Insolvency
1. What is 'Insolvency'
Insolvency refers to a state of financial distress and an inability to pay off debts.
1.1. Official Definition of 'insolvency'
The primary legislation dealing with ‘insolvency’ is the Insolvency and Bankruptcy Code (IBC), 2016 (and the rules and regulations framed thereunder). However, the act does not define ‘insolvency’.
1.2. Types of 'insolvencies'
1.2.1. Insolvency usually takes two forms: cash-flow insolvency and balance-sheet insolvency
Cash-Flow Insolvency: This happens even if the debtor has enough assets to eventually pay everything off. However, they lack the immediate cash resources to pay their bills on time. For example, a company might own valuable equipment and inventory, but not have enough cash on hand to cover payroll or rent.
Balance Sheet Insolvency: This occurs when a person or company's liabilities (debts) outweigh their assets (everything they own). In simpler terms, they are underwater financially; they wouldn't have enough money from selling everything they own to cover what they owe.
1.2.2. The other way of classifying insolvency is corporate and personal insolvency:
Corporate Insolvency: It relates to the insolvency of businesses like corporations, LLCs, etc. The reasons for insolvency can include poor management, declining sales, or economic downturns. Shareholders' personal assets are generally protected from creditors, except in certain situations.
Personal Insolvency: It relates to the insolvency of individuals. It occurs when someone cannot pay their personal debts, such as credit cards, medical bills, or loans. Individuals may file for bankruptcy to discharge some debts and get a fresh financial start. The process considers an individual's income and assets to determine how much debt they can repay.
1.2.3. Insolvency vs Bankruptcy - Insolvency is frequently confused with the concept of bankruptcy:
The law defines insolvency as a situation where someone owes more money (liabilities) than they have assets to cover it. If left unaddressed, this insolvency can lead to different legal outcomes depending on the type of debtor. For individuals or non-corporations, it might end in bankruptcy. For companies (corporates), it could result in liquidation, which means selling all assets to pay off debts. However, insolvency isn't always a dead end. It's a financial state, and sometimes temporary fixes are possible without needing legal protection from creditors through bankruptcy. In short, insolvency is a starting point, and bankruptcy is a potential consequence. Not all cases of insolvency lead to bankruptcy, but all bankruptcies start with insolvency. There are usually two options for dealing with insolvency: working things out with creditors or, in the case of corporations, liquidation, and for individuals, bankruptcy.
2. Insolvency Process
Corporate Insolvency Resolution Process (CIRP) is the process of resolution of insolvency of a corporate debtor.
The process is provided on a combined reading of the IBC Code, the Insolvency and Bankruptcy (Adjudicating Authority) Rules, 2016 and the IBBI (Insolvency Resolution Process for Corporate Persons) Regulations, 2016. The stepwise procedure is as follows:
On a minimum default of Rs.1 crore by a corporate debtor, CIRP can be initiated with respect to the corporate debt. The initiation can be done by a stakeholder, a financial creditor, an operational creditor or a corporate applicant by filing an application with the Adjudicating Authority (AA). The stakeholders have the right to initiate the process however there is no binding obligation to do so.
The AA in the case of a corporate person is the National Company Law Tribunal (NCLT) that has territorial jurisdiction over the registered office of the corporate person.
People who are not eligible for initiation of CIRP are:
- a corporate debtor who is undergoing CIRP,
- a corporate debtor who has completed CIRP in the last twelve months;
- a corporate debtor or a financial creditor who has violated any of the terms of resolution plan approved in the last twelve months; and
- a corporate debtor in respect of whom a liquidation order has been made.
Financial creditor: The process can be initiated on an individual as well as jointly basis, by filing an application and providing evidence of default.
Operational creditor: In this case, there is a need to deliver a demand notice to the corporate debtor mentioning the default amount. If after the expiry of the period of ten days from the date of delivery of the notice or invoice demanding payment, the operational creditor does not receive payment from the corporate debtor then it may initiate CIRP by filing an application with the AA.
Creditor: Here the need is to produce the evidence of the default with information utility (IU) along with the application.
Corporate applicant: The process may be initiated simply by filing an application with the AA.
2.1. Interim Resolution Professional (IRP):
When the process is initiated by the financial creditor and the corporate debtor there is a requirement of proposing the name of an Interim Resolution Professional (IRP) in the application. It is optional for the operational creditors filing the application to propose an IRP.
The proposed IRP is appointed within fourteen days from the insolvency commencement date. If no IRP is proposed in the application then the AA makes a reference to the IBBI and the IBBI recommends an IRP within ten days of receipt of such reference from AA.
The IPR holds office for 30 days after the appointment. Immediately upon appointment of the IRP, the management of the affairs of the corporate debtor vest in him. The powers of the board of directors of the corporate debtor are suspended and exercised by the IRP.
The IRP manages the operations of the corporate debtor as a going concern. He takes control of assets of the corporate debtor. The claims for dues are invited by the IRP. These claims have to be submitted before the resolution plan is approved by the Committee of Creditors.
2.2. Adjusting Authority:
Application is admitted within a period of fourteen days of its receipt if it. In case there is a default in the application then the authority can give time for rectification. If the default still exists then the application can be rejected. Before admission of the application, the withdrawal is also permitted. Once admitted the process has to be completed within a time period of 180 days.
2.3. Moratorium Period:
Afterwards order declaring a moratorium is passed and it continues till completion of CIRP. During moratorium period, only the essential goods and services such as electricity, water, telecommunication, and information technology services, to the extent these are not a direct input to the output produced or supplied by the corporate debtor, are not terminated or suspended or interrupted.
2.4. Committee of Creditors
CoC is constituted by IRP, composed of all the financial creditors of the corporate debtor.
The composition primarily includes
- Eighteen largest operational creditors by value, and
- One representative of workmen and employees each; other than the workmen or employees already included in the group of eighteen largest operational creditors.
The IRP has to report the AA, regarding the constitution of CoC on or before the expiry of thirty days from the date of his appointment and convenes the first meeting of the CoC within seven days of such filing.
2.5. Resolution Professional:
The CoC decides on the appointment of Resolution Professional (RP). The RP conducts the entire resolution process and manages the operations of the corporate debtor during the CIRP.
The RP presides over the meetings of the CoC. The decisions are taken by CoC by a vote of seventy five percent of the voting shares.The RP has to appoint registered valuers to determine the fair value and liquidation value of the debtor, within seven days of RP’s appointment. The information memorandum (IM) has to be submitted to each member of the committee within two weeks of his appointment, by RP. The IM is a document containing the information required by resolution applicants to draw up a resolution plan for the corporate debtor.
It is the duty of the RP to apply to AA for directions or orders wherever he finds preferential transactions, undervalued transactions, extortionate credit transactions and fraudulent transactions. The RP invites resolution plans from eligible resolution applicants. A person is not eligible to submit a resolution plan if he is an undischarged insolvent, is a wilful defaulter, has an NPA account, has been convicted of an offense punishable for more than two years, is disqualified to act as a director, is prohibited from accessing or trading in securities market, etc.
The cost of this process includes:
a. the amount of interim finance and the cost incurred in raising such finance;
b. the fees payable to RP;
c. any cost incurred by the RP in running the business of the corporate debtor as a going concern;
d. any cost incurred at the expense of the Government to facilitate CIRP;
e. amounts due to suppliers of essential goods and services; amounts due to a person whose rights are prejudicially affected because of the moratorium imposed;
g. expenses incurred on or by the interim RP to the extent ratified and fixed by the CoC; and
h. other costs directly relating to the corporate insolvency resolution process and approved by the CoC.
The approved resolution plan is submitted to the AA by the RP fifteen days before the expiry of the 180 days. If the AA is satisfied with the resolution plan, it approves the resolution plan. On approval by the AA, the resolution plan is binding on corporate debtors and its employees, members, creditors, guarantors and other stakeholders involved in the resolution plan. After getting the approval the process ends along with the moratorium period.
2.6. Failure of the CIRP:
If an approved resolution plan is not submitted to the AA within the maximum period or extended period permitted then it triggers the liquidation process.
2.7. Appeal procedure:
Person aggrieved by the order of the AA can prefer appeal to the NCLAT. Further appeal can be filed in the Supreme Court, no other civil court holds jurisdiction over the matter.
3. International Experience
Usually, insolvency is defined similarly across jurisdictions; however, the legal treatment of the insolvent varies across jurisdictions.
Australia
Insolvency resolution is primarily governed by the Corporations Act (2001) in Australia. Insolvency deals with the financial distress of companies; whereas, bankruptcy deals with the financial distress of individuals.
Canada
The Companies' Creditors Arrangement Act (CCAA) deals with insolvency, and is primarily aimed at restructuring. The Winding-up and Restructuring Act is relied on to wind up banks, insurance companies and trust corporations, etc.
United Kingdom (UK)
Similar to India and Australia, bankruptcy is used to refer to the financial distress of natural persons; whereas, insolvency is used in the context of companies. The main legislation is the Insolvency Act 1986 (modified to a great degree by the Enterprise Act, 2002). It does not cover personal insolvency in Scotland.
United States of America
The insolvency law is primarily set forth in the U.S. Bankruptcy Code
4. Appearance of 'insolvency' in Database
The official website of the Insolvency and Bankruptcy Board of India (IBBI), https://ibbi.gov.in/en
5. Research that engages with 'insolvency'
An overview of the research that has been conducted on the concept within the Indian Justice context, by non-government bodies like Academic Institutions, Research Organisations, CSOs, think tanks and other such bodies. This section seeks to explore:
Modern Corporate Insolvency Regime in India: A Review
The article argues that the Insolvency and Bankruptcy Code (IBC) has been a positive development for the Indian economy, but there is still more work to be done. The IBC is a law that allows for the orderly resolution of insolvency. However, the article also identifies a number of unfinished agenda items.
This unfinished agenda for IBC includes creating a framework for individual bankruptcy, group insolvency, and cross-border insolvency, as well as improving procedures for fraud detection and data collection.
Assessment of Corporate Insolvency and Resolution Timeline
This research paper analyzes the delays in the Corporate Insolvency Resolution Process. The CIRP has to be completed within 270 days, but the paper finds delays which are common in the entire process, especially for complex sectors having many creditors. The biggest delay involved getting approval for the resolution plan from the Committee of Creditors (CoC) and the adjudicating authority.
The paper provides its suggestions that this may be due to a focus on maximizing recovery rather than reviving the company. It also suggests that there may be a lack of qualified resolution applicants due to restrictions on Asset Reconstruction Companies (ARCs). In nutshell, the research suggests that changes are needed to make CIRP more efficient and effective from this particular perspective.
6. Related terms
Bankruptcy - The situation where a person or organization is unable to pay back their debt. In response to this inability to pay debt, the concerned insolvent organization can initiate bankruptcy proceedings. The process of Bankruptcy involves evaluation of the assets and liabilities of the company followed by liquidation[1].
Insolvent - A person, who cannot meet their financial obligations. This means they don't have enough money or assets to pay their bills and debts. Insolvency is a financial state whereas bankruptcy is a legal declaration and process[2].
Pauper - The term Pauper has been substituted with the term indigent person in CPC. As per the understanding provided by Order 33 CPC, Pauper is a man without means, being permitted to maintain or defend a suit in forma pauperis and that the privilege of maintaining a pauper suit is a personal privilege granted to people who have no means of carrying on or continuing litigation[3].
