditors (if any). A Creditors’ Committee is then formed constituting all such creditors who come forward, provided each of the creditors must be owed an average debt of atleast 10% of the total debt owed.
The Creditors’ Committee must decide (with 75% majority) whether the Insolvency Professional should continue to act as the Resolution Professional. The Resolution Professional thus decided upon is then appointed by the NCLT.
If the Committee is of the opinion (with 75% majority) that the proceedings are very complicated and more than 180 days shall be necessary to resolve the same, they may pass a resolution for an extension by 90 days. The Resolution Professional has the sole responsibility to conduct the insolvency proceedings within the said time.
The Resolution Professional shall compile the statistics regarding the corporate debtor to enable the Resolution Applicant to prepare the resolution plan. A Resolution Applicant is the person who has the duty and responsibility to submit the Resolution Plan.
The plan thus submitted is to be approved by the Creditors’ Committee. On approval of the plan, the Committee must decide on options of a restructuring of the Corporate debtor. This is then sent to the NCLT for approval and implementation.
If the Committee is unable to come up with a unanimous binding decision, the debtor’s assets shall be liquidated for the purpose of repayment of the creditors.
The liquidation of the assets of the Corporate debtor is carried out only if the Creditors’ Committee is unable to come up with a Resolution Plan or decide upon such liquidation or the Plan is rejected by reason of not being in adherence with the IBC or if the Plan is flouted by the Corporate Debtor. The Government has also made provision for fast-track insolvency proceedings in certain cases. The Insolvency and Bankruptcy Code also provides for the Corporate Debtor to initiate insolvency proceedings when it has the capacity to pay creditors by such liquidation and it has not indulged in any default. It is mandatory for such Corporate Debtor to present a Declaration of all Directors stating that the said insolvency is not being undertaken to defraud any person. No specific time period for resolution of insolvency proceedings has been stated in the IBC with regard to individuals or partnership firms due to the range of diverse businesses that may be undertaken.