Insolvency V. Bankruptcy V. Liquidation – Difference as per IBBI Act

The Insolvency and Bankruptcy Board of India (IBBI) Act, 2016 deals with financial situations of debtors who are unable to repay their debts. Here’s a breakdown of the key terms:

Insolvency:

• A financial condition where a debtor is unable to pay their debts as they become due.
• The IBBI Act provides a framework for dealing with insolvency situations in a time-bound manner.
• It prioritizes revival of the debtor if possible, but also allows for liquidation as a last resort.

Bankruptcy:

• A legal status declared by a court when a debtor is proven to be insolvent and unable to meet their financial obligations.
• Under the IBBI Act, bankruptcy is a specific stage within the insolvency resolution process for individuals and partnership firms.
• It triggers the distribution of assets to creditors according to a set priority.

Liquidation:

• The process of selling a debtor’s assets to repay creditors.
• It occurs when an insolvency resolution process fails to revive the debtor or when creditors decide liquidation is the best course of action.
• The IBBI Act lays down procedures for a time-bound liquidation process to maximize value for creditors.

Here’s a table summarizing the key differences:

In essence:

• Insolvency is the overall financial condition.
• Bankruptcy is a legal declaration within insolvency for specific debtor types.
• Liquidation is the process of converting assets to cash for repayment within insolvency or bankruptcy.

Analysis of Differences

Understanding Insolvency:

Insolvency refers to a financial state where a debtor is unable to pay their debts as they become due. This inability can stem from various factors, including economic downturns, mismanagement, unforeseen circumstances, or simply an unsustainable debt burden. The IBBI Act recognizes insolvency as the starting point for a structured approach to resolving financial distress.

There are two key tests to determine insolvency under the Act:

• Cash Flow Test: This test examines the debtor’s ability to generate sufficient cash flow to meet its current liabilities (debts due within a year).
• Balance Sheet Test: This test compares the debtor’s total assets with its total liabilities. If the liabilities exceed the assets, the debtor is presumed to be insolvent.

The IBBI Act and its Role in Insolvency Resolution:

The IBBI Act provides a framework for dealing with insolvency situations in a fair and efficient manner. It aims to:

• Maximize value for creditors: By seeking revival of the debtor wherever possible, the Act prioritizes minimizing creditor losses.
• Promote entrepreneurship: By providing a mechanism for restructuring and reviving businesses, the Act encourages a second chance for struggling entities.
• Balance interests of stakeholders: The Act recognizes the interests of all stakeholders involved, including creditors, employees, and the general public.

The Stages of Insolvency Resolution:

The IBBI Act outlines a structured process for resolving insolvency situations. This process can be broadly categorized into three stages:

1. Insolvency Initiation: This stage involves identifying and initiating the insolvency resolution process. Creditors, the debtor itself, or authorized persons can initiate the process by filing an application with the National Company Law Tribunal (NCLT) for companies or with the Adjudicating Authority for individuals and partnership firms.
2. Corporate Insolvency Resolution Process (CIRP) or Individual Insolvency Resolution Process (IIRP): This stage focuses on reviving the debtor as a going concern. A resolution professional is appointed to oversee the process, assess the debtor’s financial viability, and develop a revival plan. Creditors work together to formulate a plan for restructuring debt, infusing fresh capital, or selling the business as a whole.
3. Liquidation: If the revival plan is not approved or fails to yield results within the stipulated timeframe, the debtor enters liquidation. This stage involves selling the debtor’s assets to settle outstanding debts with creditors according to a specified order of priority.

Bankruptcy under the IBBI Act:

The term “bankruptcy” has a specific meaning within the IBBI Act. It refers to a legal status declared by the NCLT or Adjudicating Authority for individuals and partnership firms, respectively, after the debtor is proven to be insolvent. Once declared bankrupt, the debtor’s assets are vested with the bankruptcy trustee, responsible for asset realization and distribution to creditors.

Choosing the Right Path: Revival vs. Liquidation

The ultimate goal of the IBBI Act is to maximize value for creditors. The choice between revival and liquidation depends on various factors, including:

• Viability of the debtor: If the debtor has a sustainable business model and the potential for profitability, revival might be a viable option.
• Debt burden: A heavy debt load makes revival challenging and might favor liquidation to settle outstanding dues.
• Creditor sentiment: The willingness of creditors to provide additional time or support for restructuring plays a crucial role in revival efforts.

The Benefits of the IBBI Act:

The IBBI Act offers several advantages over the previous insolvency regime:

• Time-bound process: The Act sets time limits for each stage of the insolvency resolution process, ensuring faster resolution and minimizing uncertainty.
• Transparency: The process is transparent with provisions for information dissemination to all stakeholders.
• Professional oversight: Insolvency professionals oversee the process, ensuring expertise and adherence to best practices.
• Creditor involvement: The Act empowers creditors to participate actively in the decision-making process.
• Focus on rescue: The Act prioritizes revival over immediate liquidation, offering a lifeline to struggling businesses.

Challenges and Considerations:

While the IBBI Act offers a structured framework, there are challenges to consider:

• Litigation delays: Disputes between parties can lead to delays in the insolvency resolution process.
• Debt overhang: Existing debt can impede the debtor’s ability to attract fresh capital for revival.
• Market conditions: A weak economic environment can hinder revival efforts.

Additional Considerations:

• Cross-border insolvency: The IBBI Act addresses domestic insolvency situations. Complexities arise when dealing with debtors with assets or liabilities in multiple jurisdictions.
• Awareness and education: Increased awareness about the provisions of the IBBI Act among businesses and the public can lead to earlier identification and resolution of financial distress.
• Alternative dispute resolution mechanisms: Utilizing efficient mechanisms for resolving disputes within the insolvency resolution process can expedite the process and minimize delays.

Bankruptcy of individuals and firms – Part III of IBC, 2016

Part III of IBC, 2016 (containing sections 78-187) deals with insolvency resolution and bankruptcy for individuals and partnership firms.

This Part shall apply to matters relating to fresh start, insolvency and bankruptcy of individuals and partnership firms.

Debt Recovery Tribunal (DRT) will be the Adjudicating Authority and Debt Recovery Appellate Tribunal (DRAT) will be the Appellate Authority for individuals and firms.

Flow of insolvency resolution process for individuals

• The process will be managed by ‘resolution professional’ under the direction of ‘Adjudicating Authority’.
• Insolvency Resolution Process will be initiated.
• Finalise ‘repayment plan’ with concurrence of debtor and committee of creditors.
• Upon consensus on repayment plan the individual or firm will get a discharge order.
• On failure to finalize the repayment plan, the creditors/debtor can file an application for ‘bankruptcy’ and the Adjudicating Authority may pass the bankruptcy order.
• The resolution professional who is a bankruptcy trustee will take over estate of the bankrupt. He will sell or dispose it off and satisfy payments of creditors to the extent possible.
• After that, the bankrupt will get a ‘discharge order’.
• The discharge order will be registered with Board (IBBI) in a register referred to in section 196 of the Code.

Important Definitions (Sections 3 and 5)

Claim Sec. 3(6) means

(a) a right to payment, whether or not such right is reduced to judgment, fixed, matured, unmatured, disputed, undisputed, legal, equitable, secured or unsecured. or

(b) right to remedy for breach of contract under any law for the time being in force, if such breach gives rise to a right to payment whether or not such right is reduced to judgment, fixed, matured, unmatured, disputed, undisputed, legal, equitable, secured or unsecured.

Corporate Person Sec. 3(7) means

(a) a company as defined u/s 2(20) of the Companies Act, 2013;

(b) a LLP as defined u/s 2(1)(n) of Limited Liability Partnership Act, 2008; or,
any other person incorporated with limited liability under any law for the time being in force but shall not include any financial service provider.

Corporate Debtor Sec. 3(8) means a corporate person who owes a debt to any person.

Creditor Sec. 3(10) means any person to whom a debt is owed and includes

• a financial creditor,
• an operational creditor,
• a secured creditor,
• an unsecured creditor and
• decree holder.

Debt Sec. 3(11) means a liability or obligation in respect of a claim which is due from any person and includes

• a financial debt and
• operational debt.

Default Sec. 3(12) means non-payment of debt when whole or any part or instalment of the amount of debt has become due and payable and is not paid by the debtor or the corporate debtor, as the case may be.

Financial information Sec. 3(13) in relation to a person, means one or more of the following categories of information, namely:

(a) records of the debt of the person;

(b) records of liabilities when the person is solvent;

(c) records of assets of person over which security interest has been created;

(d) records, if any, of instances of default by the person against any debt;

(e) records of the balance sheet and cash-flow statements of the person; and
such other information as may be specified.

Financial Service Provider Sec. 3(17) means a person engaged in the business of providing financial services in terms of authorisation issued or registration granted by a financial sector regulator.

Base Resolution Plan Sec. 5(2A) means a resolution plan provided by the corporate debtor under clause (c) of Sec. 54A(4).

Corporate applicant Sec. 5(5) means—

(a) corporate debtor; or

(b) a member or partner of the corporate debtor who is authorised to make an application for the corporate insolvency resolution process or the pre-packaged insolvency resolution process, as the case may be, under the constitutional document of the corporate debtor; or

(c) an individual who is in charge of managing the operations and resources of the corporate debtor; or

(d) a person who has the control and supervision over the financial affairs of the corporate debtor.

Corporate Guarantor Sec. 5(5A) means a corporate person who is the surety in a contract of guarantee to a corporate debtor.

Dispute Sec. 5(6) includes a suit or arbitration proceedings relating to-

(a) the existence of the amount of debt;

(b) the quality of goods or service; or

(c) the breach of a representation or warranty.

Financial creditor Sec. 5(7) means any person to whom a financial debt is owed and
includes a person to whom such debt has been legally assigned or transferred to.

Financial Debt Sec. 5(8) means a debt along with interest, if any, which is disbursed against the consideration for the time value of money and includes–

(a) money borrowed against the payment of interest;

(b) any amount raised by acceptance under any acceptance credit facility or its dematerialised equivalent;

(c) any amount raised pursuant to any note purchase facility or the issue of bonds, notes, debentures, loan stock or any similar instrument;

(d) the amount of any liability in respect of any lease or hire purchase contract which is deemed as a finance or capital lease under the Indian Accounting Standards or such other accounting standards as may be prescribed;

(e) receivables sold or discounted other than any receivables sold on non-recourse basis;

(f) any amount raised under any other transaction, including any forward sale or purchase agreement, having the commercial effect of a borrowing; 2

Explanation: For the purposes of this sub-clause,

(i) any amount raised from an allottee under a real estate project shall be deemed to be an amount having the commercial effect of a borrowing; and

(ii) the expressions, “allottee” and “real estate project” shall have the meanings respectively assigned to them in clauses (d) and (zn) of Sec. 2 of the Real Estate (Regulation and Development) Act, 2016,

(g) any derivative transaction entered into in connection with protection against or benefit from fluctuation in any rate or price and for calculating the value of any derivative transaction, only the market value of such transaction shall be taken into account;

(h) any counter-indemnity obligation in respect of a guarantee, indemnity, bond, documentary letter of credit or any other instrument issued by a bank or financial institution;

(i) the amount of any liability in respect of any of the guarantee or indemnity for any of the items referred to in sub-clause (a) to (h) of this clause.

Financial position Sec. 5(9) in relation to any person, means the financial information of a person as on a certain date.

Initiation date Sec. 5(11) means the date on which a financial creditor, corporate applicant or operational creditor, as the case may be, makes an application to the Adjudicating Authority for initiating corporate insolvency resolution process or pre-packaged insolvency resolution process, as the case may be.

Insolvency commencement date Sec. 5(12) means the date of admission of an application for initiating corporate insolvency resolution process by the Adjudicating Authority u/s 7, 9 or 10, as the case may be.

Insolvency resolution process period Sec. 5(14) means the period of 180 days beginning from the insolvency commencement date and ending on 180th day.

Interim Finance Sec. 5(15) means any financial debt raised by the resolution professional during the insolvency resolution process period or by the corporate debtor during the pre-packaged insolvency resolution process period, as the case may be, and such other debt as may be notified.

Liquidation commencement date Sec. 5(17) means the date on which proceedings for liquidation commence in accordance with section 33 or section 59, as the case may be.

Operational creditor Sec. 5(20) means a person to whom an operational debt is owed and includes any person to whom such debt has been legally assigned or transferred.

Operational Debt Sec. 5(21) means a claim in respect of the provision of goods or services including employment or a debt in respect of the payment of dues arising under any law for the time being in force and payable to the Central Government, any State Government or any local authority.

Personal Guarantor Sec. 5(22) means an individual who is the surety in a contract of guarantee to a corporate debtor.

Preliminary Information Memorandum Sec. 5(23A) means a memorandum submitted by the corporate debtor under clause (b) of Sec. 54G(1).

Pre-packaged Insolvency Commencement Date Sec. 5(23B) means the date of admission of an application for initiating the pre-packaged insolvency resolution process by the Adjudicating Authority under clause (a) of Sec. 54C(4).

Pre-packaged Insolvency Resolution Process Costs Sec. 5(23C) means:

(a) the amount of any interim finance and the costs incurred in raising such finance;

(b) the fees payable to any person acting as a resolution professional and any expenses incurred by him for conducting the pre-packaged insolvency resolution process during the pre-packaged insolvency resolution process period, subject to Sec. 54F(6);

(c) any costs incurred by the resolution professional in running the business of the corporate debtor as a going concern pursuant to an order u/s 54J(2);

(d) any costs incurred at the expense of the Government to facilitate the pre-packaged insolvency resolution process; and

(e) any other costs as may be specified.

Pre-packaged Insolvency Resolution Process Period Sec. 5(23D) means the period beginning from the pre-packaged insolvency commencement date and ending on the date on which an order u/ss 54L(1), or 54N(1), or 54-O(2), as the case may be, is passed by the Adjudicating Authority.

Related party in relation to a corporate debtor Sec. 5(24) means-

(a) a director or partner or a relative of a director or partner of the corporate debtor

(b) a KMP or a relative of a KMP of the corporate debtor;

(c) a LLP or a partnership firm in which a director, partner, or manager of the corporate debtor or his relative is a partner;

(d) a private company in which a director, partner or manager of the corporate debtor is a director and holds along with his relatives, more than two per cent. of its share capital;

(e) a public company in which a director, partner or manager of the corporate debtor is a director and holds along with relatives, more than 2% of its paid-up share capital;

(f) anybody corporate whose board of directors, managing director or manager, in the ordinary course of business, acts on the advice, directions or instructions of a director, partner or manager of the corporate debtor;

(g) any limited liability partnership or a partnership firm whose partners or employees in the ordinary course of business, acts on the advice, directions or instructions of a director, partner or manager of the corporate debtor;

(h) any person on whose advice, directions or instructions, a director, partner or manager of the corporate debtor is accustomed to act;

(i) a body corporate which is a holding, subsidiary or an associate company of the corporate debtor, or a subsidiary of a holding company to which the corporate debtor is a subsidiary;

(j) any person who controls more than twenty per cent. of voting rights in the corporate debtor on account of ownership or a voting agreement;

(k) any person in whom the corporate debtor controls more than 20% of voting rights on account of ownership or a voting agreement;

(l) any person who can control the composition of the board of directors or corresponding governing body of the corporate debtor;

(m) any person who is associated with the corporate debtor on account of-

(i) participation in policy making processes of the corporate debtor; or

(ii) having more than two directors in common between the corporate debtor and such person; or

(iii) interchange of managerial personnel between the corporate debtor and such person; or

(iv) provision of essential technical information to, or from, the corporate debtor.

Related Party in relation to an individual Sec. 5(24A) means-

(a) a person who is a relative of the individual or a relative of the spouse of the individual;

(b) a partner of a LLP, or a LLP or a partnership firm, in which the individual is a partner;

(c) a person who is a trustee of a trust in which the beneficiary of the trust includes the individual, or the terms of the trust confers a power on the trustee which may be exercised for the benefit of the individual;

(d) a private company in which the individual is a director and holds along with his relatives, more than 2% of its share capital;

(e) a public company in which the individual is a director and holds along with relatives, more than 2% of its paid-up share capital;

(f) a body corporate whose board of directors, managing director or manager, in the ordinary course of business, acts on the advice, directions or instructions of the individual;

(g) a LLP or a partnership firm whose partners or employees in the ordinary course of business, act on the advice, directions or instructions of the individual;

(h) a person on whose advice, directions or instructions, the individual is accustomed to act;

(i) a company, where the individual or the individual along with its related party, own more than 50% of the share capital of the company or controls the appointment of the board of directors of the company.

Resolution Applicant Sec. 5(25) means a person, who individually or jointly with any other person, submits a resolution plan to the resolution professional pursuant to the invitation made u/s 25(2)(h) or pursuant to section 54K, as the case may be.

Resolution Plan Sec. 5(26) means a plan proposed by resolution applicant for insolvency resolution of the corporate debtor as a going concern in accordance with Part II.

Resolution Professional Sec. 5(27) means an insolvency professional appointed to conduct the corporate insolvency resolution process or the pre-packaged insolvency resolution process, as the case may be, and includes an interim resolution professional.

By addressing these considerations and continuously improving the implementation of the IBBI Act, India can create a more robust and efficient framework for dealing with financial distress, fostering a vibrant and resilient business environment.

Disclaimer: This blog post is intended for informational purposes only and does not constitute legal advice. It is recommended to consult with a qualified professional for legal guidance on specific situations.